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Questions Raised About the Profit-Shifting Effects of Tax Reform

Posted on February 21, 2017 by Nathan J. Richman

A significant portion of the GDP effects from the House GOP tax reform proposals on net interest deductions and full capital expensing may stem from profit shifting and correcting statistical distortions, a former OECD official said February 17.

While much attention has been paid to the exchange rate effect of the border-adjustable tax proposal in the House GOP's "A Better Way" tax reform blueprint, the transitional effects of the proposals to remove the net interest deduction and allow full expensing of capital expenditures have received less notice, said Thomas Neubig, former deputy head of the Tax Policy and Statistics Division of the OECD's Centre for Tax Policy and Administration. 

These effects could include a reversal of debt shifting where the flow is out of the U.S. rather than in, Neubig said at the annual Tax Council Policy Institute symposium in Washington. He added that profit-shifting incentives would similarly reverse from moving profit into the United States rather than out.

"This might be one way that President Trump achieves his higher gross domestic product projections," Neubig said, "because distortions in the national statistics, for instance over the transfer pricing, currently lower U.S. GDP estimates." Removing profit shifting out of the U.S. and further adding profit shifting into the U.S. would each increase the measure of GDP, he said. Neubig said that disallowance of interest deduction in the U.S. could lead multinational companies to shift their borrowing to foreign subsidiaries that would then get a tax benefit from other countries.

Aruna Kalyanam, Democratic tax counsel for the House Ways and Means Committee, said that while removal of the net interest deduction is often discussed along with full capital expensing, there should also be some analysis of the provisions separately, particularly when evaluating the disruptive effects of the changes. "The transition rules on the interest side here, they're going to have to be extraordinary," she said. 

In addition to transition rules, the changes would require new, special rules for small businesses because their needs are different from those of larger corporations, Kalyanam said. Another issue arises from using removal of a permanent benefit to pay for a timing benefit, she said.

Neubig said that he is skeptical of the advertised benefits of expensing because of recent survey findings that only 13 percent of the 1,000 businesses surveyed make decisions based on the marginal effective tax rate examined by policy analysts. He said, "Almost 90 percent look at the statutory tax rate or look at the financial statement . . . effective tax rate."

Looking at the effects of both full expensing and the loss of net interest deductions, Christopher Wolter, vice president of tax at Boeing, said that reinvestment in operations requires cash rather than generally accepted accounting principles income. On the other hand, he said, recurring deductions that keep pushing back when the government gets repaid can be equivalent to an interest-free loan from the government.


The topic of profit shifting also arose when the discussion turned to the "innovation box" proposal introduced during the last Congress by former Rep. Charles W. Boustany Jr. and current House Ways and Means Committee ranking minority member Richard E. Neal, D-Mass. Mary R. Duffy of Andersen Tax LLC said that questions have been raised about the effectiveness of the section 41 research credit, which has been criticized as being weak compared to other countries' research incentives. 

John L. Harrington of Dentons said that the effectiveness of research incentives is very difficult to measure. Further, countries lacking in research and development are likely to enact the most aggressive incentives, he said.

Neubig said that evaluations of comparative research incentives should avoid looking at individual provisions in isolation and also consider nontax incentives as well. He said the OECD's base erosion and profit-shifting project found a "concern that the emergence of the patent boxes oftentimes increases opportunities for profit shifting."

Wolter said that comparative issues are important, but more for where to conduct research rather than for whether to conduct additional research. He said that the patent box concept also provides an incentive for keeping intellectual property within a country for use in further commercialization.

Kalyanam posed the question of how much the analysis of manufacturing incentives should focus on "where you make the widget or how the widget is made." Incentives that lead to manufacturing using imported robotics may not be the best answer, she said, adding that Neal is fond of remarking on the thousands of precision manufacturing jobs in Massachusetts that are unfilled because the workforce lacks the necessary training.

Educating the labor force may change the incentives for multinationals deciding where to locate their operations, Kalyanam said. Neubig added that giving away tax revenue to specific industries may reduce the amount available for education and infrastructure spending, which may be more important for the growth of the U.S. economy.