Consideration of a minimum corporate income tax

One of the provisions buried in the Build Back Better bill is the implementation of a minimum tax rate of 15% for corporations, with Elizabeth Warren serving as the most vocal champion and chief cheerleader. Given that 55 high-profile profitable corporations paid no taxes in the last fiscal year, the idea of applying a minimum tax is seen as a way to correct a tax outcome that many regards as unfair.

Fairness, of course, is in the eye of the beholder. In the case of corporate taxes, for example, some argue that any tax is unfair as the same earnings are taxed a second time when distributed to shareholders. Thus, imposing corporate taxes in the first place allows for double taxation. Moreover, some contend that these taxes have spawned an over-the-top evolution of lobbying by special interests that have disproportional detrimental effects relative to the relatively small contribution that corporate taxes make to total Federal taxes collected [Corporate taxes account for about seven percent of total Federal tax revenues.] It seems, however, that this view is held by the minority and most people endorse the idea of taxing corporations. The debate thus seems to be on how those tax liabilities should be determined.

As a prelude to how we got to the point where profitable companies have managed to avoid paying the taxman, it’s important to recognize the different responsibilities of two key regulatory institutions: the Financial Accounting Standards Board (FASB) and the Internal Revenue Service (IRS). FASB is an independent agency, authorized by the Securities and Exchange Commission to set the generally accepted accounting principles (GAAP). These accounting rules must be followed by public companies in the US, and they serve as the basis for myriad capital allocation decisions. The better-known IRS, on the other hand, is a bureau within the Treasury Department that’s responsible for applying rules voted upon by Congress, in the collection of tax revenues.

A number of definitions are in order: FASB rules require public companies to generate income statements, which report net income or net profit during the prescribed accounting period — generally a quarter or a year. Net income and net profit both measure the difference between reported revenues and reported expenses for the period. This resulting difference is the amount used when calculating a company’s earnings per share. [Company often calculates other profit measures, besides net profit. For instance, gross profit is total revenues less only those expenses relating to the cost of goods sold.]

The real reason some profitable companies have been able to operate without any Federal tax liability is that the IRS bases its tax calculations, not on net income or net profit as defined by GAAP, but instead on taxable income, defined (or determined) by the IRS as set out by laws enacted by Congress. These laws allow for (a) scores of deductions far in excess of any expense items permissible by GAAP, often with those deductions benefiting specific industries or companies, and (b) the exclusion of some forms of revenues that companies earn. The resulting taxable income values can end up being a far cry from the GAAP’s net income figure. As a result, both in theory and in practice, companies might have a positive net profit but zero or negative value for taxable income, putting those entities squarely in Elizabeth Warren’s sights.

The separation of the two authorities has served, thus far, to insulate FASB from pressures that could move it away from its position of independence. If and when FASB’s net income measure becomes more relevant to the determination of taxes for more companies, these budgetary considerations may likely cause FASB to become the target of pressure from Congress and special interests seeking to influence the way revenues and expenses are measured and reported under GAAP.

Congress clearly has had, and actually still could have, an alternative approach, aside from implementing a minimum corporate tax based on net income — one that would do more to protect FASB’s independence. That is, it could reassess the definition of taxable income. To the extent that the current taxable income definition inappropriately exaggerates expenses or excludes revenues, those elections can, and should, be adjusted. Many such provisions serve the narrow interests of a minority of companies at the expense of the rest of us. Unfortunately, Congress simply hasn’t shown the will or the capacity to change those kinds of rules, irrespective of how blatantly unfair they appear to be.

The proposal to apply a minimum tax rate of 15% to GAAP reported net income strikes me as a second-best alternative. While a better solution might be for Congress to overhaul the rules for determining taxable income, that path appears to be unlikely. If we are to have a corporate tax based on income, replacing the current definition of taxable income with GAAP net income strikes me as a reasonable adjustment — one that deserves bipartisan support.