President Biden has proposed a minimum corporate tax of 15%. Has he forgotten that the United States already has a minimum tax rate and that it is upper more than 15%?
US corporations are required by law to pay, at a minimum, 21% of their US taxable income in taxes, after adjusting for losses and tax credits. The 21% federal rate has been in place since 2018, and before that, the minimum tax rate was 35 percent. The minimum tax we have today is just the normal corporate tax rate. So why talk so much about a new minimum tax if we already have one?
It turns out that minimum taxes are really just an adjustment to the tax base — the thing that gets taxed. The amount that corporations pay in income taxes is equal to the tax base multiplied by the tax rate. The tax base, or taxable income, is difficult to calculate and difficult to explain. The tax rate, on the other hand, can be summed up in a single number.
While the Internal Revenue Code is about a million long words, section that defines the US corporate tax rate boils down to about 100 words. The important part of the article contains only 16 words: “The amount of tax imposed by paragraph (a) shall be 21% of the taxable income.” The majority of the Internal Revenue Code defines the tax base, dictating the relevant tax treatment for seemingly countless types of economic inflows and outflows. Given this complexity gap, it’s easy to see why politicians ignore the tax base and focus on the tax rate.
However, focusing on the tax rate is misleading. Much of the current criticism of the tax code stems from concerns about the tax base, not the rate. A minimum tax like the one Biden has proposed implies that there would be a minimum tax of 15% on a different tax base than what we currently use.
So what would that different tax base be? The details of the initial tax proposals are still hazy. But, Biden has already propose a minimum tax of 15% on financial accounting income, an income figure that differs from taxable income for a variety of reasons. Take for example depreciation. Financial accounting, or accounting income, requires companies to depreciate fixed assets based on actual economic depreciation, because investors need to know the true net worth of company assets. The tax code, on the other hand, allows for much faster depreciation, as it lowers the after-tax cost of investing and further stimulates business investment. Taxing income from financial accounting is a bad idea since accounting and tax rules differ for a reason. A recent informal poll Accounting professors – including ourselves – across the political aisle couldn’t find a single one who thought taxing financial accounting earnings was a good idea. And while Congress could use another alternative tax base, including alternatives being discussed globally, that’s also not a good idea. Indeed, regardless of the alternative tax base decided by lawmakers, any minimum tax proposal would require companies to calculate taxable income twice, adding unnecessary uncertainty and complexity to the system.
And it’s not just a matter of double counting taxable income. A minimum tax would erode the very tax incentives Congress is trying to create. Research and development activities, clean energy investments, and capital expenditures all receive favorable treatment in the tax code. Minimum taxes, however, are only effective if they cancel out items that receive preferable tax treatment. Inevitably, a minimum tax would affect the production of public goods and therefore reduce the ability of the tax code to steer businesses in ways that benefit society.
Although minimum taxes may seem like a new idea, the concept should sound very familiar. It’s because we’ve already tried minimum corporate taxes. The widely disdained Alternative Minimum Tax (AMT) for businesses was exactly that type of minimum tax. The AMT was eliminated by the Tax Cuts and Jobs Act in 2017 because it was so universally reviled. Businesses simply found it too onerous to have to calculate taxable income twice in two different systems. Let’s not reimplement something that has already failed.
Minimum taxes are a distraction. If legislators don’t like the rules defining the tax base under our current system, they should just change them. Adjusting the tax code directly is a much better solution than layering a separate, independent tax system on top of our current system, which would increase complexity and compliance costs while undermining positive economic incentives.
Fabio B. Gaertner is Associate Professor and Cynthia and Jay Ihlenfeld Professor for Business-Inspired Learning at the University of Wisconsin-Madison.
Jeff Hoopes is an associate professor at the University of North Carolina and research director of the UNC Tax Center.