Cliff-Diving

The Organization for Economic Cooperation and Development’s most recent “technical guidance” on the 15% global minimum tax seemingly ended hopes that the body would grant some kind of special exemption for the U.S. and its similar but looser version, the 10.5% tax on global intangible low-taxed income.

By designating GILTI as a “blended controlled foreign corporation regime,” it did grant U.S. taxpayers some relief, but they still face the prospect of retaliatory taxes under the OECD’s Pillar Two system in the upcoming years.

U.S. advocates of Pillar Two are now looking to the future–two years, in fact, to what looks to be the only opportunity on the horizon for Congress to enact Pillar Two-implementing legislation into law. Itai Grinberg, a Georgetown University law professor and former U.S. Treasury Department official who led the OECD negotiations, recently noted that the expiration of many Tax Cuts and Jobs Act provisions in 2025 could give the Biden administration leverage to enact some of these changes into law.

The “Tax Cliff,” as some wonks are calling it, is looking to be a mega-showdown with the potential to sway many hundreds of billions in taxes. The conventional wisdom is that the scheduled changes, mostly affecting individual taxpayers, will be too harsh for Congress to let go into effect. Lawmakers will be forced to come to some agreement that will likely require a wide range of policies for everyone to get on-board. In theory.

These “cliffs” have become one of the key ways that anything gets done in Washington, as Congress has become too polarized and sclerotic to work through anything resembling normal order. High noon-style showdowns, staring contests with potentially devastating consequences, have become a regular occurrence. (There’s even one coming up sooner than 2025–the debt ceiling. But it’s not likely to produce extensive tax changes, if only because neither side seems to have the patience for it this time around.)

As it happens, I’m somewhat familiar with these cliffs. I spent my 30th birthday literally running around the halls of the U.S. Capitol and sipping bourbon with fellow reporters in the Senate press gallery as we followed developments in the 2011 debt ceiling crisis. At the time, I was a correspondent for U.S. News & World Report. As the effects of that last-second deal played out, helping to create the 2012 “Fiscal Cliff,” I also wrote about it for Bloomberg Tax.

So I know what to expect in these cliff standoffs–which is anything. They’re inherently messy and unpredictable, a volatile mix of partisanship, ideology, personalities, arcane Congressional procedure and divergent interests. This one could well pave the way for international tax reforms and more consistency with the new global standards. But count on nothing but chaos.

The 2011 debt crisis ended with the creation of the “Supercommittee,” a commission of lawmakers that were supposed to come to some agreement on deficit reduction. It turned out to only be “super” in its ineffectiveness–the deadline for it to produce results passed and it was disbanded. That set up another deadline, the effective date of the dreaded “sequester,” indiscriminate budget cuts which were meant to be the Supercommittee’s motive to get something done.

As it happened, that coincided with the expiration of the Bush 2001 tax cuts, which Democrats had vowed to repeal. So it created something of a mega-deadline that became known as the Fiscal Cliff. Maybe Congress would finally achieve a “Grand Bargain,” a deal on taxes and spending that both parties could sign onto to deal with the burgeoning national debt, people hoped.

Part of the appeal with this is that the Bush tax cuts were already set to expire in current law. So, in theory, if Congress permanently increased taxes by up to two-thirds of the pre-Bush rates, it would actually be a tax cut according to current law. That's if they choose to use a “current law” baseline, rather than a “current policy” one. This is a way around influential activist Grover Norquist’s iron-clad “pledge,” that most Republicans sign onto, to never raise taxes. (Though Norquist hasn’t always agreed with that interpretation.) Even if one doesn’t buy into that math, a mega-deal could be designed so that on aggregate taxes aren’t raised, even on a current policy baseline. Tax hikes could be offset with tax cuts elsewhere. That requires some creative thinking and tough decision-making, though.

Alas, the chances of a substantial Fiscal Cliff deal in 2012 turned out to be illusionary. Congress ended up extending all but a tiny portion of the Bush tax cuts, and the sequestration budget cuts went into effect. It ended up being yet more evidence that Congress sometimes can’t get its act together, even when the stars are seemingly aligned and the consequences of inaction are dire.

It would take five newsletters to run down all of the expiring tax provisions that will play into the upcoming Tax Cliff. But here are some of the key ones. These were all enacted to reduce the TCJA's overall cost and comply with the Byrd Rule, the requirement that legislation not add to the deficit after 10 years (if it's enacted through reconciliation.)

Perhaps the biggest item is the 20% deduction for pass-through entities, businesses that are typically self-owned or a partnership. There are many tax experts who would be happy to see it expire, but it’s proven to be politically durable, and even Democrats may step up to defend it. There’s also the increased standard deduction, which has been a godsend for many normal income tax filers–even if their overall tax payments didn’t change so much, it saves them from the complicated business of itemizing deductions. That's set to reverse in 2025, also.

Full expensing and bonus depreciation, which allow businesses to access deductions for spending faster, have already begun to phase out and will be eliminated completely by 2025. Full expensing for research and development costs has already expired, replaced with a 5-year amortization schedule. But that could still be in play for a Tax Cliff deal. So to would the looser restriction on the deductibility of interest in Section 163(j)--today it’s based on a percentage of EBIT, earnings before interest and taxes, but it was previously EBITDA, adding depreciation and amortization. (That was still a pretty strict limitation, in line with recommendations from the OECD’s 2015 Base Erosion and Profit Shifting project.)

The tax rates on both GILTI and its domestic counterpart, foreign-derived investment income, are set to rise in 2025. FDII will increase from 13.125% to 16.4%, while GILTI will rise from 10.5% to 13.125%. The latter is interesting, because it will bring it slightly closer to the 15% rate agreed to by the OECD–narrowing the gap that needs to be overcome.

In many ways GILTI is actually harsher than the OECD’s Pillar Two, even as Pillar Two applies on a country-by-country basis. GILTI doesn’t allow net operating losses or excess foreign tax credits to be carried forward, making it especially punitive to companies with losses or in cyclical industries. Despite the name, it sometimes can apply at rates much higher than 10.5% due to limitations on foreign tax credits.

It may well be that switching a current-law GILTI at 13.125% for a country-by-country one at 15% and allowing for more flexibility with income (and no FTC restrictions) would be a wash for taxpayers, a deal that companies would be willing to take. Arranging for that trade-off would be totally reasonable for an uncontroversial fine-tuning of the law–but unfortunately, Congress doesn’t do “totally reasonable” these days. This change, if it’s going to happen, needs to be part of a bigger package to have any hope at all.

In years past, Congress would enact “technical corrections” in major tax bills as a matter of routine, on a bipartisan basis. That’s no longer the case–Republicans refused to help Democrats make any adjustments to the Affordable Care Act, and Democrats responded the same way to the TCJA. “It’s your mess, you fix it,” is the basic attitude.

And even fixes like this–policy issues that can’t be characterized as mere “corrections”--would have been handled in a relatively low-key way as part of Congressional log-rolling and mechanics in the past. Those days are long gone, though.

Last year, Sen. Joe Manchin (D-WV) nixed the international tax changes that the administration hoped to include in the Inflation Reduction Act, claiming that the U.S. should wait until other countries moved before committing. At the time, the European Union was stuck at a stalemate, failing to find unanimity on the issue as Hungary held out. The impasse has since been resolved, and most countries are now moving forward. That should at least remove one of the most effective talking points against enactment in the U.S., although it was hardly the only one. (And perhaps it’s questionable whether that was Manchin’s true concern.)

Maybe Republicans would be willing to set aside their steadfast opposition to the OECD agreement as a way to extend the bulk of the Tax Cuts and Jobs Act, one of the key legislative accomplishments of President Donald Trump’s administration. And maybe Democrats would be willing to sign off on significant tax cuts for businesses and the wealthy in exchange for other tax benefits such as an expanded child tax credit or earned income tax credit to help the poorest.

All the ingredients are there–but this is a Congress full of Gordon Ramseys who may never agree on the cooking. Time will tell.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• I held this newsletter until Friday so I could include President Biden’s annual budget request, which includes a host of international proposals. (Seen here in the "Green Book" from Treasury.) Most of those were previously seen in prior budget requests or the Build Back Better Act. In total they raise $1.16 trillion over the next 10 years. Since the traditional budget process has broken down, the White House budget request is little more than a messaging document, but it’s worth keeping an eye on to see what proposals are in the mix for policy discussions. It does include a new proposal that it claims will close a loophole allowing companies to avoid both Subpart F and GILTI taxes, raising $3.6 billion. (See “Revise the rules that allocate Subpart F income and GILTI between taxpayers.”) Crypto miners will certainly be interested in a new proposed 30% excise tax on electricity used for computer processors in crypto mining, which critics say is having a devastating environmental impact.
• Back in February, the OECD held the first meeting of the “Inclusive Forum on Carbon Mitigation Approaches,” a new body aiming to help countries meet the carbon-cutting goals they have set. After having coordinated action on international taxes, the OECD hopes it can take a leading role in cutting greenhouse gas emissions, what’s sure to be one of the top issues in global taxes for the future. Last week the OECD posted a meaty piece on the pricing of carbon, another example of how it’s moving into this space.
• Maryland Sen. Chris Van Hollen (my former rep!) re-introduced legislation to require public country-by-country tax reporting by multinational corporations, what they already have to report to governments privately as part of the OECD’s BEPS project. These global blueprints give tax authorities a better idea of where the problematic jurisdictions are–if a country shows low employees and taxes but high profits, there’s likely some tax planning going on–and if made public would no doubt be a source of significant PR headaches. The bill was praised by transparency advocacy groups. This legislation has been introduced in the past and hasn’t gained much traction, but it’s always something that Dems could push as they continue to blast corporations for alleged tax avoidance and use of tax havens.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Ghost, who premiered in Daredevil Comics #5 in 1941. (“Ghost” is also the name of my newsletter platform provider.) Another WWII hero who fought Nazis as well as the villainous alien Claw, using nothing but his exceptional strength and intelligence, as well as a mysterious “Ghost plane.” For some reason, he also never took the costume off, even when relaxing around his home.

Contact the author at amparkerdc@gmail.com.