President Biden signed the Inflation Reduction Act into law this week. The headlines will focus on the environmental and energy policies designed to address the climate change crisis, as well as important health policy reforms. The bill’s tax provisions are also crucial—they are intended to pay for much of the legislation’s new spending. To understand the bill’s major new tax reforms, we sat down with Adjunct Lecturer in Public Policy Jay Rosengard, who teaches courses on tax policy and public finance and directs the Mossavar-Rahmani Center for Business and Government’s Financial Sector Program.
Q: The bill includes a new 15% minimum tax on corporations. Why did the bill’s proponents argue that a minimum tax was necessary?
Many clearly prosperous corporations are not contributing tax revenue to fund government infrastructure and services essential for their prosperity. For example, in 2019, 20% of large corporations reporting profits to shareholders of more than $100 million paid zero federal income taxes—some even received tax refunds. The purpose of a 15% minimum corporate tax is to ensure corporations are paying their fair share by addressing this legal, loophole-enabled difference between book income reported to shareholders and taxable income reported to the IRS.
Q: Is it an effective way of raising revenue from corporations? Are there other tax loopholes that Congress should have also considered?
It is effective because it is similar to our AMT (alternative minimum tax) for wealthy individuals: both are straightforward to calculate and thus relatively easy to implement. It is also equitable in that even if all tax avoidance measures taken to reduce a corporation’s tax liabilities are legal, they nevertheless violate the fundamental tax principle of paying in accordance with one’s means.
The most egregious tax loophole not closed (at the insistence of Senator Kyrsten Sinema in exchange for her vote) is the carried interest tax. This loophole benefits a small number of America’s richest, namely partners in private equity firms and hedge funds, who make their money my managing other people’s money. Their share of profits would normally be taxed as earned income at 37% but instead is taxed at the much lower 20% capital gains rate (as long as it is held for at least three years). Not only is this blatantly unfair, but closing the loophole would have also generated about $14 billion in tax revenue.
Q: How is this related to Treasury Secretary Janet Yellen’s attempts to broker a worldwide 15% minimum corporate tax?
During the early stages of taxation of cross-border activities many steps were taken to avoid double taxation of corporations. Now the problem is that many large businesses do not pay corporate income taxes anywhere, and the most mobile often get tax credits from multiple jurisdictions. This had led to a “race to the bottom” as countries competitively lower tax rates to attract foreign investment. The worldwide 15% minimum corporate tax promoted by Secretary Yellen tries to ensure that corporations pay their fair share of taxes where they generate their profits. This was endorsed by the G20 and is supported by 132 countries, comprising 90% of global GDP. However, the agreement will not be effective without the support of the United States, the world’s largest economy. The new U.S. law indicates we fully support the international effort and will not undercut it by becoming a de facto tax haven.
Q: In addition to the changes to the tax code, the bill provides nearly $80 billion to increase IRS enforcement capacity. Why does the IRS need additional funding, and how is the agency expected to use and prioritize these new resources?
Even as IRS responsibilities have increased in size, scope, and complexity, in the last decade, its budget has fallen (net of inflation) 15%, its work force has shrunk by more than 20%, its enforcement budget decreased 25% (again net of inflation), and its audit rate of the top 1% in 2017 was one-third of the audit rate in 2011. The IRS needs these funds to modernize its IT systems. This includes improving taxpayer service by introducing pre-populated returns. The IRS already receives all necessary tax information for most Americans from employers, banks, and brokers so should be able to send taxpayers completed returns for their approval or correction. The funds are also necessary to reduce the estimated $7.5 trillion tax gap (revenue due but not collected) over the next decade by enhancing its enforcement capabilities. This will improve the efficiency and equity of our tax system, as well as generate significant revenue: when combined with the 15% minimum corporate tax and a 1% excise tax on stock buybacks, it will raise an estimated $450 billion over the next decade.
Photograph by AP Photo/J. David Ake, File; Headshot by Stephanie Mitchell/HPAC