Article | Tax Law
How The States Can Tax Shifted Corporate Profits: An Application of Strategic Conformity
by Darien Shanske*
From Vol. 94, No. 2
94 S. Cal. L. Rev. 251 (2021)
Keywords: Tax Law, Corporate Law, State Law
The combination of pandemic, recession and federal dysfunction has put severe fiscal strain on the states. Given the scale of the crisis and the essential nature of the services now being cut, it would be reasonable for states to contemplate inefficient—and even regressive—revenue-raising measures. Yet surely they should not start with such measures. They should start with making the efficient and progressive improvements to their revenue systems that they should have made anyway.
Improving the taxation of the profits of multinational corporations—the topic of this Article—represents a reform that would be efficient, progressive, and relatively straightforward to administer. Not only would such a reform thus represent good tax policy, but it would also raise significant revenue. And, if substantial revenue, efficiency, progressivity and administrability are not sufficiently motivating, then I will also add that it would be particularly appropriate to make these changes during the pandemic so as to raise revenue from those best able to pay during the current crisis.
To be sure, the argument that states can and should tax multinational corporations more has the whiff of paradox. After all, there is general consensus that no nation-state is currently taxing multinational corporations very effectively and, further, that subnational governments are in an even worse position to do so. This is because multinational corporations can exploit the mobility of capital even more easily between parts of the same country. Nevertheless, I will argue that the American states find themselves in a particularly strong position to do better at taxing multinational corporations and this is in part precisely because of the missteps made at the federal level.
The Tax Cuts and Jobs Act (“TCJA”), passed in December 2017, contained several provisions, including rules concerning Global Intangible Low-Taxed Income (or “GILTI”), that were meant to combat income stripping. The GILTI provision identifies foreign income likely to have been shifted out of the United States and subjects it to U.S. tax.
In this Article, I argue that the states should and can tax GILTI income. The basic policy argument is simple: states should not miss a chance to protect their corporate tax bases. The amount of revenue at stake is not trivial; it could be as high as $15 billion per year for the states as a whole or the equivalent of a 30% boost in corporate tax collections.
The basic legal argument is also simple: it cannot be the case—and it is not the case—that states need to take corporations at their word as to where their income is earned. If the states can make a reasonable argument that nominally foreign income has in fact been shifted out of the United States, then their choices as to their tax system should be respected.
This Article makes several other core arguments. First, the Article argues that returning to mandatory worldwide combination as a complete alternative to GILTI conformity would be preferable to GILTI conformity alone. Second, the Article argues that offering taxpayers a choice between GILTI conformity and worldwide combination is preferable to GILTI conformity alone.
Finally, this Article places all these issues in a larger framework of strategic conformity. As with GILTI, the states should look for other opportunities where they can take advantage of federal miscues while also advancing sound tax policy.
* Professor, UC Davis School of Law. Many thanks to audiences at the Association of Mid- Career Tax Professors, the NorCal Tax Roundtable, the University of Minnesota Law School Perspective on Taxation Lecture Series and to Eric Allen, Revuen Avi-Yonah, Kimberly Clausing, Steven Dean, Peter Enrich, Michael Fatale, David Gamage, Mark Gergen, Kristen Hickman, Ken Levinson, Michael Mazerov, Amy Monahan, Susie Morse, Michael Simkovic and Adam Thimmesch. I am particularly grateful to David Gamage who coauthored some shorter pieces on which this Article is based. All opinions and mistakes are my own.