Build Back Better is a chance to finally make corporate taxes line up better with profits

Harry Truman once said of Richard Nixon that he could lie out of both sides of his mouth at the same time. True or not, major corporations do a more respectable version of this every year. They report their annual “income” both to the Internal Revenue Service, for purposes of determining how much income tax they owe, and to investors under financial accounting rules.

Strictly speaking, these are different measures that serve different purposes. Yet their both being called “income” is no coincidence. They really are versions of the same thing. The IRS needs a measure of profitability in order to determine how much tax companies owe. For good reason, those that are doing very well owe more federal income tax than those that are struggling. Investors likewise need a measure of corporate profitability, to help them in gauging the value of different companies’ shares. Making profits, albeit over the long run, is after all the point from an investor’s perspective.

Given the twin measures’ distinct purposes, a company’s managers have an incentive to make its taxable income as low as possible, and its financial accounting income as high as possible. This can have damaging effects on the accuracy of both measures, even if the managers act entirely lawfully in preparing them. There simply is vast scope for managers to arrange transactions that generate tax but not financial losses, or that raise book profits but not taxable income. Managers also have a great deal of leeway, in cases where either the facts or the rules are unclear, to make self-serving judgments that both lower reported income and raise reported profits, with little risk that they will ever get in trouble for this.

These planning opportunities have long helped to make corporate tax avoidance both incredibly successful and publicly infamous. Between 2018 and 2020, the Institute on Taxation and Economic Policy reports that 39 of America’s largest companies paid zero dollars in federal income tax, despite their reporting combined net profits of $122 billion. During this same period, an additional 73 profitable U.S. companies paid a combined effective federal income tax rate of just 5.3 percent — barely one-fourth of the nominal U.S. corporate income tax rate at the time.

The Build Back Better Act that just passed the House would directly address this problem, for the first time in more than 30 years. A key provision in the bill, known as the corporate alternative minimum tax, would require companies with more than a billion dollars of annual profits (as reported to shareholders) to pay at least 15 percent of those amounts in federal income taxes. Because this is a “minimum tax,” it would have no effect on companies that were already paying enough. Corporate tax avoidance is currently so prevalent that the provision, if it becomes law, is expected to raise $319 billion in revenue over the next decade.

The proposed corporate minimum tax admittedly is not perfect. For example, in some cases, it might lead corporate managers to be more careful in how they micromanage the exact annual relationship between taxable income and reported profits. Yet it is not as if either measure performs pristinely today. At least, under the minimum tax, the companies would find it harder than they have in the past to play games with both measures, at the same time, in opposite directions.

In an ideal world, the proposed corporate minimum tax might be less appealing than just getting the tax base right. However, anyone who thinks that this is politically easy — or perhaps even feasible — has not spent much time observing the efforts of well-funded corporate lobbyists. The provision’s emerging so late in the drafting process for the Build Back Better Act reflected its superior political optics and salience, which become especially important virtues when the legislative process is so ill-functioning.

Consider some of the spending components of the Build Back Better Act that this $319 billion in projected revenues could help to fund. For example, these revenues exceed 80 percent of the act’s estimated $390 billion cost for funding childcare and universal pre-K. Or alternatively, they exceed 90 percent of the combined cost of its expanding affordable home care ($150 billion) and extending the full current-year provision of child tax credits to needy families ($190 billion).

The benefit of those outlays would far exceed any detriment that even the minimum tax’s worst critics could reasonably attribute to it. And it is not as if, in this fraught political moment, we can just wait for an even better funding mechanism to happen along. 

Simply put, the corporate alternative minimum tax on book income is more than good enough — and has its own distinctive virtues — at a time when millions of Americans whom the Build Back Better Act would aid are still suffering.

Daniel Shaviro is the Wayne Perry Professor of Taxation at NYU Law School.