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Fix the Law to End the Wishy-Washiness of Taxing Book Income

Aug. 12, 2022, 8:45 AM

When a tax on financial accounting (book) income was initially proposed, there were concerns that it would hurt R&D-intensive companies, so these companies got a carve-out in the tax proposal. Soon after, companies with large pension plans complained and likewise got a carve-out in the minimum book tax. Now, in the past week, there have been concerns that the minimum tax on book income would hurt manufacturers, so Congress is planning on adjusting the proposal to spare these companies as well.

Notice a pattern? In all these instances, Congress previously passed a tax law to favor a group of firms, often for economically sound reasons. There are certainly arguments in favor of using tax policy to incentivize R&D and manufacturing, for example. But the nature of a tax on book income is to punish companies that Congress previously rewarded, adding a complex layer of taxation instead of directly modifying the tax code.

The purpose of book income is to give investors a sense for how a company is performing. Financial accounting doesn’t have carve-outs for expenses related to R&D, manufacturing, or investing—loopholes that incentivize certain economic activity. Unlike the tax law, financial accounting merely counts the income companies have. This means that any tax that penalizes firms for having higher financial accounting income than taxable income—a situation that arises precisely because Congress previously rewarded these companies with extra tax deductions and credits—will hurt these same companies Congress tried to help.

This innate wishy-washiness is the essence of the bill and results from taxing something that was never meant to be taxed: financial accounting income. Congress created the tax law so that some kinds of companies will pay less in tax. And now that they do pay less, Congress wants to close these loopholes. But instead of fixing these perceived flaws by removing the incentives Congress previously put in place, Congress is planning on “fixing” the law by layering on the tax code additional policy that would claw some of those benefits back. But not for everyone—as we are seeing, this is politically tricky, as many companies receiving tax goodies likely will succeed in carving them out of the minimum book tax.

What’s the alternative? Congress should amend the tax code they created rather than fashion an entirely new system of patchwork. For example, David Morse recently praised the tax on book income because it would target the foreign interests of large multinationals. If Congress wishes to be out of line with most countries on Earth and tax the foreign earnings of US companies, it should simply repeal the foreign provisions of the Tax Cuts and Jobs Act, which exempts some foreign earnings from US taxation. Instead, Congress has proposed to include financial accounting income, which counts all foreign income, as part of the tax base. This indirect method is far inferior to solving problems directly and puts Band-Aids on perceived tax flaws instead of fixing them.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Fabio Gaertner is an associate professor and the Cynthia and Jay Ihlenfeld Professor for Inspired Learning in Business at the University of Wisconsin-Madison.

Jeff Hoopes is an associate professor at the University of North Carolina and the research director of the UNC Tax Center.

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