Biden’s global tax revolution won’t leave Israel untouched
In Israel, it’s been two years since we have had a functioning government. That will remain the case for the time being as the coalition talks are underway and, if it depends on Prime Minister Benjamin Netanyahu, they will continue through a fifth round of elections.
But elsewhere there are governments that are galloping forward and showing their citizens what a functioning government is all about. One of those is led by Joe Biden, who has turned out not to be a nice old grandpa but an activist president leading a revolution in the United States and beyond.
Biden has been unveiling reforms at a dizzying pace, most prominent among them a plan to invest $2 trillion in infrastructure by raising taxes, mainly on corporations. Treasury Secretary Janet Yellen has proposed raising the corporate rate to 28% from 21% and the minimum rate American corporations pay where they are formally based no matter where that is to 21% from 10.5%.
The plan goes beyond America’s borders: Yellen spoke of the need to reach a global agreement on an agreed minimal corporate tax and to put an end to the race to the bottom by governments seeking to lure businesses to their countries with ever-lower tax rates.
From Israel’s perspective, the most dramatic element of the plan is raising the corporate rate for U.S. companies abroad. The 21% minimum rate effectively creates a global minimum because all U.S. corporations will be liable for that rate on their profits. Companies that move their headquarters to Ireland, because the rate there is just 12.5%, will still owe the U.S. Internal Revenue Service another 8.5%.
If so, Ireland’s low rate will be emptied of any significance. Why then would any U.S. corporation take the trouble to set up in Dublin if it’s going to have to pay 21% anyhow?
The 21% minimum is believed by observers to be a bargaining chip for future negotiations with other developed countries. The goal, as she has said, is to reach a global agreement on a minimum rate. If they don’t, then American will set a de facto rate of 21% and enforce it elsewhere around the world.
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It’s impossible to discount the ability of the Americans to change the world order if they desire to. After the 2008 financial crisis, when the U.S. decided to crack down on tax evasion by U.S. citizens via foreign bank accounts, it imposed FATCA (the Foreign Account Tax Compliance Act), requiring foreign banks to reveal what U.S. citizens held in their accounts.
Banks that dared to refuse the U.S. demands on grounds of banking secrecy, received notices saying they were no longer allowed to operate in U.S. territory. That threat was enough to persuade banks all over the world to set aside the principle of confidentiality and hasten to report to U.S. authorities what American citizens held in their accounts. An aggressive act, FATCA put an end to the use of foreign banks to evade taxes.
Biden wants to establish a similar kind of regime for global taxation – except that global taxation is clearly much more complicated than banking, so that his and Yellen’s views have been met with a great deal of skepticism. The world’s rich have long been united in a conspiracy to prevent governments from making them pay their fair share of taxes. They are equipped with battalions of accountants and lobbyists, who make sure that the world’s tax regimes are so complicated that it’s easy to find loopholes. That’s certainly the case in many countries and even more so between countries.
Biden’s predecessor, Donald Trump, set a 10.5% minimum tax on U.S. corporations (as part of his 2017 GILTI reforms), but these reforms remain mainly on paper. The multiplicity of loopholes, which weren’t addressed by Trump, prevented U.S. tax officials from putting the new minimum into practice.
Because the Americans failed to impose the 10.5% levy, many are skeptical that the 21% minimum will ever be enforced. The feeling in Israel, since the Biden administration revealed its plan on April 5, is that the odds of any change happening are poor. Israel, it follows, can sit quietly without worrying too much about its impact.
Quite to the contrary, Israel may even benefit: The plan to raise the U.S. corporate rate to 28% would only encourage U.S. companies to move overseas and for Israeli companies that opened headquarters in the U.S. to return home. In short, the Americans are suckers and we will benefit from that.
Israel is also celebrating at America’s expense. The Israeli corporate tax rate is 23%, not very different from the U.S.’s 21% rate, but Israel offers tax breaks for big exporters. The Investment Encouragement Law, under which big U.S. companies operate in Israel, offers much-reduced tax rates of between 5% (as Intel pays, in addition to big investment grants) to 16% for the big research and development centers operated by the U.S. and other foreign companies.
That’s a lot less than the 28% the Biden White House is proposing, and it effectively makes Israel a tax shelter.
But that perspective assumes that the Biden administration is a bunch of suckers, that it would raise the corporate rate to 28% and fail to enforce the global minimum, thereby pushing more and more U.S. corporations to move abroad. But there’s also the possibility that the administration will succeed where Trump failed, that it will close loopholes and truly impose the 21% minimum. In that case, the rules of the global tax game will change – for Israel, too.
Israel is heavily reliant on the investment law as a tool for drawing foreign investment and for keeping Israeli high-tech companies from fleeing. It has had three main effects.
The first is to attract big manufacturers to Israel, first and foremost Intel. Intel has invested billions of dollars in erecting plants here. Raising the minimum tax to 21% would constitute a major shock, but the feeling is that due to big investments Intel has already made here and Israeli-government grants, any change in U.S. taxes presents no short-term threat.
The second effect has to do with the big U.S. RD centers in Israel. While most pay a 16% rate, profits are slim to begin with. The tax break they get isn’t big, but they operate in Israel anyway, despite the relatively high costs, among other reasons, due to high salaries and the strong shekel. They are in Israel due to the quality of research, not because of the tax rate, so any change in the U.S. rate won’t influence their decision on whether to stay or not.
The third effect is on Israeli tech companies with subsidiaries in the U.S. They divert most of their profits to Israel to take advantage of the lower rate they are entitled to under the investment law. In the event that they would have to pay the 21% minimum rate no matter what, they would no longer have any incentive to move profits to Israel.
In the end, no one can assess the impact of a changing U.S. tax regime on Israel. But they certainly make the campaign promises of Netanyahu and Naftali Bennett to lower Israeli taxes look ridiculous. Around the world, taxes are going up, corporate taxes in particular. America is setting the tone.