Concluding its flagship effort to rearrange the world of corporate taxation, the OECD is making a valiant push for two tax “pillars” in its grandly named Base Erosion and Profit Shifting (BEPS) initiative:
- Assign a chunk of corporate earnings to countries where consumers reside.
- Establish a global minimum corporate tax rate.
The “pillars” have a solid sound, but if adopted they will spawn tax confusion and could deprive the U.S. Treasury of significant revenue.
Start with the reassignment of a chunk of corporate earnings to countries where consumers reside.
This pillar is designed to overturn the established principle that corporations are taxed in the jurisdiction where they have a physical presence. The objective is to impose a “digital services tax” (DST) on U.S. tech giants like Facebook, Amazon, Netflix, and Google, for purveying their internet services to users around the globe. The DST formula would assign some percentage of corporate group earnings to each country where users live. The underlying rationale is that digital firms gain valuable knowledge from their users and hence the residence country is entitled to a tax bite.
No doubt digital firms gain valuable insights as to the purchasing proclivities of their users. The problem with this rationale is that — contrary to the wishes of the French Treasury and other DST advocates — the rationale is not confined to digital firms. All firms that serve consumers and most that serve industrial buyers constantly learn from their customers.
This is just as true for Veuve Clicquot, Airbus, Ferrari and LVMH as it is for Facebook or Google. The U.S .Treasury would be foolish to agree to limit pillar one to digital traffic. And extension of pillar one to a range of goods would expose many US imports to the IRS. DST advocates should beware of what they wish — new corporate taxes on merchandise trade could substantially exceed DST revenues.
The administrative dimensions of pillar one boggle the mind. Only tax lawyers and accountants could find delight in this brave new world. Equally troublesome, less tax revenue will accrue to jurisdictions that actively encourage innovation, while more tax revenue will accrue to nations that passively consume. Countries that want to tax consumption — indirectly the goal of the DST — should instead fine-tune their value-added tax systems (VAT), not complicate their already complex corporate tax systems.
The second pillar is equally fraught, though the prospect of a global minimum corporate tax has great appeal. As Senator Russell Long famously said, there is a secret to raising taxes: “Don’t tax you, don’t tax me, tax the fellow behind the tree.” The fellow truly behind the tree is the multinational corporation, reviled for paying its executives too much and the tax collector too little.
The core weakness of pillar two is rooted in basic tenets of political economy.
National legislatures, curiously enough, think that it is their task to juggle the conflicting demands of raising public revenue with calls to create good-paying jobs and spark innovation. If OECD nations manage to agree on the concept of a minimum tax rate (12.5%? 20%? — the figure remains to be settled), we may be sure that legislators who feel thwarted will, in the first instance, create new deductions and credits in their systems. The OECD minimum will be a floor in name only.
Worse, some countries will escape the confines of a minimum tax through new subsidies to favored firms. The result will be more jagged, and thus more distortive, national systems of taxation and subsidization.
Candidate Biden, who enjoys every prospect of becoming president, promises to raise the U.S. corporate rate from 21% to 28% and apply that rate to U.S.-based multinational corporations whether they produce in the United States or abroad. If elected, and if he carries a Democratic majority in the Senate, President Biden can enact that promise. U.S.-based multinationals will then end up paying higher tax bills than many foreign firms, hobbling American competitiveness in world markets.
Whether or not the OECD adopts pillar two, there is little chance that all OECD nations, plus China, will follow the U.S. lead.
Gary Clyde Hufbauer is a Nonresident Senior Fellow at the Peterson Institute for International Economics. He served in the US Treasury as Director of the International Tax Staff.