Pillar Two Windfall Blowing Away?

Last year, in President Biden’s annual budget request to Congress, the U.S. Treasury Department estimated that implementing the Organization for Economic Cooperation and Development’s 15% global minimum tax, along with other changes, would raise more than a trillion dollars over the next decade.

This year’s budget request, with few policy changes, estimates nearly half of that, at $510 billion over the same 10-year period.

This didn’t go unnoticed on Capitol Hill, and when Treasury Secretary Janet Yellen came to the Senate Finance Committee last month to testify about the budget, Sen. Mike Crapo, R-Idaho, asked her about the discrepancy. Yellen admitted that as other countries implement the tax, it lowered the expected revenue gain.

“When there are changes abroad it does change the estimates,” she explained.

Budget scorekeepers often can’t, or aren’t authorized to, make assumptions about how policies could change from the snapshot when they are estimating. So as other countries enact the Pillar Two rules, grabbing some of available low-taxed income, that means there’s less for the U.S.

But one point to keep in mind is that this means the score was always going to be $500 billion. Or less. Pillar Two isn’t a game of “Finders Keepers”–the revenue is sourced based on ordering rules set by the OECD. Who gets to it first won’t determine where the revenue goes in future years.

This is yet another reminder of how fluid the various revenue estimates for Pillar Two are, and how unreliable it could be as a source of potential income for any given country. The current data is already limited, and how Pillar Two plays out will depend largely on decisions that haven’t been made yet–by countries and by taxpayers.

In the U.S., as the great 2025 Tax Cliff approaches, those who hope that taxing offshore income could offset other expensive priorities may be disappointed.

The perhaps exuberantly optimistic predictions by Treasury of a trillion-dollar windfall stand in contrast to more reserved predictions from the Joint Committee on Taxation about possible revenue effects of Pillar Two. When it scores legislation, JCT is also restricted to current laws as they stand–but in June 2023, they drew up a report for the Senate Finance Committee outlining several possible scenarios.

The JCT found that any outcome where the world enacts Pillar Two, the U.S. is bound to lose revenue compared to what they would have earned had Pillar Two stayed in the drawing room. If the U.S. elected to do nothing, it could lose $122 billion over 10 years. But if it enacts Pillar Two legislation, it would only lose $56.5 billion. Since we’re now in a world where most countries have already implemented the policy, this means the choice to the U.S. is whether to gain $65.5 billion by enacting Pillar Two in full, against this new baseline.

Interestingly, in the scenario where everyone enacts Pillar Two, most of the new U.S. revenue would come from domestic income, according to JCT. The report states that the difference between the two estimates is largely due to receipts from a qualified domestic minimum top-up tax, the (optional) Pillar Two tax which picks up local income if it is taxed below 15%. This would apply to local subsidiaries of foreign multinational corporations or U.S.-based ones if they had income that qualified.

While the U.S. would also enact, in this scenario, an income-inclusion rule, which taxes low-taxed foreign income held by U.S. multinationals, that wouldn’t be as big a source of revenue, it would seem. Or the under-taxed profits rule, a protective measure which taxes foreign multinationals if they hold low-taxed income in other jurisdictions. The JCT does predict that the U.S. could gain from “a small increase in profit shifting into the United States”–that’s something you don’t hear about often. What this probably means is that the U.S. could gain from the indirect effects of the disincentives for base erosion created by all of these new criss-crossing rules.

While it’s anyone’s guess how this all plays out, I still think the odds of the U.S. passing a QDMTT are pretty long. It’s not a requirement to be compliant under Pillar Two, and we’ve got our own minimum tax covering local income anyways. That leaves the potential U.S. haul even smaller. I keep going back to JCT’s estimate that changing the 10.5% tax on global intangible low-taxed income to a country-by-country calculation–the crucial distinction between how GILTI works now and how it would work under Pillar Two–would raise $57 billion, and that’s including a few other changes as well. ($57 billion is remarkably similar to JCT’s $65.5 billion estimate of what Pillar Two would raise for the U.S., although I’m still wrapping my head around whether that’s a coincidence.)

$57 billion is still a lot of money, but it’s hardly enough to cover the massive tax changes being considered for the 2025 tax overhaul.

My main takeaway from this is that the amount of easily grabbable shifted income out there may be less than people are expecting–or at least more diffuse and with fewer obvious rightful destinations. More of the expected revenue gains from Pillar Two may be from local income enjoying preferential rates due to tax credits or incentives, something the local countries aren’t going to be eager to give up.

On the other hand, so many of these numbers require assumptions and ranges, it’s all arguably a bunch of guesswork. We’re probably just going to have to wait and see what the dollar figures really are–except by then, most of the key decisions will have already been made.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

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LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• Most weeks, I find documents to link to for these news items. But the biggest news of the past seven days is something that’s not there–namely, the text for the OECD’s Pillar One Amount A agreement, something the organization promised by the end of March. As of this writing on April 3, there’s still no document, and the absence certainly hasn’t gone unnoticed. Of course, self-imposed deadlines are often hard to keep. The issue is that without signs of progress, participants and observers are likelier and likelier to declare the project dead–something that’s been the assumption anyways since it became clear that the U.S. wouldn’t be able to ratify the treaty, at least without a massive change in the political dynamics. It may be time to start talking more about what happens after Pillar One is defunct, and the OECD exclusively focuses on Pillar Two. No doubt, countries will look for ways to keep elements of Pillar One alive, especially the Amount B language to simplify the transfer pricing of certain functions. But without the political buy-in, that may face an uphill climb.
• The Internal Revenue Service releases a report on advanced pricing agreements every year, outlining trends and progress. APAs are agreements between taxpayers and governments–often, between a taxpayer and two governments on both sides of a transaction–to settle on pricing for a five-year period. This protects the taxpayer against audits while governments are guaranteed a certain amount of revenue. The 2023 report shows that 156 APAs were executed in 2023–a sharp increase from 2022 and the most of any year in the past decade.
• The Australian Senate on March 27 approved legislation to tighten the country’s rules on deducting interest, bringing Australia closer to the OECD’s model as updated by its 2015 tax avoidance project. I don’t always include these legislative changes in weekly updates, but I thought this was interesting since it comes as the U.S. Congress considers loosening its thin capitalization rules, as part of the bipartisan tax agreement now before the Senate. But the two pieces of legislation don’t use exactly the same methods, so it’s not necessarily an apples-to-apples comparison. The U.S. would still be within the OECD’s ranges with the change.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Every week, a new character from the Golden Age of Superheroes who's fallen out of use.

The Green Mask, first appearing in The Green Mask #10 in 1944. Son of a famous crimefighter who uses the same name, Johnny Green transforms into a super-human when he is outraged by injustice, sometimes requiring him to yell. (Shades of The Hulk here). He's one of many characters who used the Green Mask mantle.

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