Nations have been negotiating over international tax reforms at the G-20 and Organization for Economic Cooperation and Development for nearly a half-decade. Last year, it looked like the project could be near the finish line.
Today, it’s clear it’s at a crossroads.
The first part of the agreement, Pillar One, a new income taxing system based on sales, is delayed until at least 2024. The European Parliament remains locked on Pillar Two, a new 15% global minimum tax, as Hungary refuses to rescind its veto of implementing legislation. Opposition to the agreement continues to build in the U.S., especially among Republicans who claim the Biden administration left Congress out of the loop as they conceded taxing rights to foreign tax authorities.
Failure of the project would be a black eye for the Biden administration, which touted the agreement as a historic accomplishment for fairness, as “an important step in moving the global economy forward to be more equitable for workers and middle class families in the United States and around the world.”
But arguably, the administration’s rhetoric on the proposals may be a reason why the process has–temporarily, at least–run aground.
In fact, how elected officials and much of the media talks in general about global tax reform and international tax avoidance has fundamentally distorted the debate, giving many unrealistic assumptions about what can be accomplished and how. Lofty promises of giant, accessible piles of overseas cash are hitting the hard realities of number-crunching and real policy implementation, as policymakers begin to grasp stark truths about what they’ve signed onto.
Despite all of this, the project is far from hopeless. But what ends up passing and surviving as policy may be very different from what all of its creators imagined.
One of the most controversial parts of the package is the UTPR—proposed legislation under Pillar Two which once stood for the under-taxed payment rule, but is now just the letters without the acronym. (In OECD negotiations, even the names get complicated.)
Originally pitched as an enforcement mechanism allowing countries to tax intercompany payments to low-tax jurisdictions which refuse to implement Pillar Two, it has grown into a much broader taxing paradigm. To everyone’s apparent surprise–although in retrospect it shouldn’t have been–countries which enact the UTPR will be able to tax U.S. companies on their U.S. income, should domestic tax incentives lower its domestic effective tax rate to 15%.
That’s even if Congress retains the U.S. 21% corporate tax rate or pushes it higher, and even if it changes the tax on global intangible low-taxed income to comply with the new OECD standards. (Which at this point seems unlikely.)
While Treasury claims this would be a rare concern, taxpayers worry that this dynamic could negate tax credits for worthy goals such as research and development, green energy and low-income housing. These are all credits that could push a company’s domestic effective tax rate below 15%, despite the higher overall U.S. rate. Administration officials said they’ll do everything they can to protect these Congressionally sanctioned incentives.
It’s worth asking why. The administration vowed to end the “race to the bottom,” which encourages countries to compete with lower and lower tax rates over investments and jobs. The UTPR was designed with that purpose in mind–to ensure that countries couldn’t stay in the race by neglecting to enforce or implement the new OECD rules. It’s designed broadly to hit not just fully noncooperative jurisdictions, but those which achieve low effective tax rates through incentives or exemptions.
There’s no reason why energy or technology credits should be considered special in this system–and, indeed, Treasury officials have noted that creating a list of acceptable tax policies to be exempted from the UTPR and Pillar Two would be a hopeless endeavor. It’s just that these aren’t what anyone thinks of when they think about international tax avoidance or unfair tax competition.
In effect, the U.S. wants to forge an arms truce without itself disarming.
Participants in these global negotiations have never seen quite eye-to-eye on what they’re meant to accomplish. The project began in 2017 as a response to the proliferation of digital services taxes across Europe, amid growing political pressure and public outrage over the alleged non-taxation of mostly American tech companies. Initially focused on taxing digital transactions, it grew to include Pillar Two to include tax havens more generally. Similar to U.S. GILTI, the tax targeted jurisdictions with low tax rates and little economic substance, which are often used to shield profits from valuable intangible assets like intellectual property.
To the extent any consensus is possible at the OECD, nations seemed to agree that low-taxed intangible profits were a major concern for the international tax system.
But as the project continued, officials began to use larger, more ambitious terms to describe its goals. It wasn’t just about ending pure tax havens–it became about stopping the “race to the bottom” in global tax competition, the drive for countries to lure new investments through the use of everything from low tax rates and light tax enforcement to generous tax incentives. Conceptually, this isn’t just for intangible income–it can include real tax credits that countries use to attract real, bricks-and-mortar activity to their borders.
The OECD itself acknowledged this divergence in views, while describing the proposed “substance-based carveout” for Pillar Two in a January 2020 update. The carveout, an exemption for income equal to 10% of a company’s depreciable tangible assets, is one key way the tax would narrow its focus to the intangible income used in on-paper profit-shifting. Some countries believed that such a carveout would “undermine the policy intent and effectiveness” of the policy, while others believed “such carve-outs are necessary to ensure that the focus of Pillar Two” remains on base erosion and profit-shifting issues, the OECD said.
The substance-based carveout became part of the final agreement, but the tension between these two viewpoints never left. Other aspects of Pillar Two, such as the broad UTPR rule, seem more geared toward the expansive view of the project.
The rhetoric widened much faster than political support grew. It’s a lot easier, and politically palpable, to focus on nefarious profit-shifting schemes–or tax avoidance in a particular industry–than to conduct a broad review of all the various tax policies nations use to try to keep their economies afloat. Was the world ready to agree on an acceptable range of taxation?
It’s questionable. Especially because even the U.S. doesn’t seem ready for the discussion.
Scoping the Debate
For domestic consumption, President Biden has often excoriated companies for low, or zero, effective tax rates. The stat that 55 profitable Fortune 500 companies paid zero 2020 taxes–taken from a report from the Institute on Taxation and Economic Policy–has become a dependable staple of his stump speech, as frequent as “folks” or “it’s no joke.”
He implies that it’s only through manipulative, hidden tactics that companies can achieve these low tax rates and skip out on their obligations to the public. The reality may be much more complex and resistant to black-and-white characterizations.
According to ITEP’s own report, taken from the companies’ public filings, many of these companies reduce tax payments through research and development credits, the expensing of new equipment or investments, and deductions for stock options. Whether or not these policies are wise, for the most part they’re clear preferences enacted by Congress, to achieve transparent goals. And, bafflingly, they’re often policies which the Biden administration has sought to protect. It agreed to an exemption to its own corporate minimum tax, part of the now-stalled Build Back Better legislation, for the R&D credit.
It’s as if the public declared it immoral whenever a company zeroes out its tax bill, even if it condones all of the factors that achieve that low rate as moral. If that sounds like a logical contradiction–well, look at how this policy debate is playing out.
Part of this has to do with the difficulties of defining scope in public debate. The amount of money involved in base erosion seems astronomical, and as far as most people are concerned it is. But it’s still relatively small compared to the overall economy, or the structure of the tax system.
While pinning down the exact amount of income that is shifted to havens for tax purposes is notoriously difficult, evidence suggests that the amount of obvious tax avoidance the government could easily grab back is less than the public rhetoric would suggest. The Joint Committee on Taxation estimates that the provision of the Build Back Better Act which would change GILTI into a country-by-country calculation–the primary loophole Democrats say renders it ineffective at stopping tax abuse–would raise $57 billion over 10 years. The OECD itself estimated that the total amount of new revenue that its Pillar Two would raise for all countries, excluding the U.S., is around $30 billion annually. That figure is seemingly confirmed by an early estimate from University of Oxford professor Michael Devereux, who also found that an early version of the proposal would raise $30 billion.
A billion here, a billion there, and sooner or later you’re talking about real money, as famed Sen. Everett Dirksen (probably never) said. But not nearly as much as, say, the R&D credit, which JCT says costs the U.S. $81 billion for five years. Or accelerated depreciation of new investments, which JCT scores at $183 billion for the same five-year period. Those are policies which most often result in low effective tax rates, and they dwarf any likely international tax fix.
That’s not to say that international tax avoidance isn’t a problem–for the dollars themselves or to preserve public faith in the tax system. But it’s no substitute for more fundamental questions about how the tax system should work.
There’s no R&D exemption for the OECD’s Pillar Two, despite pleading from the U.S. business community. Treasury has proposed converting R&D into a refundable tax credit, which softens the blow, tax-wise. Based on accounting principles, the OECD’s policy would count a refundable credit as an increase in a company’s income, rather than a decrease in its tax payments. John Peterson at the OECD said up-front subsidies, rather than non-refundable credits to be paired with future profits, are preferable in terms of policy and transparency.
Despite all of these problems, it would be unwise to bet against Pillar Two continuing in some form. Now that these tools are out there, it’s inevitable that at least a few countries will use them. The big question is whether enough countries will enact them to create the “critical mass” that OECD officials said would be necessary for the regime to fully take form. With Hungary currently blocking any adoption of the rules among European Union countries, and U.S. implementation apparently stalled, that’s looking shakier than it once did. But the lure for new revenue could prove to be too powerful to be stopped.
But it will not, of course, end the public debate on international tax avoidance–a debate which could continue to drift from the core realities of the tax system.
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.
OTHER NEWS OF THE WEEK
Sen. Joe Manchin, the Democrats' crucial 50th Senate vote, seemingly ruled out including international tax fixes in whatever reconciliation legislation passes through Congress, in an interview with a local West Virginia radio station. You can listen to the full interview here. Is this the final word, or will Manchin reverse himself yet again?
The Senate Finance Committee recently released a report excoriating pharmaceutical giant AbbVie's tax practices, which allegedly allow it to have a 11.2% effective global tax rate, even as most of its sales are in the U.S. The report is clearly timed to push the Dems' proposed GILTI tax changes, and it squarely blames the 2017 Tax Cuts and Jobs Act for allowing AbbVie's tax maneuvers. (Even though, most of them would have been legal under the prior regime.)
Need some light summer beach reading? The OECD released almost 100 pages of new guidance on Pillar 1 on July 11. Many tax practitioners are likely wondering if it's worth digging in, given the current CW that P1 faces long odds of ever becoming active.
PUBLIC DOMAIN SUPERHERO OF THE WEEK
Loyal followers know I'm an avid Batman and DC Comics fan--unfortunately, I can't risk posting any Batpics here that could summon Warner Brothers' legal team on this new venture. But the Internet has compiled a fascinating and massive database of superheroes who've fallen into the public domain, mostly from comics' Golden Era (the 1920s-50s), and I thought it might be fun to explore it for a weekly feature. We'll see how this goes.
The first entry--Moon Girl, created by Johnny Craig, Gardner Fox, & Sheldon Moldoff in 1947. Raised as a princess with superhuman strength in the kingdom of Samarkand on (Saturn's?) moon, she came to Earth in search of a male suitor worthy of her hand in marriage. In the meantime she fights crime while working as a schoolteacher under an assumed name.