The October 4th to October 10th, 2021 trade report with L.C.
The 164 countries participating in OECD-hosted talks on global taxation have reached agreement, the Paris-based OECD announced on October 8th. The agreement sets a 15% global minimum tax (Pillar 2) and sets conditions for how large companies can be taxed for earnings in countries where they aren’t physically present (Pillar 1 – encompassing the digital services tax).
The OECD projects that governments altogether could gain new tax revenue of around $150 billion annually, while about $125 billion of current tax revenue would be allocated differently among governments.
Translation: US corporate taxes will increase and foreign countries will get more of the take and the US less.
Achieving this agreement was a priority for the Biden administration, and the US president released a statement saying, “This international agreement is proof that the rest of the world agrees that corporations can and should do more to ensure that we build back better.” Of course, most governments are happy to have external factors make it easier to raise taxes, especially since the pandemic was a blow to government revenues and channeled profits away from many domestic companies to the tech/Internet giants. Still, the few countries that use low tax rates to attract foreign investment will lose revenue, and taxes will be higher for some large companies.
Finance ministers from most of the participating countries had endorsed the outline of the agreement, which was reached in the “Inclusive Framework” talks on “Base Erosion & Profit Sharing” (BEPS) in July, but until now it wasn’t clear that the deal would be concluded in time to be endorsed by leaders at the October 30th to 31st G20 Summit in Rome. Preliminary to that, G20 finance ministers, meeting in Washington on October 13th, are expected to give their final approval. And then the deal would be signed at a convention in 2022 with implementation expected the following year.
Details yet to come
Even now, though, there remain technical details that may take months to put into final form, including model legislation, implementation plans, and the text for the multilateral treaty dealing with Pillar 1. But it will likely take even more time for many countries to implement and ratify the pact, as it will be domestically controversial for many governments – including the US.
The agreement has to be approved by each individual country, each of which has to change its domestic tax regime to conform to the minimum rate and ratify the treaty dealing with Pillar 1. The OECD is expected to draft proposed legislation for this. It also expects to hold an international convention next year to approve the treaty text. Many countries have bilateral tax agreements with trading partners, which will be disrupted by the new agreement and have to be terminated.
No enforcement mechanism for now
Should any signers violate their commitment to keep taxes at least at 15% to attract foreign investment, the deal does not appear to have an enforcement mechanism, though provisions could change before it is finalized. (Setting tax rates is a responsibility of sovereign governments so enforcement is a delicate issue.)
Four countries – Kenya, Nigeria, Pakistan and Sri Lanka – were the only holdouts. (Some developing-country activists called the agreement a “raw deal” for low-income countries.)
Ireland, which had strongly objected to a compulsory minimum tax, said last week it would join the deal, noting the minimum tax will be imposed in Ireland only on multinational giants and not domestic corporations, for which it intends to keep its current 12.5% tax. Dublin had presented certain conditions for its approval, and this week accepted the deal, with some changes including, reportedly, removing the words “at least” from a commitment to keeping corporate tax rates at “at least 15%.” That language had worried Ireland because it could leave it open that the minimum rate could be raised in the final agreement. Estonia and Hungary had also not signed on in July but did so now.
For Yellen, low taxes = “race to the bottom”
The US welcomed Ireland’s reversal, with Yellen saying, “As of this morning, virtually the entire global economy has decided to end the race to the bottom on corporate taxation.” But there are still countries that say they support the agreement but want to be able to waive the tax minimum for certain activities or disagree about the DST provisions. For the EU to sign on, there has to be a consensus of EU member countries. There is now, but it’s not certain it will hold.
For the US, the agreement would align the GILTI tax – “Global Intangible Low-Taxed Income” – more with other countries. GILTI is the US minimum tax on profits made abroad, which the administration has proposed to double to 21% while halting tax “inversions” through which a company moves headquarters to a low-tax country to escape US taxes. But it will also trigger tax increases in some states, despite this likely being unconstitutional.
DSTs exchanged for a broader tax heist
The countries that signed on to the OECD tax regime have agreed to a treaty on Pillar 1 that would let a country tax 25% of profits above a 10% profit margin earned by multinational companies with global revenue of at least about $23 billion. That is expected to encompass about 100 companies. This is supposed to be more fair to the US than digital services taxes (DSTs) — that almost exclusively hit just the giant US internet/tech companies.
One of the immediate impacts is that the threat of US retaliation for foreign imposition of digital services taxes on major US companies should be ended. Countries are now committed to dropping existing DSTs and have pledged not to implement new ones while the treaty is being brought into effect. Instead, they will tax major multinational companies’ earnings in their countries according to the agreement’s guidelines.
National tax sovereignty abandoned
The US internet companies themselves have said they recognize that their profits in other countries should be taxable but said they needed to have a common framework so they don’t have to comply with an unworkable patchwork of different and constantly changing tax demands around the world. This is despite the fact that they already manage to happily deal with just such constantly changing patchwork of state and local sales taxes in the US.
Supposedly the pandemic made taxing the Internet giants in a new way necessary because countries lost tax revenue as economies shut down while the online companies’ profits soared as people became more dependent on the Internet for work, leisure, and shopping. With their headquarters in low-tax Ireland and taxation based on where headquarters, not customers, were located, many Internet companies escaped the taxes levied in high tax France and Germany, among others. But this territorial-based form of taxation, which respected national sovereignty, could have been preserved by simply reckoning multinational companies to have virtual offices in countries where they had customers, albeit no brick-and-mortar buildings, and taxing them in a non-discriminatory fashion. The Biden-Yellen backed OECD approach nurtures a chimera, part territorial and part global, the global part of which is managed by a supranational body, the OECD, and which discriminates against large US corporations.
Force tax increases abroad to lessen damage from tax increases in the US
The Biden administration hopes to raise US corporate taxes without driving companies offshore to lower-tax domains. But if the president gets his wished-for hike in the US corporate tax from 21% to 28%, most other countries will become more attractive than the US. The OECD average rate now is about 23%. The new rules will, however, likely make it less attractive for giant companies to register their intellectual property and the profits they gain from it in low-tax foreign domains.
The real basis for the glee of the Biden administration – which officials admit – is that they feel the deal gives them the go-ahead to raise US corporate taxes, including on large US-based multinational companies, and regulates the taxes other countries can impose on those huge companies for money earned within their borders.
Will trigger state tax increases
But the administration’s OECD tax coup is going to be a lot more expensive for US corporations than the American public realizes. Corporate taxes are not ultimately paid by corporations. They are passed on to consumers and industrial purchasers as higher prices, to their employees in reduced wages and salaries, and stockholders (including employee retirement funds and charitable foundations) as reduced dividends. It will trigger unexpected additional tax increases in many states because of tax linkages to Global Intangible Low-Taxed Income (GILTI) provisions.
In any event, it is not clear that Congress will approve the Biden tax hikes – and raising US tax rates has to be done by Congress. The Democrats have put the tax increase into their reconciliation bill, the massive “human infrastructure” package funding education, welfare, and other social programs that, since done under the budget reconciliation process, can’t be filibustered. The package has no Republican support – in fact, the ranking Republicans on the House Ways & Means and Senate Finance committees criticized it this week, saying the administration “used this global forum to advance its short-sighted domestic tax agenda.” Other Republicans are already predicting the treaty won’t be ratified. Republican opposition is not sudden: they have made their opposition to what the US was doing in the BEPS talks clear for some time.
Cost considerations
Meanwhile, Democrats still disagree among themselves about its contents and funding level of their reconciliation bill, so it is not clear if and when that bill will be finalized and when it might pass Congress. Hiking the corporate tax rate is one of the provisions some Democrats want removed from the legislation. Yet with solid Republican opposition, the reconciliation bill is the only realistic way the administration can use the OECD deal to raise US taxes. According to the Tax Foundation, $3.5 — more likely $5 — trillion reconciliation bill being marked up in the House Ways and Means Committee will cost the US a 1% decline in long-term economic output, destroy 303,000 jobs, and reduce after-tax incomes for 80% of US taxpayers.
So even in the US – the strongest supporter of the global minimum tax – it is not clear if and when the administration can take advantage of the agreement to raise US rates. And regarding the Pillar 1 treaty, it would require the votes of two-thirds of the Senate – a tough pull given the Republican opposition to raising taxes, to “ceding sovereignty” in multinational agreements, and to some aspects of the DST provisions. Treasury Secretary Janet Yellen suggested this week that the US might be able to implement Pillar 1 (DST) without ratifying a treaty – so, many of these details regarding how the deal will actually be implemented remain up in the air.
L.C. reports on trade matters for business as well as Founders Broadsheet.
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