Two Important Issues that Must Be Resolved in “Global Tax Reform”

May 25, 2021

After years of debate, leaders of more than 130 countries are quickly moving to reach an agreement on some fundamental changes to cross-border tax rules, possibly by the summer. These changes would require some multinational companies to pay more taxes in countries where they make their sales and adopt a global minimum tax.

However, there are two major issues that will need to be part of the agreement that are not often in the spotlight: removal and prevention of tax measures that would be contrary to the agreement, and the tax base for the global minimum tax.

First, the global agreement should outline which current tax policy measures are contrary to the new structure and set a clear path both for removing those policies and preventing future unilateral approaches to taxing foreign businesses.

The new policy that is being negotiated would direct some multinational companies to pay taxes in countries where they have their sales. This is intended to bring peace to some recent international tax disputes. In recent years, countries have been adopting a variety of tax tools like the French digital services tax (DST) that applies to foreign companies. In fact, politicians have often commented on the DST by specifically naming certain large digital businesses.

This approach has taken the tax reform joke from former Senator Russell Long and twisted it into, “Don’t tax you, don’t tax me, tax the company from overseas.”

But taxing the company from overseas with a discriminatory policy like a DST can have consequences. The U.S. has threatened tariffs against several countries that have adopted DSTs, and a tax and trade war would be costly for the global economy.

So, part of the global deal would be for a country like the U.S. to say to France and other countries, “OK, you get to tax our companies more, but we have conditions.” As the U.S. Treasury Department outlined in a slide show in early April those conditions include limiting the application to the 100 largest companies and repealing and preventing future contrary rules.

A global agreement would not be worth the paper it is written on if it gives countries a new tool to tax foreign companies without also removing the problematic tools they are currently using. A comprehensive list of contrary policies should not only be limited to DSTs but would also include policies like equalization levies and diverted profits taxes which are also used to target foreign companies.

In a way, the goal of the negotiation is to weed the garden of international tax before planting the seeds of a new system. But because weeds can grow back, the agreement also needs to prevent new tax rules that are contrary to the new structure. (It is possible that the new structure would create problems of its own, and I have written about that elsewhere.)

Second, the global agreement must outline a consistent tax base for the global minimum tax.

Last week, the U.S. announced that it would be comfortable with a global minimum tax rate of at least 15 percent. Any good tax policy analyst would know that a rate without a base does not tell the whole story.

The goal of the global minimum tax is not just to establish a minimum statutory rate, but rather an effective tax rate that accounts for the way the tax base is designed. Two countries could both have a 15 percent statutory rate, but if one country provides more deductions or credits than the other, the effective tax rates would differ under the two systems.

The U.S. has had a sort of minimum tax on foreign earnings since the 2017 tax reform put Global Intangible Low Tax Income (GILTI) into law. The Biden administration has proposed not only increasing the minimum tax rate on GILTI (to 21 percent from 10.5 percent) but also proposed changing the tax base by eliminating some deductions.

An OECD proposal from last October had a different tax base from GILTI, though. Based on documents provided to the public last fall, policymakers were considering several features that are not present in GILTI including loss carryforwards and deductions for labor costs.

If the U.S. is suggesting a 15 percent effective rate as the minimum acceptable rate for a global agreement, then the tax bases of the various minimum taxes adopted as part of the agreement should be aligned to minimize complexities and unintended consequences.

The Biden administration has offered some proposals to change GILTI’s tax base, some of which run contrary to the OECD proposal. The proposal to eliminate a GILTI deduction for foreign assets like plants, equipment, and machinery actually runs in the opposite direction of the OECD outline. That outline provides both a deduction for a share of the value of foreign assets and payroll costs. The outline also discusses providing year-to-year adjustments like excess tax carryforwards, another element that is missing from GILTI.

It is valuable to have a standard tax base when a company is calculating whether it has paid a global minimum effective rate of 15 percent. Otherwise, a foreign company might use one calculation with different deductions, treatments of losses, or taxes paid than a U.S. company.

The tax base, like the rate, should be a minimum standard (preferably with full expensing). If the purpose of the global minimum tax is to limit the benefits of shifting profits to low-tax jurisdictions, then the tax base should reflect that goal.

However, the Biden administration’s approach is heavy-handed and would impact U.S. business decisions on overseas investment whether that investment is in a foreign manufacturing or distribution operation serving foreign markets. In short, it would penalize the global success of U.S. companies.

A global minimum tax with a broad base like the Biden administration has suggested for GILTI could deter cross-border investment and lead to negative economic consequences in countries that are home to large multinational companies. The existing evidence that we have on these consequences could get compounded by broad adoption of higher taxes on the foreign earnings of companies.

While it seems that countries may be closing in on an agreement this summer, there are still very important considerations that remain. Eliminating contrary unilateral taxes on foreign businesses and tailoring the tax base for the global minimum tax are areas where policymakers need to find agreement and recognize that the wrong choices could have serious consequences.

 

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Global Intangible Low Tax Income (GILTI) is a special way to calculate a U.S. multinational company’s foreign earnings to ensure it pays a minimum level of tax. GILTI was adopted as part of the 2017 Tax Cuts and Jobs Act (TCJA) and can lead to high tax burdens on foreign profits, putting U.S. companies that operate abroad at a disadvantage.

Tariffs are taxes imposed by one country on goods or services imported from another country. Tariffs are trade barriers that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers.

The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

Full expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs.