(Bloomberg Businessweek) — When I interviewed Kimberly Clausing in 2017, she was an economics professor at Reed College in Portland, Ore., with intriguing but seemingly unachievable ideas for how to make multinational corporations pay taxes. I wrote that her plan was worth studying “if only to see how much better things could be if politics didn’t get in the way.”
Well, look at her now. In January, just five days after starting a new job at UCLA School of Law, she was offered the position of deputy assistant Treasury secretary for tax analysis. She took a leave from UCLA a month later to make the move to Washington. Her boss, Treasury Secretary Janet Yellen, and her boss’s boss, President Joe Biden, have embraced international cooperation in fighting tax avoidance. And the long-shot agenda that Clausing and a circle of academics and activists campaigned for is suddenly looking doable. “There is a strong international consensus around addressing these problems, and our action can encourage action abroad,” she said in February in testimony to the Senate Finance Committee.
After decades of undermining one another, 139 rich and poor nations are closing in on a framework for taxing multinational corporations that would be the biggest change in the system since 1923. The goal is to create a united front to prevent corporations from playing one country off against another, recognizing that a race to the bottom in taxation has no winner, only a bunch of revenue-deprived losers.
Multinationals are worried. On April 12 the Business Roundtable, which is the voice of large U.S. corporations, released a member survey showing 76% of chief executive officers believe that one key plank of the Biden plan—doubling the rate on profits earned abroad—would do “moderately” to “very” significant harm to their competitiveness. “The proposed tax increases on job creators would slow America’s recovery and hurt workers,” Business Roundtable President and CEO Joshua Bolten, who was President George W. Bush’s chief of staff, said in a statement.
Taxation of multinationals is a brain-taxing subject, filled with reform jargon like Pillar One, BEPS, GloBE, and Gilti and minimization tactics such as “patent boxes” and “the double Irish with a Dutch sandwich.” The complexity is the outcome of a cat-and-mouse game in which regulators close loopholes and corporate tax lawyers quickly discover new ones.
The underlying problem is simple, though. Individual nations operating on their own, no matter how big and powerful, can’t easily corral corporations that operate across borders and can shift operations—or even just reported profits—to tax havens such as Bermuda and the Cayman Islands. The Organization for Economic Cooperation and Development estimates that this shell game deprives government coffers of as much as $240 billion a year. So joining forces is essential.
The Biden administration’s enthusiasm for squeezing more tax revenue out of multinationals has given fresh impetus to a yearslong project of the Paris-based OECD and the Group of 20, which includes many of the rich countries in the OECD, along with others such as Brazil, China, India, and Indonesia. Almost 100 smaller nations have been invited to participate, making it a truly global effort.
For the U.S., the top priority is plugging the tax revenue leak opened up by tax havens. For Europe, it’s taxing the U.S. tech giants, which make a lot of money in Europe but pay little tax there because they have few employees or facilities in the region. For developing countries, it’s a taxation formula that gives them a bigger share of the pie, since they’re the most dependent on corporate income taxes to fund government. For all, it’s about reversing the decades-long flow of income toward capital and away from labor.
The emerging agreement has two parts, or what the OECD calls pillars. The first would change how the right to tax corporations is allocated between countries, relying less on a company’s physical presence as the main criterion. The second pillar attempts to stop the race to the bottom in tax rates by creating a global minimum rate.
We are in what Reuven Avi-Yonah, a professor at the University of Michigan Law School, calls the fourth age of regulation of international corporate taxation. In each age, diplomats, accountants, and economists have wrestled with the same set of issues and come up with different answers.
Taxation of corporate profits began in 1909 but became significant during World War I to pay for the war. The first age of coordination began in 1918, when the U.S. adopted the foreign tax credit, and was crystallized in 1923, when the League of Nations—predecessor of the United Nations—named four economists to solve a basic problem: How to make sure corporate profits got taxed once and only once.
The panel, consisting of economists from Great Britain, Italy, the Netherlands, and the U.S., came up with two guiding principles that are still honored today. “First bite of the apple,” as it’s now known, dictated that the country where the profit was earned had the first chance to tax it. The country where it was headquartered could also tax it, but only after giving the company credit for taxes paid abroad, as the U.S. did with its foreign tax credit. The other, called the “benefits principle,” determined that the right to tax flowed from benefits conferred by the taxing government, so business income should be taxed where companies had a physical presence. Multinationals were required to use an “arm’s-length” standard in dealings with their foreign subsidiaries, setting prices for transactions equal to those that would prevail in an exchange between independent parties. The goal: to prevent the shifting of profits to affiliates in lower-tax jurisdictions by underpricing sales to them and overpricing purchases from them.
The second age began in the 1960s, when the U.S. was the world’s most powerful economy but was beginning to suffer the balance-of-payments problems that ultimately forced it off the gold standard. Multinationals were deferring taxation on foreign profits indefinitely by keeping the money (nominally) abroad, so in 1962 the Kennedy administration won passage of Subpart F of the Internal Revenue Code, which allowed the government to tax certain profits of foreign subsidiaries as if they’d been repatriated.
The race to the bottom in tax rates defined what Avi-Yonah calls the third age of tax policy, starting in the early 1980s. As rates fell overseas, President Ronald Reagan and his cabinet were motivated by a fear that U.S. multinationals would lose competitiveness if overtaxed at home. In the name of attracting foreign capital, the U.S. lightened taxation of interest income earned in the U.S. by foreigners. In the 1990s the U.S. narrowed Subpart F, making it easier for U.S. companies to defer taxes on earnings abroad.
By 1998 or so, though, it was becoming clear to government leaders that this race to the bottom benefited no one but the corporations themselves and the handful of nations that taxed them lightly in exchange for getting more of their business. The fourth age—cooperation—began haltingly and then gained impetus from the global financial crisis. In 2015 the OECD completed its first set of standards aimed at fighting erosion of the tax base and profit-shifting. Those proved insufficient, so now it’s trying again.
President Donald Trump’s Tax Cuts and Jobs Act of 2017, which landed in the midst of the OECD talks, did one good thing for international taxation. To suppress avoidance, it imposed a minimum tax on profits from intangible assets such as patents, trademarks, and copyrights that are attributed to low-tax jurisdictions. This provision is called Gilti, which stands for global intangible low-taxed income and is pronounced “guilty,” as in “caught you cheating.”
But the main thrust of the 2017 act was to lower taxes on U.S. corporations. Trump didn’t get along well with the Europeans in the OECD, fearing their real agenda was to impose taxes on the digital revenue of U.S. tech giants. In June 2019, then-Treasury Secretary Steven Mnuchin asked for the OECD’s new system to be set up as a “safe harbor” so U.S. companies could either opt into it or stay with the old system. In January 2021, Trump authorized, then suspended, 25% tariffs on $1.3 billion in French goods, including handbags and lipstick, in retaliation for a 3% tax on digital services the country imposed in 2019. Austria, Italy, Poland, Spain, Turkey, and the U.K., among others, have since introduced similar levies.
Biden is no happier than Trump about digital-services taxes on the likes of Facebook Inc. and Alphabet Inc.’s Google, but his administration isn’t just saying no. It’s proposing a formula that would apply to about 100 of the world’s biggest companies, not single out American tech. Countries would be able to tax companies in proportion to the share of profit, or perhaps revenue, they made in the country, even if the company had little or no physical presence there, according to a draft document first reported on by the Financial Times and subsequently viewed by Bloomberg News. Also, Yellen has taken back what Mnuchin said about wanting the OECD plan to be just an option for U.S. companies. Biden is proposing to roughly double the U.S. tax on foreign income of U.S. multinationals, to 21%, which is well above the 12.5% global minimum tax that was under discussion in the OECD/G-20 talks.
America’s peers in the OECD speak glowingly about the new spirit of cooperation from Washington. “Finding an agreement by summer is within reach, especially now that the United States have confirmed they are dropping the safe harbor principle,” French Finance Minister Bruno Le Maire said in February. He got even more enthusiastic after hearing Biden’s plan in April, telling reporters that “what is on the table is a real tax revolution.”
The OECD estimated last year that its two pillars, along with the U.S.’s Gilti provision, would increase taxes on multinational corporations by as much as $100 billion a year. The tax take could be larger if Biden manages to push through higher rates and other nations followed suit. Would that discourage companies from investing and hiring? No, says economist Thomas Philippon, a finance professor at New York University’s Stern School of Business, because a substantial share of those untaxed or undertaxed profits are “excess”—meaning they’re above what companies require to grow. (Excess profits, an economic concept rather than an accounting one, are generated by companies with monopolies or near-monopolies in their market sectors.)
Opposition in the months ahead will come from multinationals and tax havens, especially the seven that Clausing named in her February testimony because they have either low statutory tax rates or large loopholes: Bermuda, the Cayman Islands, Ireland, Luxembourg, the Netherlands, Singapore, and Switzerland. Compromises will have to be struck over rates and formulas, but returning to the status quo ante is no longer conceivable. Pascal Saint-Amans, director of the OECD’s Center for Tax Policy and Administration, likes to say there’s no Plan B if the project fails, but there is a Plan C: chaos.
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