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When the U.S. on Thursday announced a détente with European countries that had slapped a levy on U.S.-based internet giants, it marked the latest piece of good news for negotiators crafting a comprehensive international agreement to tax corporate profits.
But a much bigger question still hangs over these talks: Can the U.S. deliver on its promise to join in the global deal, which is meant to come into effect in 2023?
At issue is whether President Joe Biden’s administration can sign on to the agreement — negotiated through the Organisation for Economic Cooperation and Development — with Democrats controlling only a razor-thin majority in Congress. Amid staunch Republican opposition, the political math likely means that, at best, U.S. lawmakers could approve only part of the wholesale rewrite of the world’s tax system, experts say.
U.S. Treasury Secretary Janet Yellen has said the administration will find a way over the next year to join the agreement. But the snag lies with Congress, where Democrats are scrambling to finish work and unify the party on sweeping social policy legislation that also happens to be the one and only vehicle for pushing tax changes through by year-end.
If Democrats succeed in passing that measure — a heavy lift as is, because it effectively requires party unanimity — it could include language that would align the U.S. with one of the two core elements of the OECD deal: the establishment of a global minimum corporate tax of 15 percent. But the other plank — which would tax profits of huge multinational firms, including digital giants, and then re-allocate the cash wherever they have operations globally — would likely require changes to existing tax treaties, because it rests on international cooperation.
And therein lies the rub for Democrats: Treaty changes require two-thirds approval in the 100-member U.S. Senate, including the support of 17 Republican senators. To date, Republican opposition is rock solid.
Republican Senator Patrick Toomey was blunt in a recent hearing: “I think that’s unlikely to happen.”
As some tax experts see it, as long as the world’s largest economy is at least partially committed, it won’t be a fatal blow to the global agreement overall. But under such a “half in, half out” scenario, it could mean that more and more countries jump on the digital-tax bandwagon on their own to get a swipe at those profits absent an international deal.
“If the global deal falls apart, it’s more likely that countries like India and others look at digital taxes,” said Reuven Avi-Yonah, professor at tax law at the University of Michigan. “These countries will continue to move unilaterally.”
Progress to date
For years, countries tried to find a way to tax giants like Facebook and Google, which operate in many jurisdictions where they have little or no physical presence. That’s one reason why such firms often pay hardly any tax.
Under the OECD-led process, negotiators sought to address that shortfall by finding a way for national governments to pocket some of that profit, based on a formula that distributes that cash depending on where companies operate. They also pitched a minimum corporate tax rate to stop multinational firms from exploiting tax havens to reduce their overall global bill.
These talks dragged on for years and faced political headwinds, including the position of the Donald Trump administration that any such overhaul should be merely voluntary. But the change in U.S. presidents, combined with pressure from the digital-tax boomlet in Europe, opened the door to a rough framework agreement last summer. That was followed by sign-off by G20 nations earlier this month, clinched with the support of longtime low-tax holdouts like Ireland after considerable horse-trading.
The first part of that deal, known as Pillar One, ensures that the world’s 100 biggest companies pay taxes on their global operations and sales. It uses a complex formula in which 25 percent of the profits for companies with a profit margin of at least 10 percent and annual revenues of at least $20 billion will be divided up globally. That way, governments around the world, including in developing countries, will be able to capture additional tax revenue from those firms, which include the internet giants. The OECD estimates the provision would distribute around $125 billion in corporate tax receipts among participating governments.
The second part of the deal, Pillar Two, sets an international effective minimum corporate tax rate of 15 percent for companies with annual revenues of at least €750 million. It would allow countries, collectively, to pocket an additional $150 billion in yearly tax revenue. Those changes are expected to come into force by 2023, after national governments approve the required domestic legislation.
Getting to yes in Congress
Despite progress at the global level, U.S. political divisions mean that everything hangs in the balance in the next few weeks in terms of what Washington can deliver. Democrats are throwing all their efforts into getting their massive social-spending bill — which covers everything from health care to parental leave to climate change — over the line with the barest of majorities. It will also include an array of tax hikes, including on corporations, to pay for some of these programs.
Because Republicans are uniformly opposed to that bill, Democrats in the Senate are relying on a special procedure, known as reconciliation, that lets them pass certain types of legislation in the upper chamber with just a simple majority of 50 votes, rather than the usual requirement of 60 to break a filibuster. Their challenge is getting recalcitrant moderate Senate Democrats on board while ensuring that the very narrow Democratic majority in the House of Representatives also signs on.
The other challenge for congressional Democrats and the Biden administration is that there are no other real options for advancing tax changes this year, because the reconciliation option can usually be used just once every fiscal year.
However, they do have one advantage in that the U.S. already has a provision, enacted in Trump’s 2017 tax reform, that taxes U.S.-based multinationals on their foreign income, known as Global Intangible Low-Taxed Income (GILTI). The measure is meant to broaden the net of U.S. taxation on American firms that would otherwise park their profits abroad.
In its current form, the GILTI effective rate is around 10 percent, and it allows firms to “pool” their international liability across high- and low-tax jurisdictions. To harmonize that provision with the OECD deal, then, Congress would likely have to raise the rate to the agreed global minimum rate, as well as apply it country-by-country, which economists say would bring in much more in tax receipts.
“GILTI is a weak stick but at least it’s a stick,” said Thornton Matheson, an economist and senior fellow at the Urban-Brookings Tax Policy Center in Washington, D.C. “Right now the U.S. is the only major country applying a global minimum tax. Through an expanded system like Pillar Two, you could bring in a lot more revenue.”
That change still may be a heavy lift, given that some moderate Democrats and many Republicans are concerned that changes to GILTI language could wind up topping the 15 percent global rate and make the U.S. uncompetitive compared with other countries. Some also say that the U.S. shouldn’t get ahead of other countries in adopting that tax. But at the very least, House and Senate negotiators have already written legislative language that can be used in the final iteration of the social-spending bill if they want to tap into international taxation to help pay for their domestic priorities.
Glass half full?
Should Democrats succeed in passing their domestic agenda and include sufficient changes for international taxation, the U.S. could put something on the table in the OECD talks. And Democrats may have a chance to enact tax fixes again next year, should they pursue another reconciliation package — although the 2022 congressional midterm elections may make lawmakers more skittish about any sort of bold legislation, including controversial tax hikes.
Still, the question remains how the U.S. could sign on to Pillar One without a super-majority of Democratic and Republican senators backing treaty changes. In this scenario, then, the final OECD deal may be largely centered on a global minimum tax, but lack a mechanism to tax and reallocate profits from the largest multinationals, including the digital giants.
Would that leave the likes of Facebook and Google off the hook? Not necessarily, in the eyes of some economists, who say more countries keen for the extra revenue may pass digital taxes of their own. If these levies hit large multinationals, the firms’ home countries could offer them a foreign tax credit to make up the difference — similar to what the U.S. agreed to on Thursday with European negotiators: The European digital taxes will continue until the OECD deal takes effect, and until then, Washington will let multinationals write off those payments to the U.S. Treasury.
At a broader level, however, the U.S. strongly opposes other countries going their own way on digital taxes as long as the OECD deal is being worked out.
In terms of getting to a global deal, the U.S. is “indispensable because so many large multinationals are based there,” says Dhammika Dharmapala, an economist and professor at the University of Chicago Law School. “But absent a deal, if other governments feel they need to find another way to tax digital giants, they can address that through their own digital taxes.”
Despite their unpopularity in Silicon Valley, he added, those kinds of levies are attractive to some governments in that they tax gross receipts — in the countries where consumers actually live — rather than profits, which can be shifted.
“If there’s a political push for taxing digital firms, these [levies] are a more direct and targeted solution, and if their rate is not too high, they may not be too disruptive,” he added. “In that sense, digital taxes are perhaps not as bad as some have suggested.”
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