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Friendly Fire in a Tax War

Posted on Aug. 15, 2019

Take it from this old-timer: There ain’t nothing like public emotion to get a tax law enacted, and there ain’t nothing like nationalistic patriotism to get public emotions ginned up. The Europeans want to tax U.S. Big Tech with an unprincipled ad hoc digital services tax. Why? Because those companies aren’t paying much tax in Europe, and they are out-competing the locals left and right.

We’ve seen this movie before. Same plot, different cast. In the early 1990s Congress was itching to tax Japanese companies doing business in the United States with an unprincipled ad hoc minimum tax. Why? Because those companies weren’t paying much tax in the United States, and they were out-competing the locals left and right.

Much to the credit of Treasury as an institution, the good people at 1500 Pennsylvania Ave. opposed the minimum tax targeted at Japanese companies back then as much as they oppose the DST now. About that old proposal — which was championed by the House Ways and Means Committee chair, Democrat Dan Rostenkowski, and senior Republican Bill Gradison — the words of Assistant Treasury Secretary Fred T. Goldberg in 1992 could be used verbatim by Treasury officials now for their case against the DST:

MR. PICKLE [Democrat of Texas]: Now with respect to this particular bill, H.R. 5270, they set a minimum amount of taxable income that would be reported by a foreign corporation, roughly 75 percent. I want to ask you, do you support the minimum tax provision of this particular bill, 5270?

MR. GOLDBERG: No sir, we oppose that provision.

MR. PICKLE: And why?

MR. GOLDBERG: We believe that it violates the anti-discrimination provisions in our existing treaties. We believe that it results in the taxation of something other than taxable income. We believe that it violates the international norms regarding the arms-length standard, and we believe it is a fatally flawed provision.

Right now, with the DST, we have a bit of an international tax war simmering.  But on plain old international corporate income taxation, you might not notice that promoting national interests is not always a top priority. In fact, you might see the opposite. Consider the following two points.

Point 1: Probably without fully thinking things out, in the high-stakes negotiations at the OECD, the French and the Germans are advocating that nations adopt a minimum tax on foreign profits on a per-country basis. This means that if, for example, a multinational pays 6 percent tax in Singapore, which is less than the minimum tax rate of, say, 10 percent, the multinational must pay 4 percent minimum tax to its home country — no matter what.  Under an overall minimum tax — the alternative to the per-country version, favored by Treasury — the multinational can escape that 4 percent minimum tax if it invests in high-tax countries like France (which will have a 28 percent corporate tax rate in 2020). Thus, there is an incentive to invest in France under the version of the minimum tax favored by the United States that is not present in the version favored by France. Yes, that is backward of what you might expect.

Point 2: Probably without fully thinking things out, Congress in 2017 enacted a sweeping change in the U.S. tax treatment of multinational profits that, under some circumstances, actually provides an incentive for U.S. multinationals to shift profits out of the United States to a high-tax country like France. Worse still, the U.S. treasury foots the bill while the French treasury garners all the gain. Yes, a loose-tongued politician might say U.S. taxpayers are subsidizing European big government.

Oh well, it won’t be the first time that combatants have imposed self-inflicted wounds. And it won’t be the first time that tax policies have side effects that damage the very folks who advocate them.

Here’s a numerical example of point 2:

Example: A U.S multinational shifts $100 of profits from the United States to a country with a 30 percent rate. U.S. tax on U.S. income is reduced by $21. Foreign tax increases by $30. So far the U.S. multinational has lost $9 net. But that’s not the end of the story. Under the new international tax rules from the Tax Cuts and Jobs Act, the United States (in most circumstances) will impose a 10.5 percent minimum tax on foreign profits. That adds a $10.50 burden, and the U.S. multinational now is down $19.50. But also, under the TCJA, the multinational is entitled to a foreign tax credit. If that multinational has been paying low foreign tax (that is, using tax lingo, it is in an excess limit position), the FTC is equal to 80 percent of the $30 of foreign tax paid. That $24 of U.S. tax reduction because of the FTC is greater than the $19.50 imposed on the multinational up to that point. So the U.S. multinational nets $4.50 of tax reduction for shifting profits out of the United States to a country with a 30 percent rate. To add insult to injury, the foreign government gains $30 while the U.S. treasury loses $34.50. Ouch!

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