Allison Christians, the H. Heward Stikeman Chair in Tax Law at McGill University, tells Tax Notes contributing editor Robert Goulder about her proposal for a global excess profits tax as the third pillar in the OECD’s digital economy project.
The interview has been edited for length and clarity.
Robert Goulder: Hello, Allison. Thank you for joining us.
Allison Christians: It's great to be here, Bob.
Robert Goulder: I wanted to congratulate you on your recent article that ran earlier this month. It's getting a lot of attention and the timing just couldn't be better.
Allison Christians: We do think that a lot of governments are going to be looking for some money wherever they can find it, so this is the time to be talking about innovative or different ways of taxing.
Robert Goulder: What you propose in the article is certainly innovative. I have to confess that when I first saw that headline, I did a double take. Like everyone else in the international tax community, I've been obsessing over the work of the OECD inclusive framework and trying to figure out how exactly would pillar 1 and pillar 2 work if these were broadly adopted.
Then I saw your headline and you mentioned pillar 3. My first thought was, "Oh no, I missed something. I'm going to have to go back and start reading hundreds of pages from the OECD because I totally glazed over pillar 3." But this is your own idea. This is, let's call it, a stabilizing supplement to what the OECD is proposing, correct?
Allison Christians: That's right. Like you, I've been busy trying to keep up with the OECD work on the digitalization of the economy and the two pillars. I've been a frequent critic of what's been going on in that project. Right now it's all hands on deck. You have to work with the infrastructure that you have, not the one you want.
We have two pillars. They do different things, but for the last year I've been studying how they interact or if they interact. The idea of the third pillar came to me because I was using elements from both of those two pillars, and it made a lot of sense to make it a stabilizing third pillar. You can't sit on a stool with two legs.
Robert Goulder: There's also a global public health crisis going on: the COVID-19 pandemic. That actually features indirectly to what you're proposing because in the third pillar you're talking about a global excess profits tax. That's a quirky tax to be talking about.
It's a bit of a relic from a bygone era, yet it seems very timely and specifically well tailored to exactly what's going on in the world today. It's a blending of things that are very old and very new.
Let's back up a little bit before we get into the granular aspects of your article. When I first explain an excess profits tax to somebody, their immediate reaction is that it somehow feels redundant or duplicative because unless you're a tax haven, almost all countries already have a corporate income tax.
If you already are extracting a tax on capital returns at the entity level via the corporate income tax, why then would you need this extra thing that kind of feels like a surtax tax?
Allison Christians: That's right. We're going to see a lot of corporations not having to pay a corporate tax in the coming year because they're not going to be profitable. A lot of firms are going to be in a situation where the corporate tax is not doing much of anything except carrying losses forward for a while.
But then again, there are going to be instances where the economy is really broken, but it is going to work to the financial advantage of some firms. That's really what the excess profits tax is trying to get at.
I actually really like the OECD's term for this. They talked about super profits, and I actually liked that a lot better. Super profits tax, or SPT, isn't a great acronymn. An excess profit tax, or a global excess profits tax, gets us GEP tax.
The idea is that the economy is broken in a fundamental way. Everything is turned upside down. Who stands to make a profit in this economy is not from their own innovative creative business advantage, but rather just this market brokenness.
An excess profit tax sounds old. It sounds like something you could throw about a hundred years ago in the mix of a world war, but actually I think it's of a piece of an idea that some firms benefit from market conditions that have nothing to do with their business decisions. You can liken it by a different name.
A resource rent tax is sort of the same idea. In the good years of when the market inexplicably kind of explodes, there's the resource rent tax. In many years it doesn't get used at all, and in some years it will get used.
But I would even connect it then to pillar 1. Pillar 1 talks about routine and residual profits. What is a residual profit? The idea is that it's the value added by the particular business acumen of the firm. Some part of those residual profits we're looking at for a redistribution through the OECD digitalization project.
Why are we doing that? One explanation is because old nexus rules don't work. We have to give a new nexus. Another reason we're doing that is because we understand that we don't have a word for the value that's being created in countries that are contributing to this innovative digitalization industry. We don't have a word for that. We don't have a way to tax that.
When you talk about residual profits start carving out a slice of that, you're thinking, "OK, this piece of the residual profit, the one that we're going to redistribute, is somehow in the wrong place. The value isn't correctly articulated."
I think an excess profits tax is doing a very similar thing. It's of a piece to those other ideas. Intellectually, I know it's a little bit much, but what is really the difference between an excess profit, a super profit, a monopoly rent, a resource rent, and then this little piece of the residual profit in a digital firm that is not created by the firm itself, but is created by the market that creates the conditions for that firm to thrive?
Robert Goulder: Does the tax have almost a quasi-punitive nature to it? It doesn't tax a company that was smart or efficient. It sounds like you're trying to develop a tax that is targeting companies that were just too lucky at the wrong time.
Allison Christians: I don't think we should attach anything pejorative to it. I think it's more a reflection on the market than the firm. When the market is broken and a monopoly exists, that's not the firm's fault.
Every firm would like to be a monopoly. That's the nature of the business. Of course I want to be the only "me" there is. I don't want any competition because I'm great the way I am. I want everybody to buy my products. That's the natural inclination of the firm.
But in the perfect market there would be no monopoly, and there would be no excess profit. It's the failure of the market that makes us say, "OK, we need to fix it." There I think we can liken it to other taxes that are thinking about failures such as, for example, the failure to internalize certain externalized costs.
I'm talking about a carbon tax. There's not an economist in the world that won't say that you need a carbon tax. Not because people are doing a bad thing, but because externalizing the consequences of carbon on society while internalizing the province is an economic error. We need to fix that error.
It's not the firm isn't doing something bad by not internalizing those costs. They're just following the logic of what the market has valued. The market has not put a price on that externalized future costs of carbon. It's the same idea. You could think of it as punishment, but to the extent it's punishment, it's a punishment of our collective inability to sustain a functioning market. It's not a punishment of a firm at all.
Robert Goulder: I wanted to ask you about the temporary nature of these taxes. As we've mentioned before, we've seen them about a hundred years ago. The United States had one during World War I and World War II. If I'm correct, these taxes fell out of favor very shortly after the war was ended. What you've just described makes all the sense in the world. It seems like a great tax. Why is it that they sort of recede from public view once the crisis is over?
Allison Christians: We really would need a historian to really give us the big picture on this. But I would say there's a couple of ideas here. Name the tax that Americans like. I'll wait.
You can't. Any tax that you can get rid of will be gotten rid of.
The income tax was supposed to be a temporary measure at one point. Let's not forget that those were war taxes as well. But the income tax survived, as did the payroll tax, which was created later, also survived.
Why did those survive? Historians will give us different ideas, but it's clear the idea was you peg it to the benefit, and then people will never be able to destroy that tax. With the income tax, it's the idea that if you don't have income, you don't pay it.
That's the ability to pay notion. It's such an emotionally satisfying explanation for how a tax should work. Those with abilities should pay; those with great abilities should pay more.
An excess profits tax by its name starts thinking, "OK, when the market is fixed or we go back to normal, whatever that looks like, we don't need this because now the market isn't broken anymore. It's functioning."
These are the stories we tell ourselves. We're obviously wrong about that all the time, right? We were wrong about the market being perfectly competitive in 2008. It crashed. We were wrong in the 1970s, and we were wrong in 1929. We've been wrong many times.
A normal amount of market failure we tolerate with a combination of regulation and taxation. But when the whole thing goes completely wrong, and we can all look around objectively and say, "This has really broken," that we can see the need to understand that these things have long-term consequences.
We can't just sit by, and we can't regulate them away. We've got to figure out how to incorporate that into a tax system.
Robert Goulder: Let's say I'm a multinational corporation, and I'm trying to figure out if I would be subject to a excess profits tax. Computationally, what's going on? What does the tax base look like? How do you differentiate between a super profit and an ordinary profit? Because the latter would presumably be exempt.
Allison Christians: Exactly. This is where the OECD's pillar 1 starts to come in handy. Those of us who studied pillar 1 have been saying for quite a long time, "How are you going to draw the line between routine and non-routine profit?"
It might be a little controversial to say that economists cannot draw that line. We all know that economists cannot draw that line. It defies the drawing. I've said it before, I've said it in different places, but you just simply can't take the dollar and refragment it. You can't take something that's the product of multiple inputs, and then fragment it out and say what it belongs to. It's really hard to draw that line.
That tells us that we're going to draw a political line. We're going to make a compromise. We're going to say we'll use some economic studies and estimates to try to figure out what's normal.
In an excess profits tax, we're going to call that the normal routine. In pillar 1, we're going to call that the routine profits. We have normal and routine as cognates in this world. Then in the OECD framework, in the digitalization project framework, we have this excess, which is called non-routine or residual.
That doesn't mean that the market's broken in the OECD model. Although one might say some part of it does mean the market is broken. We need to fix where value is being allocated under that model. We're trying to figure out, "OK, what's the construction of this base?"
There's a political decision that is going to be made between routine and non-routine. We can see it in the OECD's calculation where they suggest what percentages it might be. Tax Notes reported on a report by KPMG that looks like a transfer practicing study, which they call an economic study.
They examined the returns to firms. They came up with some different scenarios and numbers and gave us what they considered to be routine and non-routine. You go a little further and you see some researchers have also looked at this, and they've proposed some numbers.
In the column that my co-author and I wrote for Tax Notes, we took one of those studies that showed the routine looks like 8 percent on average. The non-routine looks like 14 percent, so together that's 22 percent. We say, "OK, very conservatively, let's assume that 14 percent non-routine or residual profit is not the result of market failure."
I don't actually think that's correct. I think some of it is the result of market failure, but we'll be conservative. We'll assume none of it is. We'll just take that 22 percent and say that's the political compromise that we've come up with so far as to what is sort of a normal average. If you are well above 22 percent, then that starts to look like excess.
That's just a place to start. But we understand it's a political compromise. It's a political statement, not an economic one.
Robert Goulder: These rates that you're mentioning, they would be uniform across the economy? You wouldn't have one set of rates for say the pharmaceutical industry and one for the automotive sector, right?
Allison Christians: I'm not in charge of the universe, so if you ask me, I will say I look at that KPMG study and they say it's cross sector, cross industry, and cross country. But they do break it down, and you can see some variations. I wouldn't mind if the policymakers of the world decided we do need to break that down into industry. I don't have a problem with that.
I think the key here is that you need to know which industry you're in. For some firms, it's not so clear. Are they in communication? Are they in delivery? Which industry is Amazon in? Is it delivering services to people? Or is it delivering stuff to people? Google's doing a lot of different things, too.
I could see there being a discussion about that. In the interest of not having time to get everybody on board, you could just go with that KPMG study and others in the OECD's own estimates to kind of hover around a solid number across the board.
Robert Goulder: You say in your paper that it would be problematic if this was done at the national level. There are these imperfections with taxing capital income at the national level. If you try to do this with an excess profits tax, all the old defects of the corporate tax would be baked into an excess profits tax.
Since you can't do it or you shouldn't do it at a national level, it has to be done at a global level. Harmonized, coordinated, and internationally. Thus pillar 3. You need a project like the OECD's inclusive framework to be the springboard for something like this.
Can you explain a little bit more about why this would not really be ideal as a unilateral level? Say France adopted one like they adopted a digital service tax, and everyone's saying, "Well, we're not sure how well that's going to work." Why can't a country just do an excess profits tax as a one-off?
Allison Christians: I think some countries could certainly do an excess profits tax as a one-off. I think the U.S. probably can do it. But why? It's because the U.S.'s ability to collect tax information on its firms is extremely sophisticated. That's not the case for other countries.
I'm going to reach out of the digitalization project for a minute and say there's a tool out there that the OECD helped bring into existence, which is country-by-country reporting. This tool erases intercompany information asymmetries a lot of countries have with firms. It also makes firms more coherent and consistent in their reporting up the chain. Just using that resource, using that tool, it's there. The OECD is collecting information on firms on a global basis, so basically global consolidated tax information.
That's going to be far more useful to understand whether there's a real profit. If you don't have that country-by-country report, you're just looking at your local firm as a subsidiary, the story they're telling you, and that bakes in all of the problems that we have with information asymmetry and transfer pricing and all that stuff. But if you can use those resources that are at the international level already. If you can use the closest thing we've got to global consolidated reporting, then it's going to give you a more accurate picture of which firms are actually in this position where they in fact do have a supernormal profit now.
You could also use that information not just to pick a percentage as I've suggested, but do the other kind of excess profits tax base, which is look at over the years. You could isolate which firms now have profits well in excess of what they had before. You could do a different kind of a system with country-by-country reporting, then you can do local reporting for a lot of countries. Not all, but for many.
Robert Goulder: Now we've identified what is an excess profits. We have figured out the base and how we're going to tax it. Who gets to collect the money? How do you apportion this amount of money that's being taxed?
One of the whole purposes of the Base Erosion Profit Shifting (BEPS) project was to respond to the interests of sourced countries. Now we're calling them market jurisdictions. They're maybe not exactly the same thing, but we'll just use them interchangeably for this exercise. They felt very hard done by the old existing rules for permanent establishment, arm's-length transfer pricing. One of the whole points of BEPS is to do something so that those countries have a more robust juridical taxing rights. How do you deal with apportionment?
Allison Christians: I think this is maybe the most difficult, and also possibly most interesting, aspect of a GEP tax really. If it's a transition tax, a temporary tax, then it's a tax with a purpose. The purpose is to respond to a market that's broken. Why is the market broken? It's broken because the world is facing an unprecedented health crisis.
In some countries, they don't need a GEP tax to deal with the problem because they'll deal with it in whichever way they have because they have resources. Other countries are already overwhelmed by the financial needs to respond to COVID-19.
I think it will be controversial to say this, but it shouldn't be to say that obviously the inclusive framework was set up. It doesn't have much of a mandate other than to wait for the OECD, the secretariat, to give it the proposal and then decide whether there's consensus or not.
But instead the inclusive framework could give this as a mandate to the OECD secretariat and say many of the members of the inclusive framework are in a situation where they are overrun with budgetary problems.
A GEP tax is, if not a solution, at least a nod in the direction that the problem is universal and so should the solution. The inclusive framework is, if nothing else, positioned with an ear at the OECD, and it should have a mouth at the OECD as well. I think this is where the political decision about how you collect that tax and how you distribute it comes in.
Here we'll finally pull in pillar 2. Pillar 2 envisions that there's an idea that if one country doesn't use its taxing power that another country has the backup source jurisdiction or residence jurisdiction can do backup taxation.
I think this is the idea that should carry through to the GEP tax. That is you would think if you're using CbC reporting, then the GEP tax is probably being collected at the level of the parent. But if the parent country doesn't want to tax, it should drop down the chain. That's how pillar 2 kind of envisions the world.
We'll use that idea first. But the distribution then has to be mandated by the inclusive framework and should be mandated as a global solution for the pandemic.
Robert Goulder: How do you feel about earmarking the proceeds of an excess profits tax? In doing some research for this interview, I stumbled upon this piece where a writer was arguing to have an excess profits tax in the U.S., specifically to bail out the postal service, which is interesting because that sort of invokes issues related to Amazon and so forth. Who should be paying for this door-to-door delivery of things. But we won't get into all of that. How do you feel generally about earmarking receipts?
Allison Christians: We know that earmarking can be a powerful emotional tool or instinctive tool to help explain what it is that we're doing with a tax. But I think here, my sympathies lie with the postal service. I understand it is much beleaguered at this moment. I get it. But my sympathies lie, I think far deeper with the mass migration event in India that resulted after people fled the cities once it was locked down, and they had no jobs, no money, no resources, and no bus service to go home. My sympathies lie with the places in the world where people are in crisis right now.
Earmarking to crisis is hard. I get it. Not everybody can turn their sympathies to internal migrant workers in a foreign land. Especially now that we seem even more distant, perhaps, without travel.
I understand that. I think earmarking is one of those things that again, it's the global decision making process that has to go into that. Would I personally support it? Yes. If the inclusive framework members decided that the GEP tax money should be 100 percent used to purchase personal protective equipment (PPE) and distribute it to those on the front lines in the neediest countries, I would not be adverse to that.
Does that make economic sense? Do you raise a GEP tax, which is supposed to be market fixing, for the purpose of the health needs of the poorest countries? I don't know if there's an economic argument there.
I think there's a real need-based argument there, and a normative based argument there that a lot of people will simply not accept. But I think until we get the pandemic in control everywhere, we will have it in control nowhere.
The pandemic is why I'm proposing the GEP tax with my co-author. The pandemic is the reason that countries are in really bad shape right now, ever more than they have been before. Earmarking to resolve that problem doesn't maybe make economic sense, but it makes policy sense.
Robert Goulder: Allison, I want to thank you for writing this article and for publishing it with us. Our Tax Notes readers have really enjoyed it. I look forward to talking again soon when you come back with the global excess profits tax part two.
Allison Christians: I look forward to it as well. Thanks so much, Bob.