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Pillar 3 for the OECD: A Global Excess Profits Tax

David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: pillar 3? The OECD inclusive framework has been working on updates on how to tax an increasingly digitalized economy. The proposed approach uses two pillars, but could there, or should there, be a third? Joining us from his home in Virginia to talk about a new proposal making its way through the tax community is Tax Notes contributing editor Robert Goulder. Bob, welcome back to the podcast.

Robert Goulder: Thank you, Dave. It's good to be back.

David Stewart: Now, here at Tax Notes we've been following the OECD's two-pillar approach for a number of months now, but this is the first time I'm hearing of a pillar 3. Can you tell me where this came from?

Robert Goulder: Yes. Well, first I have to say, don't worry, you're not alone. Absolutely nobody had heard of pillar 3 until they picked up a copy of Tax Notes earlier this month, least of all our friends over at the OECD. This is a completely new wrinkle on what the inclusive framework is hoping to achieve. And the concept originates from Professor Allison Christians with McGill University in Montreal. And our readers will recall that Allison is a regular contributor to Tax Notes. In fact, she has a regular column that's very popular called "The Big Picture."

David Stewart: What is Professor Christians proposing?

Robert Goulder: Basically she is calling for an excess profits tax that would function as a type of corporate surtax, meaning it's applied on top of the existing corporate income tax, not in lieu of. And the key points that she wants to make in our interview is that first of all, we have seen excess profits taxes before. They're not new or experimental. In fact, looking back over the last hundred years, they've been used sparingly, often during national emergencies. The U.S. actually had an excess profits tax during both World War I and World War II. History suggests that the popular support for these taxes tends to evaporate once the war or the crisis of the moment has passed. Well, yeah, so what? Here we are in the spring of 2020, and while the nation is not technically at war, we certainly have a full-blown national emergency on our hands in the form of the COVID-19 pandemic. And conveniently the fundamental nature of an excess profits tax just happens to fit our current predicament rather nicely.

David Stewart: All right, let's go to that interview.

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: Well, we do think that a lot of governments are going to be looking for some money wherever they can find it, so I guess 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. And I have to confess that when I first saw that headline, I did a double take. Because like everyone else in the international tax community, for the last year or so, 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 and establishing new international consensus for how we're going to tax corporate profits.

And then I see your headline and you mention pillar 3. And my first thought was, "Oh no, I missed something. I'm going to have to go back and start reading hundreds of pages of materials 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: Yeah, that's right. So like you, I've been busy really trying hard to keep up with the OECD work on the digitalization of the economy and the two pillars. And as you probably know, I've been a frequent critic of what's been going on in that project. But right now it's kind of all hands on deck, and you have to work with the infrastructure that you have, not the one you want.

And so we have two pillars. They do different things, but I've been sort of studying for the last year how they interact, or if they interact. And I think the idea of the third pillar came to me because I was using elements from both of those two pillars, and it just made a lot of sense to make it a stabilizing third pillar. You can't sit on a stool with two legs.

Robert Goulder: And, of course, there's also a global public health crisis going on: the COVID-19 pandemic. And that actually features indirectly to what you're proposing because you're talking about, in the third pillar, 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. So it's sort of a blending of things that are very old and very new.

So let's back up a little bit before we get into the granular aspects of your article. An excess profits tax. When I first explain it to somebody, their immediate reaction is that it somehow feels redundant or duplicative because unless you're a tax haven, almost all countries, right, already have a corporate income tax. So 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 really? But they're not duplicative, are they? And they're not redundant.

Allison Christians: That's right. I think, well, we for sure, we're going to see a lot of corporations are not going to have to pay a corporate tax in the coming year because they're not going to be profitable. And I think 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's going to be some firms that are in a moment where the economy is really broken, but it is going to work to the financial advantage of some firms. And that's really what the excess profits tax is trying to get at. I actually really like the OECD's term for this when they were discussing this. They talked about super profits, and I actually liked that a lot better. It's not a great acronym, right? Like a super profits tax is a SPT, whereas an excess profit tax, or a global excess profits tax, gets us GEP tax.

But the idea is just the economy is broken in a fundamental way. Everything is turned upside down. Who stands to make a profit in this economy is the function of the brokenness of the market and not from their own advantage, their own innovative creative business advantage, but rather just this market brokenness. So I would just say 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 with kind of idea that some firms benefit from market conditions that have nothing to do with their business decisions. And so you can liken it by a different name. You know, a resource rent tax is sort of the same idea. You know, 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. You know, what is a residual profit? Well it's the idea is it's something that is the value added by the particular business acumen of the firm. And some part of those residual profits we're looking at for a redistribution through the OECD digitalization project. Why are we doing that? Well, one explanation is oh, well, because old nexus rules don't work and we have to give a new nexus. But 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. So we don't have a way to tax that.

And so when you talk about residual profits and then you 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 it's in the wrong place. The value isn't correctly articulated." And I think an excess profits tax is doing a very similar thing. It's of a piece to those other ideas. And 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: So, 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: Yeah. I don't think we should attach anything pejorative to it. I think it's more a reflection on the market than the firm. So 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. I mean, 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. And I want everybody to buy my products, right? So that's the natural inclination of the firm. But in the perfectly 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." And so 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.

So there I'm talking about a carbon tax. Like 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, we're doing a bad thing maybe, but it's because externalizing the consequences of carbon on society while internalizing the province, it's just an economic error. We need to just fix that error.

And 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. And the market has not put a price on that externalized future costs of carbon. So it's the same idea. So 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. And 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 the war years -- World War 1, World War 2 -- and if I'm correct, these taxes fell out of favor very shortly after the war was ended. Why is it-- because 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. One is name the tax that Americans like, I'll wait. Right? You can't. So any tax that you can get rid of will be got rid of. And then if you think about the taxes that survived their temporary nature, because income tax was also supposed to be a temporary measure at one point. So, let's not forget that those were war taxes as well. But the income tax survived and the payroll tax, which was created later, also survived. And why did those survive? Well, historians will give us different ideas, but certainly with the Social Security, it's clear the idea was you peg it to the benefit, and then people will never be able to destroy that tax, right? And with the income tax, it's the idea that, well if you don't have income, you don't pay it.

And so 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. And an excess profits tax by its name starts thinking, "OK, well when the market is fixed or we go back to normal, whatever that looks like, well we don't need this because now the market isn't broken anymore. It's functioning."

Now, these are the stories we tell ourselves. I mean we're obviously wrong about that all the time, right? Like we were wrong about the market being perfectly competitive in 2008. We were really, really wrong about that, and it crashed. And we were wrong in the '70s, and we were wrong in 1929, and so we've been wrong many times.

But there's this idea of there's something like a amount of wrongness, a normal amount of sort of market failure that we tolerate with sort of a combination of regulation and taxation. But when the whole thing goes completely wrong, and we can all look around objectively and say like, "This has really broken," that we can see the need to understand that these things have long-term consequences and 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: Well, all right. 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? I mean, how do you differentiate between a super profit and an ordinary profit? Because the latter would presumably be exempt.

Allison Christians: Yeah, exactly. So this is where the OECD's pillar 1 starts to come in handy having studied that. Right? So those of us who studied pillar 1 have been saying for quite a long time, "Well, how are you going to draw the line between routine and non-routine profit?" And 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. So it's really hard to draw that line. And that tells us that we're going to draw a political line. We're going to make a compromise, and we're going to say we're going to use some economic studies and we're going to use some estimates to try to figure out what's normal.

And in an excess profits tax, we're going to call that the normal routine. And in pillar 1, we're going to call that the routine profits. So we have normal and routine kind of as cognates in this world. And then in the OECD framework, in the digitalization project framework, we have this excess, which is called non-routine or residual. And 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. So when 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. And then Tax Notes reported on a report by KPMG that looks like a transfer practicing study really, which they call an economic study, where they examine the returns to firms. And they come up with some different scenarios, and they come up with some numbers and give us what they consider to be routine and non-routine. And then you go a little further and you see some researchers have also looked at this and they've proposed some numbers.

So in the column that my co-author and I wrote for Tax Notes, we took one of those studies and they showed that the routine looks like 8 percent on average. The non-routine looks like 14 percent, so together that's 22 percent. So we just say, "OK, very conservatively, let's assume that 14 percent non-routine or residual profit, we'll assume none of that is 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 we'll say that's the political compromise that we've come up with so far as to what is sort of a normal average. So if you are well above 22 percent, then that starts to look like excess.

Why not? 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: And 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: Well, fortunately 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, cross country. But they do break it down, and you can see some variations. So I wouldn't mind if the policymakers of the world decided we do need to break that down into industry. I mean that's fine. I don't have a problem with that.

I think the key here is that you need to know which industry you're in. And so for some firms, well which industry are they in? Are they in communication? Are they in delivery? Like Amazon, to which industry is it in? Is it delivering services to people? Is it delivering stuff to people? Is it doing something else entirely? Google's doing a lot of different things, right? So I could see there being a discussion about that. And in the interest of not having time to get everybody on board, you could just go with that KPMG slash other research studies in the OECD's own estimates to kind of hover around a solid number across the board.

Robert Goulder: So you say in your paper that it would be problematic if this was done at the national level. That there are these imperfections with taxing capital income at the national level. And 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. And since you can't do it then 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. And you need a project like the OECD's inclusive framework to sort of 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: Oh, 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. ability to collect tax information on its firms is extremely sophisticated. And that's not the case for other countries.

And so I'm going to reach out of the digitalization project for a minute and say, look, there's a tool out there that the OECD helped bring into existence, which is country-by-country reporting, and this tool erases intercompany information asymmetries, right? So it erases some of the information asymmetries a lot of countries have with firms. And it also makes firms more coherent, consistent in their reporting up the chain. So 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, not maybe for the U.S. but for other countries. If you don't have that country-by-country report, and you're just looking at your local firm as a subsidiary, the story they're telling you, and then 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.

And you could also use that information not just to pick a percentage as I've suggested, but you could also do the other kind of excess profits tax base, which is look at over the years. And you could isolate which firms now have profits well in excess of what they had before. So you could do a different kind of a system with a CBCR, country-by-country reporting, then you can do local reporting for a lot of countries. Not all, but for many.

Robert Goulder: OK, Alison, 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? How do you apportion it?

Because one of the whole purposes of the BEPS project was to respond to the interests of sourced countries. And 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: Yeah, I think it's a great question. And I think really here is maybe the most difficult, and also possibly most interesting, aspect of a GEP tax really. And that is if it's a transition tax, a temporary tax, then it's a tax with a purpose. So the purpose is to respond to a market that's broken. And why is the market broken? Well, it's broken because the world is facing an unprecedented health crisis.

And in some countries, let's face it, 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.

So I think, I think it will be controversial to say this, but it shouldn't be controversial to say that obviously the inclusive framework was set up. And 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, many of the members of the inclusive framework are in a situation where they are overrun with budgetary problems. It was existing debt, and new spending problems, and a GEP tax is, if not a solution, it's at least a nod in the direction that the problem is universal and so should the solution be. And so the inclusive framework is, if nothing else, is positioned with an ear at the OECD, and it should have a mouth at the OECD as well. And I think this is where the political decision about how you collect that tax and how you distribute it comes in.

I just want to add one little technical point to that. Here we'll finally pull in pillar 2. So 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.

And 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. And so we'll use that idea first. But the distribution then, I think, 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. And 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: Well, I mentioned Social Security before, so 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. You know, my sympathies lie with the places in the world where people are in crisis right now. And I think 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, right?

And I understand that. So 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? Yeah. If the inclusive framework members decided that the GEP tax money should be 100 percent used to purchase 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? Like, do you raise a GEP tax, which is supposed to be market fixing? Do you raise it 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.

So I think that's earmarking to the pandemic. The pandemic is why I'm proposing the GEP tax with my co-author. And the pandemic is the reason that countries are in really bad shape right now, ever more than they have been before. So earmarking to resolve that problem. It 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. And 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.

David Stewart: And now, coming attractions. Each week we highlight new and thought-provoking commentary from our magazines. Joining me now from her home is Content and Acquisitions Manager Faye McCray. Faye, what will you have for us?

Faye McCray: Thank you Dave. In Tax Notes Federal, Michael Cannon explains how corporations can hold onto NOLs after ownership changes. Four practitioners from Caplin and Drysdale provide options for how U.S. shareholders can use losses incurred through controlled foreign corporations. In Tax Notes State, Martin Eisenstein, Michael Carey, and Jamie Szal discuss issues with the sales tax treatment of AI products and services. Walter Hellerstein discusses a recent court decision regarding formulary apportionment of income. In Tax Notes International, three tax professionals in Singapore examine the transition away from LIBOR and consider the issues that businesses should address with the changeover. Nicolás José Muñiz Arias discusses Latin America’s taxation of cross-border services. And on the Opinions page, Robert Goulder asks whether digital services taxes are as bad as we think. Benjamin Willis dives into the Underworld and Matrix movies to answer why tax laws are so complicated.

David Stewart: You can read all that and a lot more in the pages of Tax Notes Federal, State, and International. That's it for this week. You can follow me online at @TaxStew, that's S-T-E-W. And be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.

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