Adam N. Michel
Last week, the Ways and Means Committee held a hearing on Pillar One of the Organisation for Economic Co‐operation and Development’s (OECD) plan to remake the global business tax system and raise taxes on American businesses in the process.
Pillar One consists of two parts, Amount A and Amount B. Amount A is a multilateral convention to redistribute about $200 billion of large multinational corporate profits to countries based on customer location, regardless of a company’s physical location. An accompanying Joint Committee on Taxation report estimates that US multinationals account for 70 percent of Amount A’s redistributed profits, resulting in annual US revenue losses between $100 million and $4.4 billion (using 2021 data). The multilateral convention is designed so that it will not take effect without US Senate ratification (requiring a two‐thirds vote).
Amount B of Pillar One is a new formulaic system for apportioning income between countries for routine marketing and wholesale distribution arrangements. The more simplified system is intended to limit aggressive and expensive transfer pricing audits by countries seeking to expand their tax base.
I review the major features of the international tax system, give background on the OECD inclusive framework process that resulted in Pillar One, and discuss reforms in my recent Cato policy analysis “Bold International Tax Reforms to Counteract the OECD Global Tax.”
Each of the witnesses and most of the committee members highlighted numerous ways that both components of Pillar One (and Pillar Two, for that matter) are fundamentally flawed. However, none of the witnesses were willing to tell the committee what they needed to hear: the Pillar One cure is worse than the digital tax disease. It’s time for the United States to abandon the OECD inclusive framework and pursue reforms prioritizing lower taxes and true international tax stability.
Are Digital Taxes Worse than Amount A?
Pillar One is intended to replace a patchwork of digital services taxes and other novel tools that many countries use to tax large US technology firms on the revenues from users in their countries. By replacing digital services taxes, Pillar One’s value is to reduce the economic costs of discriminatory unilateral taxes on digital products and return stability to the international tax system.
After more than five years of work, it is eminently clear that predictability and certainty are, at best, secondary goals in the OECD negotiations. Instead of prizing stability, Pillar One primarily aims to extract additional revenues from US businesses. France and a handful of other mostly European countries originally enacted or proposed digital services taxes as a mechanism to force action at the OECD. Their goal has always been to increase taxes on domestic US corporate profits through digital services tax or the OECD. The incentives in the Pillar One negotiations have been flawed from the start.
By capitulating to the demands of the most aggressive countries, the OECD Pillar One process encourages future agitation with unilateral taxes by countries seeking additional revenues or new forms of taxation. The inclusive framework institutionalizes destabilizing unilateral actions. Thus, Pillar One worsens international tax uncertainty by opening the door to redistributing taxing rights based on novel principles in response to bad actors.
Discriminatory taxes on digital products and services are economically costly, but US policymakers should remember that, like tariffs, the costs of digital services taxes fall primarily on consumers in other countries. If France, Canada, or any other country wants to impose new taxes on its citizens, that is its choice. Similar to the trade context, retaliatory measures—or new global tax systems—are also not a sensible solution. Poor domestic policy of other countries is not a good reason to force a novel international tax increase on a larger share of businesses, creating even more uncertainty and raising costs. Without the promise of a globally coordinated replacement, these economically costly domestic taxes are also less likely to proliferate.
Failure of Stability Agenda
The testimonies of the four witnesses made it clear that the current OECD Pillar One work product has failed at its primary goal of ensuring tax certainty in a number of fundamental ways. I’ve explained before how various arbitrary formulas and thresholds in Amount A will create instability in the final multilateral convention. The witnesses made three additional points that deserve emphasis.
Digital services taxes, not prohibited. The multilateral convention lists eight digital services taxes meant to be replaced by Pillar One and outlines other prohibited activities that resemble these taxes. However, the Amount A rules allow some countries to keep their existing digital services taxes if they decide to opt out of the multilateral convention, and according to witness Rick Minor, the multilateral convention includes “vague exceptions” that could lead to new discriminatory digital taxes in the future, a point echoed by fellow witness Daniel Bunn.
Expands double taxation. Redistribution of taxing rights based on new principles requires an offsetting reduction in the losing jurisdictions to ensure the same profits are not taxed twice. The multilateral convention does not fully make these necessary adjustments, opening American firms to new forms of double taxation. Amount A allows tax credit systems (which can be inadequate for fully adjusting tax liabilities) instead of requiring the better exemption method. These adjustments also rely on uncertain changes to domestic tax laws across almost 140 signatory countries. There are additional concerns around the treatment of withholding taxes and gaps in how the marketing and distribution safe harbor account for certain taxes paid.
Amount B falls short. If Amount B protected firms from the uncertainty of aggressive transfer pricing audits and simplified a highly complex system, it could be worthwhile. Unfortunately, Amount B will likely add uncertainty and future instability rather than fix it. The benefits of predictability are directly undermined by the new rules being entirely optional, their narrow application to marketing and distribution of tangible products, and the continued possibility of new nonquantitative, subjective methods for applying Amount B.
While each of these problems is fixable, they are the product of an OECD process held captive by countries more concerned with increasing global business taxes than ensuring international tax certainty.
Multilateralism Works When It Is a Limiting Institution
Multilateral policy coordination is worth pursuing when it is used to restrain the expansion of harmful unilateral domestic policy. This is the chief selling point of the OECD’s tax work: multilateral disarmament of aggressive, duplicative, and discriminatory tax mechanisms. Instead of pursuing this type of mutually beneficial coordination, the OECD has designed a system to replace unilateral taxes with a similar global tax system that expands state power, limits market competition, and increases the costs of cross‐border investment. By abandoning its historical framework of mutual agreement to limit costly tax and trade barriers, the OECD project to expand taxing rights and reallocate sovereign tax bases will be unable to deliver the promised stability.
Instead, the United States has the opportunity to opt out of the OECD system and redefine itself as the world’s premier business destination by focusing exclusively on increasing the attractiveness of the United States as an investment destination. Congress could lead pro‐growth global tax reform by example. It could reduce the corporate tax rate, permanently expand full expensing to attract new domestic investment, and complete the transition to a fully territorial tax system. These reforms would directly support American workers and create strong incentives for good policy in other countries.
