Will The US Find An Effective Response To OECD “Digital Tax” Effort?

The lack of a comprehensive response to the OECD’s rapid march toward a radical rethinking of the principles of corporate taxation, and even statements offering support for the initiative, suggests that the Trump administration lacks a full appreciation of the agenda of the OECD and its dominant European membership, as well as what that means for both US interests and the global economy.

Contextualising The OECD Focus On Digitalisation

While the digitalisation project seemed to emerge suddenly, along with an aggressive self-imposed timeline, it is best understood as the latest front in a decades-long war against tax competition that reflects the OECD’s evolution from an agency primarily concerned with encouraging trade and eliminating double taxation to one preoccupied with advancing the interests of rich, European welfare states.

An out-growth of the Base Erosion and Profit Shifting (BEPS) project, the OECD’s digital tax initiative has arguably surpassed the rest of BEPS in scope and significance, as it seeks nothing less than a fundamental rewrite of the principles of international taxation. No longer would physical presence serve as the foundation for tax obligations should the OECD get its way. Instead, taxing rights would be allocated by some yet-to-be-determined formula based on where customers, or end users, are located. Replacing the physical presence standard with a destination-based system would reduce the efficacy of jurisdictions providing low tax rates to attract mobile capital, resulting in higher global tax burdens.

This is what the members driving the OECD agenda have long desired. In 1998 the OECD released a report called “Harmful Tax Competition: An Emerging Global Issue.” The authors were open about their goals to eliminate tax competition because it “may hamper the application of progressive tax rates and the achievement of redistributive goals”. Essentially, tax competition thwarts the policy preferences of high-tax welfare states.

The Trump Administration Takes Notice

The OECD identified two avenues to pursue as part of the digital tax project. Both Pillar 1, which seeks to reallocate corporate profits based on sales instead of physical location, and Pillar 2, which seeks a global minimum tax rate, serve to limit the effects of tax competition. The Trump administration, however, is primarily treating the issue as a raid on American tech companies rather than a systemic attempt to alter the global tax landscape. In so far as France and others are designing their DSTs to almost exclusively hit American firms, they’re not wrong that US-based firms are being singled out. But they risk missing the big picture.

Earlier this year, as France worked toward implemented a DST, the Trump administration threatened significant retaliatory tariffs. This approach was not unreasonable as the DST is itself a form of tariff, and the US Trade Representative concluded, after an investigation. that it was discriminatory. The threats of retaliation succeeded in getting France to back off, at least until the end of the year. Treasury Secretary Steven Mnuchin even expressed support for the minimum global corporate tax rate, defying the traditional position of Republican administrations in favour of tax competition. “It’s something we absolutely support,” he said in Paris, “that there’s not a chase to the bottom on taxation.” This mirrors the language of OECD loyalists who have long complained that competition would lead to an elimination of corporate tax revenues despite all empirical evidence to the contrary.

The tech industry’s position is to oppose DSTs at the national level while pushing for an OECD agreement. As Mark Zuckerberg explained on behalf of Facebook, “We want the OECD process to succeed so that we have a stable and reliable system going forward”. This seems to be the logic that has guided the Trump administration’s response thus far. Unfortunately, the industry position is myopic and plays right into the hands of the high-tax nations.

It’s understandable that businesses seek consistency over a patchwork of changing tax systems, even at the cost of higher tax burdens. But the US is not a business and thus can afford to consider the larger picture. Simply put, acceding to the OECD process amounts to rewarding high-tax nations for using threats and coercion to hijack the global agenda.

Playing Hardball With The OECD

The OECD purports to be a consensus-based organisation. It uses this idea to deflect criticisms that come from placing onerous burdens on IFCs and low-tax jurisdictions. But it’s an illusion. Despite jumping through years of costly hoops to satisfy OECD requirements, IFCs still find themselves blacklisted by the EU and attacked by its member nations. The OECD uses peer-review to judge the degree to which IFCs comply with its regulatory and information sharing requirements, but no such process exists for high-tax nations who engage at the OECD level in bad faith by reaching agreements only to then unilaterally impose stiffer requirements.

Even the threat of such action distorts the multilateral process. High-tax European nations have hung the Sword of Damocles over the global economy in the form of threats to impose unilateral taxes on the gross receipts of international businesses. The OECD is dependent upon these threats to advance its agenda, as they drive otherwise reluctant parties to the bargaining table. To emphasise the point, Director of the OECD’s Centre for Tax Policy and Administration Pascal Saint-Amans warned, “There’s no plan B. There is a plan C – for chaos. And I believe that”. Translation: Agree to our terms, or else.

Despite benefiting from high-tax nations controlling the agenda through threats to impose confiscatory taxes, the arrangement erodes the OECD’s credibility over time. IFCs ought, by now, to see that they will not satisfy the rich welfare states until they are completely unable to compete. The US should similarly recognise that engaging in the OECD process at this point only serves to perpetuate a cycle of bad faith negotiation.

The Trump administration attempted to thread the needle with a “safe harbour” proposal that would essentially have allowed multinational corporations to choose the current rules or the new international tax system featuring apportionment and global minimum taxes. Almost needless to say, this went nowhere. Corporate avoidance of confiscatory taxes is precisely what the high-tax cabal seeks to eliminate.

There is a better approach available to the Trump administration. It should reach out and coordinate with IFCs and low-tax jurisdictions, and together they should inform the OECD that it has strayed well beyond its original mission and make clear that they refuse to agree to any attempt to move toward tax harmonisation. This will force the OECD to confront the hypocrisy of its self-proclaimed consensus model, while also effectively calling the bluff of France and other nations threatening to place tariffs on foreign digital services. Let them and their citizens bear the brunt of the economic pain they desire instead of outsourcing the dirty work to the OECD.