Beware the digital tax trap

The business tax reforms embedded in the Tax Cuts and Jobs Act (TCJA) remain the crown jewel of the Trump administration’s economic policy. They are part of the reason that year-over-year macroeconomic growth has ramped up from 1.3 percent in the second quarter of 2016 to over 3 percent in early 2019, that labor productivity growth has rebounded to 2.4 percent in the first quarter of 2019 and that there is reason to expect an upshift from the previous trend growth rate of 2 percent or below.

That crown jewel will be at risk when Treasury Secretary Mnuchin attends this week’s G7 Finance Minister summit in France.

Among the key elements of the TCJA was a transformation of the corporation income tax away from a worldwide orientation and toward a system that more closely resembles taxation on a territorial system (which prevails in almost every other country); that is, American taxation of income earned in the United States with the remainder of global income taxed by the country of its source. Unlike other countries, however, the U.S.

recognized that such a system requires a mechanism to ensure that multinationals do not shift income to avoid tax; the TCJA’s concept of Global Intangible Low-Taxed Income (GILTI) fills this role.

GILTI is far from perfect (and could be made better by Treasury, but that is a tale for another day). Nevertheless, it has a key design virtue: taxes on all income outside the U.S. are aggregated to make sure that firms pay a fair minimum rate on it all. This means it protects the U.S. tax base, not that of foreign countries.

Therein lies the danger.

France’s contribution to recent tax policy is the adoption of a 3 percent tax on the revenue of large tech companies, a move that is offensive in three ways. First, it is a slap in the face to G20-directed work on taxation that concluded it was impossible to “ring-fence” the digital economy and, thus, levy a digital services specific tax. France is not alone in violating these tenets (the UK just did so as well). The second sin is that this tax is, effectively, designed to tax only American firms. Finally, the tax base is revenue rather than profit, and thus ignores where that profit is earned (and often that is in the United States).   

France’s new digital tax is unfair and provocative. President Trump has ordered an investigation into the tax, and among Secretary Mnuchin’s objectives will be to get the French to drop it in favor of a broader approach on taxation in the digital age, but one that affects all global companies (e.g., French), not just tech companies and not just American companies. This would be consistent with the so-called “Pillar 2” of the Organisation for Economic Co-operation and Development’s ongoing work. (“Pillar 1” is about rebalancing profit between different countries—incidentally, another thing to watch closely.)

It is at this juncture that the U.S. has the most to lose. France is also eager to engage in a minimum tax discussion: “We are willing, especially with Steven Mnuchin, to give new impetus during the G7 in Chantilly on the very specific topic of minimum taxation,” French Finance Minister Le Maire said in an interview last month. But France is interested in a country-by-country minimum tax that is at odds with the TCJA philosophy.

A country-specific approach requires assigning income and expense items to countries with special rules to deal with assignments of either the same item to more than one country or any item to no country. It is about protecting the tax bases of other countries, not the U.S. base. And this is a recipe for massive, unneeded complexity and a fertile ground for international disputes.

Secretary Mnuchin and his aides should oppose the country-by-country minimum tax in no uncertain terms, no matter how tempting it is to buy a little peace on digital tax and broader trade issues. It makes no sense to undercut a key policy victory by the president to buy into a future of complexity and conflict on international taxation.

Douglas Holtz-Eakin is president of the American Action Forum and former director of the Congressional Budget Office.