Bold International Tax Reforms to Counteract the OECD Global Tax

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Libertarian leaning think tank the Cato Institute published a tax policy paper with some bold claims and some bold plans for US tax reforms (https://www.cato.org/policy-analysis/bold-international-tax-reforms-counteract-oecd-global-tax). The starting point of the paper is that CIT is harmful for investment and the world economy. CIT is also portrayed as overly complex as compared to taxing all shareholders directly. (But what if the shareholders just defer income by leaving it in companies? What if the shareholders are foreign? These questions are not discussed.) In line with this, the paper concludes that tax competition – like anything else that reduces the CIT burden – is good and the problem is misunderstood and overstated.

But the author recognizes that repealing CIT altogether is not realistic. So instead, he proposes to cut CIT rates to 12% (to undercut the 15% Irish CIT rate), repeal CFC, GILTI, BEAT, restrictions on interest deduction, US taxation on citizenship, all US WHT, eligibility for foreign tax credit and threaten to leave the OECD. Bold indeed. The obvious question on what this would do to the deficit and if there’s any offsetting measures is not answered. It is unsurprising that ceteris paribus, the economy would benefit if you only take a tax burden out of the equation. But obviously, something has to give at the government side as well, whether that’s spending reduction, taxes elsewhere, quantitative easing or just letting government debt soar (all options have downsides, but I won’t dig into them here).

But the US is of course a sovereign country and if they find a way to make it work, they could go down this path. The repeal of foreign tax credits implies that US also abandons its double tax treaties (DTTs), whether through termination or through ceasing to apply them. US DTTs were always quite different from other DTTs anyway, but if they stop applying them, I suppose there’s no real need for the US to be at the table at OECD level anymore to discuss how DTT rules work.

With US no longer disregarding DTT rules, it’s not clear why the US would insist strongly (as the author suggests) that other countries can’t tax US MNEs. They are sovereign countries too. In essence, the paper moves to both reject the US adhering to international rules, but then requires the rest of the world to strictly adhere to the old version of international rules. These approaches don’t combine very well.

In some of the more bolder claims, the paper says that the OECD’s plan is to increase ETRs and distribute taxing rights away from the US. As evidence, the paper points to one CNBC article. (This fits into a theme here that the boldest claims are either not supported or point to other publications by like-minded think tanks.) The paper then moves on into a slippery slope fallacy  that accepting Pillar 1 and Pillar 2 implies the US would also encourage the OECD to harmonize individual income taxes, carbon taxes and environmental standards.

If Congress rejects the OECD, it is not clear why the OECD countries wouldn’t be able to go ahead. Although the paper doesn’t consider profit shifting as a problem, the OECD countries obviously disagree. Though the author insists on strict territoriality, that concept too requires adherence to some sort of profit allocation, including transfer pricing (TP) rules reviled here as overly complex. And there’s one view of Pillar 1 and Pillar 2 that fits into a territoriality thought too: the idea that current TP rules do not accurately capture where value is created and that Pillar 1 and Pillar 2 are attempts to (clumsily) redefine nexus and tax base. The author seems to recognize the possibility but says the rest of the OECD would ‘primarily hurt their domestic economies by increasing the cost of locating in their country’. But if Pillar 1 and Pillar 2 is the cost of participating in the economic life, such countries have already made such choice (particularly on Pillar 2).

The paper is also an entertaining read for its partisan portrayal of research on profit shifting. There’s a section on how MNEs can reduce ETRs by transferring valuable IP to companies located in the Cayman Islands which could come straight out of a TJN publication. It is comical, as it seems to ignore most TP rules including DEMPE. The paper also criticises research on profit shifting as overstating the issue and in revealing point calls it a definitional issue. I wholeheartedly agree. It is a definitional issue and much research on profit shifting sweeps this point under the carpet. But this publication does the same by sticking to an alternative definition of profit shifting and automatically considering any profits as not shifted if they are combined with real economic activity. The whole point of the discussion on profit shifting is that many of MNE profits, even those reported in supposed tax havens, are combined with real economic activity as TP rules require them to be so. However, there is a question on whether those TP rules are sufficient in today’s world.

The OECD, for better or worse, is trying to answer the question. There’s many points you can disagree with them about how they answer the question and you can just scroll through my blog to see the many intricate points being discussed. The only time the paper comes close in answering the question is the comical example on profit shifting with IP, which suggests that the author agrees that the TP rules are insufficient. The author’s solution is to withdraw from both CIT and international tax rules altogether. If only things were that simple.

Obvious disclaimers: this is not advice. These views are my own and do not necessarily represent my employer.

Bold International Tax Reforms to Counteract the OECD Global Tax | Cato Institute