WHEN G20 FINANCE ministers meet on July 18th and 19th, avoiding a new trade war will be high on the agenda. Cash-strapped governments around the world are planning to whack taxes on online services. But America regards these as a grab for its companies’ profits, and is considering retaliation against ten digital-tax proposals. On July 10th it said it would respond to France’s tax by hitting French handbags, lipstick and soap with tariffs of 25%. Unless a truce is struck, the tariffs will go into effect in January.
The root cause of the dispute is a flaw in the international tax system. In order to avoid taxing businesses twice, governments typically apply the corporate tax to firms that are legally domiciled on their shores or have a local physical base, and link the amount due to the location of their assets and production. But now many companies provide online services and can shift intellectual property to low-tax regimes with the click of a button. A system intended to stop profits being taxed too much allows them to be taxed too little.
In 2017 40% of profits made by multinational firms outside their home country were shifted to tax havens, reckon Thomas Torslov, now at the Danish Ministry of Taxation, and Ludvig Wier and Gabriel Zucman of the University of California, Berkeley. That meant more than $200bn in forgone tax revenue, equivalent to 10% of global corporate-tax receipts. This is a relatively small amount: by comparison, governments worldwide have unleashed stimulus of $5.4trn in response to covid-19. But it is symbolically important and rightly irks taxpayers, who must fill the hole.
For several years now, the OECD, a club of rich countries, has convened governments in the hope of plugging the tax leaks. The idea is that the G20 meeting lays the groundwork so that the OECD’s summit, planned for October, yields results.
The talks cover two proposals, or “pillars”, in OECD-speak. The first is meant to direct more of the global-tax take towards places where the customers of digital firms live. Corporate-tax liability will depend not on whether companies are physically present in a country, but on whether they have a “sustained and significant involvement” there. Pillar two establishes a global minimum tax. The OECD reckons that the two proposals could together raise corporate-tax revenue by up to 4%.
Pillar two has the greater chance of being agreed—and would raise more revenue. The idea of a global minimum is to blunt companies’ incentives to shift profits to low-tax jurisdictions. There is still some haggling to be done. But some sort of agreement should be possible, if only because governments can go it alone. The Americans, for example, enacted a version in 2017, with a tax on global intangible low-taxed income (GILTI). Havens can offer all the perks they want, but American companies still face a rate of at least 10.5% on GILTI associated with their foreign affiliates.
That might explain why Steven Mnuchin, America’s treasury secretary, was reasonably positive about the second pillar last month. But he wants to put talks on the first on hold. In December he proposed that the new system should be optional for American firms. The suggestion, which would in effect neuter any new rules, was badly received by other countries. But as it stands, the OECD’s plan is unbalanced: it asks America to hand over the right to tax its companies to other countries, without getting much in return.
Without an agreement on pillar one that divvies up tax rights, a proliferation of digital-tax schemes seems likely. (The European Union’s resolve to implement one may have been stiffened by its loss on July 15th of a big tax case against Apple.) These taxes are a much cruder fix than a pillar-one solution. Companies could face a stack of competing tax bills. The levies also mostly apply to revenues rather than profits, and often try to exempt domestic champions. To top it all off, they are a recipe for trade conflict. ■
This article appeared in the Finance & economics section of the print edition under the headline “Digital divide”