TIPP Insights: Sen. Manchin saves American corporations from global tax police

(Photo by NICHOLAS KAMM/AFP via Getty Images)

By TIPPINSIGHTS EDITORIAL BOARD, TIPP Insights

Much of last week’s wrath against Joe Manchin was from the Left, which bitterly complained about how he killed the Biden administration’s effort to combat climate change by spending $555 billion that we don’t have.

But Manchin didn’t stop there. He did Americans another big favor when he walked away from tax proposals championed by Treasury Secretary Janet Yellen to create a global minimum tax of 15%. “I said we’re not going to go down that path overseas right now because the rest of the countries won’t follow, and we’ll put all of our international companies in jeopardy, which harms the American economy,” he told a West Virginia radio station on Friday. “So we took that off the table.”

The administration wants us to believe that the Global Minimum Tax would benefit America’s corporations because bureaucrats from 130 countries agreed to the idea first proposed by the OECD in 2016.

So, what brought us here?

The tax code in most countries was not written for the digital economy. A fundamental tenet of taxation has been that corporations pay taxes based on where they are headquartered. But when consumers worldwide can order products and services with a mouse click and get them delivered to their homes, would it not make better sense to tax companies on where they operate?

There is some justification for this line of thinking. For instance,  if Apple sells an iPhone online to a customer in Buenos Aires, the logistical process requires an Apple subsidiary in Argentina to store the device in a local warehouse and ship it to the customer, using local infrastructure and presumably, local employees. So, Argentina should get a piece of the tax revenue that America would get for hosting Apple’s headquarters in Cupertino.

Countries have been particularly annoyed that the big American tech companies derive so much of their revenues from their citizens but pay very little income tax [applicable Sales and Goods and Service Taxes are still levied]. An elegant solution would be for companies in those countries to innovate and launch products and services to compete with American brands. The easier solution – is just to tax the profiteers. So Yellen offered the 130 countries a deal that looked like it exclusively targeted the largest tech companies.

Under Pillar 1, global corporations with at least 20 billion euros (today, $20 billion) in revenue with at least a 10% profit margin would have to cough up taxes in each jurisdiction that they operate.

Suppose an American company has $25 billion in revenue and a profit of $3.75 billion, a margin of 15 percent. This company would fall under Pillar 1.

The 10 percent profit floor equals $375 million and would be taxed in its home country, America, as has always been the case. Suppose the top tax rate of 21% applied to this company, the IRS would collect $78.75 million.

The profits above this floor are $3.375 billion. 20% of this “excess profit” – $675 million – will become taxable in each country the company sells based on a percentage of sales. This money would have been taxed in America under existing rules, but Yellen agreed to waive those tax revenues of $141.75 million (at the 21% tax rate).

If the company generated 40% of its revenues from Argentina, a country with a top tax rate of 35%, Argentina would tax the company $94.5 million ($675 million x 40% x 35%). If the remaining 60% of the sales came from neighboring Brazil with a top tax rate of 34%, the company would have to pay $137.7 million to Brazil. The American company’s tax obligation would be significantly increased, and the IRS would be donating its legitimate tax collections to two foreign governments.

The IRS would continue to tax the corporation at the 21% U.S. tax rate for the remaining excess profit revenue not subject to international distribution.

Pillar 2 rules are more complicated. Each jurisdiction would be required to tax every entity at a minimum rate of 15%. Barbados (5.5 percent), Uzbekistan (7.5 percent), and Turkmenistan (8 percent) levy the lowest corporate rates. Fifteen jurisdictions do not impose a corporate tax but would be required to start collecting the 15% tax instantly.  The tax obligations of an American company operating in these countries would significantly go up.

Why would an American administration agree with other nations to increase American companies’ tax obligations overseas? Yellen supporters say that the so-called top-up rules and other Pillar 2 provisions would raise about $200 billion of additional tax revenues for the United States over a decade, so this is a small price to pay. Never mind that the same supporters backed Yellen when she said last year that American inflation was “transitory.”

Yellen’s concern is that many American companies engage in tax shifting. Say, a big American technology company opens up a small office in Dublin and transfers most of its intellectual property to an Irish subsidiary. When filing U.S. taxes, the company claims a considerable deductible expense for royalties paid to its Irish subsidiary, a fully legal maneuver. In doing so, it substantially lowers its net income in the U.S., paying the IRS a lower amount in taxes. The Irish subsidiary earns a significant royalty income but pays a much lower 12.5 percent tax rate on it, saving the global corporation 8.5 percent of its income in taxes.

Yellen’s ideas are to eliminate tax competition among countries altogether. She said so in April 2021, advocating for “renewed international engagement, recognizing that it is important to work with other countries to end the pressures of tax competition and corporate tax base erosion.”

If private companies had engaged in price collusion to thwart other companies, these governments would have pursued antitrust cases against them. But because governments cooperate for the so-called public good, engaging in a collusive approach regarding taxes somehow excuses them?

Indeed, in America, individual states, as the laboratories of democracy, devise tax and spending policies to differentiate themselves from other states. Some companies – not all – decide to relocate out of New York or California and move to Texas and Florida, attracted by zero corporate taxes.

The consideration of tax implications of business decisions, a pillar of corporate strategy, should not be taken away from company boardrooms and socialized across the globe to meet the whims of governments. While tax shifting issues are severe, Congress can deal with these relatively efficiently by passing amendments to the 2017 tax law. There is no need for tax collusion with countries worldwide to achieve the same goal.

We are glad Sen. Manchin pulled the plug on this terrible idea.

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