Apparently, the U.S. administration of President Donald Trump hasn’t tired of picking trade fights with allies and partners. Last month, the United States announced that it was withdrawing from international talks on tax reform — negotiations driven by the rise of electronic commerce — and threatened to retaliate against countries that adopted new taxes without its participation in the discussions.
The U.S. position reflects a pro-business outlook that is hostile to all new taxes, coupled with the Trump administration’s disdain for international agreements that it does not dictate. Rejection of years of work does the world a disservice; the likely patchwork of taxes that will follow will harm the businesses his administration wants to protect.
The United Nations Conference on Trade and Development estimates that 1.4 billion people shopped online in 2018, spending $25.6 trillion, an 8 percent increase over the previous year, and equal to about 30 percent of global GDP. The U.S. topped the list of countries with e-commerce sales ($8.6 trillion), Japan was second ($3.2 trillion) and China was third ($2.3 trillion). When ranked by e-commerce sales as a share of the total economy, South Korea surpasses all countries with a staggering 84 percent, Japan is second (66 percent), the U.S. is third (42 percent), while China’s digital sales account for a meager 17 percent of its gross domestic product.
The explosive rise of digital commerce has exacerbated one longtime tax problem and created a new one. The old problem occurs when companies shift internal revenues among corporate entities; “tax planning” is well-honed among multinational corporations whose operations traverse jurisdictions with wildly disparate tax rates.
While all companies do this — some more aggressively than others — this effort assumes outsize significance in the digital economy where intellectual property is the most valuable commodity and its provenance easily manipulated. They are abetted by governments who compete to provide the most “hospitable” tax structure for multinational companies. Apple’s decision to establish its European headquarters in Ireland was prompted by the prospect of an effective annual tax rate of less than 2 percent.
The result is impressive accounting legerdemain. In 2012, Irish subsidiaries of U.S.-based firms reported profits of $135 billion, or about 60 percent of Ireland’s GDP. In Luxembourg, the amounts are even bigger. Subsidiaries of U.S. firms operating there had $68 billion in profits, more than 120 percent of the country’s GDP.
Brick and mortar competitors of digital businesses complain about unfair competition, and one of their loudest complaints is that their physical presence creates a much higher tax burden. A European Commission survey reports that the average tax rate for digital businesses is 9.5 percent, while that of traditional businesses is 23.2 percent. When the competition is foreign, the complaints increase in intensity.
As important as the volume of those sales is the way that digital revenues are generated. There are easily understood differences between digital and analog sales: digital books versus hard copies. Similarly, the provision of services raises basic questions about where each transaction occurs and the appropriate taxing jurisdiction. Does the sale occur where the buyer lives or where the seller is located? How is online advertising properly taxed? More vexing still is big data, which is generated in one place and used somewhere else and the “transaction” is never identified.
The OECD Secretariat reckons that between $100 billion and $240 billion in corporate income taxes are lost annually because of tax base erosion and profit shifting by multinational enterprises. Lost revenues of that magnitude focus the mind: the OECD in 2012 launched the Base Erosion and Profit Shifting (BEPS) Project to address the problem. It issued a final report in 2015, and a second expanded round of discussions commenced the following year; those talks included 137 countries and jurisdictions, some of the world’s leading tax havens among them.
In January they reached an agreement in principle that was endorsed by Group of 20 finance ministers the next month. That agreement has two pillars: The first addresses the issue of physical presence, and allows taxation of a company without an actual office in the jurisdiction if total sales volume exceeds a certain threshold. The second sets a minimum level of corporate taxation over all groups in a multinational enterprise. The agreement is estimated to increase tax revenues by at least $100 billion. Jurisdictions that enticed corporations with low rates will lose some of that revenue; funds will flow to other jurisdictions that had not been as obliging.
Japanese companies should be relatively unscathed by the proposals. Companies that engage in aggressive tax avoidance will be impacted but Japan’s most profitable multinational companies are manufacturing enterprises, selling parts and components, and are not digital in nature. A “back of the envelope” analysis concludes that less than 200 Japanese companies would feel the effects of the new proposal.
Alarmed by the failure to respond to the new realities of 21st century commerce, frustrated by the glacial pace of OECD negotiations, and worried that national governments would fill the gap on their own — which would create a new patchwork of taxes — the European Commission proposed in 2018 its own digital tax provisions. It called for a 3 percent indirect tax on revenue from online ads, online platforms, user data and other digital services of businesses with an annual global revenue of €750 million or more.
The U.S. opposed the move as did European governments that benefit from the current system. As feared, the breakdown prompted individual governments to adopt new digital services taxes. That infuriated Washington, triggering unfair trade practice investigations by the U.S. Trade Representative and calls for another trade war with offending governments. One of them, France, agreed to suspend imposition of its new tax until the end of the year, by which the OECD will (hopefully) reach an agreement.
The U.S. has two objections: first, that a global pandemic is the wrong time for new taxes and second, that the proposed agreement unfairly discriminates against U.S. firms. The first has the ring of legitimacy, but the U.S. is never happy when other governments impose new taxes. Moreover, digital businesses are advantaged during a pandemic as more people shop from home. Governments are deprived of even more tax revenue when they need those funds to cope with the disease.
As for the second objection: while most of the hardest-hit companies are from the U.S., that list is not exclusively American. Negotiations expanded to include “consumer facing businesses,” like big luxury goods conglomerates, to bring more non-U.S. corporations under the new tax.
The U.S. may have bought time, but only if an agreement is forthcoming. U.S. Trade Representative Robert Lighthizer said that the U.S. remains open to a compromise, but a deal — with headlines declaring “new taxes on U.S. companies” — seems unlikely during an election campaign.
Patience is running thin, and not just among Europeans. India and Australia, among others, are contemplating a digital tax. French Finance Minister Bruno Le Maire warned that “Whatever happens, we will apply a tax on digital giants in 2020 because it is a question of justice.”
Failure to act collectively will produce another global patchwork of tax rules, which is bad for business, governments and consumers. The digital economy demands new thinking about and new approaches to governance: Thus far, there is precious little of either.
Brad Glosserman is deputy director of and visiting professor at the Center for Rule Making Strategies at Tama University as well as senior adviser (nonresident) at Pacific Forum. He is the author of "Peak Japan: The End of Great Ambitions."