What the OECD Side-by-Side Deal Really Means for US Tax Sovereignty and Profit Shifting
An illusion of sovereignty + an event on the Work Opportunity Tax Credit
I have two recent pieces that address different sides of the same international tax debate: the OECD’s effort to constrain national tax systems through Pillar Two, and the empirical record that is often used to justify that effort in the first place.
The first, published in Bloomberg Tax, examines the OECD’s newly agreed to “side-by-side” agreement and the claim that it preserves US tax sovereignty. The second, published in Tax Notes, reassesses the data on profit shifting by US multinationals after the 2017 Tax Cuts and Jobs Act (TCJA). Read together, the two pieces raise the question: what problem is the global minimum tax actually solving, and at what cost?
If you will be on or around the Hill on Thursday, January 15, join us for a lunch event on the Future of the Work Opportunity Tax Credit. Elena Patel from Brookings and Jack Salmon from Mercatus will join me to discuss the history and economic effectiveness of this recently expired tax credit, and why Congress should not extend it.
Register here.
The Side-by-Side Deal and the Illusion of Sovereignty
In his statement on the side-by-side agreement, Treasury Secretary Scott Bessent argued that it both protects US tax sovereignty and provides the basis for building international tax stability. In my Bloomberg commentary, I argue that the agreement may accomplish one of those goals, but it cannot do both.
If the agreement works as intended, stabilizing the international tax system, it will constrain Congress’s freedom to set domestic tax policy.
The agreement’s statutory and effective tax rate safe harbors lock in current tax rules, binding future Congresses to a narrow range of acceptable tax policies—unless they’re willing to expose US firms to the Organization for Economic Cooperation and Development’s extraterritorial undertaxed profits rule, or UTPR.
If, instead, that agreement is only a temporary waypoint as other countries look to design Pillar Two-compliant side-by-side regimes, abandon domestic top-up taxes, and compete for global corporate investment through new incentives, the project could continue to fragment due to its own complexity. If the side-by-side system ultimately accelerates Pillar Two’s collapse, it may prove to be a useful transitional step away from a project that should never have started.
One additional point worth emphasizing is that the agreement is not, despite repeated claims, a meaningful simplification of the global minimum tax.
OECD documents mention versions of “simplification” dozens of times, but as practitioners have noted, the reality falls short. PwC’s Will Morris observes that “in several cases, there is more complexity, as with the tax credit safe harbor.” There will also continue to be significant compliance burdens, including filing Pillar Two information returns and calculating tax liabilities under each foreign jurisdiction’s qualified domestic minimum top-up tax, in addition to existing US rules.
Profit Shifting is Smaller Than You Think
Writing for Tax Notes, I investigate the empirical justification of the OECD’s global minimum tax agenda.
Profit shifting is often described as a growing and urgent threat to the corporate tax base, necessitating a costly global solution to the problem. Yet, the data tell a different story. Using multiple imperfect but complementary data sources, I show that US multinational profits reported in tax havens peaked before or shortly after the 14-percentage-point corporate income tax rate cut in 2017 and have been declining since.
As the excerpted figure below shows, tax haven profits were also not especially high when appropriately measured as a share of total US corporate profits, reaching only the low double digits, compared to some claims that tax haven profits reached 65 percent.
The piece concludes with a reminder that profit shifting can be a force for good.
Profit shifting is not harmful and is often a force for positive fiscal reforms. A large body of academic literature shows that foreign investment in low-tax countries is complementary to domestic investment and employment. The pressures that drove profit shifting ultimately pushed the United States, and much of the world before it, to lower corporate tax rates, an adjustment that improved investment incentives and economic growth around the world.
The phenomenon that boosters of Pillar Two both overstate and seek to eliminate played a role in correcting bad policy.
Read the Full Pieces
These summaries only scratch the surface. The full arguments and additional data are presented in the original publications.
US’ Global Minimum Tax Carveout Is an Illusion of Sovereignty, Bloomberg Tax
Reassessing Profit-Shifting Trends Post-TCJA, Tax Notes Federal.