Side-by-Side Pillar Two Deal a Good Start Toward Tax Simplicity

The June G7 side-by-side agreement on the global minimum tax proposal has come under fire for not being effective enough, but there is little to worry about. If anything, it may improve Pillar Two.

Twenty-eight countries have criticized the vision for the US international corporate income tax system to coexist with the 15% minimum tax in Pillar Two of the two-pillar global tax deal. But the G7 statement commits to the spirit of the global agreement rather than a rote checklist of requirements.

Simplifications for high-tax, high-substance countries—that is, large countries with plentiful business operations and tax rates above 15%—would be a welcome improvement. So too would be a second look at nonrefundable substance-based credits. Both are consistent with the US negotiating position.

First, consider the agreement’s important objective: not to jawbone high-tax countries into following a rigid prescription, but to protect high-substance countries from base erosion. Unprecedented and coercive elements of Pillar Two, such as the undertaxed profits rule, should be applied to low-tax countries, not high-tax countries such as the US.

Make no mistake—the US has relatively high corporate income taxes, at least compared to Pillar Two’s requirements. Its domestic tax rate of 21% greatly exceeds Pillar Two’s minimum of 15%, and it includes a separate minimum tax of 15% as well.

While the statutory rate on US international income falls below 15%, its less generous foreign tax crediting, loss carryovers, substance exclusion, and interest deductibility all make for a regime that’s about as stringent as a Pillar Two income inclusion rule, if not more so.

The US isn’t the type of troublemaker the UTPR was intended to pursue. The OECD has extended a temporary “safe harbor” to high-tax countries such as the US before. Often, delaying a tax increase is a sign that policymakers aren’t sure the increase should be happening in the first place. Let’s cut to the chase and make things permanent.

Further, exempting high-tax, high-substance countries more generally from some Pillar Two requirements could be a simplification of the onerous country-by-country reporting system. While country-level calculations for low-rate jurisdictions can expose and correct profit shifting, one can get many of these benefits with a far simpler regime that mandatorily excludes high-tax jurisdictions.

US tax economist Kyle Pomerleau suggested the US adopt this idea in a working paper; it could work well for Pillar Two as well, collapsing the number of separate tax baskets from hundreds to as few as two.

Second, the G7 statement was right to take a new look into the treatment of substance-based nonrefundable credits in Pillar Two. These are treated as much larger tax cuts than substance-based refundable credits (mostly for arbitrary path-dependent reasons), even though the latter are strictly more generous.

This would seem to have Pillar Two’s priorities backward. It’s a larger concern for the US research and development system than anyone else, but as with the high-tax exception, it has the potential to benefit other signatories as well.

Some pushback against the US position is valid. The qualms were expressed in response to a US presentation from July and OECD work in August on the side-by-side proposal.

The Estonian delegation reportedly objects to a “push down” system that could give the US system for net controlled foreign corporation-tested income a better place in the stacking order of taxes—critically, it would go ahead of some Pillar Two taxes in the queue.

Even if allowing “push down” is optional, this is a relatively aggressive posture the US is reportedly taking. It makes sense for the US Treasury Department to ask for this arrangement, but it also makes sense for other tax authorities to oppose it.

The US has a reasonably robust system for containing profit shifting; it’s already working toward the Pillar Two goals. In many cases, its negotiating posture is curbing unreasonable sidetracks, not undermining the whole project. Pillar Two signatories should feel confident they can work side by side with the US on their major goals.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Alan Cole is a senior economist at the Tax Foundation, with focus on business taxes, cross-border taxes, and macroeconomics.

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