Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: the G-7’s agreement on digital taxes, May’s inflation numbers, the EU’s fine on Amazon, and Glenn Hubbard’s suggest for international tax authorities. To sign up for the Capital Note, follow this link.
Where does Google come from?
The big headline from this weekend’s meeting of G-7 financial ministers was an agreement to set a global minimum tax rate of 15 percent on corporations. But an equally consequential pillar of the deal pertains to the taxation of digital services.
Pillar 1, as negotiators call it, gives OECD member nations the right to tax the largest and most profitable businesses, regardless of these companies’ physical presences. If the deal goes through, multinational corporations will face a 20 percent tax on profits generated anywhere.
The digitization of the global economy has posed a conundrum for international tax authorities. Digital platforms generate revenue globally: Anyone, anywhere who uses Google search generates some amount of money for the company. While most tech firms are headquartered in the U.S., tax authorities abroad recently began laying claim to the revenues generated by these firms in their jurisdictions.
France led the way with its digital-services tax in 2019, levying a 3 percent tax on the gross revenues of digital businesses with more than $750 million in global sales. The previous administration’s U.S. Trade Representative argued that the tax unduly harmed U.S. businesses, because the large multinationals subject to the tax were virtually all American. OECD discussions on digital taxation began under the Trump administration but were paused by former Treasury secretary Steven Mnuchin during the COVID-19 pandemic.
The resolution reached by the G-7, to my mind, essentially codifies a slightly more reasonable version of the digital-services tax. Instead of taxing gross revenues, as France did, the G-7 deal will tax profits. However, it still applies only to the largest, most profitable businesses globally, of which one-third to one-half are American. Big Tech firms have largely supported the proposal because it removes the uncertainty and complexity of the patchwork regime that had taken shape in recent years.
But the tax carries a number of distortions. Corporations can shift costs to certain jurisdictions to artificially reduce profits. And by targeting only large companies, the tax will, on the margin, reduce the economies of scale that are a natural product of digital industries. Then there’s the case of Amazon, a tech firm whose e-commerce business is barely profitable but whose cloud services business is a cash cow.
For now, the agreement delivers more questions than answers.
Around the Web
Inflation is reaching its highest point in over a decade
Consumer prices leapt 5 percent in May year-over-year after gaining 4.2 percent in April, with some sectors experiencing gains not seen in decades. The growth of the money supply has been off the charts. A survey by NFIB, the largest advocacy group for small businesses, found that 48 percent of businesses reported raising prices, compared with just 5 percent who reported lowering prices — the widest gap since 1981. In addition, Factset found that in the first quarter, more S&P 500 companies brought up inflation in their earnings calls than any other quarter since the data firm began keeping track in 2010.
A European Union privacy regulator has proposed a fine of more than $425 million against Amazon.com Inc., part of a process that could yield the biggest-yet penalty under the bloc’s privacy law, people familiar with the matter said.
Luxembourg’s data-protection commission, the CNPD, has circulated a draft decision sanctioning Amazon’s privacy practices and proposing the fine among the bloc’s 26 other national authorities, the people said. The CNPD is Amazon’s lead privacy regulator in the EU because Amazon has its EU headquarters in the Grand Duchy.
The core use case for crypto is called DeFi, a recently coined abbreviation for “decentralized finance.” DeFi doesn’t have a formal definition, but it typically includes the use of the blockchain to borrow and lend using auction markets; to trade in unconventional derivatives; to trade one set of crypto assets against another; and for unusual forms of insurance. The profit opportunities arise in part because the blockchain eliminates the need for traditional financial intermediaries, with their fees and associated regulations.
An example: Say you have some money to invest, but government bond rates are too low and you already have plenty invested in publicly traded stocks. You might allocate some of your portfolio to the loan auction markets built on Ethereum, in essence tossing some crypto into the market and seeing at what price it will be lent out. You could end up with yields of 6% or more, though some of these opportunities are very risky.
In the Financial Times, economist Glenn Hubbard argues that the G-7’s global minimum tax is poorly designed:
A 15 per cent rate is not particularly useful without an agreement on what the tax base is. Particularly for the US, home to many very profitable technology companies, the concern should arise that countries will use special taxes and subsidies that effectively target certain industries. The US has had a version of a minimum tax of foreign earnings since the Tax Cuts and Jobs Act of 2017 enshrined GILTI (Global Intangible Low-Taxed Income) provision into law. The Biden administration wants to use the new global minimum tax to raise the GILTI rate and expand the tax base by eliminating a GILTI deduction for overseas plant and equipment investments.
For a 15 per cent minimum rate to make sense, countries would need a uniform tax base. Presumably, the goal of the new minimum tax is to limit the benefits to companies of shifting profits to low-tax jurisdictions, not to distort where those firms invest. The combination of a global minimum tax with the broad base advocated by the Biden administration could reduce cross-border investments and reduce the profitability of large multinational firms.
Instead of taxing profits, governments should tax cash flows, argues Hubbard:
There is a better way to achieve what Yellen and her finance minister colleagues are trying to accomplish. To begin with, countries could allow full expensing of investment. That approach would move the tax system away from a corporate income tax toward a cash flow tax, long favoured by economists. In this revision, the minimum tax would not distort new investment decisions. It would also push the tax burden on to economic rents — profits in excess of the normal return to capital — better satisfying the apparent G7 goal of garnering more revenue from the most profitable large companies. And such a system would be simpler to administer, as multinationals would not need to set up different ways to track deductible investment costs over time in different countries.
In the debate leading up to the 2017 US tax law changes, Congress considered a version of this idea in a destination-based cash flow tax. Like a value added tax, this would tax corporate profits based on cash flows in a given country. The reform, which foundered on the political desirability of border adjustments, limits tax biases against investment and boosts tax fairness.
Returning to the numbers: countries with large levels of public spending relative to gross domestic product, as the Biden administration proposes, fund it mainly with value added taxes, not traditional corporate income taxes. A better global tax system is possible, but it starts with a verdict of “not GILTI”.
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