Pillar 1 and Pillar 2 - Risks and Opportunities the Global Corporate Tax Agreement Poses for Competitiveness

In global competition for labor and capital, tax law is one of the most-used tools by all countries.

Some policymakers argue that decades of global tax competition aimed at attracting business investment have amounted to a “race to the bottom on corporate taxation.” These concerns have driven nearly 140 countries, led by Organisation for Economic Co-operation and Development (OECD) and Group of 20 (G20) countries, to negotiate a two-part global tax agreement aimed at establishing rules for the taxation of digital goods and services in a 21^st-century economy (“Pillar One”) and setting a minimum rate of corporate taxation (“Pillar Two”).

The Biden administration negotiated an October 2021 agreement on behalf of the United States, but implementation has stalled due to political disagreements in Congress. The U.S. would need to pass legislation to implement Pillar Two, and may need to pass legislation to implement Pillar One too.

Republicans have expressed deep concerns with the agreement as negotiated and want to stop it. Democrats, meanwhile, have proposed raising significant new revenue through the agreement by increasing taxes on business income earned abroad by U.S.-based companies. Each approach carries risks to U.S. competitiveness, while the agreement writ large carries a risk to economic growth:

1. Double Taxation Risk: While some Republicans want to stop the global agreement in its track, failure to implement the agreement while other countries move forward could lead to double taxation of U.S. multinational companies, harming those companies and their workers.
2. Revenue Maximizing Risk: Attempting to maximize revenue through taxation of business income earned abroad, as the Biden administration has proposed, could also hurt U.S. companies and workers by making the U.S. a less competitive location for businesses to invest in workers, tangible assets like factories and equipment, and research and development.
3. Economic Growth Risk: It is important to note that only people can bear the burden of a tax. Corporations pass along any tax liability to people in the form of higher prices, lower wages, reduced return to capital (lower stock prices and dividend payments), or some combination of the three. Unfortunately, tax policy debates often fail to recognize this key point.

Summary of the Global Tax Agreement

The OECD/G20 Inclusive Framework announced the outline of the two-pillar agreement in October 2021 includes the following provisions.

	Pillar One	Pillar Two
Goals	-Reform taxation of global business income to account for the new digital economy -End countries’ imposition of unilateral digital services taxes (DSTs) on major tech companies	-Push countries to set a minimum corporate income tax rate -Address “race to the bottom” on global tax competition
Taxpayers Affected	-Multinational companies with €20 billion or more in annual revenue and profitability above 10% of revenues -Primarily aimed at global tech companies	Multinational companies with €750 million or more in annual revenue
Tax Base	-Residual profit: financial statement (i.e., book) income, after exempting profits equal to 10% of revenues -Transfer pricing issues related to companies’ marketing and distribution activities in any variety of countries are to be addressed through the development of a “safe harbor” intended to streamline disputes	Financial statement (i.e., book) income, excluding 5% of the value of tangible assets and payroll
Tax Rate	25% of residual profit	15% of financial statement income
Revenues Flow To	Countries where a company derives at least €1 million in revenue (just €250,000 if the country’s GDP < €40 billion) where goods and services are consumed by end users	Countries that have implemented a 15% minimum tax
Enforcement	-Multilateral Convention; details yet to be determined	A domestic-based rule and a separate treaty-based rule that enable countries that have implemented the 15% minimum to increase taxes on companies headquartered in countries that have not implemented the 15% minimum

The Double Taxation Risk

With the European Union, Japan, and other countries beginning to implement Pillar Two through legislation, there is a risk that U.S.-based companies will be subject to two layers of taxation on the same income: one in the U.S., under Global Intangible Low-Taxed Income (GILTI) rules created in 2017, and another through Pillar’s Two’s Undertaxed Profits Rule (UTPR), which countries could begin levying against U.S. companies as early as 2026.

The UTPR was designed as a backstop to the 15% minimum tax, to guard against corporate profit-shifting into countries that refuse to agree to or implement Pillar Two. The UTPR allows countries that have implemented Pillar Two to effectively tax the global profits of multinational companies operating in their borders but headquartered in a country that has not implemented Pillar Two—if that company is paying taxes on its income at a rate of less than 15%.

Take, for example, an online retailer headquartered in the U.S. but with a French subsidiary that owns and runs shipping facilities in France. Under Pillar Two, if the U.S. headquarter company is paying a rate of less than 15% in the U.S. but the French subsidiary is paying at least 15% in France, then France could effectively raise taxes on the U.S. headquartered company to bring it up to the 15% minimum. This would harm U.S. companies and their workers, while also hurting the U.S. Treasury, which would lose revenue according to a recent analysis from the nonpartisan Joint Committee on Taxation.

The double taxation risk of the UTPR was a primary motivation for recent House Republican legislation that would raise U.S. taxes on individuals and companies based in countries that implement Pillar Two, deemed “retaliation” by some observers. But retaliating against countries that implement the agreement could also lead to poor outcomes for U.S. companies and competitiveness, including bilateral and multilateral disputes that would harm the domestic and global economies.

The Revenue Maximizing Risk

There are also economic and competitiveness risks to using Pillar Two as a revenue-maximizing effort in the U.S. The Biden administration has for years proposed raising the corporate tax rate from 21% to 28% and doubling the effective GILTI rate from 10.5% to 21%. These proposals would also apply GILTI tax on a country-by-country basis rather than a global blended basis, which is required by the Pillar Two rules.  The country-by-country approach generally leads to higher taxes on companies because they cannot “blend” low-taxed income with high-taxed income to achieve a higher average tax rate.

Some of the Biden administration’s proposals are to conform U.S. GILTI rules to Pillar Two, avoiding the risk of double taxation through UTPRs. Other Biden proposals, though, would raise hundreds of billions of dollars more in revenue than needed for compliance. For example, instead of raising the GILTI rate from 10.5% to 15%, the minimum rate agreed to under Pillar Two, the Biden proposal would raise the GILTI rate to 21%. Their proposal would also eliminate the ability of U.S.-based multinationals to carve out a portion of income earned abroad from U.S. taxation, even though the global agreement allows it.

These reforms would collectively raise nearly half a trillion dollars in the FY2024-33 period, but could harm U.S. companies, workers, and competitiveness in the process.

A Bipartisan Path Forward on International Tax Reform

There is a bipartisan path forward for policymakers. The U.S. should closely assess the economic and administrative effects of the global tax agreement and work with stakeholders at home and around the globe to avoid the most harmful consequences to our economy. BPC encourages members of both parties to pursue solutions that avoid double taxation and avoid tax increases so large that they harm U.S. companies and workers. Failing to avoid these risks could harm U.S. competitiveness for decades to come.