For years, corporate tax reform in the US has been dead in the water, in part because of deep disagreements within the American business community over what such a restructuring should look like. But the European Union’s increasingly aggressive effort to force its members to collect tax on US-based multinationals has the potential to change that dynamic.
The EU’s push has resulted in a series of major initiatives, none bigger than its decision to order Ireland to collect a stunning $14.5 billion in back taxes from Apple. That ruling has generated a swift backlash from the US high-tech industry, US policymakers across the political spectrum, and from Ireland itself. Yet, for all the howling, it might open the door for long-awaited US tax reform.
To understand why, think about two kinds of US corporations—those that pay lots of taxes and those that pay little or none.
Some—especially companies whose business is built on intellectual property—have structured themselves in a way that sharply reduces their worldwide taxes. They shift income to related firms located in low-tax or no-tax countries while allocating interest costs and other expenses to the high-rate US. The result: Many pay effective tax rates in the single digits.
At the same time, firms such as retailers, without the ability to shift income to low-tax countries, pay quite high effective tax rates.
That split hamstrings the debate over corporate tax reform, especially the version that would eliminate tax preferences in exchange for a lower corporate rate.
If you are already paying close to the top statutory rate of 35 percent, you love that swap. After all, you are paying a high effective rate because those tax preferences are not helping you, so why not support legislation to ditch them in exchange for a lower rate?
But for low-tax firms, the political calculation is dramatically different. If tax preferences make it possible for you to pay an effective rate of 10 percent, why would you give them up in return for a new US statutory rate of 28 percent, or even 25 percent? How do you explain to your shareholders why more than doubling your rate is a good thing?
Until now, the international system of taxation has worked beautifully for you. The high US rate means you can shift costs to your domestic units and take a 35 percent deduction. At the same time, you pay little tax to those low-rate countries and because you defer US tax on that worldwide income until you repatriate it to the US (which you never do), you don’t pay US tax on that income either.
But now the ground may be crumbling from under that system. Many of those politically influential low-tax firms such as Apple, Google, Starbucks, and Amazon have become targets of the EU. After all, what better way for any government to raise tax revenue than to turn non-resident corporations into cash cows? By forcing member countries to collect taxes from those US-based firms (and many of those countries are happy to be forced) the EU is trying to break the cycle of tax competition that has largely benefited those US multinationals. In effect, it is creating a new minimum tax for multinationals. Worse, this new environment could subject these firms to double-taxation on the same income.
Those firms will appeal these rulings and try to use their muscle to get the EU to back off. And they may be partially successful. But the days when these firms benefit so much from tax competition among countries may be coming to an end, at least in Europe.
As it does, one can only wonder if it could help open the door to a consensus business tax reform plan. After all, if those firms are going to have to pay taxes somewhere, perhaps they’d prefer paying in the US. That might soften the populist backlash that drove the candidacies of Donald Trump and Bernie Sanders and are making it so hard to get to yes on important trade agreements.
This story originally appeared on TaxVox.