Pillar Two: Electric Boogaloo

The global tax deal and Pillar Two are shaking up the tax landscape worldwide, introducing a web of complexity and confusion. Today, we untangle the key aspects of these proposals, diving into the latest updates, compliance hurdles, and their ripple effects on industries and smaller nations. 

Join Daniel Bunn, President & CEO of the Tax Foundation, and Senior Economist Alan Cole, as they sit down with Kyle Hulehan to explore what the future holds for global taxation and what it means for the United States.

Links:
https://taxfoundation.org/blog/global-tax-agreement/
https://taxfoundation.org/blog/pillar-two-flaw/
https://taxfoundation.org/taxedu/glossary/oecd-pillar-2-global-minimum-tax/

Transcript

Kyle Hulehan: 0:00

The global tax deal and pillar two are shaking up the tax landscape worldwide. Introducing a web of complexity and confusion. Today, we untangled the key aspects of these proposals diving into the latest updates, compliance hurdles and their ripple effects on industries and smaller nations. Hello and welcome to the deduction, a tax foundation podcast. I'm your host Kyle. And today we brought up the big guns for a large and complex topic. We're joined by Daniel Bunn, president and CEO of tax foundation and Alan Cole, senior economist here. At the tax foundation gentlemen, it's good to have you both in the show today And i'm just going to set the stage real quick for our listeners We're talking about the global tax deal and we're talking about pillar two today These are you know, very complex topics, which is why we have two of the best on here today but before we get into that, I just want to you know, take this moment to get a quick update from daniel he's a busy man. He's got a packed schedule. He's always moving around. He's got a lot going on And I'm just wondering, what have you been working on? What have you been engaging with lately? and where have you been taking the tax foundations message?

Daniel Bunn: 1:08

Yeah. Thanks so much for having me on the podcast, Kyle. it's been a busy time. at the federal level in Washington DC, we're preparing for what some people have called,tax Superbowl or taxmageddon, depending on which way you look at it. A lot of tax policy on the table, at the U S federal level in 2025. but we've also recently launched tax foundation Europe. And I was in Europe last week with meetings, with policy makers. in London and Budapest and looking at opportunities to promote, sound tax policy, around the world. but it is a very busy time.

Kyle Hulehan: 1:41

And honestly, I've actually. I want to follow up real quick with this. What is a place that you've been for tax foundation in unusual place? What's a place that you like, at the tax foundation that you've traveled for that you're maybe had a surprising or interesting story from

Daniel Bunn: 1:57

So one place I've been able to go with Tax Foundation, on a trip several years ago, back in 2019 was Moldova. there was a conference and economic policy conference there. And as part of that trip, there was a sort of side venture to Transnistria, which is this kind of breakaway, self governed area that still is essentially under communism. And you walk, walk through the streets and there's these different statues and memorials, to, to communism, and the communist leaders. And it's a very strange kind of experience. in, the modern world to walk back and see, okay, there's some places in the world that haven't really moved on, over the last 40 years or so. So I'd say that's probably one of the more interesting places I've been as part of my work with tax foundation.

Kyle Hulehan: 2:44

That is a really fascinating story. and yeah, these are, those are some places that maybe it sounds a little bit like they're a little bit lost in time, but I guess to catch up. With modern times and where we are and to keep this on track. I don't want to get too off the rails. I'm wondering, Alan, I'm gonna I'm gonna throw this over to you. what's the latest on the global tax deal? And what are the current developments? what's going on right now?

Alan Cole: 3:08

the big picture is that a lot of countries have nominally agreed to establish this 15 percent global minimum tax on large corporations. In practice, though, it's Europe that's full steam ahead on this, and three of the world's largest economies, the United States, India, and China, are still really yet to move on the global minimum tax agreement known as Pillar 2. they're still almost in a kind of wait and see mode, and there are Good reasons to believe that, the path to adoption and compliance might, The stymied for quite a while. for example, in the United States that Republicans in Congress have been skeptical of, pillar twos benefits that the United States, they note that increases in taxes abroad on us companies almost necessarily mean less money left for shareholders and. The U. S. Treasury to split between them and furthermore, compliance with pillar 2, would almost require the U. S. to rewrite some elements of its tax code, to international specifications. And, neither 1 of these things, seems great of a deal to congressional Republicans or like something that they would support. And, we may be looking at a situation where Republicans are more likely than average to take the Senate next year, which is where treaties would need to be ratified. so the path to. Global adoption is not so clear on the, global minimum tax, but it is certainly, moving along in Europe.

Kyle Hulehan: 4:50

You know, imagine if everyone's playing a game and we're trying to get everyone to agree on the same rules. And there's people that kind of want to be playing either different games or, they don't want to play it the same way. These aren't family or house rules. They want to play by, they want to, some people want. The instruction manual, and some people want to be doing it a little differently, and maybe that doesn't quite work. Either way, it'll be educational because I'm sure you guys can follow up with that. But I think I'm just trying to make it more digestible for the audience. Does that make sense?

Daniel Bunn: 5:19

Yeah. So one thing that, The concept that's been used to describe the global minimum tax is that of a cartel, where everyone is trying to, look at the incentives for tax competition, and, some policymakers have made the choice that certain types of tax competition, they, they don't like them, so that they're, so they're going to try to get everybody to agree to not use tax policy in certain ways. doesn't mean that tax competition is eliminated. but this kind of group of countries has decided, Hey, these are going to be the boundaries, for tax competition. And that's, creates a couple of problems because you immediately run into definitions of what is a good way to compete using fiscal policy and what is a bad way. And some different countries use subsidies or grants or tax credits in a variety of different ways. And what we're seeing is as these rules kind of progress. a lot of, jurisdictions essentially thinking through, Oh, well, under these new rules where we've said, these certain tax credits are more or less, going to get penalized under the minimum tax rules. well, we can move our fiscal policy away from those to the, kind of subsidies that the minimum tax won't be as harsh against. So you're absolutely right. This is a game. People are agreeing to the rules, but the rules create new strategies and opportunities for countries and for companies to work within.

Kyle Hulehan: 6:59

Yeah. a cartel is only just a little different from a game. So I think I pretty much nailed that. but yeah, Daniel, I'm coming back to you here again. So how does the U. S. stack up against other countries when it comes to complying with Pillar 2 and the global tax deal overall?

Daniel Bunn: 7:15

So depending on where you sit in the world, you could have very different answers to this question. so I was on Capitol Hill in 2017, when the Tax Cuts and Jobs Act was adopted, and some pieces of that law, essentially became the template for the global minimum tax. So you could say the U. S. has been ahead of the game since 2017 with rules that create sort of a floor for the amount of tax that or the tax rate that companies face around the world. However, if you're not in the U. S. and if you don't have an appreciation for what happened in 2017, you may be looking at the U. S. and say, the U. S. has done absolutely nothing whatsoever to comply with this set of rules. and both answers would be right in some respects. it is true, like I said, that the U. S. kind of set a template, for these rules. But it's also true that the U. S. has not done anything to adopt the rules that have been actually agreed to, because, The standards are in a lot of ways very different. They're meeting the same policy concern, which us at Tax Foundation, we think about the policy concern and the tool. other people care about, I would say, different aesthetics of policy and say, the U. S. hasn't actually adopted word for word what the OECD, these countries around the world agreed to. Therefore, it hasn't done anything to comply.

Kyle Hulehan: 8:46

I'm going to say this with much love and respect for America as an American citizen. that sounds pretty on brand for the U. S. That sounds like we're really, just following right through with what people think of us and how we think of ourselves, actually. but to keep this rolling, Alan, I'm going to throw this over your way. What are some of the unusual consequences we've seen from Pillar 2 that might Significantly impacts smaller countries. I

Alan Cole: 9:16

If you're a small country, you've got, one of two strategies, and it almost depends on how small you are. If you're a somewhat small country, you kind of love this tax on large global companies, because the reality is, even if you're a small, rich country, most of the large global countries Companies will be, from elsewhere, probably the United States, maybe Germany on occasion or France on occasion or something like that. and you are looking forward to the idea that, you can, tax them a little bit higher, not worry about competitive, pressures against your close by neighbors because they'll also be, raising their tax rates. you might think about, say, the Benelux countries. those are countries that are close together. You can just drive from 1 to the other. It would be very easy for them to get into a tax competition that. Reduces their taxes below 15%. and that would be, that would be a bit of a struggle for them to raise revenue from the corporate income tax the other possibility is that you're a very, very small country or jurisdiction, say something more like Bermuda, and then your strategy is a little bit different there. It's not even so much about the commerce that happens within your borders. It's about can you find any way to be friendly enough to, Global corporations or, global assets, global income that a little bit of, income that doesn't really. By any rational basis, belong in your jurisdiction. Can you do enough to attract people into making a holding company that put some sort of real valuable asset there, even if it's value is largely derived from workers and consumers who live elsewhere. Um, that's, of course, the, you could call that the tax haven strategy, the low tax country strategy. That's what pillar two is trying to. kill off, but it may not be succeeding because if you look at what these countries are doing, they are trying to conform with the. Letter of the rules under pillar to without necessarily conforming to the spirit of them. They're still trying to find ways to offer what's effectively very low taxes, to global income, global assets, but they're finding a way to call it a 15 percent rate. even if it's understood by both parties, both their treasury and, the corporations involved to not really be 1. So that's the bear case for Pillar 2, the case that maybe this isn't working at all. If you see added complexity while countries basically just try to restore the status quo, then you might say, we're wasting a whole lot of effort and getting the same results.

Kyle Hulehan: 12:14

Yeah, we're often talking here about trade offs and it sometimes seems when it comes to the global tax deal in pillar two, as far as like I've seen in the conversations I've had, it's not always seems worth it. It doesn't always seem worth it. And I do want to point out one thing that you mentioned, Alan, which was, I almost stopped everything when you said Benelux countries. That's why we have you on today for stuff like that. We get pools like this. this is why Alan's here today. I want to switch over to Daniel now, and I'm wondering, as we're talking about, this effect on businesses and what could happen, are there specific industries or sectors that you think will be impacted the most by the global tax deal?

Daniel Bunn: 12:57

That's a great question. I think the impact by design is going to be less about industry or sector and more about the size of companies. There's a revenue global revenue threshold. That essentially exempts a lot of smaller multinationals, but once you're above that threshold, you're in and you have to do full compliance and there currently are some sort of safe harbors that provide simpler compliance in some circumstances, but these are potentially temporary. So a company that it's based in the U. S. and has earnings in, let's say, 50 other jurisdictions. They're probably going to have to do at least 50, different calculations to, analyze whether they're paying the 15 percent that Mount Allen mentioned earlier. and com these tax rules. And these are brand new wholesale tax rules. These aren't rules that were pre existing in any country's tax laws before this minimum tax. So countries are putting in these laws and companies are having to figure out what these new definitions and terms and calculations and filing requirements, all mean for their, overall compliance burden. And then on the government side, Governments are going to have to, analyze and potentially audit these, these, tax filings and figure out, what the kind of net, impact is going to be for them as well. So it's more of a size thing than any sort of, sectoral thing.

Kyle Hulehan: 14:39

Yeah, that's starting to sound really complex. And very complicated. And it's bringing in a lot of new things. And this segues perfectly into my next question for Alan, which is, what kind of retaliation could we see from countries, that don't want to comply with these rules? And could you maybe explain what a mechanism for complying is? I think it's called UTPR.

Alan Cole: 15:04

Yeah, so the UTPR is the, Rule by which Pillar 2 countries are essentially going to try to make other countries adopt Pillar 2. It's a little bit like one of those schoolyard games where, you start out with one person, as the zombie in zombie tag. And as they tag other people, they become zombies too until there's one person left running around and trying to avoid everybody. That's UTPR mechanism is and it is. You could call it an extraterritorial where, countries go beyond what's in their borders to try to police, more worldwide, taxation of companies. so Here's how it works say that there isn't a, a qualified domestic minimum top up tax. That's the pillar to compliant tax, in a country where a company operates. And then let's say, that their parent, Entity or their country where their headquartered also doesn't really worry about enforcing pillar 2 and say that they're paying less than 15%. that could be a failure of pillar 2 if that's allowed to go on. what the, uh. does is it says any country where that company operates can say, hey, over in this other jurisdiction, even though it's not our jurisdiction, we noticed that your tax rate is too low. So we're going to charge you. Extra attacks on your stuff over here, even if your income tax rate over here is fine. Um, we're going to charge you extra income tax to make up for the fact that essentially you weren't paying enough income tax in this other jurisdiction that we have nothing to do with. And the results of that can get a little bit crazy, like you could imagine a huge U. S. conglomerate and it has, just some small footholds in, small foreign countries, some of them in Europe, and the small foreign countries could essentially take it upon themselves, to, say, This U. S. Tax policy does not meet the pillar to 15 percent standard. so we're going to go after your kind of satellite holdings in our small countries, but based on the revenue, income and tax profile of the entire conglomerate, and that's Something that really hasn't been allowed in international tax before. That's not a thing that you're supposed to be able to do. you're supposed to be able to tax within your borders or if it's one of your companies, but you can't go off and make assertions about other people's borders and other people's companies, except to the extent that they are practicing within your borders. So the UDPR is a little bit. Unprecedented and, you could easily, say as a country, we've never seen this before. we don't allow it. We don't agree to it. and, just because we said rates should be 15 percent in general doesn't mean that we've agreed to, let other countries reach into our tax base. Retaliation against that could basically take the form of, a trade war sort of situation with, something resembling, escalating tariffs, maybe literal tariffs, or maybe something more on the income tax side. we know that, The U. S. Has gotten a little bit more bellicose about trade in the last few years. we've seen the U. S. more willing to assess tariffs for better or for worse. And one proposal out of House Republicans, more of a messaging proposal than anything, would say that essentially, if, Global firms, from the U. S. Are assessed with a discriminatory tax, and they make sure to include the U. T. P. R. And that, then, we could be justified in levying discriminatory taxes against inbound investment into the U. S. And you get the sense that the authors of the bill don't actually really want to be assessing discriminatory taxes on inbound investment, and they like in inbound investment. They are trying to exert leverage over foreign policy makers and tell them, hey, cut us a break.

Kyle Hulehan: 19:13

So if I have this correct, U T P R, you can basically just, I want to hit this home for the audience, you can basically just swoop in and tax a country more if another country didn't tax enough. So you can just take other people's money. They're like, ah, you didn't take enough. So I'm going to grab some of that.

Alan Cole: 19:31

Yep, yep, you could imagine, the revenue service of Hungary or Romania going out and, uh, talking about what's going on in the U. S. and attempting to do the IRS's job, essentially.

Kyle Hulehan: 19:46

I know that I work here at a tax organization, but I'm just, I'm like dumbfounded by that. and I know I've heard people talk about it before, but when you really think about it in this context, it's no, I'm just going to take a little bit from them. I'm just going to take it. Like it does not make sense. a lot of sense to me. it really doesn't. and we're talking about UTPR, we're talking about Pillar 2, but before that there is something called Pillar 1. 1 comes before 2. Daniel, could you briefly break down for us What pillar one is and how that fits into the global tax deal and the conversation we're having today.

Daniel Bunn: 20:21

So, Alan's comment about zombie tag. I'm going to continue to use the zombie term here because pillar one at this stage is essentially, if not fully dead, dying or in zombie land. Pillar one attacks a different policy concern than the global minimum tax. So the global minimum tax is about how much a company might be paying in taxes around the world. Pillar one It's about where a company might pay taxes. multinational companies have customers all around the world, and they make choices about where they produce, where they do their research and development and where they're, their workers are. And standard tax rules based on where a company is located, we call this, residence based taxation. you look at where profits are generated based on the activities of the company in production, R& D, and so forth. However, Policymakers looking particularly at large tech companies, and some other large brand companies were saying, hey, there's a lot of value from the consumer. we want to make sure that some of the profits that these companies are, generating are taxed in the location where the consumer is, even if. The company doesn't have any employees or research and development in those jurisdictions, and this is, looking at the kind of the destination of, of corporate, activity. So where the customer is, we, we talk about this in destination based terms. Now, that's perfectly, fine logic. You could create, and Tax Foundation has looked at proposals, in the past that do create a wholly consistent corporate tax regime focused on the location of final consumption. But, that's not what Pillar 1 was really doing. It was saying, okay, we're going to rely on residents for some parts of corporate profits, where the headquarters are, where the employees are, and things like that. and then for another part of corporate profits, there's this formula that slices off a slice of corporate profits, and they say, we're going to find out where the customers are. for that slice of corporate profits and taxed those profits in that, jurisdiction. Now, it's been an extremely interesting but not super fruitful process over the last five years. So unlike Pillar 2, the global minimum tax, there is currently no agreement on the rules for Pillar 1. And one of the problems that pillar one was trying to solve was countries doing a sort of self help approach to taxing companies based on their, consumers or activities in their jurisdictions. And this self help approach is commonly seen in digital services taxes. Canada implemented one very recently. But these are taxes on revenues, not profits. Profits are your revenues minus your costs. You have to take out the costs in order to get a tax on profits. And taxing revenues is very harmful economically. It, essentially punishes companies that have lower profit margins. if you're making a 2 percent profit margin, and there's a 3 percent tax on your revenue, you are going to be paying more in tax, than you're making in profits that would be available for your shareholders. But if you're making a 10 percent profit margin, suddenly you're able. to pay the tax. So pillar one's trying to say, okay, we don't like this self help, revenue focused, solution that a lot of these countries are working on. We're going to create this other thing that is focused on profits. But it is a clear zero sum game because if you're taking profits from taxable profits from one country and moving them to another, the country where the profits are leaving has, we'll have concerns about, well, Hey, all of a sudden my tax revenue, is no longer going to the U S treasury. Maybe it's going to France or some other, other jurisdiction. And it is just created a policy kind of, standstill. Okay. for negotiating out, Pillar 1. There's, there was a deadline at the end of June for there to be this draft, or agreed to treaty text for Pillar 1. we are now, at July 25th. and it's not clear if this final agreement will ever be reached. so that's where Pillar 1 stands. And even though it is, one comes before two, Pillar 2 is much further along.

Kyle Hulehan: 25:14

I see. And so if I'm going to make this really simple or for it to work in my brain and maybe for the listeners, this is totally hypothetical. Uh, YouTube. Is getting money from people watching videos in France. there's no employees in France, And so France now wants to get some of that money. Is that kind of how pillar one is?

Daniel Bunn: 25:38

Yeah, pillar one would say, Hey, you've got a lot of, consumers or users in France and we're going to use a formula that says France gets part of YouTube's profits based on the amount of consumers of their products in France, even though in your scenario, they have no employees in France. and this is similar to the UTPR situation that we were talking about earlier where a country is reaching in, to another jurisdiction's tax base and saying, hey, we want the money to be over here rather than over there. Again, you can conceptually get to a holistic policy. allocates where taxes are paid based on consumption. But this is building this little piece that's really complex onto an existing superstructure that mostly looks at where corporates have their headquarters and their workers and R& D and production and such.

Kyle Hulehan: 26:36

yeah, it's certainly adding a lot of complexity onto it. and as we're explaining this and working through it, you can just see how complex and complicated all of this is. So I think we can see that some of this does not work so well. and as we're wrapping up here, I have this final question for Alan, but Daniel, for free to jump in after he responds with anything else, maybe you want to add, Alan, where do you think All of this is heading. What's the future of the global tax deal in pillar two? And is there any hope for a solution? Are there better ideas? What do you got?

Alan Cole: 27:09

I think it's possible that, the global minimum tax deal doesn't become truly global and it remains, a project of, Europe and some other OECD countries, but not say, the big economies of China, India and the U. S. I don't think that outcome is necessarily, Necessarily means a total failure, because it does mean that European, countries, would be, able to cartelize a large region and, keep competitive, pressures from, tax rates going too low, which is an objective that they want, at the same time, it isn't really like the United States, or for that matter, many other large countries that have been slower on pillar two. It's not like the United States is really the problem that Europe was attempting to solve in pushing for the global minimum tax the United States we think of it as a low tax country, and it is on personal income, but on corporate income, the United States really hasn't been a driver of tax competition. In fact, it's been a bit of the opposite because it has such a strong economy, such a large economy, so much leverage. over, even the largest corporations, it's been able to sustain, high corporate income tax rates, 35 percent before 2017 and still 21 percent after. that's above by a considerable amount, the 15 percent global minimum. so an absence of, U. S. participation, does not really imply that. The U. S. Would be pursuing, say, a tax haven strategy. that, costs Europe. It's, tax base. that's not really something that, the European Union has to worry about. And so I think, accepting a partial win is one of the possible outcomes here, for, European policy makers. it's also possible that, Especially if you've got, a very strong result for the U S Democrats, in the upcoming 2024 election, they might decide, it's best to just not haggle over, slight differences and instead, become more fully, committed. Compliant with pillar two. And in that case, hopefully you would use that as an opportunity, to simplify and knock out some U. S. Provisions so that, over the short run, there's change and, and U. S. Firms have to get used to something new, but in the longer run, they might be able to say, at least our reporting at least our definitions of Things are standardized with some of the other larger economies, and that could provide some upside

Daniel Bunn: 29:55

Yeah, and I'll just, Kyle, I appreciate your patience with the detail in this, in this call and admit that Alan and I both are regularly scratching our heads looking at how this all came together and trying to understand the justifications because some of the results are, Just, so complex and contrary to the initial, goal or we see it that way. and it makes it for, a very, stimulating intellectual exercise, but one that requires a lot of patients just trying to figure out like what is actually happening here and what did policymakers, intend. And then once you get through that, The kind of full picture you're able to step back and say, Wait, none of this really makes any sense.

Kyle Hulehan: 30:39

You know, it's funny, I was doing a lot of prep for this podcast today. And I was rereading a lot of the great articles you guys have written on this stuff. And I kept getting to the conclusion. And I was like, Oh, they're just saying, this doesn't make sense. We're confused. This is challenging. This is unnecessarily complicated. And that was like the theme of all of this. And I think the theme of this as we've seen it throughout. And, and yeah, it does require patience. Cause you're like, what's going on? I don't quite get it. so yeah,I'm right there with you and I have no problem being patient, especially when you guys are on here being so eloquent and,look, hey, zombies came up a few more times than I expected, but I appreciate you guys being on the show today. And I just want to give you guys one last runway, each of you to just plug anything you're working on right now. That's always how we kind of wrap things up.

Daniel Bunn: 31:22

Yeah, so I've got a couple of opportunities to speak to some groups coming up, and most of what I'm doing is collecting a lot of the work that we've been doing focused on 2025 and try to make sure that it connects. with the various audiences so that they can understand the stakes of the game and some of the ways that they can think through, pro growth policy options that kind of support the principles that we espouse.,

Alan Cole: 31:50

and I'll be first looking to Canada and it's digital services tax. These are, uh, kind of almost pillar 1, proto pillar 1 taxes, but assessed individually and ad hoc by a variety of countries. And, There's a good case to be made that these are discriminatory against U. S. companies and in the case of Canada in particular, that's especially of concern because Canada has a free trade agreement with the U. S. And if there's 1 thing we've learned today, it's. It's definitely that tax policy kind of bleeds into trade policy, and some of these taxes look an awful lot like tariffs. And I expect that we'll see some complaints to that effect about the Canadian tax. Further down the line, I'll be looking at the U. S. response to Pillar 2, and how the U. S. international policy has changed. Provisions could be changed in the upcoming tax reform cycle. We think it's likely that there's going to be a tax reform bill or some kind of tax bill in the next Congress. And so there's an opportunity to look at the international provisions then, and I'll be trying to get a bit of a head start on that.

Kyle Hulehan: 33:08

Gentlemen, thank you for being on the show today.

Daniel Bunn: 33:11

Thanks,

Alan Cole: 33:12

you.

Kyle Hulehan: 33:16

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