Europe’s Digital Tax Proposal Should Spur Revisions to U.S. Tax Code

The United Kingdom and the European Union took a big swipe at the United States last week. Both the British government and the European Commission floated the idea of a “digital tax” on Facebook, Twitter, and other tech companies they believe are evading European taxes. But if tax avoidance is the issue — and Europe believes it can act unilaterally against U.S. companies — maybe it’s time for the United States to follow a similar path on international taxation.

It’s understandable that the U.K. and EU announcements didn’t sit well with the U.S. Chamber of Commerce. But House Ways and Means Chair Kevin Brady (R-Texas) also called the British proposal a “blatant revenue grab.” And Treasury Secretary Steven Mnuchin similarly warned that the EU plan would “unfairly” penalize U.S. tech companies. Mnuchin urged Europe’s policymakers to pursue the issue through the Organization for Economic Cooperation and Development. It was undoubtedly a diplomatic suggestion. But if Europe opts to go its own way, and tries to seize revenue from U.S. companies, Congress should consider legislative action to end similar tax avoidance schemes by foreign and multinational companies.

Americans have become all too familiar with the tax havens that multinational corporations use to re-route profits and avoid paying U.S. taxes. Europe’s overreach on tax avoidance could finally be the impetus for Congress to modernize America’s tax system and address the wider tax haven problem.

Under the present taxation system, for example, a pharmaceutical company can avoid paying U.S. taxes by parking its patents in Ireland. The company can happily sell into the lucrative U.S. market and then simply direct the profits to Ireland in the form of “royalty payments.” Agribusinesses, entertainment firms, and other global companies have developed similar schemes to avoid paying their tax obligations.

In the face of the EU’s aggressiveness, Mnuchin may have unwittingly announced the solution, however, thanks to his suggestion that the EU should focus on taxing income, not sales. What the United States could do is finally start taxing income based on the proportion of a company’s sales that occur in the U.S. market. In other words, a multinational company would finally be required to pay taxes on profits generated specifically from sales made to customers located in the United States.

Many states in the United States already use something along these lines, known as “Sales Factor Apportionment.” They tax companies based upon profits generated specifically from sales within their state. If Congress overhauled the corporate tax system and transitioned to a mechanism that utilized sales factor apportionment, it could finally eliminate the mechanism that allows global companies to shift their profits overseas. These companies’ tax liabilities would finally — and logically — be assessed based on the market in which they sell their good and services, not where they locate their patents or intermediary proxies.

It should be galling to the American people that multinational firms can so easily shirk their U.S. tax obligations — simply by claiming their company is located, insured or routed through the Cayman Islands. Every day, these companies generate enormous profits by selling into the U.S. market. But they pay only minimal taxes — unlike smaller domestic U.S. firms that lack clever accounting tricks, and are left to face a full tax load.

Since the EU believes it can penalize U.S. tech firms through unilateral tax fees, the United States should respond in kind and adopt a system requiring overseas companies to pay their fair share of taxes. It would be a perfect response to the U.K. and EU launching a new salvo in the global taxation arena, and one that could put America’s domestic companies on a more competitive footing with their overseas counterparts.

David Morse is tax policy associate director at the Coalition for a Prosperous America.

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