Tax war between the U.S. and Hungary

The United States stated last week that it will cancel its tax pact with Hungary. What precipitated this economic war?

The U.S. Treasury Department said last week that it was cancelling a tax pact with Hungary that had been in effect for 43 years. What precipitated this economic war? Janet Yellen, the secretary of the Treasury, wants Hungary to sign on to the OECD-brokered global minimum corporation tax of 15%, but Hungary is not playing ball. Meanwhile, Yellen has her own troubles back at home.

There are two corporate minimum taxes in effect, one in the United States known as "GILTI" (which stands for "global intangible low-taxed income") and a different set of OECD standards for the rest of the world. And what a complex web they have woven!

Commence with GILTI. In December of 2017, Donald Trump signed into law a hefty tax reform. Among many other measures, it reduced the U.S. corporate tax rate from 35% to 21% and imposed GILTI, a minimum tax on overseas subsidiaries of U.S. multinational corporations. However, it turns out that GILTI lacks bite. There is one worldwide computation, and as a consequence, overseas high-tax income is averaged with low-tax income. When tax planning is factored into the equation, GILTI generates very tiny amounts of additional tax revenue.

As part of its most recent tax-and-spending measure, the Biden administration seeks to tighten GILTI, namely by making it country-specific. Foreign profits that are tax-exempt in Bermuda, for example, would no longer be averaged with Mexican earnings that are taxed at 30%; rather, the U.S. parent business would bear direct tax on the Bermuda earnings. There is nonetheless an issue.

With a 50-50 split in the Senate, the administration needs each and every Democratic vote: no Republican senators are expected to vote for the bill. But West Virginia Democrat Joe Manchin is a question mark. Manchin is concerned that U.S. multinational corporations will be at a competitive disadvantage if the GILTI amendments are implemented before other nations formally agree to implementing the OECD package. Thus returning us to Hungary.

Hungary is a member of the European Union, and according to EU regulations, changes to tax legislation require the unanimous approval of all 27 member states. At the most recent meeting of the EU finance committee in mid-June, Hungary voted against the implementation of the OECD tax. Its government expressed worry over an extra tax burden on Hungarian enterprises, which are already under strain due to the conflict in Ukraine.

In retaliation, the United States stated this week that it will cancel its tax pact with Hungary. The hope appears to be that Hungary will capitulate and accept the deeply flawed OECD package, and that Senator Manchin will then wave the white flag of surrender, allowing the GILTI changes to proceed before the midterm elections in the United States, which appear likely to give the Republicans control of Congress. In the meantime, the United States maintains treaties with nations such as Cyprus, Bangladesh, Pakistan, and the Philippines that never agreed to the OECD idea in the first place. The tax treaty between the United States and the Russian Federation as well as its draconian regime remain in effect.

Republicans in the United States have a different perspective on all of this. Senior House Republicans have written to the Hungarian government to praise it for its foresight and to offer conversation while Hungary continues to assess its position on the OECD proposal.

Thus, we are at an impasse. It would be a fantastic thing if this entire house of cards collapsed, which is still a possibility. Politicians frequently use the phrase "race to the bottom" to suggest that the OECD tax is required to detect corporate tax evaders. Not even even close to the truth. The majority of countries have previously embraced earlier OECD measures to combat corporate tax evasion, while corporation tax as a proportion of GDP has been on the increase in many industrialised nations, including Canada, for almost fifty years.

In large part, "race to the bottom" refers to sovereign governments exercising their policy discretion to reduce corporate tax rates and introduce credits and accelerated deductions to stimulate job creation and economic growth in their home countries, resulting in effective domestic tax rates below 15%. Now, the OECD tax would reverse a portion of these incentives.

Finance Minister Chrystia Freeland announced in the federal budget earlier this year that Canada will adopt the OECD tax, and senior officials at the Department of Finance are now diligently working to transform the 70-page package of brutally complex OECD model rules into coherent legislative proposals. We are currently in the summertime. Minister Freeland should allow these individuals to take a break and observe whether the U.S. and EU plans are ever implemented.

By fLEXI tEAM