Adam N. Michel
The House-passed reconciliation bill includes a new tax measure designed to retaliate against foreign taxes that discriminate against American businesses. This new tax takes aim at the proliferation of targeted and extraterritorial taxes, legitimized and promoted by the Organisation for Economic Co-operation and Development’s (OECD) two-pillar Inclusive Framework.
I recently summarized the OECD project, its current status, and possible future paths in a report for Geopolitical Intelligence Services.
The proposed retaliation tax sends a powerful signal to Europe and the rest of the world that Congress supports President Trump’s executive order to abandon all commitments made by the previous administration regarding the OECD global tax deal. However, instead of allowing the already fragile OECD process to crumble under its own weight, Congress’s retaliation tax introduces unnecessary risks to the American economy by directly imposing taxes on inbound investment and delegating new taxing authority to the Trump administration.
The OECD’s targeted taxes are wrong, but so is retaliatory taxation. The two economic costs don’t cancel out; they compound, leaving everyone worse off.
What Is Section 899?
The new tax, called Section 899, targets countries imposing taxes specifically identified as unfair: digital services taxes (DSTs), diverted profits taxes (DPTs), and the OECD’s Pillar 2 UTPR (formerly known as the undertaxed payments rule). The provision is estimated to raise $116 billion over ten years and recently cleared the Senate parliamentarian as eligible for the reconciliation process.
Section 899 operates in two main ways:
First, it imposes higher income tax rates on various types of US-earned income by foreign individuals, businesses, foundations, and governments. The additional tax rate starts at 5 percentage points above statutory rates, escalating to 20 percentage points, and overrides existing tax treaty reductions.
Second, it includes an enhanced base erosion tax (Super BEAT), which intensifies the existing Base Erosion Anti-Abuse Tax (BEAT) on US subsidiaries of foreign multinational companies from targeted countries, increasing their US tax obligations.
The goal of these targeted tax hikes is to discourage other countries from imposing taxes that disproportionately burden US firms by raising taxes on the offending government’s citizens and businesses. Section 899 attempts this by reducing the attractiveness of US investments for targeted foreign investors. If the foreign taxes remain in place, the Tax Foundation estimates that Section 899 would raise taxes on investment from countries that make up about 80 percent of the US inbound foreign direct investment stock.
This blunt tax increase comes with significant costs and uncertainty. Kyle Pomerleau and Stan Veuger note that raising taxes on inbound investment under Section 899 would “shrink the US capital stock, reduce labor productivity, and reduce wages.” Jack Salmon observes that one way to interpret the Joint Committee on Taxation score of Section 899 is that it is economically self-defeating, “raising tax rates while reducing revenue by scaring off investors and depressing asset prices by the 2030s.”
Congress Delegates More Taxing Power to the Executive
The new provision also significantly expands executive taxing power. Section 899 grants extensive discretion to the Treasury secretary in determining what constitutes an “unfair” foreign tax. While explicitly including DSTs, DPTs, and UTPRs, the text also allows the Treasury to designate additional extraterritorial or discriminatory taxes, with few guardrails, beyond excluding common taxes, and no formal procedural safeguards.
The Trump administration has already signaled its willingness to wield delegated tax and trade authority with impunity, often stretching the bounds of its statutory powers. Establishing a new taxing authority with open-ended definitions would heighten global investment uncertainty and further erode trust in the US market.
A Better Path?
The extraterritorial and discriminatory taxes are as bad, or worse, than Republicans in Congress say they are, but they do not justify sweeping new taxes on investment.
Instead, Congress could pursue a positive agenda to counter the European-led OECD tax project. As I’ve previously argued, the best way to undermine the OECD Global Tax Deal is to make the United States the most attractive place in the world to invest, build, and expand businesses. Rather than defaulting to retaliatory taxes, Congress should defund US contributions to the OECD, make the 2017 business expensing provisions permanent (which the current House bill fails to do), and further reduce the corporate tax rate.
You can read additional recommendations for Congress in my Cato at Liberty blog, “Trump Issues Executive Order Dealing Blow to OECD Global Tax Cartel.”