When someone wants to change the rules right in the middle of a game, it’s not easy to find an appropriate reaction. When two players are working toward the same end, it becomes even more difficult for the others. Is it better to stoically insist on the old guidelines, go along with the new ones or to tip over the table and stomp out of the room?
The last option is the only one that German Finance Minister Wolfgang Schäuble cannot choose should U.S. President Donald Trump and British Prime Minister Theresa May begin stretching, undermining or completely redefining the internationally established tax framework. Schäuble is the host of this year’s meeting of G-20 finance ministers, which takes place in mid-March in the southern German spa town of Baden-Baden. At the very top of the agenda is the joint fight against tax dodging and the use of tax havens to stash profits.
But the British and Americans are not of a mind to adhere to Schäuble’s priority list. Rather, they appear to be determined to change gears from cooperation to confrontation. Prime Minister May recently announced her intention to transform her country into a tax haven, with the plan calling for the corporate tax rate to be slashed to between 10 and 15 percent. And the new U.S. president is in the process of instigating a trade war while at the same time warning the Germans and the Japanese of a currency war.
On the one hand, Trump plans to shrink the corporate tax burden almost as far as his counterpart in London, from the current level of 35 percent down to 20 percent or lower. On the other hand, the plans of the political novice in the White House go far beyond mere tax cuts. Trump has discovered tax policy as a weapon in trade policy. He wants to implement tax exemptions for exports while slapping levies on imports in the hopes that such measures will reduce America’s chronic trade deficit.
Schäuble and his staff are following the plans of the tax revolutionaries with mixed feelings. Officials at the Finance Ministry believe that if Britain and the U.S. were to go it alone, it would be akin to committing tax-policy hara-kiri and they hope that the potential negative consequences might ultimately prevent Trump and Co. from actually following through. That, in turn, would mean that the established international tax system might actually survive.
Bolstered Economic Egotism
But the more pessimistic scenario has Finance Ministry officials concerned that Trump might unleash a tariff war and they have begun considering what the appropriate German response should be. Just a few weeks ago, Schäuble was in favor of launching a counterattack should import tariffs be imposed on German goods. In January, he said that the proposals made by the U.S. and Britain were forcing him to consider reforming corporate tax law, including lower tax rates. Now, his staff is in favor of a more defensive approach and coyly refer to their plans as “tax-protectionist measures.”
Schäuble doesn’t plan to unveil those measures in Baden-Baden. On the contrary, the official focus of the meetings will remain on cooperation and international harmonization. But the bolstered economic egotism currently being displayed by the U.S. and Britain won’t make that a simple task. Schäuble is faced with the challenge of preserving the achievements of the last several years while at the same time finding a strategy for Germany to respond to the new situation.
Either way, Berlin’s stint as president of the G-20 isn’t likely to deliver harmonious images of effortless international cooperation of the kind that might be useful in the coming German general election campaign. Indeed, the coming weeks and months of grappling with the neo-nationalists from London and Washington will be decisive in determining whether the G-20 format has a future at all. And currently, it’s chances for survival don’t look good. The plans of Trump and May are nothing less than an outright attempt to destroy it.
The British anticipate that slashing the country’s corporate tax rate to an extremely low level will attract foreign companies, especially from European Union member states, to relocate there. That, London hopes, will bring both jobs for the country’s workers and money for the state coffers — perhaps even enough to compensate for the harm caused by the UK’s departure from the EU.
It is a strategy that can work well for countries that aren’t home to major industries and which don’t produce many goods or offer any services themselves. They don’t have much tax revenue to lose. But for most industrialized economies, which tend to be dependent on stable tax revenues, it is riskier. Britain is still home to a huge service and finance sector in addition to large industrial corporations. When the government slashes taxes to attract foreign companies, it will see tax revenues generated from domestic companies plunge. The bet, of course, is that the additional revenues from companies moving to the country will be greater than the taxes lost through the lower rates.
Foreign Policy Tool
But when measured against the plans being made in Washington, the UK’s strategy is relatively harmless. Trump’s ideas represent nothing less than systemic change, with his government transforming tax policy into a tool of foreign policy. In the crude worldview of the Trump camp, the American trade deficit is proof that countries with trade surpluses, like Japan and Germany, are systematically sucking prosperity from the U.S. And they intend to put a stop to this alleged plundering with the help of tax policy.
Republican economists have developed a model called “border adjustment,” a plan whereby exports would be exempt from taxes but companies would not be able to deduct money they spend on imports. General Motors, for example, would no longer be able to deduct the money it spends on car parts from German manufacturer Bosch from its revenues. That means the U.S. carmaker would have to buy the parts from its taxed profits, making the German products more expensive and less attractive.
It doesn’t take much imagination to see that such a systemic change would result in considerable turmoil in the global economy. And countries that rely heavily on exports, Germany first and foremost, would be hardest hit.
But consumers and companies in the U.S. would also suffer considerably, particularly those enterprises that are reliant on imports. Were they able to absorb the higher costs of importing the products they need, they would pass along those increases to consumers. That reduces consumer purchasing power, leaving them less money left over to buy other goods and services. The result would ultimately be a loss of prosperity.
If companies decided not to raise their prices, the higher cost of imports would reduce their profits, making them less likely to make investments. Other companies would likely be driven out of business entirely. Either way, it will be the workers who bear the brunt — exactly those people who Trump is allegedly interested in helping.
‘We Aren’t Defenseless’
But if the U.S. does implement the “border adjustment” plan, the country would also risk undermining its tax revenues. The new model would present some American companies with extensive opportunities to reduce their own tax burdens. What, for example, would prevent Boeing from founding a subsidiary overseas to which it could then sell its airplanes? Legally, such planes would count as exports, which would be tax free under the plan. The savings would also apply to those planes that were reimported into the U.S. The company would be able to book the profits without paying taxes on them. And the chronically underfinanced U.S. government would suffer even greater shortfalls.
As such, Schäuble and his team are hopeful that logic will prevail and the Americans will elect not to move ahead with the systemic shift. They remain, however, concerned about the possibility that an international race to reduce tax rates might ensue. And they have begun making preparations.
“We aren’t defenseless,” says one Finance Ministry official. “We also have alternatives.” One of those is making adjustments to the foreign transaction tax law. The law currently considers income from abroad to be “passive income” and is not taxed, the assumption being that it has already been taxed in its country of origin, the UK for example. If Germany were to declare the UK to be a “low-tax country,” however, that foreign income would then be added to a company’s domestic earnings and taxed accordingly.
The Ministry, though, says that new instruments could also be introduced. The tax office could, for example, limit tax deductions on deliveries to Germany from British companies, a move which would limit the damages to Germany’s coffers. Another possibility would be requiring banks to withhold a certain percentage of every payment made by a German company for imports from a British company and send it along to the tax office, a procedure known as “deduction of tax at source.”
The advantages are clear: Such measures would limit the losses to German tax revenues. But the disadvantages are significant. They would represent a significant hindrance to the free trade of goods and services.