Matters Column

The physics behind trade policies and taxes

April 13, 2018
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High school was many years ago for most of us. Reunions seem to come up more often as the time flies by. Memories of favorite teachers and classes resurface as one reflects on those years. I did my best to pay close attention in many of my high school classes, including physics class. I did retain some of it and that has helped with understanding some of my children’s high school science assignments. For me, the physics topic was interesting as it explained many of the questions I had on how things did what they did. It also allowed for the use of some of the math principles that I also picked up along the way. I wasn’t sure how it would relate to my chosen field of taxes until recently.

As I have tracked some recent headlines relating to trade and taxes, it reminds me of my physics classes. The rush at year-end 2017 for implementing a tax reform package coupled with the recent North American Free Trade Agreement (NAFTA) and other trade negotiations have caused me to revisit science. We have discussed in past columns how trade and tax policy can impact the global economy. Since the global economy is so interwoven with what happens in the U.S., many countries have been evaluating how U.S. tax reform may impact economic performance in their respective markets.

One recent headline in Canada referred to U.S. tax reform as “Trump’s tax tsunami.” It was an interesting assessment given taxes, at least on the surface, historically have had little connection to natural phenomena and science. However, taxes can change some of the business dynamics in an economy. That recent headline was likely, in part, in response to the anticipated impacts of the specific tax changes in the U.S., including reduced corporate income tax rates, capital asset expensing and changes in the taxation of income earned outside the U.S.

And then there is trade policy. NAFTA, the Trans-Pacific Partnership and other trade agreements are in a state of flux in recent months. In a global economy, the impact of having or not having such trade agreements may have a significant economic impact in certain countries. The recent announcement on U.S. levying tariffs with respect to imported steel and aluminum also has garnered wide attention by trading partners of the U.S. In addition, the recent U.S. announcement of tariffs on goods produced in China and the immediate reaction of China in announcing tariffs on certain U.S. goods exported to China shows how volatile international trade can be. The actions back and forth by the U.S. and its trading partners remind me of the past and the Smoot-Hawley Tariff Act. The dramatic change in U.S. tariff rates under that act created a trade war, and this is considered by some to have actually worsened and lengthened the extent of the Great Depression in the 1930s.

In recent years, the use of certain international tax planning structures by many U.S. multinationals resulted in a significant response by the Organisation for Economic Cooperation and Development (OECD) and the European Union (EU). The OECD’s Base Erosion and Profit Shifting (BEPS) initiatives and EU’s state aid investigations were a result of their reaction to certain international tax planning. Additionally, the EU is in the process of having member states implement legislation reflecting the Anti-Tax Avoidance Directive (ATAD) proposals.  

And, as a follow-on to the BEPS and ATAD activity, the EU reportedly is considering a turnover tax (gross receipts tax) on the revenues of certain digital services. The focus of the tax would be to tax digital and technology companies based on where their users are located rather than where the income is earned. Thus, some of the common technology and digital companies we all know as household names may be subject to this new tax in an effort by the member nations in the EU to capture tax revenue from the digital economy.

Ireland, the home or headquarter base for many U.S. digital and technology companies with operations in Europe, has expressed concern in how a digital turnover tax will impact the U.S. and other foreign companies based in Ireland. As we have discussed in the past, Ireland has a low corporate tax rate (12.5 percent) and has been pulled into some of the EU State aid inquiries as a result of the tax planning implemented by many multinational companies.

One may ask why the back and forth among the major trading countries on these issues? Drawing on my physics education, perhaps it is the working of the laws of motion described by Sir Isaac Newton. Recall, the third law: “For every action, there is an equal and opposite reaction.” The recent tax and tariff activity definitely has had action and reaction. Based on this, I pondered whether the recent actions in tax and trade tariffs might actually provide evidence of the link between Newton’s third law and international tax and tariff policy. My analysis of science and taxes is a little in jest, but there is an impact on local country economies to these types of actions on changing taxes and tariffs.

The result of changes in tax and tariff policy between the U.S. and its trading partners might create some economic disruption from this back-and-forth activity. We have seen some of this activity and actions before. ‎Hopefully, those involved in making these decisions have taken into account the history of past actions and the resulting consequences. Some great minds have commented on activity that is repeated without full consideration of the past consequences of past actions. The philosopher George Santayana is known for his quote, “Those that do not remember the past are condemned to repeat it.” And, we are all familiar with Albert Einstein’s quote, “Insanity is the doing the same thing over and over and expecting different results.” Advice from some great minds that many should heed in the context of tariffs and taxes. Stay tuned, it may be interesting to watch and experience.

William Roth is a tax partner with the local office of international accounting firm BDO USA LLP. The views expressed above are the author’s and not necessarily those of BDO. The comments are general and not to be considered specific tax or accounting advice or relied upon for the purpose of avoiding penalties.

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