While attentions focused on the continuing COVID-19 pandemic and the protests following the death of George Floyd, the United States last week made a significant under-the-radar announcement. The U.S. Trade Representative (USTR) opened an investigation into the digital taxes targeting American firms that have been imposed or are under consideration in Australia, Brazil, the Czech Republic, the European Union, India, Indonesia, Italy, Spain, Turkey and the United Kingdom.

The United States is exactly right to be concerned about the various digital services taxes (DST) that have been imposed or are under consideration. The taxes in question vary slightly, but they generally “tax the gross revenues of large digital companies” and largely tax gross income rather than net profits. Almost all are written in a way that exclusively targets America’s largest technology companies for burdensome and discriminatory treatment.

As noted by Gary Hufbauer of the Peterson Institute for International Economics, the EU’s DST is a de facto tariff that violates various World Trade Organization (WTO) rules. DSTs would hamstring some of America’s most innovative companies. The move to open an investigation is drawing bipartisan praise. Senate Finance Committee Chairman Chuck Grassley (R-Iowa) and Ranking Member Ron Wyden (D-Ore.) issued a joint statement supporting USTR’s decision.

At the same time, the investigation could open the door for a larger trade war with several countries. USTR’s investigation invokes Section 301 of the Trade Act of 1974, which allows the U.S. to identify foreign trade practices that are “unjustifiable,” “unreasonable,” or “discriminatory” barriers that burden U.S. commerce. Unlike several other trade authorities used to protect domestic companies from foreign competition, Section 301 is ostensibly designed to give the United States leverage to tear down foreign trade barriers and pry open foreign markets.

Between its enactment in 1974 and the early 1990s, the United States frequently invoked Section 301 to impose tariffs, a policy renowned trade economist Jagdish Bhagwati dubbed “aggressive unilateralism.” Such actions infuriated trading partners. As part of the so-called “grand bargain” in the Uruguay Round negotiations that converted the General Agreement on Tariffs and Trade into the WTO, the United States agreed to drop unilateral enforcement under Section 301 for matters falling within WTO agreements in exchange for binding dispute settlement. Between 1995 and the beginning of the Trump administration, Section 301 largely fell out of favor and burdensome foreign trade barriers were targeted through the WTO’s dispute settlement system.

Today, the United States has undermined the WTO’s dispute-settlement system in a number of ways and is back to using Section 301. Our recent foray into aggressive use of 301 should give the Trump administration pause as it pursues a new investigation. In 2018, for instance, USTR released its Section 301 report that documented a number of unfair and burdensome Chinese trade practices, including intellectual property abuses, theft of trade secrets, forced technology transfer and others. Relying on the report, the Trump administration imposed aggressive tariffs on imports from China.

Though the United States and China signed a detente in January, the president’s tariffs cover about 70 percent of imports from China, with the average tariff between six and seven times higher than when the trade war began. As countless studies have confirmed, American consumers, not Chinese exporters, are paying the president’s tariffs. Likewise, a recent study from the New York Federal Reserve found that American firms lost $1.7 trillion in market capitalization from lower investment growth as a result of the trade war with China.

In other words, the trade war has exacted a heavy toll on the American economy, and it is not clear that Beijing has made, or will make, significant structural changes to its economy. For example, China is even more reliant on its state-owned enterprises to meet the aggressive purchase requirements called for under the deal signed in January, the opposite of the U.S. goal to nudge Chinese firms to operate on more market-oriented terms.

If the United States is right to defend some of its leading global companies, but tariffs could trigger another costly trade war with several countries, what should policymakers do?

The best answer is the one required by law. We should file a dispute at the WTO. The de facto tariffs under consideration by these trading partners are inconsistent with their WTO commitments. If the United States were to prevail, the respondent countries could either remove the offending measures or the United States would have permission to impose countermeasures without the threat of retaliation. That is how the system was designed to work and it has worked well over the last 25 years.

Likewise, as the United States negotiates free trade agreements with the United Kingdom and others, it could push for bans on DSTs. As part of the narrow agreement struck between the U.S. and Japan last fall, the two countries agreed to “ensur[e] non-discriminatory treatment of digital products, including coverage of tax measures.” Similar prohibitions would likely require large concessions from American trade negotiators. But if defending its leading tech companies from foreign discrimination is a top priority, such concessions could be worth it.

Large countries already are trying to negotiate a multilateral solution to digital taxation issues through the Organization for Economic Cooperation and Development (OECD). It makes sense as part of that process to ensure taxes are not discriminatory against American firms and are consistent with longstanding principles. It also is important that the United States exercise more leadership in fixing some of the existing issues with that proposal, which currently threatens to create double taxation on numerous sectors.

Perhaps USTR is trying to pressure countries to rescind digital taxes or avoid adopting them in the first place. When France enacted its DST, USTR issued a lengthy Section 301 report and threatened stiff tariffs on a number of French products in response. France ultimately delayed the tax until 2021 and USTR held off on imposing tariffs as the two sides try to negotiate a solution. The only problem with this strategy is that, if other countries do not back down the way France did, the United States would have to move forward with tariffs.

The United States should do all it can to defend some of its most innovative companies from discriminatory foreign tax treatment, but an aggressive trade war with a number of the large trading partners subject to USTR’s investigation could be catastrophic for the economy, just as it starts to recover from the damage wrought by COVID.

Image credit:  MNBB Studio

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