Much change is coming to Washington, DC, now that Republicans have seized control of the US House of Representatives. Uncertainty surrounds President Biden’s ability to pass his economic agenda through a divided Congress and few can predict the path US fiscal policy will take at home or abroad.
However, despite a bleak outlook for a national bipartisan legislative agenda, it is important for US legislators to realize that the rest of the world continues to legislate. In particular, the European Union will continue to implement fiscal and trade policies that affect the US economy. Without a legislative response, US consumers and businesses may find themselves on the losing end of EU policies.
It is equally important that US politicians understand why the EU has been pursuing ostensibly protectionist policies, such as the Carbon Border Adjustment Mechanism (CBAM) or Digital Services Taxes (DST), and what transatlantic policy outcomes the EU hopes to achieve with its US counterparts. Therefore, to understand where EU politicians come from, US politicians need to review the theoretical underpinnings of the Transatlantic Trade and Investment Association (T-TIP) before rushing into a protective tit-for-tat response.
What was T-TIP?
The Transatlantic Trade and Investment Partnership (T-TIP) was a failed free trade agreement negotiated under the Obama administration between the United States and the European Union.
According to to the Office of the United States Trade Representative (USTR), T-TIP “would be a state-of-the-art agreement aimed at providing greater compatibility and transparency in trade and investment regulation while maintaining high levels of health, safety, and environmental protection . It would also “help promote US competitiveness, jobs, and international growth.”
For him European ComissionT-TIP was a tool to boost employment and investment in the EU by reducing regulatory barriers between allies.
However, for both the US and the EU, T-TIP had a broader objective. By harmonizing “Western” standards across a wide range of industries, the allies would not only ease the compliance burden on companies to boost trade and investment, but also “provide the basis for global standards”.
These standards would then be used to require other geopolitical players, such as China or Russia, to meet Western standards or risk losing the ability to trade with economically powerful nations. Especially given the failures of the World Trade Organization to enforce the rules of international trade, this strategy was designed to put the USTR and the European Commission back in control of the enforcement of rules-based trade.
Why did the T-TIP fail?
T-TIP failed for multiple reasons; however, two trends came to the fore during the negotiations and have continued to affect US-EU relations ever since.
On the one hand, the European public became skeptical of the EU’s ability to negotiate a trade deal with the US that would uphold what they perceived to be higher EU standards. The public feared a “race to the bottom” of standards driven by US companies and the lack of government oversight. Thus, it made it difficult for EU politicians to gain public support for the deal and fueled public mistrust of the US business community.
Second, President Trump came to power in 2016 and changed the direction of US trade policy. Not only did the United States suspend the T-TIP negotiations, but the Trump administration also placed multiple duty about the EU. It was not until November 2021 that the steel and aluminum tariffs were rolled back under President Biden.
Post-T-TIP EU trade strategy
Since learning the domestic and international lessons from the T-TIP failure, policymakers in Brussels have adapted their trade (and fiscal) strategy vis-à-vis the US.
The underlying premise remains the same: the EU wants to counter Chinese economic power and protect European standards, working with the US to set global standards across industries and relying on access to its powerful economic markets to boost growth. change in other countries.
However, the EU has adjusted to the realization that, in order to rally domestic support for a trade deal with the US, the EU must first enshrine high European standards into EU law.
Furthermore, it is not obvious that the US trade strategy includes working with the EU as it did under the Obama administration. Therefore, the EU has included financial incentives (or sanctions) for US companies doing business in the EU in the hope of convincing the US to return to the negotiating table for trade deals.
Until the US returns, the EU will continue to implement European standards across all industries into EU law and will penalize the US for non-compliance. By doing so, the EU believes it can benefit from additional revenue from protectionist trade policies while positioning itself as the pioneer in global standard setting. It could also raise the geopolitical profile of the EU through trade and take advantage of the EU’s Single Market in a way familiar to US trade officials from an earlier age.
EU issues for Congress in 2023
There are three main EU tax and trade issues that Congress should keep an eye on in 2023.
One, the EU agreed to implement a CBAM tariff that will apply to US producers importing carbon-intensive goods into the EU. Although the fee will not begin until 2026Policymakers should continue to work on growth-friendly solutions to carbon pricing in the US.
Second, the EU unanimously agreed to implement Pillar Two of the OECD’s global tax deal and set a minimum tax of 15 per cent in the EU. Most countries hope to have the ability to start taxing companies that don’t pay a rate of 15 percent by 2024 and this could start to seriously affect US companies. strategy to adopt Pillar Two or another tax regime that avoids a complicated mess for American companies.
Finally, the EU hopes to introduce legislation to implement Pillar One sometime this year (assuming a final agreement is reached in the OECD). EU officials have made it clear that if Pillar One fails in the EU or the US, DST will once again be on the table in the EU. Congress should consider what to do in either scenario.
In all of these areas of tax policy, it is essential that Congress build a long-term strategy to support America’s economic growth. Once Congress has a comprehensive strategy, it will be in a much stronger position to negotiate joint fiscal and trade ideas with the EU.
Risks for the EU’s fiscal and trade strategy
While the EU views financial sanctions on US companies as a way of putting pressure on the US government to return to the negotiating table, it is important that the EU does not overdo it by driving private investment away from the EU. in the meantime.
According to the Tax Foundation International Tax Competitiveness Index, many European tax codes are currently less competitive than the US tax code. This means that there is already a disadvantage for companies investing in the EU relative to the US.
Furthermore, while subsidies for US industry certainly do not qualify as principled pro-growth fiscal policy, a tipping point was apparently exposed by the growing European temptation to shift production to the US to benefit from the Inflation Reduction Act tax credits.
On top of that, most of the EU’s recent fiscal and trade policies are not designed on pro-growth principles. CBAM, for example, does not give European producers an export rebate for carbon emissions purchased in the EU on products sold in a third country. This makes European products less competitive in foreign markets and may tempt European producers to shift production of carbon-intensive goods to less onerous jurisdictions.
Also, depending on how EU countries implement Pillar Two, there may be disputes between the US and the EU over the tax rights of US companies in the EU.
Finally, if Pillar One is not implemented, the European DSTs will go back to punishing mostly US tech companies.
All of these policies leave room for the EU to lose significant private investment due to an uncompetitive trade environment and the possibility of facing punitive trade measures from the US, with partners only trading or investing in the EU if the economic growth is a priority.
The future of taxes and trade between the US and the EU
The EU’s one-sided approach to carbon taxes, the fast track on the global minimum tax, and the threat of renewed efforts on DST mean that US politicians are faced with some tough decisions. Policymakers on both sides of the Atlantic must take into account pro-growth fiscal and trade principles that promote a rules-based international order and increase opportunity.
The United States still has an opportunity to work with the EU and be a world leader in standards and free trade. However, it will be necessary for policymakers to decide who the real adversary is: the party across the aisle, the EU, or international bad actors like China and Russia. Only then will policymakers seek solutions that put pro-growth fiscal and trade policy above tit-for-tat protectionism.
