The United States’ Strategic Use of Tax Policy: An Analysis of Section 899 and Geoeconomic Leverage

The recent legislative saga surrounding Section 899, often dubbed the "retaliatory tax," offers a compelling case study in the evolving landscape of geoeconomic statecraft, demonstrating how tax policy can be weaponized to achieve foreign policy objectives. While economic tools like sanctions and tariffs have long been recognized as instruments of international leverage, the successful deployment of Section 899 in influencing global tax negotiations marks a significant, albeit potentially risky, expansion of this toolkit. This move by Washington, culminating in the exemption of U.S. multinationals from certain contentious provisions of the global minimum tax, has ignited debate among policymakers and academics alike regarding the conditions under which such tax-based coercion can be successfully repeated and its long-term implications for the global economic order.

The Genesis of a Global Tax Overhaul and U.S. Disengagement

The international community, under the auspices of the Organisation for Economic Co-operation and Development (OECD), embarked on a monumental effort to overhaul global tax rules for multinational corporations. This initiative, known as the Two-Pillar Project, aimed to address the tax challenges arising from the digitalization of the economy and combat base erosion and profit shifting (BEPS). In October 2021, over 130 member jurisdictions, including the United States, agreed to an outline for these new rules.

Pillar One, intended to reallocate taxing rights to market jurisdictions where customers reside, aimed to impact an estimated $200 billion in corporate profits. Pillar Two, on the other hand, introduced a global minimum tax of 15 percent, projected to increase global tax revenues by an estimated $220 billion. The implementation of Pillar Two, particularly, began in 2024, with more than 65 countries having already adopted or drafted legislation to transpose these rules into national law.

Crucially, the OECD’s Pillar Two framework includes an Income Inclusion Rule (IIR) and an Undertaxed Profits Rule (UTPR). The IIR allows a parent company’s home country to tax foreign income if it falls below the 15 percent minimum. The UTPR, an unprecedented mechanism, permits countries to impose taxes on a business even if its parent company is not headquartered there, provided parts of the larger group pay less than 15 percent tax in another jurisdiction. This latter rule became a significant point of contention for the United States, as it would have allowed foreign governments to levy higher taxes on U.S. companies based on their effective tax rate in the U.S., despite the U.S. Congress never having legislated such rules.

The Biden administration’s failure to enact domestic tax law changes to align with the global minimum tax through a Democratic-controlled Congress, particularly after losing the House in the 2022 midterms, left the U.S. tax base exposed to these new international rules. This vulnerability, coupled with ongoing disputes over digital services taxes (DSTs) — which primarily targeted U.S. tech firms in various European nations and were perceived as unilateral tariffs on services — set the stage for a dramatic policy response from Washington.

A Timeline of Escalation: From Rhetoric to Legislation

The political groundwork for Section 899 began to solidify in the lead-up to the 2024 U.S. presidential election. House Ways and Means Chairman Jason Smith (R-MO) emerged as a vocal critic of the OECD process, signaling that a Republican administration would consider the global tax deal discriminatory and extraterritorial.

• May 2023: Chairman Smith introduced a bill proposing that the Treasury Department identify foreign countries imposing "extraterritorial and discriminatory taxes" and increase U.S. withholding and income taxes on citizens, corporations, and partnerships tied to those countries. The proposed escalation involved a 5 percentage point annual increase, capped at 20 points, 180 days after a country’s listing.
• July 2023: Representative Ron Estes (R-KS) introduced a separate bill, dubbed "Super BEAT," aiming to make the existing Base Erosion and Anti-Abuse Tax (BEAT) more punitive for foreign-owned entities operating in the U.S. that were part of "extraterritorial tax regimes." The BEAT, enacted in 2017, was designed to prevent profit shifting out of the U.S. by large multinational corporations.
• January 2025 (Post-Election): Following his victory in the 2024 presidential election, President Trump, on his first day in office, issued a Presidential Memorandum declaring the OECD’s Global Tax Deal as having "no force or effect" in the U.S. He directed the Treasury Department to investigate discriminatory foreign tax rules and develop protective measures. Simultaneously, he referenced Section 891 of the 1934 retaliatory tax measure, signaling a readiness to deploy historical tools of economic coercion.
• The Following Day: Chairman Smith reintroduced H.R. 59, the "Defending American Jobs and Investment Act," initiating the formal congressional process for what would become Section 899. This bill mandated Treasury reports listing countries with extraterritorial or discriminatory taxes.
• May 2025: House Budget Committee Chairman Jodey Arrington (R-TX) introduced H.R. 1, later known as the "One Big Beautiful Bill Act" (OBBBA). This omnibus legislation incorporated a retaliatory tax provision that merged concepts from both Smith’s and Estes’ earlier bills, solidifying the framework for Section 899. The House quickly passed its budget reconciliation proposal to the Senate for consideration.

The Substance of Section 899: A Powerful Threat

The House version of Section 899 proposed significant increases in U.S. withholding and income tax rates on "applicable persons" from targeted countries, applying a 5 percentage point annual increase up to a 20-point cap on top of statutory rates, beginning as early as January 2026.

Beyond this, it fundamentally reshaped the BEAT:

• The BEAT rate would increase from 10 percent to 12.5 percent.
• The $500 million gross-receipts threshold for application would be eliminated.
• The 3 percent base-erosion-percentage floor for inbound corporations would be removed, making nearly all deductible payments to foreign affiliates subject to the tax, irrespective of company size.
• Key exceptions, such as the cost of goods sold and services cost method, would be turned off.
• Crucially, Section 899 explicitly targeted any country imposing a digital services tax, the UTPR, or a diverted profits tax.

The Senate’s version of Section 899, while retaining the core structure, introduced some modifications. It capped the rate increase at 15 percentage points (rather than 20) and applied it against the treaty rate, effectively preventing a de facto treaty override. The effective date was pushed back to January 2027, and portfolio interest was carved out, lessening the impact on foreign holders of U.S. debt. The "Super BEAT" in the Senate version also saw an increased rate of 14 percent (from the House’s 12.5 percent), eliminated the $500 million threshold, and reduced the base erosion percentage threshold to 0.5 percent, while turning off a newly proposed high-tax exception.

These detailed provisions underscored the severity of the proposed retaliatory measures, sending a clear and unambiguous message to U.S. allies and trade partners.

A Diplomatic Breakthrough: The Side-by-Side Agreement

As Congress advanced the OBBBA with Section 899, the U.S. Treasury was simultaneously engaged in high-stakes negotiations with G7 countries. The central objective for the U.S. was to secure an exclusion for U.S.-parented groups from the IIR and UTPR provisions of the global minimum tax, which Washington viewed as extraterritorial and an infringement on American tax sovereignty. Treasury Secretary Bessent reportedly made it clear that failure to reach an agreement recognizing the equivalence of the U.S. tax system for Pillar Two purposes would lead to the implementation of Section 899.

This strategic interplay of legislative threat and diplomatic negotiation bore fruit. On June 28, 2025, the G7 nations finalized a statement on a "side-by-side solution." This landmark agreement stipulated that U.S.-parented groups would indeed be exempt from the IIR and UTPR, provided that Congress removed Section 899 from the OBBBA. Congress complied, and the OBBBA was signed into law on July 4, 2025, without the retaliatory tax provision. The U.S. system, with its existing minimum taxes like net CFC-tested income (NCTI), the corporate alternative minimum tax (CAMT), and Subpart F, was officially recognized by the OECD’s Inclusive Framework as meeting the conditions for a qualified side-by-side system—a unique qualification at the time.

Unpacking Section 899’s Success: Multiple Perspectives

The successful outcome of Section 899, achieving its policy objective without ever being fully enacted, has prompted extensive analysis. Several theories attempt to explain its efficacy:

1. The Prevailing View in Washington: Access to the U.S. Market as Leverage. This theory posits that the U.S. financial market is an indispensable asset for businesses and citizens of targeted countries. The prospect of increased tax rates on capital invested in the U.S., a significant "chokepoint" in the global financial system, generated intense lobbying pressure from affected firms on their home governments. These governments, particularly among U.S. allies, found that acquiescing to U.S. demands was less costly than enduring the economic fallout of Section 899. The U.S. legislative process, in this view, provided a clear and credible "off-ramp" for the threat, making compliance a rational choice for the target countries. This aligns with academic theories of "sanctions paradox," where allies with "low-conflict expectations" are more likely to yield to credible threats.

2. The "Make It Right" Idea: A Return to Original Intent. This perspective suggests that many countries involved in the BEPS/Inclusive Framework process recognized that the U.S. had, in fact, adopted the first global minimum tax in 2017. The initial 2020 OECD Blueprint report had even envisioned "grandfathering" the U.S. rules through an equivalence determination. The Biden administration’s subsequent shift in negotiation objectives created a deviation from this original understanding. Therefore, when Republicans, openly critical of the OECD deal, regained power and reiterated the demand for equivalence, it wasn’t a completely new ask but rather a return to a previously understood contingency. While publicly perceived as yielding to Trump’s threats, G7 countries may have privately viewed the side-by-side solution as a technical correction, aligning with earlier expectations for the U.S. system.

3. The EU’s Geoeconomic Calculation: Overplaying and Compromise. This theory, rooted in "weaponized interdependence," argues that the EU itself wields significant market power, especially given that 80 percent of the world’s largest multinationals have a legal presence within its borders. The EU’s robust implementation of Pillar Two, including the UTPR, was a tool to influence global tax competition. From this viewpoint, other G7 countries, particularly within the EU, negotiated for U.S. firms to remain subject to Qualified Domestic Minimum Top-Up Taxes (QDMTTs) as part of the side-by-side solution. The UTPR’s continued existence, even if not applicable to U.S. firms, provided the EU with an enforcement mechanism for non-U.S. headquartered companies. Therefore, for the EU, accepting the compromise to drop Section 899 while retaining QDMTTs and the UTPR (for others) was a worthwhile trade-off, serving both domestic European audiences and maintaining a degree of leverage in global tax dynamics. It suggests the EU initially aimed for more but was prepared to accept a beneficial compromise.

The Broader Implications of Tax Statecraft

The success of Section 899, while notable, carries significant risks and necessitates a nuanced understanding of its underlying dynamics. Misinterpreting why it worked could lead to costly policy missteps in the future.

• Economic Costs and Financial System Vulnerability: Had Section 899 been fully implemented, it would have significantly impacted inbound investment from countries accounting for over 80 percent of U.S. inbound Foreign Direct Investment (FDI) stock. Such a move could trigger a flight of capital, straining the U.S. bond market and potentially undermining the U.S. dollar’s status as the global reserve currency. Over-reliance on "chokepoints" can incentivize allies and rivals alike to seek dependency-reducing alternatives, eroding the long-term efficacy of such leverage.

• Lessons from Europe: The Limits of Market Access: The European Union has also experimented with leveraging its vast single market to influence external behavior through tax and trade tools, though without a direct analogue to Section 899 due to national tax competencies.

  • Carbon Border Adjustment Mechanism (CBAM): Designed to enforce international climate commitments, CBAM imposes payments on imports into the EU if the exporting jurisdiction lacks an equivalent domestic carbon price. While intended to galvanize global climate action, major economies like the U.S., China, and India have resisted adopting equivalent carbon pricing, leading to criticisms of CBAM as a unilateral tariff. Russia has even filed a WTO complaint.
  • Pillar Two’s UTPR: The EU’s swift adoption of the UTPR aims to enforce global minimum tax rules even on jurisdictions that haven’t adopted them domestically. However, major economic rivals like China and India have not adopted Pillar Two, challenging the EU’s ability to broadly enforce these rules through market access alone.
  • EU List of Non-Cooperative Jurisdictions: This blacklist, updated twice yearly, targets jurisdictions deemed non-compliant with OECD tax standards. While a World Bank report found it encouraged jurisdictions to join the Inclusive Framework, it found no evidence of impact on offshore wealth or profit shifting, suggesting that its targeting and enforcement have been insufficient against major tax havens.

These European examples illustrate that simply restricting access to a large market does not guarantee compliance from other countries, particularly when domestic political considerations or a lack of broad international consensus are at play.

Tax vs. Tariffs: Distinguishing Coercive Dynamics

While Section 899, European DSTs, and U.S. tariffs all represent forms of economic coercion, particularly against allies, their underlying dynamics differ. DSTs and tariffs often function as unilateral moves, attempting to rewrite international norms or trade relationships without a broad-based consensus. The U.S. tariffs, for instance, have struggled to reform the WTO, and Pillar One, which DSTs were meant to incentivize, remains largely unfulfilled.

Section 899, conversely, succeeded because it possessed specific characteristics:

1. A Clear Off-Ramp: The U.S. explicitly offered to withdraw the threat if its core demand—exemption from the IIR and UTPR—was met.
2. Underlying Willingness to Negotiate: The U.S. Treasury actively engaged in diplomatic discussions alongside the legislative threat.
3. An Obvious Fallback Position: The "make it right" theory suggests that the U.S. demand for equivalence was, in a sense, a return to an earlier, mutually understood position, making it easier for allies to accept as a compromise.

These elements facilitated a resolution that unilateral, often confrontational, tariffs or DSTs have struggled to achieve, as they lacked the perceived legitimacy or clear path to de-escalation that Section 899 offered.

Charting the Future of Geoeconomic Tax Policy

The experience with Section 899 provides a novel template for geoeconomic tax policy, but its application in future scenarios requires careful consideration:

• Unique Coercive Dynamics: Was Section 899 truly distinct from traditional tariffs or sanctions in its coercive dynamics? Further academic research is needed to understand whether domestic tax policy, when weaponized, operates under a different set of success parameters than other economic tools.
• Lobbying Power of Targeted Firms: A key factor in Section 899’s success was likely the lobbying efforts of foreign companies operating in the U.S. against their own governments. This "weaponization" of targeted firms, mirroring aspects of the "Brussels Effect," can be a potent, albeit indirect, coercive strategy.
• Adversaries vs. Allies: Would a Section 899-style tactic work against adversaries? The "sanctions paradox" suggests it is far less likely to succeed, as adversaries have higher "conflict expectations" and fewer incentives to comply. Using such tools against allies, while effective in this case, risks long-term damage to critical relationships.
• Consensus for Systemic Reform: Can major international systems, like global trade or tax, be reshaped by economic powers without broad-based consensus? The Section 899 case suggests that while specific, targeted outcomes can be achieved, comprehensive systemic reform often demands more collaborative approaches.
• Cost-Benefit Analysis of Implementation: The U.S. avoided the direct economic costs of enacting Section 899. Future policymakers must meticulously weigh the potential negative impacts on economic growth, U.S. debt exposure, and the dollar’s reserve status against the perceived benefits of policy change.
• Credibility of the Threat: Understanding precisely what made Section 899 a credible threat—whether it was the economic costs to targets, domestic political pressures, or even the perception of U.S. legislative resolve—is vital for assessing the likelihood of success for future similar endeavors.
• Costs of Non-Action: In the case of the UTPR, the costs of U.S. non-action were significant, including potential double taxation of U.S. firms and a perceived erosion of tax sovereignty. Policymakers must always consider these "costs of doing nothing" when contemplating coercive tools.

Conclusion

Section 899 offers a fascinating, albeit complex, new dimension to American economic statecraft. Its success in securing a side-by-side solution for U.S. multinationals highlights the potent leverage of access to the U.S. financial system, especially when deployed against allies within a framework that allows for clear demands and off-ramps. This nuanced outcome suggests that while the U.S. possesses formidable geoeconomic power, success is not guaranteed by mere economic size. Rather, it depends on a careful calibration of the threat, a clear understanding of the target’s incentives, and the specific context of the international negotiation.

As the global economic order continues to fragment, policymakers must exercise caution. A one-size-fits-all approach to geoeconomic coercion, particularly through tax policy, risks alienating allies, undermining global financial stability, and diminishing the long-term effectiveness of these tools. Instead, the Section 899 experience underscores the need for strategic, focused cooperation, even amidst competitive pressures, to achieve international outcomes that benefit all parties while minimizing collateral damage to the interdependent global economy. The challenge ahead lies in discerning when and how to wield such powerful instruments responsibly, balancing short-term gains with long-term strategic interests and the integrity of international norms.