- Current proposals to combat tax abuse are complex and unequal.
- An effective minimum tax rate redistributes under-taxed profits with considerable advantages for non-tax havens.
- With a single rule for all countries and multinationals, no contract changes are required.
Global tax abuse losses by multinational corporations run into the hundreds of billions of dollars a year – revenue much needed as the cost of the pandemic rises. However, international reform efforts have stalled and a future consensus seems unlikely.
Current OECD proposals are complex and unequal, and the only certainty is that they would generate little additional revenue. Our proposal is simpler, fairer and would generate much more revenue. In addition, it could be introduced by a coalition of willing states without the need for global agreement or treaty changes.
The current OECD process started promisingly in 2019. The original BEPS (Base Erosion and Profit Shifting) initiative, which ran from 2013 to 2015, was the last major attempt to defend the arm’s length principle, which aims to share taxable profits within multinational corporations as if each subsidiary was on Market would trade with each other prices. The realization that a more fundamental rethink was required led to the renewal of the negotiations.
BEPS 2.0 therefore took two starting points that broke with its predecessor – and these formed the two pillars of the approach. Pillar 1 was concerned with the ease of profit shifting and committed to going beyond the arm’s length principle as well as the traditional definition of “permanent establishment” and thereby apportioning at least some of the global profits of multinational corporations based on where they actually do business. Pillar 2 dealt with profit shifting incentives by proposing a global minimum tax to limit the race to the bottom.
However, despite this promising start, negotiations have gotten lost. Both Pillars 1 and 2 are generally viewed as overly complex, with the impact on revenue being highly uncertain and the benefits limited at best – even for OECD members. Lower-income countries expressed frustration at being ignored, and most models suggest minor benefits, especially under Pillar 1. Unsurprisingly, there was little appetite to move forward.
Pillar 1 seems doomed and even among OECD members there is no consensus on whether it should only cover highly digitized companies or a larger group of large multinational companies. However, the new administration of Biden-Harris has partnered with many EU countries to achieve a global minimum tax.
Here in Pillar 2 the problems arise largely from the unwieldy proposal. This includes separate measures for home countries (residence) and host countries (countries of origin) to apply top-up taxes with a complex set of rules to manage the interaction of these rights. Granting superior rights to the home countries of multinational corporations (MNEs) would particularly disadvantage lower-income countries, where multinational corporations are often based. To remedy this, the OECD proposes a third rule that allows the taxation of countries of origin. However, this would require the tax havens that benefit most from profit shifting to accept adverse changes to their tax treaties. Doing so would give them an effective veto, cause endless delays, and have little chance of success.
This is where our proposal for a minimum effective tax rate (METR) could offer a way forward. Like the OECD proposal, we determine the share of under-taxed global profits of each multinational company. To avoid a disadvantage for lower-income countries, METR reallocates these under-taxed profits to all countries where the multinational company is taxable so that each of these countries can apply its own taxes according to its own rules and rates.
By redistributing this under-taxed profit in relation to the location of the real economic activity of multinational companies, including the place of turnover, we can combine the advantages of pillars 1 and 2: placing profit in market countries at the same time as the profit incentive shift is reduced or eliminated. And since the METR is effectively a combination of two rules (for income inclusion and under taxed payments) that the OECD has determined could be applied under national tax rules, the METR would not require any treaty changes. (To take into account the market and other countries where a multinational corporation does not have a taxable presence, a fallback rule would prevent relevant profits from going untaxed.)
We modeled the METR based on the OECD’s blueprint economic impact assessment to ensure that our results are as comparable as possible. The METR is estimated to generate up to 30% higher total revenue gains at all levels of the minimum tax rate, ranging from $ 50 billion to $ 140 billion in additional revenue gains. This is because the METR allows each country assigned under taxed profits to apply its own tax rate, while the OECD proposal provides for a top-up tax to increase the rate on under taxed profits only to the minimum set.
Estimated revenue from the METR
(A) Total profits from tax revenues. Relative tax revenue gain for (B) investment hubs, (C) low- and middle-income countries and (D) high-income countries. Relative gains are calculated as an increase in current tax revenue. The METR proposal (blue) and the OECD proposal (orange).
The differences in distribution are even more striking. The METR would provide investment centers (the OECD’s euphemism for major corporate tax havens) with lower revenue increases than in other countries and lower increases than the OECD proposal (Panel B). It is important that the additional revenue gains for low and middle income countries (Panel C) are relatively higher than for high income countries (Panel D) and would bring them more absolute revenue gains than the OECD proposal. The fairer redistribution of tax rights in the METR proposal is particularly relevant if the shift in profits is not eliminated by the minimum tax rate – ie if the minimum tax rate is too low.
The World Economic Forum published its 2020 Davos Manifesto calling on business leaders to subscribe to a number of ethical principles, including:
“A company serves society at large through its activities, supports the communities in which it operates, and pays its fair share of taxes.”
In addition, the Forum’s Trade and Global Economic Interdependence platform provides a vital link between trade and tax communities to enable coherent policy making that addresses societal needs and reflects business realities.
Based on reforms led by the OECD, the work brings technical issues closer to a high-level audience and enables honest dialogue between different stakeholders on polarizing issues. You can find relevant publications here.
With significant benefits to most non-ports, including countries at all income levels, the METR has the all-important appeal of political feasibility. It provides a simple, uniform rule for all countries and all multinational companies, with no contract changes required. The METR is more equitable between countries as the rights to tax under-taxed profits are divided based on actual activity in each country. and fairer between companies because countries apply their standard tax rate to the distribution of under-taxed profits.
The METR does not provide the complete elimination of lost revenue due to corporate tax abuse. What it does offer, however, is the promise of significant new revenue at a time when it is desperately needed, and in a globally advanced fashion.
The METR proposal was published by Tax Notes International. A full version with more detailed modeling is available for download. This post and the full proposal were written by Sol Picciotto, Jeffery M. Kadet, Alex Cobham, Tommaso Faccio, Javier Garcia-Bernardo, and Petr Jansky. Alex Cobham is a member of the World Economic Forum’s Global Future Council on the new tax and monetary policy agenda.