There is unusual tension in the world of corporate taxation.
On June 5, 2021, the finance ministers of the Group of the Seven Great Industrial Nations committed themselves to a minimum global corporate tax rate on multinational companies of at least 15 percent. While a number of details remain to be worked out in broader global discussions, this historic agreement heralds an important step on the way to international corporate tax reform.
It also underscores the role that minimum taxes at the global level can play in reversing nearly four decades of declining global corporate tax rates and reducing the incentives for large multinational corporations to shift profits to low-tax territories in order to reduce their global tax liability.
Our new study examines how different types of domestic minimum tax systems can help countries maintain their corporate tax base and mobilize revenue.
Taxation over the decades
There is unusual tension in the world of corporate taxation. On the one hand, countries are competing fiercely to attract businesses and investors within their borders by offering numerous profit and cost-based tax incentives that lower their tax rates. On the flip side, governments, once successfully lured into the country, condemn these multinationals for failing to pay their fair share of corporate taxes, putting the burden on the often struggling local corporations.
Governments are increasingly relying on minimum taxes to maintain their tax base. This is especially true for developing countries with weaker tax administrations who face major challenges in effectively taxing these large multinational corporations.
The idea of a minimum tax rate is not new. At the local level, countries have been using modern forms of minimum taxation since at least the 1960s, which tax businesses on income earned on the basis of the activities carried out in their territories. The aim of this “local” (domestic) minimum taxation is to prevent an erosion of the tax base through the excessive use of so-called “tax preferences”. These tax breaks take the form of credits, deductions, special exemptions and allowances and generally lead to a reduction in a company’s tax liability. By introducing a minimum corporate tax rate, governments guarantee a lower limit on corporate contribution to public finances.
Minimum taxes are usually calculated using an alternative simplified tax base that avoids the complexity of the standard corporate tax base. They are often based on sales (gross income or revenue) or wealth (net or gross). A third alternative uses modified definitions of corporate income that explicitly limit the number of allowable deductions and exemptions.
Using a new database of minimum corporate tax regimes around the world, we show how minimum taxes have grown in popularity over the past few decades. Sales-based minimum taxes are the most common and are typically found in countries with higher statutory corporate tax rates (the statutory rate). Countries that levy a minimum tax also tend to have higher corporate tax revenues as a percentage of GDP.
We examine the impact of minimum taxes on income and economic activity by combining our new country panel database with company-level data. We note that the introduction of a minimum tax with an increase in the average effective tax rate – i.e. the tax rate actually paid by corporations after taking tax breaks into account – by just over 1.5 percentage points in relation to sales and around 10 percentage points in relation to profit.
Minimum taxes based on modified corporate income lead to the largest increases in effective tax rates, followed by those based on assets and sales. Ultimately, the impact on revenue also depends on the rate applied.
We also use company-level data to get a feel for the potential revenue that would result from the introduction of a hypothetical minimum tax of 0.5 percent on sales and a minimum tax of 1 percent on total assets. For the middle country, the former could increase seven percentage points of government tax revenue from the current level and the latter almost a third more.
This corresponds to an average of 0.2 or 0.9 percent of GDP in additional income – for the median country in our sample – for a turnover-based or asset-based minimum tax in addition to a median corporate income tax GDP ratio of 2.7 percent. These results represent significant revenue potential that deserves serious policy consideration.
The agreement reached by the G7 countries on minimum taxes has given new impetus to the revision of international tax regulations under the leadership of international organizations. As part of this revision, the Organization for Economic Co-operation and Development (OECD) and the G20 proposed in late 2020 a global minimum corporate tax that would be levied on the profits of multinational corporations. Countries would still set their own local tax rates, but if a multinational company pays less than the global minimum rate in another country, the company’s home or country of origin could supplement its tax liability to ensure it pays the minimum rate. This would reduce the benefits of shifting profits to low-tax countries.
The global proposal by the OECD and the G20 differs from the usual local minimum taxes – it would not only focus on the income generated by activities within a country. Instead, payments would only be triggered when other countries fail to adequately tax multinational corporations. In addition, the application of local minimum taxes could increase as they provide a simpler alternative to the complex provisions of this proposal for a global minimum tax that many low-income and developing countries may not be able to implement.
Powerful, but not perfect
Despite inefficiencies related to local minimum taxes, they could allow countries to generate significant revenues. In this way, setting a floor for corporate taxation – at least at the local level with moderate tax rates – can be a good option for countries that want to preserve revenue and prevent their tax base from eroding without seriously affecting business operations.
However, minimum taxes alone cannot replace reforms to broaden the corporate tax base. The proliferation of multiple tax rates and all sorts of special preferences within the standard corporate tax system creates costly distortions and low revenues – and encourages tax avoidance and evasion. Tax incentives to attract multinational corporations are likely to persist even after a global minimum tax is in place, as countries continue to do whatever they can to attract foreign investment for growth and development. However, the value of these incentives will go down as multinational corporations can only reduce their debt to 15 percent, not zero. So the first thing to do is to tackle them head-on and remove them.