It’s been a great week for a great idea. On Monday, US Treasury Secretary Janet Yellen advocated a global minimum corporate tax in her first major public address. US National Security Advisor Jake Sullivan quickly underscored the message and tweeted, “The US is determined to end the race for corporate tax rates and prevent companies from moving jobs overseas,” as the centerpiece of their national security strategy. As policymakers around the world are considering a global minimum corporate tax, it is important to understand the context behind the concept and how that tax actually works.
International corporate taxation has long been a challenge for tax authorities around the world. The advent of globalization and intangible capital in recent decades has made the taxation of multinational corporations (MNCs) increasingly difficult, and greater international cooperation is required to make such taxation more effective. A global minimum tax on profitable multinational corporations would ensure that they generate a basic turnover. While this tax would not solve all corporate tax avoidance and evasion problems and require careful consideration of its design and implementation, it would be an important and helpful step.
The development of the structure and behavior of multinational corporations presents governments with a dilemma. Should MNC profits be taxed in the jurisdictions where economic activity and value creation take place or where these companies have their technical headquarters? How should company subsidiaries and hard-to-evaluate assets such as patents be treated? These kinds of questions – alongside competing priorities such as revenue collection, global competitiveness, and tax efficiency – illustrate the difficult task for the global community.
In today’s economy, companies can easily reverse their structure and move profits to tax havens, and intangible capital (e.g. software) is more difficult to value and localize than material capital (e.g. a factory producing physical goods). Countries have battled each other for business investment, leading to a race to the bottom as statutory corporate tax rates have been falling steadily around the world for forty years. In 1980 the worldwide average statutory corporate tax rate was around 40 percent, compared to around 24 percent in 2020.
In addition, the number of tax havens has increased. And the effective corporate tax rates are even lower than the statutory rates, given the growing gaps. In 2021, the British Virgin Islands, Cayman Islands, Bermuda, the Netherlands, Switzerland and Luxembourg were rated as “the most complicit jurisdictions in assisting multinationals with corporate tax underpayment”. This involves substantial corporate tax revenues; It is estimated that governments miss $ 200 billion to $ 600 billion in revenue each year (about 10 to 15 percent of annual global corporate tax revenue).
Most economies use some version of a global or territorial tax system. In a worldwide system, domestic and foreign corporate income is taxed. To avoid double taxation, resident businesses can apply for a tax credit to offset part or all of the foreign income tax they have paid. In a territorial system, corporate tax is only paid on income generated within the jurisdiction of the country. Most advanced economies have established territorial systems.
The United States used a worldwide system until 2017 when the Tax Reduction and Employment Act (TCJA) switched the country to a hybrid model that came closer to being a territorial system. The TCJA included several notable changes, such as the abolition of a tax on repatriated dividends from the foreign subsidiaries of US multinational corporations, a minimum tax on the intangible profits of the foreign subsidiaries of US corporations, and a one-time transitional tax on past profits of foreign corporations, owned by US multinational corporations. Despite these changes, US multinational corporations have continued to shift their profits to tax territories with lower corporate tax rates, in part due to the way the law is designed. The magnitude of tax maneuvers around the world is so great that macroeconomic data is distorted by “phantom investments”, where large numbers of FDI do not reflect economic activity but empty corporate shells designed to reduce tax burdens.
To address this issue, the Organization for Economic Co-operation and Development (OECD) and the Group of Twenty (G20) have led the Grounded Erosion and Profit Shifting Initiative (BEPS) – a multilateral negotiation with over 135 countries, including the United States – since 2013. (Yellen referred to these negotiations in her remarks.) A global minimum tax, along with a separate proposal to tax technology MNCs, is now one of the two central pillars of the BEPS initiative, based in part on where their users are. The debate over a tax on digital services has been at the center of transatlantic tensions over the past year over unilateral tax and customs measures. A specific global minimum tax has not been agreed, but the basic framework for the functioning is a top-up tax.
For example, suppose country A has a corporate tax rate of 20 percent and country B has a corporate tax rate of 11 percent. The global minimum tax rate is 15 percent, and Company X is headquartered in Country A but reports income in Country B. Country A would “charge” taxes paid on Company X profits in Country B in the same way as the percentage point difference between Country B’s rate of 11 percent and the global minimum of 15 percent (e.g., Company X would pay an additional 4 percent of the profits reported in Country B in taxes). This approach would limit the collection of global tax revenues and help change incentives for businesses, as businesses would know that profits shifted to tax havens would be subject to additional taxation. This would also create transparency about corporate tax practices, as enforcing a global minimum tax would require country-specific reporting on corporate activities.
Countries have also proposed incentives to encourage low-tax countries to join the agreement, including refusing certain tax deductions on income earned in a country that does not meet the minimum tax rate. The OECD has published high-level revenue impact estimates, assuming a minimum global tax rate of 12.5 percent, and has seen significant revenue increases for countries at all income levels.
The momentum for a global minimum tax has stalled over the past year, partly due to roadblocks from the Trump administration, which has recently returned. The OECD is aiming to reach an agreement on a global minimum tax in mid-2021, and the International Monetary Fund and the United Nations Panel on International Financial Responsibility have also recommended the measure. This timing is also in line with the Biden administration’s call for a global minimum tax as part of its broader corporate tax reform proposal designed to help fund the substantial investments set out in the US employment plan.
While a global minimum tax has great potential, in practice it is undoubtedly complicated. Which countries will agree to this? How does reporting work? What counts as taxable income and which deductions should be included? Can countries enforce this? Some companies are concerned that potential double taxation and increased compliance costs will affect their competitiveness, and some tax professionals wonder how efficient and effective a global minimum tax would be.
Some aspects of these reservations make sense. And due to widespread abuse and advanced protection techniques, a global minimum tax alone will not deter corporate tax avoidance and evasion.
Nevertheless, it is still worthwhile to introduce a global minimum tax. Once a system is in place, it is easier to adjust the tax as needed to be more effective. With capital costs this low, there are good reasons to believe that companies can adjust their investment decisions without too much difficulty. Many multinational companies are already preparing for a global standard and prefer it over country-specific proposals.
Such an agreement would be unprecedented and an important indicator of the future of international corporate taxation. Given the trend towards lowering corporate taxation, the scale of lost revenue and the need for resources as the world addresses challenges such as climate change and recovery from the COVID-19 pandemic, complexity and potential imperfection should not prevent action.
Jeff Goldstein is Director of Strategy and Consulting at Fidelity Investments. During the Obama administration, he was deputy chief of staff and special assistant to the chairman of the White House Economic Advisory Council. He also worked at the Peterson Institute for International Economics. The views and opinions expressed in this article are solely its own.
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