SYDNEY and KUALA LUMPUR: Last week, the largest rich countries, home to most major transnational corporations (TNCs), agreed to a global minimum corporate income tax (GMCIT) rate. But the low rate proposed and other features will deprive developing countries of their just due yet again.
New race to bottom
On 5 June, the Group of Seven largest rich countries (G7) agreed that TNCs should all pay GMCIT of at least 15%. This rate is just over half President Biden’s promise of a 28% U.S. CIT rate during last year’s election campaign.
The G7’s 15% GMCIT rate is also almost 30% less than U.S. Treasury Secretary Janet Yellen’s 21% proposal. Her proposal was aligned with Trump’s much reduced CIT rate, rather than Biden’s 28% vow.
Unbelievably, this cut rate has been hailed as a “game changer” by the new Australian Organization for Economic Co-operation and Development (OECD) chief and the UK Chancellor of the Exchequer, among others.
Many have called for a GMCIT, especially those long concerned with reduced fiscal means. Notably, the Independent Commission for the Reform of International Corporate Taxation (ICRICT) called for a 25% GMCIT to enhance development finance.
On average, official CIT rates have fallen by twenty percentage points since 1980. In high-income countries, they fell from 38% in 1990 to 23% in 2018. Meanwhile, they fell from 40% to 25% in middle-income countries (MICs), and from over 45% to 30% in low-income countries (LICs). Despite such lowered rates, TNCs still minimise paying tax.
Fiscal crises force tax reform
Contemporary fiscal crises have been decades in the making. The tax counter-revolution of recent decades cut not only public spending, but also tax revenue. Developments in the last dozen years have forced an ongoing fiscal policy turn.
The 2008 global financial crisis was met by massive financial bailouts and recovery measures. Declining tax revenue in earlier decades and its sharp decline during the Great Recession compelled related policy rethinking.
Meanwhile, debilitating inter-country tax competition remains unaddressed. Now, the pandemic has enhanced efforts to boost fiscal means to finance contagion containment as well as economic relief and recovery.
TNCs’ ‘base erosion and profit shifting’ (BEPS) practices are hardly new, having long adverselyaffected developing countries. To be sure, all countries have lost much tax revenue to such practices.
TNCs use ‘trade mis-invoicing’–i.e., ‘paper transactions’ among linked companies–and ‘tax havens’ to minimise overall tax liability on their profits and income. Thus, effective tax rates are even lower, with many paying little in fact.
In 2013, the OECD launched its BEPS project, at the behest of the Group of Twenty (G20) largest economies, to reform taxation of TNC digital commerce (Pillar 1) and propose a GMCIT rate (Pillar 2).
ICRICT estimated yearly global revenue losses at minimally US$240bn, or 10% of global CIT revenue. Despite falling rates, CIT is still significant for government revenue, at 13-14% of global tax revenue, and 9.3% in OECD countries.
Between devil and deep blue sea
The OECD has long limited international tax cooperation to arrangements for its wealthy country members. Its BEPS proposal’s 12.5% minimum rate would raise no more than US$81bn in additional revenue yearly. Unsurprisingly, about 75% of the additional tax revenue envisaged would go to its rich member states.
The G7 proposal’s main attraction is that it seems simpler than the OECD blueprints. If more TNCs are taxed, than just a few large TNCs with profit rates over 10%, CIT revenue would rise significantly. For Yellen, a minimal Pillar 2 CIT rate on about 8,000 TNCs would yield much more.
For the G7, host countries will only have the right to tax 20% of ‘excess profits’ (over 10%) from the largest, most profitable firms. In the OECD draft, ‘residual’ profit untaxed by home–headquarters or ‘source’–countries may be taxed by host countries.
Calculating and apportioning excess profit will always be moot. As home countries have the right to tax the ‘residual’, or balance untaxed by host countries, developing countries will have no more reason to offer tax incentives to attract foreign direct investment.
Both OECD and G7 proposals favour TNC home countries, even when host countries are the main profit source. Also, mechanisms to distribute ‘extra’ tax revenue would mainly benefit the richest countries, home to most large TNCs.
Incredibly, location of TNC production or employment, often in developing countries, is irrelevant for defining host countries. With generally lower incomes, developing countries are relatively less significant as sales jurisdictions except for affordable, mass-consumed goods and services.
Tax injustice rules
Some governments are expected to seek–and gain–exemptions to protect special interests, further eroding the already modest G7 proposal, e.g., the UK reportedly wants to exclude financial services. Also, some low tax countries are among those sowing doubts about the G7 proposal.
Meanwhile, tax justice campaigners have noted the painfully obvious: the G7’s 15% minimum is too low–much lower than average rates in most MICs and LICs, and closer to rates in tax havens like Singapore, Switzerland and Ireland. The rate is seen as reflecting G7 interests and preferences.
Instead, the G24 inter-governmental group of developing countries at the IMF and World Bank urges greater priority for host countries. The G24 and African Tax Administration Forum have also proposed various practical measures. These include distributing TNCs’ global profits among countries on a formulaic basis, considering factors such as production and employment, not just sales.
An IMF policy paper also argues for greater priority for LIC interests. It urges a simpler system, given their capacity constraints, and the critical need for “securing the tax base on inward investment”.
But achieving a fair and effective outcome is difficult. According to the Tax Justice Network, a 21% minimum rate would yield US$640bn more annually. Tax equity campaigners’ other proposals are also generally fairer to developing countries.
Reverse race to bottom
The G7 has lowered the GMCIT to 15%, close to the OECD’s 12.5% proposal, and much lower than Yellen’s 21%, Biden’s 28% and the ICRICT’s 25%. But the G20 could still reverse this downward trend as it can decisively influence the OECD BEPS Inclusive Framework outcome.
A related option is to begin implementation as soon as possible at a certain lower rate, with an irrevocably scheduled commitment to quickly raise the GMCIT rate according to a pre-set timetable to, say, 25%.
Much more remains to be done, much of it urgently. Developing countries can only seek tax justice on more neutral ground provided by truly multilateral forum, namely at the United Nations with the IMF providing needed technical support.
For the time being, however, the participation of many developing countries, mainly MICs, in the skewed OECD BEPS IF has to be urgently addressed to ensure its outcome is not detrimental to their medium- and long-term interests.