End of the free lunch

The affluent West opens hunt for hidden tax treasures

Photo: AP Janet Yellen

A large portion of the modern world's wealth has been siphoned away by the Covid-19 pandemic. A logical step to internationally offset that could be the redistribution of global resources. Such actions have been widely supported by the World Bank and the UN, with the two organisations proposing that the biggest winners from pandemic-driven processes share some of their accumulated profits. It is still unclear if and to what extent such an appeal would be heeded as in the real world policies based on logical links are rarely pursued.

Still, and if we part with philanthropy, most countries are facing widening gaps in their budgets - or to put it simpler - their treasure chests are empty. Filling them again is a truly difficult challenge, and the rich Western countries placed their bets on the taxation card - more specifically on making a move to ensure a minimum global corporate tax. To some, such an intention is a shocking surprise as it will clearly undermine the development of most emerging economies. But to others, such a move was not only logical but even inevitable. For decades, the fight to lure investors has led to serious tax cuts worldwide.

Offshore 'tax resorts' have mushroomed and are increasingly popular among giant international corporations, while the emerging markets have capitalised on supplying cheap but highly qualified labour through outsourcing centres.

The first move was initiated by the administration of US President Joe Biden, who skilfully stepped into the protectionist shoes of his predecessor, Donald Trump, whose administration took a first stab at capturing revenues lost to tax havens, introducing a US corporate offshore minimum tax in 2017. The “Global Intangible Low-Taxed Income”, or GILTI, tax rate was only 10.5% - half the domestic corporate tax rate. Now the minimum corporate tax initiative was launched by Treasury Secretary Janet Yellen. She has earmarked the limits for minimum corporate taxation with estimated overall value of 21%.

Negotiations, coordinated through the Organisation for Economic Cooperation and Development (OECD), are building on previous vows to reform corporate taxation.

Countries have competed against one another for corporate investment, leading to a race to the bottom as statutory corporate tax rates have continuously fallen globally for forty years in a row. In 1980, the worldwide average statutory corporate tax rate was around 40%, compared to around 24% in 2020.

Additionally, the number of tax havens has increased. And effective corporate tax rates are even lower than statutory rates, given the proliferation of loopholes. In 2021, the British Virgin Islands, the Cayman Islands, Bermuda, the Netherlands, Switzerland and Luxembourg were ranked the “jurisdictions most complicit in helping international companies underpay corporate income tax”. There is significant corporate tax revenue at stake in all this; it is estimated that governments miss out on between $200 and $600 billion in revenues each year, which stands at around 10 to 15% of annual global corporate tax revenues.

Momentum for a global minimum tax stalled last year, partially due to roadblocks from the Trump administration, but it has returned as of late. The OECD is targeting mid-2021 to reach an agreement on a global minimum tax, and the IMF and the UN have recommended the measure as well. This timing also aligns with the Biden administration's push for a global minimum tax as part of its overall corporate tax reform proposal, intended to help pay for the significant investments outlined in the American Jobs Plan.

While a global minimum tax has high potential, in practice it is unquestionably complicated. Which countries will agree to it? How will reporting work? What counts as taxable income and which deductions should be included? Can countries enforce this? Some businesses are concerned about hits to their competitiveness from possible double taxation and increased compliance costs, and some tax experts question how efficient and effective a global minimum tax would be.

According to Reuters, France and Germany have signalled support for the US approach, which could pave the way for a landmark agreement on global tax changes this summer. It would come after years of political wrangling over reforms to the global tax system to tackle the rise of profit-shifting by multinational firms and online tech giants. The German finance minister, Olaf Scholz, said: “I'm in high spirits that with this corporate taxation initiative, we'll manage to put an end to the worldwide race to the bottom in taxation.” His French counterpart, Bruno Le Maire, who had clashed with Washington over international taxation while Donald Trump was president, said he welcomed the change in the US position. “A global agreement on international taxation is now within reach,” Le Maire said. “We must seize this historic opportunity.”

In an attempt to crack down on profit-shifting to low-tax jurisdictions, taxing rights could be granted to a portion of a multinational's profits based on where its customers reside, irrespective of the company's physical presence in a given location. Frustrated by a lack of progress after years of negotiations, several countries, including the UK and France, have launched unilateral digital services taxes until a global agreement can be reached.

To judge the overall effect of the minimum tax initiative, we may take the example of Ireland, or even Bulgaria. For the last 20 years, Ireland has had a simple message: invest here and you will pay just 12.5% tax on your Irish profits. That compares favourably to headline corporate tax rates of 19% in the UK, 30% in Germany and 26.5% in Canada. It is an article of faith in Irish politics that the 12.5% rate has been vital to attracting US investment. Bulgaria, which is another EU Member State, offers an even lower tax rate as the country has a flat tax of 10%.

US Treasury Secretary Janet Yellen has suggested a 21% minimum rate. “We are working with G20 nations to agree to a global minimum corporate tax rate that can stop the race to the bottom,” she said in a speech to employers. “Together we can use a global minimum tax to make sure the global economy thrives based on a more level playing field in the taxation of multinational corporations.” Essentially that would mean if a company paid tax at the lower Irish rate, then the US or other countries could top up that company's tax in their jurisdiction to get it to the global minimum. So if a US company had a presence in Ireland or Bulgaria primarily for the tax advantage, that advantage would disappear. So the free lunch is over.

Or maybe any lunch will be over, as the bottom line is that big companies will be lured back to the big Western economies after the introduction of a universal corporate tax. The young, the smart and the educated will no longer find chances to work in outsourcing firms as there will not be any outsourcing at all. All capital will be kept intact in the rich countries. So whoever wants a taste of the Western type of life will have to emigrate. Furthermore, emerging and developing countries will be capped by the outflow of capital and qualified workforce, or to put it simply: the rich will stay rich, countries in the middle will have no chance to catch up and become rich eventually, while the poor will forever remain as subsidised donors of demographic supply.

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