by Joseph Joyce
When the Organization for Economic Cooperation and Development began its call for a reform of the rules of global taxes in order to clamp down on the avoidance of taxes by multinational corporations, its efforts looked quixotic. But the OECD persisted, and U.S. Treasury Secretary Janet Yellen is now participating in negotiations with the other OECD members to reform the (non-)system. While there is much left to negotiate, the broad framework of an agreement to establish a new regime, which governs where taxes are assessed and the determination of a global minimum tax, now exists.
A new volume edited by IMF economists Ruud A. de Mooij, Alexander D. Klemm and Victoria J. Perry, Corporate Income Taxes under Pressure : Why Reform Is Needed and How It Could Be Designed, presents the case for implementing a global approach. The first part of the volume describes the reasons for taxing corporate profits, explains the emergence of the rules governing how multinationals could be treated, and shows the complications that the growth in services and digital trade placed on an already fragile system. The second section examines the workings of the current system, including the difference between source-based and residence-based taxes, the use of bilateral tax treaties to allocate taxing rights, and the ability of corporations to use the differences amongst tax regimes to lower their liabilities by shifting the source of their profits to low-tax jurisdictions. The third section analyzes the relative merits of various reform proposals.
The magnitude of lost tax revenues can only be estimated, since multinationals are not required to report all the data on their operations. But economists have used the available data in inventive ways to estimate the losses. Kimberly Clausing of Reed College explains the data limitations and the attempts to provide reasonable estimates with the data that are available in a recent paper, “How Big is Profit Shifting?”. Most of the profit shifting undertaken by U.S.-based multinationals occurs with a few tax havens: Bermuda, Cayman Islands, Ireland, Luxembourg, Netherlands. Singapore, and Switzerland. Clausing calculates that U.S. tax revenue losses from such activities may gave reached $100 billion in 2017, about a third of federal corporate tax revenues.
The OECD has made available a great deal of documentation on the challenges of profit shifting and the proposals to arrest these activities. Many of these analyses are summarized in Addressing the Tax Challenges from the Digitalisation of the Economy: Highlights. The first part of the document explains the proposals under negotiation, known as Pillar One and Pillar Two. Pillar One expands the right to tax a firm beyond its physical presence in a jurisdiction to include “…a significant and sustained participation of a business in the economy of the jurisdiction, either physically or remotely.” Pillar Two ensures a minimum level of tax on the profits of multinationals.
The OECD estimates that if both proposals were implemented, there would be revenue gains for low, middle and high income jurisdictions. The impact of “investment hubs” is more ambiguous, but they would lose some of their tax base. But could these changes adversely affect business activity? The OECD acknowledges that investment costs would rise, but estimates that the impact on investment would be minor.
Tibor Hanappi amd Ana Cinta González Cabral of the OECD Centre for Tax Policy and Administration present a detailed examination of the effect on investment costs in their paper, “The Impact of the Pillar One and Pillar Two Proposals on MNE’s Investment Costs: An Analysis Using Forward-Looking Effective Tax Rates.” They estimate that the rise in the effective average tax rates (EATR) of multinationals in their sample of 70 jurisdictions would be 0.4 of a percentage point, which is small compared to the existing weighted average 24% EATR. Moreover, the reduction in tax differentials would make other factors, such as education and infrastructure in host countries, more important in determining the location and scale of investments.
An agreement on multinational taxes would benefit the Biden administration, which needs revenue to pay for its ambitious infrastructure plans. The administration could use the implementation of a global tax to counter claims that an increase in the U.S. corporate income tax rate, which fell from 35% to 21% in the Trump administration, would make U.S. firms uncompetitive. A coordinated system of taxes would also be a response to the challenge to the ability of governments to tax businesses that profit shifting has posed. Only a global system would stop the “race to the bottom” of national corporate taxes that has resulted in the current tax regime.