G7 Tax Combating and the Finish of Hyper-Globalization
The G7 deal on taxing global corporations has yet to be formally approved by a larger group of countries, and many details have yet to be worked out for it to take effect. Still, it wouldn’t be far-fetched to call the deal historic
On June 5, the world’s leading economies announced an agreement that will strengthen their ability to raise taxes on global corporations. The agreement has yet to be formally approved by a larger group of countries and many details have yet to be worked out for it to take effect. Still, it wouldn’t be far-fetched to call the deal historic.
The G7 agreement has two pillars. First, it proposes a minimum global tax of 15% on the largest companies. Second, some of these companies’ global profits are reclaimed to the countries in which they do business, regardless of the location of their physical headquarters.
These goals are just as clear a sign as any that the rules of hyper-globalization – by which countries must compete in order to offer ever-sweeter business to global corporations – are being rewritten. Until recently, it was the resistance of the United States that stalled global tax harmonization. In contrast, it was President Joe Biden’s administration that pushed the deal forward.
Since the start of the race to the bottom in corporate taxation in the 1980s, the average statutory tax rate has fallen from just under 50% to around 24% in 2020. Many countries have generous loopholes and exemptions that reduce the effective tax rate to single-digit values. What is even more damaging is that global corporations have been able to move profits to pure tax havens such as the British Virgin Islands, the Cayman Islands or Bermuda without having to relocate their actual activities there. Estimates by Gabriel Zucman of the University of California, Berkeley, show that an excessive proportion of US corporations’ foreign profits are recorded in tax havens where they have few employees.
Aside from issues of administrative feasibility, the new agreement could face two conflicting objections. Proponents of tax justice will criticize the global minimum of 15% as too low, while many developing countries denounce the global minimum as an unjustified restriction that will hamper their ability to attract investment. The G7 deal seems to reflect both concerns: the low threshold could allay the concerns of developing countries, while the global distribution of profits will allow high-tax countries to recoup some of their lost revenues.
Of the developed countries, only Ireland is below the proposed minimum rate with a statutory rate of 12.5%. But there are small countries like Moldova (12%), Paraguay (10%) and Uzbekistan (7.5%) that have set their quotas particularly low in order to attract foreign investors, whom they see as a source of quality jobs and advanced technology . In an inhospitable investment environment, lower taxes are one of the few immediate ways governments can compensate businesses for the many disadvantages they face. And the effective tax rates in some Asian countries like Singapore (where the statutory tax rate is 17% but lower tax rates apply to some companies) can also be on the wrong side of the minimum amount.
The case for enforcing a common floor in corporate taxation is strongest when countries have similar preferences and want to avoid a prisoner’s dilemma in which the only reason for tax cuts is to prevent capital from flowing elsewhere. This may be true of most developed countries, but certainly not all, as the examples of Ireland, the Netherlands and Singapore show. But when countries differ widely in terms of level of development and other characteristics, what is appropriate in one country can be a barrier to growth in another.
The US and European high-tax countries could complain about the loss of tax revenue if poorer countries maintain lower tax rates. But nothing prevents such countries from unilaterally taxing their home companies at higher rates: they can simply apply the tax to the global profits of the domestic companies, which are divided according to the share of the domestic market revenue. As Zucman argues, any country can do this on its own, without global harmonization or even coordination.
This is exactly what the second plan of the G7 agreement envisages (if only part of the way). Under the agreement, the largest multinationals with profit margins of at least 10% would have to invest 20% of their global profits in the countries where they sell their products and services.
The reason that the USA prefers a global minimum in addition to the national division is that it does not want its companies to be disadvantaged by significantly higher taxation compared to companies in other countries. However, this competitive motive is no different from poor countries’ desire to attract investment. If the US gains the upper hand and loses the latter, it is due to relative power, not economic logic.
The Biden government originally wanted to set the global minimum tax at 21%. The possible compromise of 15% should be low enough to minimize tensions with poorer countries and allow the latter to sign. The balance between global rules and national sovereignty may have been appropriate in this case.
For countries like the US, however, this comes at the expense of lower tax revenues unless the second apportionment plan is strengthened. Ultimately, a global regime that improves the ability of individual countries to design and manage their own tax systems in the light of their own needs and preferences is likely to prove more robust and durable than attempts at international tax harmonization.
It is now clear that countries that act as pure tax havens – are only interested in shifting paper profits without bringing in new capital – have little to complain about. They have done a great service to global corporations by facilitating tax avoidance at a substantial cost to the coffers of other countries. Global rules are fully justified to prevent such blatant begging-your-neighbor actions. The G7 agreement is an important step in the right direction.
Dani Rodrik is Professor of International Political Economy at Harvard University’s John F. Kennedy School of Government.
Copyright: Project Syndicate