On June 5th, finance ministers of the G7 which includes the US, the UK, Japan, Germany, France, Canada and Italy, agreed to set a global minimum tax rate and granted countries the right to tax multinational companies that operate in their jurisdiction. The global minimum tax rate set at 15% ensures that even if, say, an American company books its profits in Ireland and pays a 12.5% tax rate there, the US can still levy the remaining 2.5%, bringing the effective tax rate to 15%. The second measure agreed upon ensures that large multinational companies with profit margins of at least 10% allocate 20% of their global profits to countries where they sell their products and services. Together these measures are expected to help countries raise at least US $50-80 billion a year in tax revenues. This contrasts with the previous regime where countries competed to lower their tax rates leading to a global race to the bottom. So what are the implications of this landmark deal? Which countries oppose this deal? Is this the end of tax havens?
Race to the Bottom
In the past few decades, countries have collectively been in a race to the bottom regarding taxes as they sought to attract investments. The average global corporate tax rate has fallen by a whopping 16% between 1980 and 2020 and currently languishes at around 24%. Between 1990 and 2019, the US’s corporate tax rate fell from 35% to 21%, while the UK’s rates fell from 34% to 19% over the same period. But these tax cuts would have led to increased levels of investments, right? Nope.
During the same period, the gross fixed-capital investment (as a % of GDP) in the US fell from 23.5% to 19%, and in the UK, it fell from 23.5% to 17%. Guess trickle-down economics doesn’t work after all. Despite stagnant wages, payroll taxes overtook corporate income taxes and now make up a larger share of the US national income, further fuelling inequality.
Many countries such as Ireland, Latvia, Panama, and Belize have banked on tax incentives as their primary business model. Around 15 countries, including the British Virgin Islands, Cayman Islands, and Bermuda, do not impose a general corporate income tax and are widely known as offshore tax havens. Tax havens sustain themselves by providing legal and accounting services to the MNCs and collecting fees paid by them to create subsidiaries there. Overall, different kinds of tax avoidance ranging from intra-firm transfer pricing and state-enabled inversions to smurfing and property market money-laundering are said to have cost countries between US$ 500 billion and US$ 600 billion a year in lost revenue. So what is the impact of the G7’s deal on various stakeholders?
With governments worldwide spending their way out of the pandemic and raking in trillions in debt, corporate taxation seems to be the easiest way to fill the coffers. The G7’s deal attempts to modernise the century-old international tax code and the key details are still being deliberated upon. With the decision being placed before the G20, who are said to meet this month in Venice, full implementation could take years. But here’s what we know about the possible impact on various stakeholders:
MNCs who are infamous for tax avoidance have done everything in their power to exploit loopholes and minimize or outright avoid paying their taxes. As more companies opened offices and relocated to tax havens, governments across the world have lost billions in tax revenue. Since many of the companies exploiting the tax loopholes are American, the US Treasury Department reckons that the US would raise around US$ 500 billion in revenue over a decade by closing these profit-shifting avenues.
The global minimum tax rate is believed to apply to 8,000 MNCs and the second measure applies to around 100 MNCs, with around half of the affected expected to be US companies. US companies, especially Big Tech, have come under increased scrutiny in recent years, and regulators are trying every trick in the book to make companies like Google and Amazon pay more taxes. According to Reuters, Google’s parent company-Alphabet could expect its taxes to increase by less than US$ 600 million or close to 7% more than its US$ 7.8 billion global tax bill last year if both proposed measures came into effect. Amazon’s thin margins had led some to speculate that it may be off the hook, but OECD’s Saint-Amans was quick to dispel that theory stating that OECD plans to segment Amazon’s operations to isolate its high-margin cloud services operations.
EU Tax Observatory’s analysis indicates that companies such as BP, Shell, banks such as HSBC, Barclays and the mining firm Anglo American would be among those forced to pay more taxes.
But determining the exact impact of the proposed measures is difficult due to several reasons:
- Often companies don’t disclose their revenues and tax payments by country.
- Key details about how the rules would be implemented are still being deliberated, including to what degree the taxes generated by the new measures would offset taxes owed under the existing system.
While whether or not the G7’s deal would kill tax havens is debatable, it is expected to make them far less attractive for firms looking to cut their tax liability. It is high-time tax havens change their economic model of competing on taxes alone and instead focus on other amenities such as R&D, infrastructure, broadband, educating and training their workforces.
Garnering broader support for the G7 deal could be challenging.
While some of the G20 countries such as South Africa, Mexico and Indonesia have rallied behind the G20, others are not so thrilled. US President Biden who proposed the deal, himself faces stiff opposition from his Republican colleagues.
Ireland has been one of the most vocal critics of the deal, arguing that it could be detrimental to its economic model. For close to three decades, Ireland has held fast to a low corporate tax rate of 12.5% to encourage multinationals to invest in the country. Favourable tax mechanisms allow companies in Ireland to reallocate their profits to zero-tax territories like Bermuda. Ireland is one of the most prominent tax havens attracting US$ 106 billion of the US$ 616 billion in corporate profits shifted to tax havens in 2015. Close to 180K people work for US firms in Ireland, and just ten companies, including Intel and Apple, accounted for US$ 7.2 billion or 50% of Ireland’s corporate tax revenue in 2020. For small, sparsely populated nations with no long history of industry or innovation, tax incentives could be the only way to stay competitive and attract investments.
China and Hong Kong SAR
For decades China has used special economic zones with low taxation to attract foreign investment. In recent years China has cut tax breaks and has instead relied on its huge domestic market and well-established supply chain ecosystem to attract overseas investors. It is speculated that Beijing may use the G7’s deal as a bargaining chip to reduce US tariffs on Chinese imports.
Being the 7th largest tax haven globally and the largest in Asia, Hong Kong faces more potential risks than mainland China. Close to 70% of foreign investments from the Chinese mainland is now channelled through Hong Kong SAR.
Other small countries such as Paraguay, Moldova and Uzbekistan, which have set their tax rates between 7% to 12%, are also in a dilemma.
To understand whether the deal will have any impact on the MNCs, we can look at the stock markets as the deal is basically a measure that will reduce the profits of MNCs. But the stock markets haven’t flinched. For example, the Nasdaq Composite which comprises multinational tech companies, has a valuation premium compared to the broader benchmark of the S&P 500. To make matters worse, companies like Facebook have even welcomed the deal. One of the possible solutions to make the deal more effective is to levy a 0.2% tax on publicly listed companies’ stock market capitalization rather than taxing their profits which is applicable only if it’s beyond a certain threshold. While the G7 agreement is a step in the right direction, a lot could change by the time the deal actually comes into effect. In order to address the challenges posed by inequality, it’s high time we replace the race to the bottom with a race to the top when it comes to taxes.
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