Is a global minimum tax needed?
THE ERA OF LOW TAXES, particularly low corporate taxes, appears to be coming to an end, or at least, it seems to be under even greater scrutiny. As I wrote last week, the Group of Seven (G7) leading Western industrialised nations are supporting a global minimum tax of 15% for large corporations. This is part of a broader political effort to address the profit shifting activities of large multinational corporations which seek out jurisdictions other than their original home base, from which to domicile, in order to benefit from lower taxes.
Efforts to rein in multinational firms and the countries and territories where they are domiciled are not new. For many decades, Caribbean countries and other small states have had to fight against being blacklisted as non-co-operative tax jurisdictions by the European Union, the Organization for Economic Co-operation and Development (OECD) and other advanced economies.
World leaders are hoping to finalise an agreement on a global minimum tax by the end of 2021. In theory, the agreement would limit tax competition between countries and territories by placing a floor on the effective tax rates applied to cross-border investment by large multinational firms. This is expected to increase corporate tax revenues collected by governments around the world. On the basis of a 15% tax rate, the OECD estimates that governments would collectively raise roughly $70 billion in new tax revenues.
It is estimated that governments are currently incurring US$200-300 billion in tax revenue losses world-wide. Indeed, all governments need revenue to fund social programmes and public investments. According to the World Bank, programmes providing health, education, infrastructure and other services are important to achieve the common goal of a prosperous, functional and orderly society. Importantly, achieving this common goal requires that governments raise revenues either through borrowing, economic aid or taxation. Even where governments go the route of borrowing, taxes are also needed to repay loans. The World Bank further notes that taxation is also a key ingredient in the social contract between citizens and the economy.
Hardly anyone likes to pay taxes, yet they are essential to the ordering of any society. From this point of view, one can understand in principle, the desire of advanced economies to close what they consider to be tax loopholes around the world. This notwithstanding, establishing a global minimum tax would have far-reaching implications for many jurisdictions, particularly small developing countries.
Daniel Bunn of the Tax Foundation, a leading independent tax policy non-profit in the United States, argues that higher tax revenues would come at the price of lower global investment. This is because businesses that currently utilise low-tax jurisdictions to facilitate cross-border investments are likely to encounter a significant tax hike on their current projects and face a new tax deterrent on future projects. This could lead to less foreign direct investment (FDI) and slower global growth.
According to the United Nations Conference on Trade and Development (UNCTAD), global FDI fell by 42%, presumably on the back of the global novel coronavirus (COVID-19) pandemic. For Latin America and the Caribbean, FDI fell by 37%. For countries which are net seekers of inward investment, meaning that they rely heavily on importing global capital, a global minimum tax which also affects the cross-border flow of investment would likely have a debilitating impact.
There are also other issues to consider, some of which are more systemic in nature. On a philosophical level, one can argue that a global minimum tax would result in the smallest and most vulnerable countries surrendering their fiscal sovereignty. As we have seen in the past in terms of economic relations between the advanced economies and the rest, a global minimum tax could also be seen as the former imposing their standards on the latter.
Finally, all governments should ideally have an interest in ensuring that multinational firms play by the rules. All governments should also be interested in fair and transparent tax administrations. However, the jury is still out on whether a global minimum tax is ideal, especially at a time when in a pandemic and recession environment, governments would need all the fiscal room possible to spur economic growth and recovery. A global minimum tax could have the consequence of stifling growth and recovery, especially for small developing states.