Corporate tax doesn’t work – how can we fix it, globally?

  • Taxation will play a big role in the post-pandemic reconstruction of the world economy.
  • Corporate tax has been a hot topic as some large multinationals continue to use their global presence to shift profits to tax havens.
  • The G7 have now agreed on an overall minimum tax of 15% and have proposed how it could be distributed.
  • The G7 plans are a good place to start, but there is still work to be done to ensure that the revenues are shared proportionately and inclusively across the world.

“In this world nothing is certain except death and taxesAmerica’s founding father, Benjamin Franklin, said in a letter to a French friend in 1789. His much-quoted joke seems as relevant today as it ever was – and perhaps even more.

Indeed, taxation will play an important role in the post-pandemic reconstruction of the global economy, and a fair and inclusive distribution of this tax burden will be essential for a successful recovery.

Corporate tax, in particular, has been a hot topic for some time, as large multinationals continue to use their global presence to shift profits to tax havens minimize their tax liability in higher tax countries.

To discourage tax arbitrations between countries, the G7 – the world’s top seven economies – agreed in June implement a global minimum tax of 15% on the world’s largest companies. In addition, the countries in which they operate will be able to collect a fairer share of taxes, regardless of whether the companies are domiciled or not.

Much of this plan dates back to the earlier work carried out over many years by the Organization for Economic Co-operation and Development (OECD) as part of its Base Erosion and Profit Shifting Initiative (BEPS).

Before ratification by the G20, the question is: will the G7 tax reform achieve its objectives?

Why do we need a new corporate tax system?

Between 1980 and 2020, the average corporate tax rate rose from almost 50% to around 24% worldwide. But many of the world’s biggest companies – especially the world’s biggest tech companies – pay even less than that. In the United States, for example, their effective tax rate is significantly lower than the legal rate of 21%. It is also lower than the payments made by the big blue chips in other sectors.

At the same time, payroll taxes are rising, creating a vast wedge between taxpayers and the world’s biggest businesses. Social charges now represent a larger share of US national income than corporate tax – despite wage stagnation. Business Insider quotes Gabriel Zucman, a business tax expert at the University of California, Berkeley, as qualifying this scenario “A powerful driver of inequalities”.

Corporate tax revenues decreased, while payroll tax revenues increased.

Image: Business Insider

Will the new G7 global tax rate solve the problem?

In a recent report, the World Economic Forum advocates the design of more progressive tax mechanisms to shift the tax burden from the bottom up. But will a unified corporate tax as envisioned by the G7 succeed?

There is a growing consensus that this is a step in the right direction, but there are many details that need to be worked out as to whether this would actually solve the problem.

Evaluating the impact of G7 reform depends heavily on your perspective.

The Biden administration initially targeted a 21% global corporate tax, while advocates such as Tax Justice Network and Oxfam had claimed 25%. The agreed 15% therefore falls well below.

For those who advocate a fairer corporate tax, the percentage will be too low, says Dani Rodrik, professor of international political economy at Harvard University, in an editorial for Project union. But countries that depend on corporate tax incentives to attract foreign direct investment (FDI) will find the level too high. This mainly applies to emerging economies – Rodrik cites Moldova (12%), Paraguay (10%) and Uzbekistan (7.5%) as examples.

How will the G7 corporate tax reform impact developing economies?

Even among developed economies, there are concerns. Ireland, which relied heavily on tax incentives to attract FDI (12.5%) could be affected. And in the UK, the proposed scheme could reduce two-thirds of the country’s current income from its digital tax on major global technology companies active in the UK.

However, this is nothing compared to low- and middle-income countries, arguably those most in need of more tax revenue to cope with the post-COVID recovery. As the Financial Times reported, the fear in these markets is that multinationals would still pay most taxes where they are domiciled and developing economies would see only a small portion of new tax revenues, even if labor and raw materials originate from the countries concerned.

The African Tax Administration Forum, for example, advocated for a multi-level approach corporate tax for small countries, which allows for different thresholds and tax rates in small economies.

However, the focus on the G7 – and the G20 taking the next step – also means that many low- and middle-income economies are currently not “at the table” to influence negotiations and deliberations.

a graph showing how different industries are affected by tax changes

The communications services and technology sectors are the most affected by increases in corporate tax rates and foreign income taxes.


What are the alternative approaches for a fairer corporate tax system?

Looking at the implications of the G7 deal, the biggest achievement is that even if the G20 ratifies the plans and the rough edges are smoothed out, it won’t be more than a drop in the ocean for the biggest companies in the world. Goldman Sachs analysts have predicted that the impact on the S&P 500, on average, will only be around 1-2%, and even for tech companies it will remain well below 3% (see chart).

One of the problems is that under the G7 regime, corporate tax would still be levied on profits – and, as we’ve seen, profits are a moving holiday. Not only that, but there are large multinationals whose turnover and market capitalization have increased significantly, but whose profit margins have remained below the proposed 10% threshold like a cut by the G7. So, as it stands, these organizations would not fall under the G7 scheme.

While avenues to remedy this are being studied, another proposal aimed at establishing a more equitable distribution of the tax comes from tax experts Emmanuel Saez and Gabriel Zucman at UC Berkeley. Rather than taxing profits, their proposed regime would levy a 0.2% tax on the market capitalization of publicly traded companies – the value of their shares. Most importantly, this system wouldn’t wait for profits to pass a certain threshold to materialize – it would pay much sooner. The taxes collected could be distributed in proportion to the sales made in each country, which would include non-G20 countries.

There is also a United Nations reform proposal to consider. Specifically targeted at digital service companies, the UN’s approach is based on taxing companies’ digital revenues where they are generated, country by country, rather than where the company is resident. The UN’s suggestions are supported by a growing number of emerging economies, including India, Argentina, Nigeria and Viet Nam.

Alternatively, Alex Cobham, the managing director of the Tax Justice Network, argued for the concept of a minimum effective tax rate (METR). In a recent Agenda article, he argues that the METR “offers a simple and unique rule for all countries and all multinationals, and without modification of treaties”.

The World Economic Forum released its Davos 2020 Manifesto, calling on business leaders to subscribe to a series of ethical principles, including:

“A business serves society as a whole through its operations, supports the communities in which it works and pays its fair share of taxes.

Additionally, the Forum on Trade and Global Economic Interdependence platform provides a vital link between the trading and tax communities to enable coherent policy-making that meets societal needs and reflects trade realities.

Drawing inspiration from OECD reforms, the work presents technical issues to a high-level audience and allows for an honest dialogue between diverse stakeholders on polarizing topics. You can find relevant publications here.

Smoothing Out the Wrinkles of a Global Business Tax System

With ratification pending by the G20, it is clear that the G7 proposal is a historic effort to get the world to align with corporate taxation. But ratification will only be the start of a long process of building a global corporate tax system because, as we have seen, there is no one-size-fits-all solution for countries.

The biggest question mark hangs over whether the corporate tax cut – to 15% in the case of the G7 regime – supports growth, which would be key to the post-COVID recovery. A recent meta-analysis of 42 academic studies suggested that “the attention that corporate taxation has received in debates on structural economic reforms as a source of economic growth seems on the whole overdone. Corporate tax cuts may have boosted international tax competition […] but they do not appear to have contributed significantly to economic growth.

Corporate income tax should not be seen as a panacea, and other – faster – routes should be prioritized alongside.

To close immediate budget deficits, especially in developing economies, it may be useful to consider the concept of the International Monetary Fund as a solidarity tax, taken from high incomes or assets. The IMF sees it as a way to bring together the resources needed to deal with the post-COVID recovery. This suggestion would also test the wealthy, many of whom pay no or very little tax.

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