Commentary: Under-taxed profits of multinationals could fund higher public spending in post-pandemic recovery
The G7’s groundbreaking agreement on a minimum effective corporate tax could fund important infrastructure and social services needed for a post-COVID recovery, says Yale-NUS College’s John Driffill.
SINGAPORE: The most powerful countries in the world have reached an agreement on a longstanding issue that will have global ramifications for years to come.
In early June, G7 finance ministers agreed on a “historic” deal to coordinate corporate taxation, making the largest multinational corporations pay at least 15 per cent of their profits in effective tax.
This is aimed particularly at large digital Big Tech businesses, many of which have paid remarkably little in corporate taxes in recent years, in countries where they do substantial amounts of business.
READ: Commentary: One of Big Tech’s biggest critics is now its regulator. This has implications for users globally
Amazon recorded sales of €44 billion (US$53 billion) in Europe in 2019, but paid no corporate tax, because its Luxemburg subsidiary, which runs its European operations, recorded a loss of €1.2 billion. This is despite Amazon being a highly profitable business overall.
Apple was ordered by the European Commission in 2016 to pay Ireland €13 billion of unpaid corporate taxes, because, the Commission argued, the “hybrid Double Irish” scheme used by Apple to shield €110.8 billion from taxes between 2004 and 2014 was illegal.
Apple’s appeal against that decision succeeded in 2020, and the European Commission has appealed to a higher court against the 2020 ruling. Whatever the outcome, the avoidance schemes enabled Apple to reduce its corporate tax payments substantially.
READ: Commentary: The global minimum corporate tax rate is coming our way and will change how Singapore attracts MNCs
FOOTLOOSE ECONOMIC ACTIVITY
These are signs of a widespread practice of large multinational corporations using elaborate (and, for the most part, entirely legal) schemes to reduce taxes on their profits.
At the same time, countries have been lowering their headline corporate tax rates, which have fallen from an average of 28.6 per cent in 2000 to 21.4 per cent in 2018, as countries compete for multinationals’ investments, according to OECD estimates.
This trend has been enabled by the growth of digital businesses, because it is not obvious where the profit-generating activity of such firms is located, and profits can be easily shifted to jurisdictions with friendlier corporate tax regimes.
The effect of footloose economic activity is compounded by the growth in importance of intellectual property. Many legal tax avoidance schemes rely on tax laws giving favourable treatment to profits made from royalties for its use. Consequently, the effective tax rate in many countries is much lower than the headline rate.
The OECD estimated the annual loss to be between US$100 billion and US$240 billion in 2015, or between 4 per cent and 10 per cent of global corporate tax revenue.
ENDING THE RACE TO THE BOTTOM
The agreement aims to remove the incentives for firms to shift profits to low tax jurisdictions and for countries to offer low tax rates and special deals.
If a country taxes the profits of a multinational firm located in it at a low rate, less than 15 per cent, the country in which the multinational is headquartered will be entitled to charge the firm the difference between the low tax rate and the agreed minimum 15 per cent.
If the country in which the multinational is headquartered imposes a low tax rate, countries where it does business in will be able to charge a tax on a proportion of its profits, to bring the tax up to 15 per cent.
Firms will then find no advantage in shifting profits to low tax jurisdictions. And countries will find no advantage in offering low tax rates or special deals: They will not attract such multinationals. In fact, the opposite will occur: Countries will have an incentive to raise their effective tax rates to the agreed minimum.
The G7 agreement has been criticised for setting the minimum tax rate as low as 15 per cent, which will impose little (if any) burden on multinationals and raise little extra tax revenue.
The minimum should have been set at 21 per cent, as the US has argued for. Better still, 25 per cent, as many analysts have proposed. Nevertheless, this might be a useful opening move in reversing the race to the bottom.
The G7 agreement is driven by the major economies. The biggest winner will be the United States. But there will be knock-on effects on low- and middle-income countries, who rely on corporate income tax more than the rich countries.
In 2017, African countries raised 18.6 per cent of their revenue from corporate income tax; Latin America and Caribbean countries, 15.5 per cent; meanwhile, OECD countries, only 9.3 per cent. It might be thought that if these countries are not able to offer low tax rates to attract multinationals, their government revenues, investment and development will suffer.
However, OECD estimates and academic studies indicate that low- and middle-income countries have lost out significantly from tax competition, and will gain from being able to impose higher rates. Only those countries regarded as investment hubs, with inward foreign direct investment over 150 per cent of GDP, are likely to lose.
SURGING GOVERNMENT BORROWING
Why should governments be so worried about missing revenue when corporate tax as a fraction of national income has been roughly constant over the last twenty years? There has been no general downward trend. The fall in tax rates has been offset by the growth of profits as a share of national income.
Yet governments are rightly concerned about rising public debt, growing inequality, populism, and the possible effects of artificial intelligence and robotics.
They have had to borrow massively. The 2008 Global Financial Crisis and its aftermath saw trillions spent bailing out failed banks and keeping unemployment in check.
The COVID-19 pandemic has required even more trillions to keep businesses afloat and support laid-off workers.
The United States government is pushing US$2 trillion dollars of infrastructure spending through Congress, with the US debt-to-GDP ratio forecast to rise to 133 per cent by the end of 2021, up from 65 per cent in 2007.
Japan’s will rise to 256 per cent, up from 173 per cent in 2007. Italy’s is forecast to be 157 per cent of GDP, France’s 115 per cent, up from 64 per cent.
While interest rates remain close to zero, servicing these debts is not a major burden on the public finances. But with a vigorous post-COVID-19 rebound and higher interest rates, the most heavily indebted countries could find themselves in difficulties.
REFILL PUBLIC COFFERS
High debt leaves governments with little fiscal space in which to respond to the next crisis, not to mention the growing pressure on governments to take an interventionist position in the coming years.
There is vigorous pushback against the market liberalism and hands-off public policy of recent decades.
Advanced economies like the US have seen wages of low-skilled workers stagnate, even as globalisation has raised millions from poverty in China, to some extent in India, and in many emerging markets. Industries and communities in the US mid-west have been hollowed out.
Austerity policies have eroded spending on social services and local government. Meanwhile, the richest 1 per cent and the mobile global elites have prospered.
We have already had the rise of populism, Brexit, and the election of Donald Trump. Centrist, social democratic, liberal governments, will have to respond to the sense of injustice created by growing inequality.
And governments may have to spend yet more if fears about the effects of robotics and artificial intelligence prove well-founded. Rising unemployment and falling salaries among the middle classes will intensify pressure for redistribution.
For all these reasons, governments are anticipating greater demands for public spending in coming years. The under-taxed profits of vast, seemingly uncontrollable corporations are an obvious target.
John Driffill is a Visiting Professor of Social Sciences (Economics) at Yale-NUS College in Singapore.