Opinion: G-7 rewrites rules for globalization with landmark deal to curb corporate tax havens

CAMBRIDGE, Mass. (Project Syndicate) —On June 5, the world’s major economies announced a deal that will strengthen their ability to raise taxes for global businesses. The deal still needs the formal approval of a wider set of countries, and many details remain to be worked out for it to be effective. Nonetheless, it would not be a stretch to characterize the agreement as historic.

The G-7 agreement has two parts. First, it proposes an overall minimum tax of 15% on the largest companies. Second, a portion of the global profits of these companies will be recovered in the countries where they do business, regardless of the location of their physical headquarters.

Rewrite the rules of globalization

These goals are as clear an indication that any other rule of hyper-globalization – under which countries must compete to offer global companies ever softer deals – are being rewritten. Until recently, it was US opposition that held back global tax harmonization. Now, by contrast, it was President Joe Biden’s administration that pushed the deal.

Since the race to the bottom in business taxation began in the 1980s, the average statutory rate has dropped from nearly 50% to around 24% in 2020. Many countries have loopholes and generous exemptions that reduce the rate. effective single-digit tax rate.

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Even more damaging, global companies have been able to shift their profits to pure tax havens such as the British Virgin Islands, Cayman Islands or Bermuda, without having to move any of their actual operations there. Estimates by Gabriel Zucman of the University of California at Berkeley reveal that a disproportionate share of foreign profits of American companies is recorded in such tax havens, where they employ only a few people.

Two objections addressed

Leaving aside questions of administrative feasibility, the new agreement could face two opposing objections. Defenders of tax justice will criticize the global minimum of 15% as being too low, while many developing countries will describe the global minimum as an unwarranted restriction that will hamper their ability to attract investment.

The agreement reached by the G-7 appears to reflect both sets of concerns: the low threshold could allay the concerns of developing countries, while the global distribution of profits will allow high-tax jurisdictions to recoup some of their lost revenues. .

Critics say historic G-7 corporate tax deal doesn’t go far enough

Among the developed countries, only Ireland, with a legal rate of 12.5%, is below the proposed minimum. But there are small countries like Moldova (12%), Paraguay (10%) and Uzbekistan (7.5%) that have set their rates particularly low to attract foreign investors, which they see as a source of quality jobs and cutting-edge technologies. In inhospitable investment environments, lowering taxes is one of the few immediate ways in which governments can compensate businesses for the many disadvantages they face.

And effective tax rates in some Asian countries, like Singapore (where the statutory rate is 17% but lower rates apply to some companies), can also end up on the wrong side of the minimum.

The prisoner’s dilemma

The argument for imposing a common floor for corporate taxation is strongest when countries have similar preferences and want to avoid the prisoner’s dilemma in which their only reason for lowering taxes is to prevent the capital to go elsewhere. This can apply to most developed countries, but certainly not to all, as the examples of Ireland, the Netherlands and Singapore indicate. But when countries differ widely in terms of levels of development and other characteristics, what is appropriate in one may be a barrier to growth in another.

The United States and high-tax European countries could complain about losing tax revenue when poorer countries keep rates lower. But nothing prevents these countries from unilaterally taxing their parent companies at higher rates: they can simply apply the tax to domestic companies. global profits, distributed according to their share of income from the domestic market. As Zucman argued, each country can do it alone, without harmonization or even global coordination.

This is precisely what the second part of the G-7 agreement envisages (although it is only part of the way). Under the agreement, the largest multinational companies with profit margins of at least 10% are expected to allocate 20% of their global profits to the countries where they sell their products and services.

The reason the United States prefers an aggregate minimum, in addition to the national allocation, is that it does not want its businesses to be disadvantaged against businesses in other countries by taxing them at significantly higher rates. But this competitive motive is no different from the desire of poor countries to attract investment. If the United States wins and the United States loses, it will be because of relative power and not economic logic.

The Biden administration initially wanted the overall minimum tax to be set at 21%. The possible compromise of 15% could be low enough to minimize tensions with the poorest countries and allow the latter to engage. The balance between global rules and national sovereignty may have been appropriately struck in this case.

But for countries like the United States, this comes at the cost of lower tax revenues, unless the second part of the distribution is strengthened. Ultimately, a global regime that improves the ability of individual countries to design and administer their own tax systems, in light of their own needs and preferences, is likely to prove to be more robust and sustainable than attempts at tax harmonization. international.

What is now clear is that countries that operate as pure tax havens – simply interested in transferring paper profits without bringing in new capital – have little to complain about. They have rendered a great service to global corporations by facilitating tax evasion at considerable cost to the treasuries of other countries. The world rules are fully justified to prevent such blatant beggar action for your neighbor. The G-7 agreement is an important step in the right direction.

This comment was posted with permission from Project Syndicate — The G-7 Tax Clampdown and the End of Hyper-Globalization

Dani Rodrik, professor of international political economy at the John F. Kennedy School of Government at Harvard University, is the author of Straight Talk on Trade: Ideas for a Sane World Economy.

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