Originally published by IFC Review on June 7, 2023.
Efforts to radically reorganise global corporate taxation passed a major milestone when the European Union unanimously agreed to implement Pillar 2, the 15 per cent global minimum tax component of the Organisation for Economic Cooperation and Development’s (OECD) dual-pillared campaign, at the end of last year. While the 138 nations then in the “Inclusive Framework on Base Erosion and Profit Shifting (BEPS)” reached agreement in October 2021 on the minimum tax, along with the Pillar 1 system reallocating tax rights to jurisdictions in which companies make sales but have no physical presence, there were questions regarding if and when domestic implementation would begin to follow.
Can low-tax jurisdictions finally rest easy? Sure, they will have to adjust to the new minimum tax and other rules, but is the bureaucratic hand-wringing from the G20 and OECD finally at an end? Perhaps it is, but how often is a crocodile really appeased if you feed it just one hand?
First, there’s the whole business of finalising specific rules and seeing them implemented in participating nations. This process is not guaranteed to succeed, with challenges surrounding the details of Pillar 1 looking particularly daunting. But even beyond that, history simply doesn’t lend itself to the idea that the high-tax jurisdictions driving the OECD agenda will be satisfied with gains from completing the BEPS project.
Motivations Behind BEPS
The whole effort began with a fairytale; namely, that corporate tax revenues were dwindling and something just had to be done or nations would be left impoverished. This is the so-called “race to the bottom” repeated ad nauseam by tax ministers and an unquestioning media. The evidence never supported this claim, as corporate tax revenues as a share of GDP among developed nations have stayed fairly level over time.
Corporate tax rates, on the other hand, have certainly changed. Tax competition brought about by cuts from Reagan and Thatcher led to decades-long reductions in statutory corporate tax rates across the developed world. The process also saw an explosion in the number of flat tax regimes and reductions in other particularly damaging taxes such as those on estates and wealth. But growth effects from adopting less economically destructive tax systems ensured that revenues did not similarly plummet.
Why did reductions in corporate tax rates that didn’t result in similar reductions in revenues prove so upsetting to tax collectors that they undertook a two-decades long war on tax competition? Part of the explanation is an ideologically driven preference for higher tax rates regardless of their revenue impact, but is that enough to explain the doggedness of the OECD’s quest to eradicate tax competition? Perhaps. But more parochial interests might also provide some insight.
The OECD claims to be operating in the interests of its collective membership. But any agreement reached on international taxes is guaranteed to have winners and losers, and I don’t think anyone will be surprised when the winners turn out to be the same bloc of European nations driving the organisation’s agenda.
Moreover, while claims of a race to the bottom and a subsequent dirth of tax revenues have proven false, it’s still likely the case that they might be able to collect more revenue if not for the fiscally disciplinary role of tax competition, and are thus resentful.
Just how much more are we talking? A recent IMF paper[i] claims that the reform “modestly raises global tax revenues,” and the OECD estimates Pillar 2 will raise around US$220 billion spread among all governments. There’s reason to suspect that figure is overstated, but even if it’s not, it pales in comparison to the over US$22 trillion spent collectively by OECD nations each year. Estimates produced by nations looking at the impact of domestic implementation range from 3-10 per cent increases in average corporate tax collection. Corporate taxes, however, make up a relatively small share of revenue for most governments—less than 10 per cent on average among OECD members.
Quite frankly, the estimated revenue figures are nothing less than an indictment of the entire endeavour.
Have bureaucrats really been hyperventilating for decades about a “race to the bottom” for their massive and very costly solution only to raise a measly one per cent of the wealthiest nation’s annual spending? The level of political dishonesty this reveals ought to be criminal.
When you consider all the evidence, it’s clear that European welfare states are concerned not just with growing corporate tax collections, but also in redistributing that revenue for their benefit. They want offshore financial centres and other nations that seek to provide regimes hospitable to business to host less of the overall economic activity so that their bloated welfare states can get more.
Will Others Follow The EU?
According to its claims, the OECD is a consensus-based organisation. It makes use of this concept to counter arguments against imposing onerous requirements on OFCs and low-tax countries. But it’s disingenuous. Low-tax jurisdictions still routinely find themselves blacklisted by the EU and attacked by its member countries despite spending years and large sums of money to comply with OECD standards. The OECD employs peer reviews to assess how well offshore jurisdictions abide by its regulatory and information sharing requirements, but no such procedure is in place for high-tax countries that engage at the OECD level in bad faith by reaching agreements only later to impose unilaterally more stringent requirements.
Given this reality, it’s fair to ask if and when smaller jurisdictions will stop playing by the rules of the game as imposed by and for the advantage of European welfare states. Will OFCs and low-tax jurisdictions ever coordinate among themselves to build a political counterweight to the emerging global tax cartel, or is perpetual appeasement the only remaining strategy?
At least for the near future, the United States is unlikely to follow Europe’s lead. Efforts to implement the agreement last year failed in the narrowly controlled Democratic Senate. It has even less chance after Republicans took power in the House and a competitive presidential election now looms. Several Republican leaders recently wrote a forceful letter contending that the Biden administration acted beyond its authority in the OECD negotiations, promising “Congress [will not] sit idly by as U.S. companies and profits are taxed in a manner inconsistent with U.S. law and our bilateral tax treaties.”
It will take more nations than just the EU to make the system work. The key element of Pillar 2, and the most galling from a perspective of fiscal sovereignty, are the “top-up” taxes in which participating nations increase tax collection on behalf of non-participating nations that tax profits at less than 15 per cent.
While appearing a clever mechanism that would allow the OECD to put the final nail in the coffin of tax competition, “top-up” taxes should be understood as just a raid on corporate coffers by another name. Economic activity in one jurisdiction doesn’t suddenly become a valid basis for taxation by an uninvolved jurisdiction simply because the one hosting the activity chooses not to tax it.
It’s nothing less than a frontal assault on the Westphalian system. No amount of false consensus will ever give it legitimacy.
The path to implementing Pillar 1, meanwhile, looks even more fraught. The agreement putting a moratorium on digital service taxes expires at the end of the year, and nations may start imposing their own taxes if the OECD has not by then completed a multilateral convention. Incompatible expectations among participants might make the details of a final rule impossible to agree upon. One interesting question then arises: If Pillar 1 falls apart, is there even enough momentum for Pillar 2 to reach the critical mass it needs?
What Comes Next
As if the variables presented thus far don’t paint a chaotic enough picture, another organisation lurks in the shadows. The United Nations agreed last year to a resolution expanding the organisation’s role on international tax. The move represents a direct challenge by developing nations to the work of the OECD as directed by rich welfare states. It’s likely that whatever comes from the United Nations will be worse as a matter of policy, but its mere emergence is an existential threat to the tax division of the OECD as it shatters the myth of consensus the organisation relies upon.
Of course, the UN has a long track record of dysfunction and incompetence, so it’s entirely possible that nothing comes of its upstart tax efforts and the OECD continues its work as planned. Let’s say it even succeeds despite the many remaining challenges. What follows?
Notably there are other ways for nations to compete than just on tax. Which makes you wonder, if the OECD gets everything it wants on taxation and there’s no advantage left for nations imposing little to no corporate tax, will they be satisfied? Or will a “regulatory race to the bottom” become the next manufactured crisis, with the inevitable calls for regulatory harmonisation following soon thereafter?
Footnotes:
[i] https://www.imf.org/en/Publications/Policy-Papers/Issues/2023/02/06/International-Corporate-Tax-Reform-529240
