A few days back there was a historic announcement by the G-7 Finance Ministers on globally harmonised rules for taxing multinationals.
The detail of the first part of the agreement, a significant US concession by the Biden administration, made it clear that “the largest global companies” with profit margins of at least 10 per cent would, in future have to allocate 20 per cent of their global profits to countries where they make their sales. If implemented this would overturn a century of international corporate taxation, where profits are taxed only where companies have a physical presence...The definition of the largest global companies is still to be ironed out. This part of the deal will require a global accord later this year. In return for this concession, the US has gained agreement from the rest of the G7 for each country to impose a minimum global corporate tax rate of at least 15 per cent. This will reduce the incentive for large companies to declare profits in tax havens or low tax jurisdictions such as Ireland because the country in which the company is headquartered will be able to top up corporate tax payments to the global minimum effective level. The US is expected to be the largest beneficiary of this second pillar of the deal.
While acknowledging this as a definitive break from the dominant narrative on taxation, especially multinational corporate taxation, Alex Cobham of Tax Justice Network urges caution on excessive optimism.
But the OECD has narrowed this substantially, and the G7 has narrowed it still further. Now only 100 multinationals are likely to be affected, and only a fraction of their profits above a 10 per cent margin will be apportioned to their sales jurisdiction (with no weighting for the jurisdictions where employment occurs). The OECD estimates this will bring in additional revenues of $5bn to $12bn a year, a 2-5 per cent reduction in the estimated annual losses of $245bn due to profit shifting. The benefits of pillar two are much greater. The OECD estimates that a global minimum tax rate of 12.5 per cent, which would apply to perhaps 8,000 multinationals, could yield nearly $100bn a year in additional revenues. Our estimates show a 15 per cent minimum rate could raise as much $275bn a year. A 21 per cent rate, favoured by the Biden administration, or a 25 per cent rate as recommended by the Independent Commission for the Reform of International Corporate Taxation, would raise far more.
The OECD approach privileges headquarter countries. This means that if a French multinational shifts profits out of Brazil to benefit from Bermuda’s 0 per cent tax rate, it would be France that could “top up” the taxes on that profit to 15 per cent. As most of the largest multinationals are headquartered in OECD countries, the majority of the benefits would go to them. G7 members, with 10 per cent of the world’s population, stand to receive more than 60 per cent of the additional revenues. The alternative proposed by the Tax Justice Network, the Minimum Effective Tax Rate (METR), would allocate undertaxed profits according to the location of the multinationals’ real activities. They would be taxed at the national headline rate, rather than at the agreed global minimum, to avoid incentivising profit shifting. A 15 per cent rate would raise as much as $460bn in additional revenues. For major G20 members outside the G7, the difference is stark. At a rate of 15 per cent, India could gain $13bn rather than $4bn; and China $72bn rather than $32bn. Additional revenues would double or even triple for countries such as Brazil and South Africa.
At a conceptual level, there are at least two factors to be considered. One, one does not know which side of the so-called Laffer curve is the marginal rate, and if reduction of rate will actually increase revenues. Second, the link between lower rates and higher investments is deeply questionable. There is little evidence on both, given the current circumstances.
Most countries have experimented with corporate tax rate reductions in recent years on the back of pressures from global and domestic "reform" constituencies. Consider India's series of reforms,
In 2016-17, new manufacturing companies incorporated on or after March 2016 were given the option to be taxed at 25 per cent plus surcharge and cess (compared to 30 per cent plus surcharge, etc.) if they did not claim profit-linked or investment-linked deductions, investment allowances, or accelerated depreciation. Additionally, the tax rate for all companies with an annual turnover of less than Rs 5 crore was brought down to 29 per cent plus surcharge and cess. In 2017-18, the tax rate for small and medium companies with an annual turnover of up to Rs 50 crore was brought down to 25 per cent. This meant about 96 per cent of companies that filed a tax return were brought under a concessional tax rate of 25 per cent plus surcharge and cess... In the following year, 2018-19, the government extended the coverage of the 25 per cent tax rate to cover all companies with an annual turnover of up to Rs 250 crore — a move that would benefit 99 per cent of companies filing tax returns and deprive the government of an additional annual tax revenue of Rs 7,000 crore...In 2019-20, the government extended the concessional tax rate of 25 per cent to all companies with an annual turnover up to Rs 400 crore, thereby covering 99.3 per cent of all companies filing tax returns. Subsequently, in September 2019, all companies not availing themselves of the various exemptions and incentives like tax holidays were allowed to be taxed at 25 per cent, inclusive of the 10 per cent surcharge and a 4 per cent cess. Moreover, manufacturing companies starting operations after October 1, 2019, were to be taxed at an overall rate of 17 per cent.
This is an impressive set of reforms in following the principles of Econ 101. And if the narrative and opinion makers were correct, there should have been greater investments and higher revenues, at least some signs. But the reality has been very different. Consider this balance sheet of India's corporate tax rate reduction,
The corporation tax collections in 2020-21 were around 17.9% lower than in 2019-20, when they had stood at ₹5.57 trillion. In comparison, income tax collections fell by just 2.3% between 2019-20 and 2020-21. They had stood at ₹4.80 trillion in 2019-20... In September 2019, the Centre cut the base corporation tax rate to 22% from the earlier 30% and 15% from the earlier 25% for new manufacturing companies... the investment-to-GDP ratio in 2020-21 falling to a two-decade low of 27.1%. It was at 28.8% in 2019-20. The ratio has largely been falling since peaking in 2007-08 at 35.8%. Hence, we have a peculiar situation where listed corporations have made their highest profits ever, and the corporation tax collections have declined. The extent of the fall can be gauged from the fact that corporation tax collections in 2020-21 were almost similar to that in 2015-16 when they were at ₹4.53 trillion.
Obviously, since there are too many things going on it's too early to pass a verdict on India's corporate tax reduction of 2019. However if we take the series of rate cuts over the last six years as a whole and compare with trends on investments and total revenues, there is at least some argument in favour of the case against corporate tax rate reductions. In any case, beyond the entrenched narrative on tax reduction, there was no evidence to back the case for lowering corporate taxes in India in 2019. Further, effective tax rates in many industries were extremely low given the large numbers of exemptions.
The argument about lowering marginal tax rates while also removing exemptions, though theoretically great, bears great similarity to that about lowering tariffs and also redistribution from winners to losers. In case of trade, as we have seen over decades, while the former has been happening, the latter is too politically fraught and with entrenched lobbies as to materialise. On the same lines, while lowering marginal tax rates happens at the stroke of a pen, the latter, even when announced, gets entangled in the deep thickets of political economy and vested interests. Even a cursory glance at the long list of exemptions in the Receipts Budget 2021-22 will reveal the scale of this challenge.
Further, the belief that tax exemptions can be eliminated with administrative diktats underestimates the power of the tax avoidance industry. Given the opaque corporate shareholding structures, complexity of tax rules, weak state capacity, open economies, globalised supply chains, multinational corporations etc, and the army of tax avoidance experts that large corporates employ, it's fair to argue that corporate tax avoidance strategies will always remain far ahead of tax regulations.
The net result will be that ultimately corporates will get their lower marginal taxes and also get to keep the exemptions! Heads I win, tails you lose!