The good and the bad in the global tax reform deal

A total of 130 countries signed up to the global tax agreement. Photo / Getty Images

OPINION:

Let us not be too curmudgeonly: the agreement by 130 countries to reform international corporate taxation is a big moment. It is not often that a global near-consensus is reached on something with such concrete consequences.

Yet while congratulations are in order, the outcome is mixed at best. Here is the good, the bad and the ugly of the reform.

First, the good. The deal addresses the worst problems of international profit taxation. These flow from the principle that taxing rights follow the residence of corporate entities. That may have made sense when value added arose from physical goods production. When value instead resides in intangible services and intellectual property, it is a recipe for abuse. It is estimated, for example, that 40 per cent of global foreign direct "investment" is structured to lower taxes rather than for actual business investment reasons.

Such invitations to game the system have not just meant that multinational corporations pay less tax than legislators intend them too. Governments also set tax rates lower than they would if they did not fear those companies would shift their profits elsewhere.

The deal attacks this by introducing a minimum global profit tax rate of 15 per cent and shifting the right to tax a slice of that profit from the place of residence to the place of sale.

Economists who have crunched the numbers find this makes a significant, if not earth-shattering, difference. A forthcoming report by EconPol researchers Michael Devereux and Martin Simmler estimates that taxing rights to $87bn of profit will be redirected to countries of sale. France's official Council of Economic Analysis (CAE) puts the number at US$130bn. At typical rates, that amounts to US$20-30bn worth of annual tax revenue.

The minimum tax, the CAE finds, could raise corporate tax revenues by €6bn-€15bn for each of France, Germany and the US.

The outcome is some way removed from the earlier focus on Big Tech. The political impetus came from European states indignant at derisory taxes paid by the US internet sector despite huge revenues generated in their markets. As they unilaterally passed sales-based digital services taxes, they gave political momentum to global talks.

But economically, it never made sense to single out digital services. The marvels of intellectual property accounting let multinationals spirit away profits from exceedingly tangible goods and services, from cups of coffee to taxi rides. Including all the biggest multinational corporations, a US demand, was therefore an improvement on earlier plans.

Now for the bad. The agreement only very partially solves the problem. Too few multinational corporations are included. Even with a minimum rate, most corporate profit will still be taxed according to the residence principle. The anomalies it spawns will therefore remain, too. The modest minimum rate leaves in place incentives to shift profits to low-tax jurisdictions (which therefore have little reason to complain). The deal will not get rid of the poor optics of belt-tightening governments and tax-dodging mega-corporations — not once politicians start seeking ways to close record public deficits.

There are also special carve-outs for banks and natural resource companies. This may be justified for the latter; it makes sense to tax them where they extract hydrocarbons and minerals. For banks, the pretext is that they are regulated and taxed in the markets they serve. But if that were true, they would not be affected by the reallocation of taxing rights. In fact, they had a lot to lose: Devereux and Simmler find the reallocated tax base would be twice as big without the bank carve-out.

Finally, the ugly. Governments have missed an opportunity to simplify the rules, leaving fertile ground for new and clever techniques to circumvent their intention. Rather than haggling about carve-outs and thresholds, leaders could have bargained over the relative weighting of investment, employment and sales in a fully formula-based allocation of multinational corporations' entire global profits.

In time, thresholds can be lowered and exemptions narrowed. But not if this deal is taken to preclude any future changes. The US has demanded that other countries withdraw unilateral digital taxes when the new rules are sealed. That's reasonable only insofar as it does not block reviews of the framework.

This welcome process must not stop here. This was a giant leap for politicians to make. Yet it remains a mere first step for the global economy.

Written by: Martin Sandbu

- Financial Times