A simpler global tax plan needed

With the Biden administration’s support, more than 130 countries have lined up in favor of a vast global redesign of the corporate tax landscape. The goal, endorsed in principle by many taxpayers, calls for multinational giants to pay their “fair share” of taxes rather than running off to tax havens like Bermuda and the Cayman Islands. As popular as these goals may be, finding practical ways to achieve them remain highly problematic. Instead, a simpler approach has a better chance of succeeding.

One proposal in the redesign advanced by leading industrial countries in the Organization for Economic Cooperation and Development (OECD) calls for a global minimum corporate tax rate of 15 percent. Another calls for reallocating and taxing a slice of profits in countries where corporate giants sell their goods or services, rather than where they produce.

The 15 percent global minimum is drawing fire in the U.S. Congress, on worries about competition from lesser taxed foreign firms. Challenges also await enactment of the proposal to reallocate tax revenues to countries that purchase the goods. A raft of disagreements can open as countries wrangle to exclude local favorites or include foreign targets among affected entities. 

Once the list of corporations subject to the reallocation is finalized, the next step would be to divide their profits between what proponents call Amount A and Amount B. Amount A represents “excess” profits above an agreed threshold of 10 percent return on assets. As many as 780 corporate giants may meet this threshold, and their excess annual profits could collectively amount to nearly half a trillion dollars. Under the current proposal, 20 percent of excess profits would be reallocated to countries where corporations sell their goods or services for taxation, approximately $100 billion.    

To calculate Amount A (taxed in part by the market country), Amount B (taxed solely by the producing country) must first be subtracted from total profits. But how are total profits to be calculated? By the financial statement of the corporate giant? By the tax laws of each country where the giant produces or sells? And how is Amount B calculated? Tension exists between producing countries, which seek a large Amount B for their tax coffers, and market countries, which strive to augment Amount A. 

The next obstacle is agreement on the formula for dividing Amount A between market countries. Finally, in some countries Amount A will already be taxed under current law when earned by a local corporation, creating another contradiction.    

The G7 answer to inevitable contradictions is a Multilateral Tax Convention (MTC). When conflicts arise between the convention and national tax legislation or bilateral tax treaties, the MTC would prevail.  

Agreeing on a convention is a huge challenge. Prior efforts at international tax reconciliation by the League of Nations, the United Nations and the OECD have taken the form of voluntary guidelines and model treaties. Even those multilateral projects took years to conclude.    

Skepticism is further warranted by the companion proposal for binding dispute settlement in the convention. Recent experience with dispute settlement in the World Trade Organization (WTO) indicates that the U.S. Senate often rejects the idea that a multilateral body can impose its will on the United States.

Finance ministers are fully aware of these obstacles. Some 25 of them have imposed or proposed digital service taxes (DSTs), simpler gross revenue taxes that resemble tariffs, largely aimed at tech giants like Amazon and Facebook. Under the G7 proposal, DSTs will be replaced by the reallocation of profits. Earlier, the Trump administration threatened to retaliate against France and other DST proponents with its own tariffs. The threat was suspended by the Biden administration as part of the G7 embrace of tax reallocation. If talks to draft a Multilateral Tax Convention drag on, however, many DSTs may be imposed.  

The best way to avert this undesirable outcome is a simpler method for reallocating tax rights. One possible approach is an agreement requiring corporate giants (including tech platforms) to establish corporate subsidiaries in each market country and to distribute all their goods and services through those local subsidiaries. Subsidiary earnings would be primarily taxed by the market countries. The G7 could then nominate an entity to monitor and adjudicate transfer prices between various units of the corporate giants, ensuring that market countries get their fair share of taxing rights.  

Simeon Djankov is a senior fellow at the Peter Institute for International Economics (PIIE).

Gary Hufbauer is a senior fellow at PIIE.