A global tax on corporations must consider developing nations

As the global economy begins to emerge from the effects of a pandemic the search is on for tax revenues that will support the rebuilding process. One area of focus is the system for taxing multinational corporations, currently a mishmash of fuzzy guidelines, abuse and negative competition.

Last week in Washington, Treasury Secretary Janet Yellen took a second important step toward rationalizing and stabilizing the international taxation system. Having already agreed to drop U.S. objections to taxing digital transactions where profits are made (a European effort to tax Silicon Valley companies for profits made in the EU),  she announced support for a “global minimum tax on multinationals,” a plan being negotiated under the auspices of the Organization for Economic Cooperation and Development.

Calling the competition to attract multinationals by lowering their tax burden  “a destructive global race to the bottom…” Yellen signaled a willingness to reach an agreement that would reach beyond the OECD to more than 140 countries.

A key part of the OECD negotiation reportedly would set the minimum tax floor at 12 percent of a company’s profit margin. The US recently lowered the corporate tax rate from 35 percent to 21 percent and the Biden administration is now considering raising that rate slightly.  However, given the many loopholes in the global system the real rate is much lower. The issue here is tax avoidance and the opportunities have been growing despite soft law guidelines and national efforts to capture tax resources from global companies. 

“Transfer pricing” rules designed by OECD to govern transactions within and between enterprises under common ownership have limited opportunities to distort taxable income. However, that hasn’t closed all the loopholes and many corporations have managed to avoid paying anywhere near the official percentage rate. Working out how a minimum rate would affect trade and investment in individual OECD countries will be complex and national parliaments will quite naturally focus on the benefits and debits that will affect their home constituencies.  

The first step will be reaching agreement among the strongest global economies, the 37 members of the OECD plus China, India and the rest of the G-20. But if  a way can be found to smooth out the inequities among this disparate grouping, what then will be the impact on the middle income and poorest economies? 

Such an endeavor will require a detailed understanding of the reach of multinational corporations, their continuous search for tax havens and supply chains that produce adequate quality at the lowest wage. Developing nations that desperately need employment opportunities find themselves competing by keeping their workers’s wages and benefits low in another, even more debilitating, race to the bottom.

Attracting foreign direct investment is an important development objective in low income countries. Yet, in addition to low wages, their attraction stems mainly from natural resources and highly populated markets. The task is further complicated in the poorest countries by such institutional weaknesses as faulty import-export and commercial codes, banking systems that lack liquidity, highly flexible tax systems susceptible to corruption and inadequate protections for labor. These manifestations of underdevelopment and the instability it creates tends to scare away foreign investment. 

Efforts have been made in the past to exchange more favorable trade provisions and debt forgiveness for meaningful economic reform. Multilateral debt relief was provided under the Heavily Indebted Poor Countries Initiative, but only when it was determined that responsible reform was underway. The same criterion is customarily applied to trade agreements giving access to the markets of OECD countries.

This type of conditionality has been long thought to be unproductive by the development community. Developing nations that succeed in overcoming obstacles to growth increasingly see themselves as partners in the quest for economic development. In response, development effectiveness principles, initially created at OECD aid effectiveness forums, have been universally adopted and conditionality has been replaced with a standard of mutual accountability and selectivity. 

Choosing the benefits of certain reforms is now seen as the prerogative of those who have to live with the consequences. 

Despite these changes in the attitudinal environment, grievances persist. The global trade and finance systems are too often tilted against development as national market protections seem impenetrable to developing economies. That won’t change with a global minimum tax. Further reforms are needed to enable the poorer economies to compete on a level playing field. That competitive edge should not force developing nations to keep their workers’ wages low, lower and lowest.

Yellen has also recommended an allocation of new special drawing rights at the International Monetary Fund to enhance liquidity for low-income countries recovering from the pandemic-related downturn. This is a balanced approach, as rich nations now vying to correct a world of tax avoidance schemes by corporations should place equal attention on the need to support economic development. 

But Western countries can do even more. A portion of the revenues captured in efforts to prevent tax avoidance should be devoted to leveling the playing field for middle and lower income countries where most of the world’s population lives. Greater market access abroad and effective support from donors for domestic reform will smooth the way for higher wages, economic growth and increased global competitiveness.

Brian Atwood is a visiting scholar at Brown University’s Watson Institute. He served as the administrator of The U.S. Agency for International Development in the Clinton administration and was the chair of the Development Assistance Committee at the Organization for Economic Cooperation and Development (OECD) during the Obama administration.