The writer, a former member of the Bank of England’s monetary policy committee, is a distinguished fellow at Chatham House
Joe Biden proves to be both brave in his tax ambitions and brave in his choice of battles. This is especially true of the latest attempt by the US President and his Treasury Secretary Janet Yellen to penetrate the corporate tax labyrinth. Secret rules have long shaped the financial structure of international companies, which use legitimate loopholes to save tax. So there are significant benefits to reforms, not least by funding Biden’s multi-billion dollar spending plans. Reform, of course, requires overcoming systemic inertia and deep-seated political opposition. Thus, the campaign will also test Biden’s ability to mobilize coalitions to drive change.
His plan responds to three different factors. First, there is the need to generate revenue after the pandemic. Raising the overall U.S. corporate tax rate from 21 percent to 28 percent would generate an estimated $ 2 trillion in additional revenue over 15 years. While not earmarked, it would help pay for the new public infrastructure the US needs. It would also show the financial markets that there are plans to contain the rise in government debt. I find it hard to believe that 28 percent is inordinately high: the Trump administration’s 35 percent tax cut in 2017 is only partially reversed.
As a way to tame deficits, corporate taxes are likely less threatening and more politically acceptable than the IMF’s recent suggestion on property or estate taxes. In the UK, Chancellor Rishi Sunak also sees corporate tax as an attractive source of income. In his March budget, he announced a gradual increase of a corporate tax rate from 19 percent to 25 percent from 2023. In fact, both countries may now be at the forefront of reversing the 20-year trend of lower corporate tax rates worldwide.
The second force behind Biden’s reform is the opportunity to close loopholes in international tax law by building on the OECD’s work with an unmistakable name on “base erosion and profit shifting.” Due to tax complexity and the room for arbitrage, raising taxes in one country often incentivizes businesses to shift profits to countries with lower taxes or ports without taxes.
The OECD describes such countries, where foreign direct investment accounts for more than 150 percent of gross domestic product, as “investment hubs”. Some of them are small countries or areas such as Hong Kong and Bermuda. In addition, so-called “related parties” revenues – usually intra-company transactions – in such hubs represent an average of 40 percent of their total revenues, according to the OECD. Thus, there is likely to be a major impact from Biden’s proposal to remove U.S. tax deductions that are being demanded by companies making payments to related parties in low-tax jurisdictions.
At the same time, Biden’s proposal of a global minimum corporate tax rate of 21 percent seeks to counter a “race to the bottom.” It is unlikely that agreement will be reached at that level. It will also be impossible to enforce. Still, establishing a global benchmark and monitoring compliance can push countries in the right direction.
Finally, the proposal to partially tax large international companies on the share of their sales in guest markets would be a sweeping global reform. Although it was long debated in the OECD, the Trump administration was unwilling to participate unless it was voluntary for corporations. Biden’s proposal, instead asking countries to sign up, would help allay justified public anger against foreign multinationals that have a large presence in host markets but pay little or no taxes there.
In Europe, technology companies such as Facebook and Google have faced those criticisms, and both France and the UK have threatened to introduce a unilateral digital services tax. The Biden proposal instead targets large companies in all sectors, which is both easier to manage and fairer as countries have different strengths in different sectors. Such a sales-based approach to a company’s allocation of tax assessments to different countries, if agreed, would be a big change. It would help build tax structures that take into account the rapidly digitalizing global economy.
Together, these three forces provide a unique opportunity to reform an outdated, opaque and unfair global corporate tax system. There will be opposition from some large corporations and many small tax havens. Estimates of the benefits and costs, and the winners and losers, will increase rapidly. So watch out for the numbers that will soon be flying in all directions. The sheer complexity of the current tax rules will make it difficult for even one company to estimate the overall impact. The effect on the business location and supply chains can only be guessed.
I have served on the audit committees of several international companies and can confirm that a lot of unproductive, if necessary, time is spent on legal tax planning. Once structures are in place and approved by external auditors, they rarely change. If they do, legal challenges can ensue. Yet few can defend the current system as economically efficient or productivity-enhancing. In contrast, Biden’s tax reform could deliver significant benefits by better matching businesses’ choice of location to underlying supply and demand. As a by-product, it can also help dispel the public’s distrust of successful international companies. So it is a bold plan, also a bold and global one, with many potential benefits.