On Wednesday, Liz Truss will use the Margaret Thatcher memorial lecture in Washington to call the Organisation for Economic Co-operation and Development (OECD) a “global cartel of complacency” whose high tax policies are holding back growth. I fear she is right.
In particular, Ms Truss will warn against the OECD’s plan for a minimum 15 per cent corporation tax rate for multinational companies, which is due to come into effect at the start of 2024. This plan is both wrong in principle and will be very hard to operate in practice.
To recap, 138 countries have now signed up to a global agreement which is designed to ‘modernise’ the international tax system. The main target is ‘profit shifting’, where companies book profits in jurisdictions where tax rates are lower.
This agreement has two elements, or ‘Pillars’. Under ‘Pillar 1’, the largest and most profitable multinationals will be required to pay more tax where sales are actually made, rather than where companies happen to be based for tax purposes.
Under ‘Pillar 2’, countries have signed up to a global minimum corporation tax rate, which will initially be set at 15 per cent. On paper, they will still be free to set their own individual tax rates, thus maintaining the illusion of sovereignty. This agreement will also not apply to purely domestic companies.
However, if signatories do not charge at least 15 per cent on the profits of a multinational firm, the country where this company is based will be able to levy an additional tax to bring the effective rate up to 15 per cent. If this works – which is a big ‘if’ – countries will have no incentive to offer a lower rate than the global minimum in order to attract international businesses.
Supporters of this plan argue that it is a necessary response to the challenges of globalisation and digitalisation. It is meant to ensure that multinationals pay their ‘fair share’ of taxes and to prevent ‘harmful’ tax competition from leading to a ‘race to the bottom’.
This is rousing, popular stuff. But it is also guff.
For a start, it is just plain wrong to treat companies as independent sources of revenue that can be tapped at will. In fact, they are only legal entities and cannot bear the economic burden of taxation themselves. That burden always lands on real people, including customers in the form of higher prices and employees as lower wages.
Of course, some of the bill (most studies suggest less than half) will be picked up by shareholders, who might be relatively well off. But not every shareholder is a tech billionaire.
The narrative that higher tax bills for ‘companies’ means that less money needs to be raised from ‘people’ is therefore fatally flawed.
I would go further. Companies make their money by providing goods and services that people want to buy. In the process, they also invest and create jobs. These are their contributions to society, not the tax they are expected – or assumed – to pay.
The concepts of ‘fair shares’ and ‘harmful’ tax competition are also slippery.
A ‘fair share’ here usually just seems to mean ‘more than they are paying now’. This often involves misleading comparisons, such as between tax bills and turnover, or between global profits and tax payable only in the UK.
The idea that tax competition is a ‘bad thing’ is strange too. Competition on tax, as in any other aspect of economic life, encourages innovation and efficiency. It also acts as an important check on a government’s ability to tax and spend.
On top of this, the OECD’s own research has confirmed that corporate taxes are the most harmful to economic growth, mainly because they drag on investment. Indeed, the share of OECD tax revenues raised from corporate taxes has actually been increasing, despite – or more likely because of – a downward trend in OECD corporate tax rates.
Both Pillars are also based on shaky foundations. As it stands, the current plan will not even achieve what its supporters hope for.
One flaw in the global minimum tax rate is immediately obvious. Currently, only a handful of countries (notably Hungary, Chile and Ireland) have statutory rates below 15 per cent.
But once the principle has been established, there will inevitably be pressure to increase the minimum rate over time. The Biden administration originally proposed a figure of 21 per cent. And since the 15 per cent will apply to the ‘effective’ rate of tax, rather than the headline rate, it may still tie the UK’s hands on policies such as freeports and investment allowances.
‘Pillar 1’ will be at least as complicated, mainly because it will require agreement on how to apportion profits between countries according to sales and a host of other factors.
Even ‘fair tax’ campaigners have raised concerns that this element will not actually touch the profits of ‘tech giants’ whose profit margins fall below the threshold for inclusion. But tax systems should not be designed to target particular companies for no good reason.
Muddying the picture even further, the UK has lobbied for big global banks to be exempt from the new scheme. This makes sense, because they typically have to hold large amounts of capital in overseas markets in which they operate, and are already subject to plenty of local regulation and tax. But other important businesses in the financial sector may also lose out, such as insurance and reinsurance.
Finally, it is not even clear that the OECD plan will raise a significant amount of additional revenue, rather than just shuffle it around. Indeed, firms headquartered in the UK but selling overseas may end up paying less money to the Treasury than they do now.
The Office for Budget Responsibility (OBR) has estimated that the ‘Pillar 2’ reforms will only raise an extra £2.3 billion a year by 2027-28, and even this is highly uncertain. It will also depend in part on US firms paying more tax in the UK, which will be strongly opposed in the US itself.
In short, the OECD’s tax plans are an enormous amount of effort for not a lot of benefit – and some potentially huge costs. Liz Truss is correct to call this out.
This piece was first published in the Daily Telegraph on 11 April 2023