Two global tax measures working their way through the OECD could be the spur to a wider reform of taxation internationally to counter climate change and inequality, writes Rod Oram
Political will and corporate support are building in many countries for some international corporate tax reforms. If they eventuate in the next year or so, they will benefit us in Aotearoa, with other countries.
But those efforts won’t address the far harder tax reforms needed to tackle the climate crisis or inequalities of income and wealth, two utterly critical factors which will determine the wellbeing of humanity for generations to come.
On climate-related fiscal measures, we have made some progress, as have some other countries. But nowhere near as much as all nations have to make, and fast. On inequalities, we, like all other countries, are avoiding the issues. Thankfully, though, some helpful new economic analysis is laying the groundwork for eventual reforms.
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International taxation of company profits is the area which will likely deliver the first reforms later this year. The need is urgent. For several decades, changes in technologies and the composition of economies have eroded the base of activities that governments tax. Moreover, it’s been easy for international companies, particular high tech ones, to channel their activity through low-tax countries to minimise their tax bills.
But governments have also made life harder for themselves. They have sharply cut taxes on companies over many decades. Likewise, many of them tax income from investments more lightly than income from work. As a result, they are struggling to raise sufficient tax revenue to meet their citizens’ needs and to invest in their countries’ futures. More debt, even at ultra-low interest rates, is only a temporary fix.
In the US, it’s estimated that some 20 percent of the tax burden has shifted from corporates to people over the past seven decades; in aggregate, big US tech companies are paying tax equal to only 16 percent of their profits; and sharp cuts in funding for the US Internal Revenue Service means it does much less auditing of taxpayers than it used to – the rate has fallen 50 percent in the past decade.
The OECD grouping of developed countries made its first attempt at reforming international company tax in 2013-15. It managed to ban some egregious practices that took full advantage of low tax jurisdictions. For example, intra-company loan schemes such as the “Double Irish with a Dutch Sandwich” which channeled profits through EU-based subsidiaries to tax havens like Bermuda and the Cayman Islands.
“The OECD/G20 base erosion and profit shifting initiative helped close down loopholes and modernise the rules,” says Angel Gurria, who retires soon as the OECD’s secretary general. “Through the system of automatic exchange of information pioneered by the OECD and approved by the G20, we began to turn the tide. Since 2009, €107 billion ($180b) in additional tax revenues have been identified. Countries have now exchanged information on more than 84 million offshore financial accounts, worth €10 trillion ($16 tr), and consequential additional revenues will follow.”
But in the first phase, the OECD failed to clearly articulate principles and to build support for deep reform. It began a second attempt in 2019, which is gaining significant momentum. The first of its two “pillars” addresses the ease of profit shifting between tax jurisdictions. Its rules would apportion at least some of multinationals’ global profits according to where their real economic activity took place. The second “pillar” addresses the incentive to shift profits by imposing a minimum tax on them by signatory countries.
Yet, these are only modest and partial remedies to tax distortions. OECD analysis suggests they would only increase tax revenues raised from companies by US$100b in signatory countries, or some 4 percent of their total tax take. Moreover, the rules would apply initially to only the 100 largest transnational companies.
Countries, led by France and Germany, are working towards reaching an agreement on these reforms via the OECD in time for the July summit of G20 finance ministers.
Michael Devereux, professor of business taxation at Oxford university, said agreement at the OECD would “let the genie out of the bottle” and be the start of wider reforms. That would prevent the international tax system from “collaps[ing] under the weight of its own complexity and competition in tax rates.”
The US is the latest country to support the measures. Two weeks ago, President Biden said the US would seek a global minimum corporate tax rate of 21 percent and raise its own rate to 28 percent from 21 percent.
Such moves would benefit New Zealand too. Our corporate tax rate has always been in the top quartile in the OECD. It is currently 28 percent, as it has been for a decade, since easing back from 30 percent. Any new OECD floor to corporate taxation would reduce the gap between the lowest jurisdictions and us, thereby making our rate marginally less uncompetitive.
Biden’s increase in rate would be the first big one since President Johnson’s in 1968 which took the rate to a nominal rate to 54 percent and the effective rate to 45 percent. Every change in the following 53 years was a tax cut, apart from a little blip by the first President Bush, a Republican, in the early 1990s. The last steep US$2 trillion of cuts in many forms of taxation by President Trump were unfunded by cost savings or by tax increases, which has caused US government budget deficits and debt to balloon.
Biden needs whatever money he can get. His American Rescue Act, passed in March with a price tag of US$1.9 tr, is aimed at stimulating 7 percent GDP growth this year and lifting incomes of the lowest quintile of households by 20 percent; his proposed American Jobs Plan to upgrade US infrastructure would cost US$2.3 tr in its current form; and his proposed American Families Plan would cost US$1.8 tr to raise US child, parental and worker benefits closer to those of most other wealthy nations.
In response to Biden’s support for the OECD’s proposals, the Information Technology Industry Council, a lobby group whose members include Apple, Amazon, Facebook and Google, said it was “encouraged” that governments were trying to reach an international agreement.
They’ve shifted to support for two main reasons. First, President Trump imposed in 2017 a 10.5 percent tax on their international earnings. The legislation calls it their Global Intangible Low-Taxed Income, pronounced “guilty”.
Second, the UK and France are leading the efforts of individual countries to impose Digital Service Taxes on such income. So rather than face a plethora of different measures, the transnationals see merit in a uniform regime, though hopefully set at a lower rate than currently proposed.
An international agreement would also be a boon to small countries such as ours. We’d gain some revenues from it whereas it would be nigh-on impossible to impose our own Digital Service Tax on the tech giants.
Support is also coming from an unlikely source – Ireland, the Netherlands and other low tax rate countries, though likewise they want a lower minimum. Like big tech, they see the benefit of uniformity to prevent a “race to the bottom”. Ireland also says its economy is now so sophisticated, international investors are now more attracted by those skills and opportunities than simply a low tax rate.
But the politics of tax reform is still fraught, particularly in the US. In addition to corporate tax changes, Biden is proposing that Americans earning more than US$1 million a year pay taxes on their capital income in line with the top rate on wage income, which he wants to raise from 37 percent to 39.6 percent. That would double the rate that is currently levied on wealthy investors.
Republicans are deeply hostile to these tax changes and to spending increases. Next year’s mid-term elections will give them the chance to win back control of the Senate and possibly the House too.
There are signs, though, political culture might be changing. For example, Francis Fukuyama, one of America’s leading political scientists, says: “There is no doubt the Reagan-era hostility to government and the Democratic party’s bias towards fiscal conservatism are dead. But arguably the pandemic did more to kill them than the election.”
Similarly, a Republican party dominated by Trump supporters is increasingly at odds with Republican business leaders. Republican moves to make voting harder in Georgia is one recent example of increasing clashes between them.
Biden’s proposals on tax are fairly ambitious but they are completely conventional in domestic terms. He’s simply raising more tax revenue to redistribute through government programmes to the needy.
In contrast, he remains opposed to pricing carbon, even though it’s one of the fundamental ways to incentivise reductions in emissions and increases in clean technology investment. One of Biden’s campaign pledges was no new taxes on those earning less than US$400,000 a year. In the climate sphere, his advisers are mindful of widespread public protests in France when President Macron made a small increase in petrol taxes two years ago.
The US resistance to climate fiscal measures goes much further. For example, John Kerry, the US special climate envoy, has raised concerns about the EU pushing ahead with a carbon border levy, warning it should be a “last resort” in the global fight to cut emissions.
Likewise, they are strongly opposed by Mathias Cormann, a conservative former Australian finance minister, who takes over as the OECD’s secretary-general in June. He strongly supports the corporate tax changes, though.
The EU is due to release in June its latest proposals for the adjustment mechanism. This is designed to increase the cost of imports from non-EU countries that have not signed up to the Paris climate goals or committed to net-zero emissions.
“If there is a serious risk of carbon leakage, if we take the measures to comply with [the Paris Agreement] and others don’t, and it leads to a disadvantage to our industries, I will have no hesitation whatsoever to introduce carbon border adjustment mechanism,” Frans Timmermans, executive vice-president for the EU’s Green Deal, said recently. This is the set of policies aimed at making the EU carbon neutral by 2050.
Wealth taxes are the other area – highly contentious but an increasingly needed mechanism – which is attracting greater study and support. For example, the UK Wealth Tax Commission was set up last year by some UK economists. It has produced a series of evidence papers and a report laying out the benefits of such a tax and new ways to design and deliver it.
An example of new thinking by US economists is Use it or Lose it: Efficiency Gains from Wealth Taxation, a paper published by the National Bureau of Economic Research.
“Wealth taxation can increase efficiency, grow the economy, and reduce inequality all at once,” its authors argue. For example, a 3 percent wealth tax would enable taxes on labour to be cut to 14.5 percent, help reallocate capital to more productive purposes, and increase consumption in aggregate while distributing it more equally than does today’s tax system.
Another advocate of new forms of wealth taxes is Martin Sandbu, an economics columnist in the Financial Times. This is one example of his analysis. His book-length prescription for new economic thinking, published last year, is The Economics of Belonging: A radical plan to win back the left behind and achieve prosperity for all. This review, which includes a link to an interview with Sandbu, is a short guide to his extensive work.
After decades of stagnant orthodoxy across almost all areas of economics policy, hopefully, imminent progress on international taxation will whet the appetite of citizens and politicians for more new, creative, ambitious and beneficial reforms.