It also highlights the role minimum taxes can play at the global level to help reverse nearly four decades of falling global corporate tax rates and reduce the incentives for large multinational firms to shift profits to low-tax jurisdictions to reduce their worldwide tax liability.
On June 5, 2021, Finance Ministers from the Group of Seven major
industrialized nations committed to a global minimum corporate tax rate
on multinationals of at least 15 percent. While there are a number of
details yet to be hammered out in broader global discussions, this
historic agreement heralds an important step forward on the road to
international corporate tax reform.
Our new study
examines how different types of domestic minimum tax regimes can help
countries preserve their corporate tax base and mobilize revenue.
Minimum taxation over the decades
There is an unusual tension in the world of corporate taxation. On
the one hand, countries compete vigorously to lure businesses and
investors within their borders by offering numerous profit- and
cost-based tax incentives, driving their tax rates down. On the other
hand, governments decry these multinational enterprises—once they have
been successfully attracted to the country—for not paying their fair
share of corporate taxes, leaving the burden to fall on often-struggling
local firms.
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The agreement reached by the G7 countries on minimum taxes
has provided fresh momentum to the overhaul of international tax rules.
Increasingly, governments are turning to minimum taxes as a means of
preserving their tax base. This is particularly true in developing
countries with weaker tax administrations, which face major challenges
in effectively taxing these large multinationals.
The idea of a minimum tax rate is not new. At the local level
countries have been using modern forms of minimum taxation since at
least the 1960s, taxing businesses on income generated based on activity
undertaken within their territory. The goal of this “local” (domestic)
minimum taxation is to prevent erosion of the tax base from the
excessive use of what is known as “tax preferences.” These tax
preferences take the form of credits, deductions, special exemptions,
and allowances and usually result in a reduction in the amount of tax a
corporation owes. By instituting a corporate minimum tax rate,
governments guarantee a floor on the businesses’ contribution to the
public purse.
Minimum taxes are typically computed using an alternative simplified
tax base that avoids the complexities of the standard corporate tax
base. They are often based on turnover (gross income or receipts) or
assets (net or gross). A third alternative uses modified definitions for
corporate income that explicitly limit the number of deductions and
exemptions allowed.
Using a new database of minimum corporate tax regimes worldwide, we
show how minimum taxes have grown in popularity over the past few
decades. Turnover-based minimum taxes are the most prevalent and tend to
be found in countries with higher statutory corporate tax rates (the
rate imposed by law). Countries that levy a minimum tax also tend to
report higher corporate tax revenue as a share of GDP.
We study the impact of minimum taxes on revenue and economic
activity by combining our new country panel database with firm-level
data. What we find is that introducing a minimum tax is associated with
an increase in the average effective tax rate—that is, the tax rate
actually paid by corporations after taking into account tax breaks—of
just over 1.5 percentage points with respect to turnover and around 10
percentage points with respect to profits.
Minimum taxes based on modified corporate income lead to the largest
increases in effective tax rates, followed by those based on assets and
turnover. Ultimately, the revenue impact also depends on the rate
applied.
In addition, we use firm-level data to get a sense of the potential
revenue that would result from the introduction of a hypothetical
minimum tax of 0.5 percent on turnover and minimum tax of 1 percent on
total assets. For the median country, the former could raise an
additional 7 percentage points of tax revenue for governments relative
to current levels and the latter almost a third more.
This translates into an average of 0.2 and 0.9 percent of GDP in
additional revenue—for the median country in our sample—for a
turnover-based and an assets-based minimum tax, respectively, on top of a
median corporate income tax-to-GDP ratio of 2.7 percent. These results
represent a significant revenue potential that merits serious policy
consideration.
Fresh momentum
The debate on minimum taxes has found new momentum with the US
proposal in recent weeks for a worldwide minimum corporate tax of at
least 15 percent. This follows years of work by international bodies to
overhaul international tax rules.
As part of this overhaul, the Organization for Economic Cooperation
and Development and the G20 had proposed in late 2020 a global minimum
corporate tax that would apply to overseas profits. Countries would
still set their own local tax rates, but if a multinational company paid
less than the global minimum rate in another country, that company’s
home and source jurisdictions could supplement its tax liability to
ensure it paid the minimum. In this way, the advantages of shifting
profits to low-tax jurisdictions would be reduced.
The OECD and G20’s global proposal differs from standard local
minimum taxes—it would not focus solely on income generated on
activities undertaken within a country. Instead, payments would be
triggered only if other countries don’t tax multinationals enough.
Furthermore, the use of local minimum taxes could end up increasing as
they provide a simpler alternative to the complex provisions of this
proposal for a global minimum tax, which many low-income and developing
countries may not have the capacity to implement.
Powerful but not perfect
Despite inefficiencies associated with local minimum taxes, they
could allow countries to tap significant revenue. In this way, setting a
floor on corporate taxation—at least at the local domestic level with
moderate tax rates—can be a good option for countries looking to
preserve revenue and prevent the erosion of their tax base without
severely damaging corporate activity.
However, minimum taxes alone cannot replace reforms that broaden the
corporate tax base. The proliferation of multiple rates and all sorts of
special preferences within the standard corporate tax system causes
costly distortions and low revenues—and encourages tax avoidance and
evasion. Tax incentives to attract multinationals are also likely to
persist even after the introduction of a global minimum tax, as
countries will continue to do what they can to entice foreign investment
for growth and development. But the value of these incentives will
decline, as multinationals will only be able to reduce their liabilities
to 15 percent and not zero. And so, therefore, the first best remains
to tackle and remove these head on.
IMF
© International Monetary Fund
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