Governments in the US and UK no longer have faith in competitive, free-market global capitalism. How else can we interpret recent policy developments? The pair have concluded that China’s rise necessitates imitation, through rank industrial policy and state-led regeneration. And in the sordid G7 tax agreement, Anglo-Saxon politicians went French: weakening the competitive constraint of national tax sovereignty and casting aside the ideals of pro-growth tax systems for crumbs of additional revenue.
The G7 deal itself is essentially a US-Europe pact. The States conceded a “Marxist” corporate tax system for mega-profitable US companies – in the Groucho Marx sense of “those are my principles, and if you don’t like them, well I have others”.
Corporate codes broadly tax profits where the firm is located as a proxy for where value creation occurs, rather than where goods are sold. Yet with digital giants not paying much in corporate tax revenue in Europe despite high sales, the continent’s governments are keen for a slice of their profits. This agreement gives them some, without the hassle that comes with fully moving to an alternative “destination-based” framework.
In return, the US wants countries to pass laws ensuring businesses headquartered within them pay at least 15pc in taxes on their profits – the so-called “global minimum corporate tax rate”. This not-so-subtle first step from the G7 aims to weaken “tax competition” worldwide. With President Joe Biden’s ambitions for much bigger government, financed in part by a corporate income tax hike, the US wants to reduce the incentive for companies to “profit-shift” by headquartering elsewhere. Again, the desire for revenue is the key motivation.
In this cross-Atlantic revenue hunt, though, the US and UK are losing sight of the bigger economic picture. Economists since Adam Smith have recognised tax systems should be certain, convenient, and efficient. They should not distort between one type of activity over another, or favour certain politically connected companies. Yet “Pillar 1” seems explicitly designed to target certain tech companies’ profits, replacing European countries’ discriminatory digital services taxes with similarly targeted corporate tax system add-ons.
Under the proposal, countries where major companies’ goods are consumed will see 20pc of any profits above a 10pc profit margin reallocated to them for taxing purposes. Given the tax base for this has yet to be agreed and companies will seek loopholes, how much revenue this will deliver is unclear. Already talk is of carving in Amazon, despite its profit-margin being lower than threshold. Rishi Sunak is already reportedly seeking to carve out City firms too. So arbitrary; so continental.
Perhaps more worrying though is that the US and UK have forgotten what they knew about the power of tax competition. The OECD has long suggested that corporation taxes are the most damaging for economic growth. Competition from corporate tax havens and low tax jurisdictions therefore has a positive effect: it forces countries’ exchequers to raise revenues to pay for government services through taxes less damaging for growth.
The pressure from Ireland’s 12.5pc rate on the UK’s doorstep, coupled with “havens” elsewhere, undoubtedly reduces the UK’s ability to collect corporate revenue. Does this leave the public coffers empty? Hardly. National taxes are projected to rise to their highest percentage of GDP since 1950 within a few years. What we are seeing here is greed for yet more without hiking VAT or income taxes transparently.
However, while all the focus is on boosting revenues by limiting profit shifting, efforts that succeed in that goal are likely to raise the cost of domestic investments. Economist Juan Carlos Suárez Serrato assessed a reform that limited the ability of US multinationals to earn profits with a low tax burden from affiliates in Puerto Rico. The effect was less global investment from the companies affected, actually leading to a reduction in US employment.
That’s the key point here: what’s good for the public finances is not synonymous with what’s good for the economy. People talk as if the new revenues from limiting “tax competition” are a free-lunch – a pot of gold just waiting to fill the government coffers to invest in “levelling up” or “our NHS.”
In reality, it is shareholders, workers and consumers who front up the burden of corporation taxes. It’s just that these effects are relatively hidden compared with the politically painful alternative of raising tax where taxpayers can see it clearly.
Thankfully, this plan still has huge hurdles to overcome. Clifford Chance tax lawyer Dan Neidle has noted the very slow process for ratifying international tax treaties. In the US, in particular, there is likely to be consternation from Republicans about allowing foreign governments to tax American multinational companies more. That makes it difficult to see how this proposal passes the US Senate, where a new tax treaty would require 67 of 100 votes. If Pillar 1 fails though, Neidle thinks, it’s difficult to see how the deal holds together.
Nevertheless, whatever ultimately happens, last week was instructive of the political zeitgeist. Just a few years’ ago, US and UK policymakers understood that corporations do not bear the ultimate burden of corporation tax, that global capital flows discipline governments towards more efficient revenue sources, and that it is private sector growth, not government largesse, that produces prosperity.
In agreeing such a targeted tax grab and setting in train the cartelisation of corporate tax rates, this agreement shows the new guiding star of tax policy is raising more and more revenue through politically fashionable means. If you think shovelling more resources through the political process is the route to economic success, then you should celebrate this deal. If you do not, well, the next few years of Anglo-American politics are going to be a rough ride.
Ryan Bourne is the author of ‘Economics In One Virus’ and an economist at the Cato Institute
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