Simpler approaches to a global tax plan

Simeon Djankov 08 October 2021

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The main proposal in the redesign of corporate taxes, advanced by leading industrial countries in the OECD, calls for reallocating and taxing a slice of profits in countries where corporate giants sell their goods or services, rather than where they produce (OECD 2020). The proposal is fashioned after the idealised residual profit allocation proposed in research by Alan Auerbach and Michael Devereux (Auerbach et al. 2010, Auerbach and Devereux 2018).  

A raft of disagreements can open as countries wrangle to exclude local favourites or include foreign targets among affected entities (Vaitilingam 2021). Once the list of corporations subject to the reallocation is finalised, the next step would be to divide their profits between what proponents call Amount A and Amount B (see Devereux et al. 2015 for an analytical treatment of reallocation). Amount A represents ‘excess’ profits above an agreed threshold of 10% return on assets. As many as 780 corporate giants may meet this threshold (Djankov 2021), and their excess annual profits could collectively amount to nearly half a trillion dollars (OECD 2020).    

To calculate Amount A (taxed in part by the market country), Amount B (taxed solely by the producing country) must first be subtracted from total profits. But how are total profits to be calculated? By the financial statement of the corporate giant? By the tax laws of each country where the giant produces or sells? And how is Amount B calculated? Tension exists between producing countries, which seek a large Amount B for their tax coffers, and market countries, which strive to augment Amount A. 

The next obstacle is agreement on the formula for dividing Amount A between market countries. Finally, in some countries Amount A will already be taxed under current law when earned by a local corporation, creating another contradiction.    

Is a multilateral tax convention feasible?

The answer to these inevitable contradictions is a multilateral tax convention (MTC). When conflicts arise between the convention and national tax legislation or bilateral tax treaties, the MTC would prevail (OECD 2020).  

Agreeing on a convention is a huge challenge. Prior efforts at international tax reconciliation by the League of Nations, the United Nations and the OECD have taken the form of voluntary guidelines and model treaties. Even those multilateral projects took years to conclude.    

Finance ministers are fully aware of these obstacles. Some 25 of them have imposed or proposed digital service taxes (DSTs) (van der Marel and Schulze 2021), simpler gross revenue taxes that resemble tariffs, largely aimed at tech giants. Under the OECD proposal, DSTs will be replaced by the reallocation of profits.  If talks to draft a multilateral tax convention drag on, however, many DSTs may be imposed.  

Simpler solutions possible

The best way forward is a simpler method for reallocating tax rights. One possible approach is an agreement requiring corporate giants (including tech platforms) to establish corporate subsidiaries in each market country and to distribute all their goods and services through those local subsidiaries. Subsidiary earnings would be primarily taxed by the market countries. Participants in this agreement could then nominate an entity to monitor and adjudicate transfer prices between various units of the corporate giants, ensuring that market countries get their fair share of taxing rights (see Acciari et al. 2021 for new microdata analysis on the profit-shifting response to tax rate changes).  

A second approach is for like-minded countries to agree, in a compact, on a list of large consumer-facing firms (including tech platforms).  The list would be periodically updated. Market countries would be entitled to impose a gross revenue tax, not to exceed (say) 2%, on sales within their territory by the listed firms.  The compact would spell out rules for calculating such revenues. Home countries of the listed firms would agree either (a) to exclude all profits attributable to the market country from home country tax, or (b) to give a credit against home country tax for the gross revenue tax collected by the market country.

A multilateral tax convention is still a first-best policy in the long run, but its foundations can be built upon a simpler proposal. Both of the approaches outlined here avoid the need for a multilateral convention, as well as the need for an empowered arbiter between producing countries and market countries. Better yet, the economics of these proposals is also based on the Auerbach-Devereux analyses.

References

Acciari, P, B Bratta, and V Santomartino (2021), “New patterns of profit shifting emerge from country-by-country data,” VoxEU.org, 28 June.

Auerbach, A, M Devereux and H Simpson (2010), “Taxing Corporate Income”, in J Mirrlees et al. (eds), Dimensions of Tax Design: The Mirrlees Review, Oxford University Press, 837-893.

Auerbach, A and M Devereux (2018), “Cash-Flow Taxes in an International Setting”, American Economic Journal: Economic Policy 10(3): 69-94. 

Devereux, M, C Fuest, and B Lockwood (2015), “Taxing the foreign profits of multinational firms,” VoxEU.org, 12 June.

Djankov, S (2021), “How an OECD tax proposal would reallocate international taxing rights more fairly”, PIIE Charts, 6 August.

OECD (2020), Tax Challenges Arising from Digitalisation – Report on Pillar One Blueprint, OECD Publishing. 

Vaitilingam, R (2021), “Corporate taxes: Views of leading economists on profit-shifting, tax base and a global minimum rate,” VoxEU.org, 06 July

van der Marel, E and P Schulze (2021), “Taxing Digital Services – Compensating for the Loss of Competitiveness”, ECIPE Policy Brief.

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Topics:  Taxation

Tags:  corporate taxes, global tax system, tax havens, multilateral tax convention, digital service taxes

Policy Director, Financial Markets Group, London School of Economics

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CEPR Policy Research