Trump Can’t Stop the Global Minimum Tax

Going Forward: State of Global Minimum Tax

Under the Biden Administration and leadership of the Treasury Secretary Janet Yellen, ^[1] the world came together to turn around the “race-to-the-bottom” of corporate tax competition.

The most common first thought in response to this goal is:

Did they think about what will happen when tax havens just don’t agree?

Your second thought should be:

Certainly, the financial experts of the world putting forward a proposal know this is the critical problem to solve and are not dumb enough to have overlooked it.

And, in fact, if you review the details of the global minimum tax framework, mechanisms to address it are at its core. Let’s skip over that mechanism for now.

The important thing to understand is that the Global Minimum Tax, or Pillar II, has withstood its first test of remaining alive through negotiations with the Trump administration with 140 countries signed on to Pillar II and a large share of developed countries has codified into law all elements of the agreement. ^[2] Unless something significant changes, it now applies to corporations with revenues approaching 1 billion dollars.

However, the Republican Party has pressured the world into recognizing the United States’ minimum corporate tax framework passed under the Biden Administration as a substitute for Pillar II. This agreement has been formalized in the OECD "Side by Side Package" ^[3] where there are two sets of rules for corporations based in the United States and another for the rest of the world. This will preserve the United States as a corporate home for tax avoidance for the time being. However, the deal struck through the leadership of Janet Yellen still survives a newly hostile United States and we will have the power to greatly increase its strength in a future Democratic administration.

Why are corporate taxes good?

First, why should we consider any tax good? There are three qualities a “good” tax has, in descending order of importance.

• It raises a lot of revenue for the government to support societal goals
• It is administrable and collected without significant evasion
• It does not introduce many incentives to change economic behavior in an undesired way

From these three qualities, there is no law of the universe that any specific tax mechanism is currently superior because the current state of society can change. The way to evaluate a good tax will remain the same.

Tariffs were the best tax before the 20th century to fund large nations by this measuring stick. The challenge for large nations was the diffuseness of economic transactions through their nation, making it economically unworkable to administer. The one place where a sufficient volume of taxable transactions occurred to raise a lot of government revenue without much evasion was through ports of entry. These practical advantages overcame the bad incentives to reduce imports.

Corporate taxes are excellent in the modern era. Because a significant share of Gross Domestic Product (GDP) is made up of corporate profits so they generate significant revenue. They are also one of the easiest taxes to collect without evasion (although there can be tax avoidance), and as an income tax it is the best taxation method to avoid incentives to change economic behavior

While from the investor standpoint, the corporate tax seems like the most blatant example of double taxation, if you flip it around and view it from a government’s perspective, it is suddenly understandable. The whole point of a corporation is to make it unnecessary to know who owns a business. The corporation is a legal entity you can regulate, tax, and punish without the bureaucratic burden of forming enforceable agreements with their owners.

Within the borders of a country in the modern day, this is not a big issue because you could simply eliminate the corporate income tax and increase income taxes on realizing capital gains and dividends. However, the personal income could be generated abroad by foreign owners and if not taxed at the corporate level, you may lose any opportunity to tax a significant share of the GDP of your economy. Trying to force every stockholder of the Coca Cola company to pay their share of German income tax on their German income is not feasible. When compounded across all combinations of owners, corporations, and countries, it is apparent that corporations provide substantial administrative simplification.

How did we get the need for a global minimum tax?

While one of the boogeymen in critiques of the capitalist, neoliberal order, corporate tax avoidance as a problem is a symptom of progress and one of the greatest successes of an international rules based order.

It’s a modern truism that there is little economic benefit to a national government to conquer or threaten other nations. This truism is because generally even if you are successful, it may expand your national income, resources, and tax base, but also increases your population and obligations, resulting in less of a net gain. However, this is only true because of the international rules based order that we have inhabited after WW2.

Taxation conflicts originate because there are two legitimate taxing authorities on corporations operating internationally. There is the government where the business activity occurs which is granting permission to a corporation to operate and there is the country whose laws govern the corporation itself, where it is incorporated.

In the pre-WW2 period, this conflict over taxation interests was left to a state of nature, resulting in negotiations of treaties on taxation that reflected the leverage each country had if it came down to open conflict. When taxation disputes were alive, corporations could be severely taxed by both countries, with neither willing to relinquish their taxation claims, and if resolved then it could be extractive of the national income of one of the parties.

After WW1 in the League of Nations, the resolution to this problem was proposed, and was ultimately adopted globally after WW2 under the leadership of the United States. A precedent of taxation was introduced where income would be taxed first where a business is operating and then the country where a business is incorporated could levy taxes. This understanding is baked into global taxation treaties around the world. This is a more natural arrangement where no country loses access to a portion of their gross domestic product that is not taxable.

While providing a more stable international tax environment for corporations and removing a major source of international conflict, it introduced a modest but consistent incentive to compete for a lower corporate tax rate.

While every government has an incentive to have a significant corporate tax rate, competition among taxing jurisdictions has slowly reduced the rate overall in a “race-to-the-bottom”, a net change that has harmed every nation’s tax base. While these incentives only apply to international corporations, they have downstream effects as it introduces the need to lower taxes on domestic businesses to not be at a relative disadvantage.

So how does the global minimum tax work?

The global minimum tax, or Pillar II, solves the following problem. If Germany were to declare that every business operating in Germany cannot utilize tax havens and must pay a 15% minimum tax for instance everywhere or pay it as a penalty to Germany, then that would be instantly disastrous for economic activity in Germany. That would increase the tax burden to operate in Germany by a substantial amount for companies operating in low tax jurisdictions.

While it would be disastrous for a single country to implement the rule to require companies operating in their country to pay a 15% tax everywhere, it is possible with a large bloc of countries coordinating their efforts. The Undertaxed Profit Rule (UTPR), does exactly that. If a company operates in Canada, the UK, almost all of the EU, Australia or South Korea, along with a few others, then the UTPR will be collected, bringing corporate tax up to a 15% minimum everywhere that corporation operates globally.

By dividing the burden across much of the global economy to enforce the global minimum tax, it is far more expensive to avoid and less extreme for each country to enforce. This is the mechanism mentioned at the start of this piece for what to do if tax havens do not agree. A corporation is then left with a free choice: either stop operating in much of the developed world or pay up.

Along with the UTPR, Pillar II has two other taxes far more countries around the world have adopted. To avoid losing any tax revenue to a UTPR enforcing country, tax precedence rules are preserved. The country where profits are earned can adopt a local top-up tax which will bring corporation’s tax liabilities up to the global minimum tax level. The jurisdiction of incorporation can adopt a top-up tax for any uncollected taxes abroad that would be taken through the UTPR. The UTPR is not called a tax but instead is a “rule” because through the design of the system it should never be collected. The incentives are in place where taxing jurisdictions with more of a claim to the tax revenue should want to collect it themselves instead of giving it up, leaving no benefit for operating in their tax haven.

A path to funding more robust public services

While the Republican Party has temporarily weakened Pillar II, it is strong enough to survive. The difference in the U.S. minimum corporate tax is that it requires a 15% minimum tax overall, rather than a 15% minimum tax in every jurisdiction. This means that corporations can use low tax jurisdictions to lower their tax liability to balance out their operations in higher tax jurisdictions up to the point their overall tax burden is 15%. Unlike Pillar II, this does not stop the “race-to-the-bottom” of corporate taxation.

While 15% may seem minor (although its projected to collect hundreds of billions in global taxes^[4]), it can establish a legal framework to build upon.

A future democratic administration can finish what Treasury Secretary Janet Yellen started. We can recommit to the international goal of all developed countries to reverse the “race to the bottom”. In fact, we can go further and put it in reverse.

Once every country has a 15% corporate tax rate, the same mechanism could far more easily push it up to 20% and the tax rate for smaller corporations can increase as well with competition that is being taxed at a higher rate. This offers a pathway to put the “race-to-the-bottom” in reverse and return corporate taxation to a level that can help fund robust public services.