Henry Nicholls/Press Association via AP Images
Finance ministers from across the G7 nations meet at Lancaster House in London ahead of the G7 leaders’ summit, June 5, 2021.
The finance ministers of the world’s seven richest economies reached a groundbreaking agreement last week, promising a new era in which harmful tax competition is replaced by tax cooperation that benefits all the countries involved.
It would impose a uniform minimum tax of 15 percent on all multinationals, over 90 percent of which are from G7 countries. If these countries impose a uniform tax of 15 percent on their multinationals, no competitive disadvantage can ensue, because all the competitors will be subject to the same rate.
The Biden administration should receive full credit for brokering this deal. It was responsible for breaking through the impasse resulting from the Trump administration’s refusal to engage in any cooperative endeavor on tax policy. Moreover, the deal eliminates the dispute about taxation of the large U.S. tech companies, which will now be subject to the same 15 percent tax as everybody else.
Since the 1960s, there have been numerous attempts to impose taxes on the foreign profits of multinationals. The United States led the effort, followed by the other G7 countries, but all of these endeavors were stymied by the argument that countries could not afford to tax their multinationals unilaterally because they would put them at a competitive disadvantage to multinationals from other rich countries. This argument culminated in the 2017 U.S. tax law that for the first time completely exempted some of the profits of U.S. multinationals from tax because this was how other G7 countries taxed their multinationals.
When the Biden administration took office, it proposed to increase the U.S. tax on the foreign profits of American multinationals from 10.5 percent to 21 percent, and abolish the 2017 exemption. But it immediately ran into the familiar “competitive disadvantage” argument, which was likely to stop any tax reform in its tracks.
The competitive disadvantage argument was always misguided, because there is no evidence that the pre-2017 regime put U.S. multinationals at any disadvantage. In fact, most of the top multinationals are American and are highly profitable, and the actual tax rate paid by the largest 100 U.S. and EU multinationals before 2017 was virtually identical. But politically, the competitive disadvantage argument proved decisive—until now.
The competitive disadvantage argument was always misguided, because there is no evidence that the pre-2017 regime put U.S. multinationals at any disadvantage.
Nor will such a deal harm developing countries. A basic rule of international tax norms is that countries where multinationals are headquartered, like the G7 nations, have to prevent double taxation by granting a full credit against their taxes for taxes paid to countries where the multinationals do business. These are often developing countries, and the agreement means that multinationals will no longer be able to play them off against each other by threatening to go elsewhere if the developing country does not give them a tax break. They also include wealthy countries, which play the same kind of games by allowing multinationals to book profits in ultra-low-tax jurisdictions.
Admittedly, many progressives will regard the 15 percent rate as much too low, and the administration seems to have given up on its effort to raise the corporate tax rate to 28 percent, at least for now. But the administration proposes to broaden the tax base by aligning it with the income reported on the multinationals’ financial statements, which may raise as much revenue as the 28 percent rate would do on a narrower base.
There are many hurdles before this agreement can be implemented. The hardest one is to agree on a common system of calculating the multinationals’ profits, but there is already in place an agreement to report these profits on a country-by-country basis that can be used as a baseline.
Another important issue is how countries like Ireland that oppose the agreement because they benefit from a 12.5 percent corporate tax rate (and frequently much lower) can be induced to cooperate. But this agreement does not require Irish cooperation, because it is based on taxation by the true headquarters jurisdiction (the G7 country), not the jurisdiction where the multinational does business or nominally locates itself for tax-avoidance purposes.
A third challenge is how to apply the agreement to the tech giants like Facebook, Google, and Amazon. The U.S. and EU have to reach an agreement on how much profit can be taxed in the country where these multinationals do business, and any such agreement requires changes to the tax treaty network. There has already been significant progress in this regard, and the G7 deal improves the chances that a final deal can be achieved this year.
Finally, any final agreement has to be enacted by Congress, and any treaty modifications ratified by the Senate. This is a major political challenge for the Biden administration.
The whole history of U.S. taxation from 1986 on suggests that it is more important to focus on the structural aspects of taxation rather than on the tax rate. Rates have changed under every administration since 1986, rising under Democrats and dipping under Republicans. But the structural features of the 1986 tax reform, as well as the structural changes enacted in 2017, are likely to survive long into the future. A future administration with a larger congressional majority may well be able to increase the rate above 15 percent.
The principle of subjecting all multinationals to a minimum tax, however, can last. Once that is achieved, the competitive disadvantage argument becomes untenable. That in itself is reason to celebrate. But in addition, the agreement is likely to raise over $50 billion in U.S. revenue from taxpayers who can afford it, all to fund projects for everyone.
