Corporate tax isn’t working – how can we fix it, globally?

This article was first published in June 2021 and updated in September 2022.

“In this world, nothing is certain except death and taxes,” said US Founding Father Benjamin Franklin in a letter to a French friend in 1789. His much-quoted bon mot feels as relevant today as it has ever been – and maybe even more so.

That’s because taxation will play a big part in the post-pandemic rebuild of the world economy, and apportioning this tax burden fairly and inclusively will be critical to a successful recovery.

Corporate tax in particular has been a thorny topic for some time, as large multinationals continue to use their global presence to shift profits to tax havens to minimize their tax liability in higher-tax countries.

To disincentivize tax arbitrage between countries, the G7 – the top seven leading economies in the world – agreed in June 2021 to put in place a 15% global minimum tax on the world’s largest corporations. Moreover, the countries in which they operate will be able to get a fairer share of taxes, independent of whether the companies are domiciled.

Much of this plan goes back to previous work done over many years by the Organisation for Economic Co-operation and Development (OECD) as part of its base erosion and profit shifting (BEPS) initiative.

In October 2021, 136 countries and jurisdictions joined the Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalization of the Economy. Then in September 2022, 5 European Union countries pledged to enact pillar two of the agreement unilaterally, even if the European Council could not reach an agreement on it.

Why do we need a new corporate tax system?

Between 1980 and 2020, the average corporate tax rate fell from nearly 50% to around 24% globally. But many of the world’s largest companies – especially the world’s largest technology companies – pay even less than that. In the US, for example, their effective tax rate is significantly lower than the statutory rate of 21%. It is also lower than the payments made by large blue chips in other sectors.

At the same time, payroll taxes are going up, creating a vast cleft between taxpayers and the world’s largest corporations. Payroll taxes now make up a larger share of the US national income than corporate tax – despite stagnating wages. Business Insider quotes Gabriel Zucman, an expert on corporate taxation at the University of California, Berkeley, calling this scenario “a powerful engine of inequality”.

Will the newly agreed G7 global tax rate resolve the issue?

In a recent report, the World Economic Forum advocates designing more progressive taxation mechanisms to move the tax burden from the bottom to the top. But will a unified corporate tax as envisaged by the G7 achieve this?

There's a growing consensus that it's a step in the right direction, but that a lot of details need to be ironed out to know if this would actually solve the problem.

Assessing the impact the G7 reform will make highly depends on your perspective.

The Biden administration had originally targeted a 21% global corporate tax, while advocates such as the Tax Justice Network and Oxfam had called for 25%. So the agreed 15% falls some way below this.

For those advocating more just corporate tax, the percentage will be too low, says Dani Rodrik, Professor of International Political Economy at Harvard University, in an op-ed for Project Syndicate. But countries reliant on corporate tax incentives to attract foreign direct investment (FDI) will find the level too high. This applies mainly to emerging economies – Rodrik quotes Moldova (12%), Paraguay (10%), and Uzbekistan (7.5%) as examples.

How will the G7 corporate tax reform impact developing economies?

Even among the developed economies, there are concerns. Ireland, which has heavily relied on tax incentives to attract FDI (12.5%) may be affected. And in the UK, the proposed regime may slash about two-thirds off the country’s current income from its digital tax on large global tech companies active in the UK.

However, that is nothing compared with low- and middle-income countries, arguably those who are most in need of more tax revenues to tackle the post-COVID recovery. As the Financial Times has reported, the fear in these markets is that multinationals would still pay most tax where they are domiciled and that developing economies would only see a small share of the new tax income, even if labour and raw materials are sourced from the countries concerned.

The African Tax Administration Forum, for example, has argued for a tiered approach to corporate taxation for smaller countries, allowing for different tax liability thresholds and rates to be set in smaller economies.

However, the focus on the G7 – and the G20 at the next stage – also means that many low- and middle-income economies are currently not ‘at the table’ to influence the negotiations and deliberations.

What are the alternative approaches for a fairer corporate tax regime?

Looking at the implications of the G7 agreement, the biggest realization is that even if the G20 ratifies the plans and the rough edges are smoothed off, it won’t represent more than a drop in the ocean for the world’s largest corporations. Goldman Sachs analysts have predicted that the impact on the S&P 500, on average, will only be around 1-2%, and even for tech companies, it will stay well under 3% (see chart).

One issue is that under the G7 scheme, corporate tax would still be levied on profits – and, as we have seen, profits are a movable feast. Not only that, but there are large multinationals whose turnover and market capitalization have grown significantly but whose profit margins have remained below the 10% threshold proposed as a cut-off by the G7. So as it stands, these organizations would not fall within the G7 scheme.

While routes to address this are being explored, another proposal to establish a fairer distribution of tax comes from tax experts Emmanuel Saez and Gabriel Zucman at UC Berkeley. Rather than taxing profits, their proposed regime would levy a 0.2% tax on publicly listed companies’ stock market capitalization – the value of their shares. But importantly, this scheme would not wait for profits over a certain threshold to materialize – it would pay out much earlier. Taxes raised could be allocated proportionally to the sales made in each country, which would include non-G20 countries.

There is also a reform proposal from the United Nations to consider. Specifically targeted at digital services companies, the UN’s approach is based on taxing companies’ digital revenues where they are generated, on a country by country basis, rather than where the company is resident. The UN’s suggestions are supported by a growing number of emerging economies, including India, Argentina, Nigeria and Viet Nam.

Alternatively, Alex Cobham, the Chief Executive of the Tax Justice Network, has argued for the concept of a minimum effective tax rate (METR). In a recent Agenda article, he argues that the METR “offers a simple, single rule for all countries and all multinationals, and with no treaty changes”.

Ironing out the creases of a global corporate tax regime

With ratification by the G20 pending, it is clear that the G7 proposal is a historic effort to bring the world to align on corporate taxation. But ratification will only be the beginning of a long process of shaping a global corporate tax system because, as we have seen, there is no one-size-fits-all solution for countries.

The biggest question mark hovers over whether lowering corporate tax – to 15% in the case of the G7 scheme – supports growth, which would be key to the post-COVID recovery. A recent meta analysis from 42 academic studies suggested that “the attention that corporate taxation has received in debates on structural economic reforms as a source of economic growth seems by and large exaggerated. Corporate tax cuts may have stimulated international tax competition [...] but they do not seem to have significantly promoted economic growth.”

Corporate income tax should not be viewed as a panacea, and other– more quick-fire – routes need to be prioritized alongside.

To plug the immediate budget gaps, particularly in developing economies, it may be worth considering the International Monetary Fund’s concept of a solidarity tax, levied on high incomes or wealth. The IMF sees this as a way to pull together the resources needed to deal with post-COVID recovery. This suggestion would also take to task high-net-worth individuals, many of whom pay no or very few taxes.