The two-pillar solution to update international tax rules for the digital age that's being considered by nearly 140 countries is projected to raise $100 billion annually in corporate tax revenues — but that estimate comes with caveats.
David Bradbury, head of the Tax Policy and Statistics Division of the OECD's Centre for Tax Policy and Administration, confirmed during a February 13 webcast that the figure translates to an estimated 4 percent of global corporate income tax revenues.
High-income, middle-income, and low-income countries would see similar gains as a share of corporate tax revenues, and both pillars are likely to significantly reduce corporate profit shifting, Bradbury added.
The estimates, however, are subject to several caveats, according to Åsa Johansson, head of the structural policies surveillance division at the OECD Economics Department. Results will depend on the design of the solution, which the inclusive framework on base erosion and profit shifting is still discussing, she said.
The underlying data also have some limitations, including timeliness, Johansson said, noting that much of the data is from 2016.
The data analysis that Bradbury and other OECD representatives presented during the webcast centered on pillar 1, which focuses on revised profit allocation and nexus rules, and pillar 2, which calls for global minimum taxation. The two pillars are the foundation of the OECD’s work toward a consensus-based solution by the end of 2020 to address the tax challenges of the digital economy.
The pillar 1 proposal calls for taxing companies on three categories of profit: amounts A, B, and C. Amount A in particular would consist of some portion of the group’s deemed residual profit.
The pillar 1 analysis focuses only on amount A and did not take into account a U.S. proposal to implement it on a safe harbor basis, according to Johansson. As part of a new work program to guide the pillar 1 work, the inclusive framework decided, among other things, to defer any decisions on the idea until the group agrees on the design of the solution.
Pillar 1 Results
The OECD’s preliminary analysis confirmed that the majority of jurisdictions would see tax revenue gains, except for “investment hubs,” or jurisdictions with inbound foreign direct investment exceeding 150 percent of GDP.
Global tax revenues would rise slightly under pillar 1. In a scenario in which residual profit under amount A is set at a 10 percent threshold based on a profit-before-tax-to-turnover ratio, pillar 1 would lead to a 0.3 percent to 0.7 percent increase in global corporate income tax revenues, according to underlying OECD graph data obtained by Tax Notes. At a 20 percent threshold, however, global corporate income tax revenues would increase by only 0.1 percent to 0.2 percent.
Most economies would experience small tax revenue gains, with middle- and low-income jurisdictions gaining more than high-income countries.
If the amount A residual profit threshold were set at 10 percent, high-income jurisdictions would see a 0.1 percent decrease in corporate income tax revenues at the low end and a 1.1 percent increase at the high end. Middle-income countries, meanwhile, would see a 0.3 percent to 1.2 percent rise, while low-income economies are projected to experience a 1.1 percent to 1.9 percent spike. Investment hubs would lose between 0.2 percent and 5 percent of their corporate income tax revenues, the data show.
If the threshold were 20 percent, high-income economies would see no change or an increase of up to 0.4 percent in corporate tax revenues. Similarly, middle-income countries’ corporate tax revenues would inch up 0.1 percent to 0.4 percent, while low-income jurisdictions would see a 0.4 percent to 0.6 percent increase. Investment hubs would lose 0.1 percent to 1.6 percent of their corporate income tax revenues, according to the data.
Another key result is that more than half of corporate profits reallocated under amount A would come from 100 multinational enterprise groups.
Pillar 2 Results
While there are many pillar 2 features that the inclusive framework still needs to decide on, the OECD's preliminary impact assessment of the so-called global anti-base-erosion proposal showed it could raise global tax revenues and curb profit shifting. The proposal effectively functions as a top-up tax to allow governments to “tax back” profits that are taxed under a yet-to-be-determined minimum corporate tax rate. Pillar 2 may apply on global MNE profits or on a jurisdiction-by-jurisdiction basis.
Assuming jurisdictional blending and a 12.5 percent minimum tax rate, the OECD took into account behavioral responses by both multinationals and governments, according to Stéphane Sorbe of the OECD Economics Department.
The analysis considers four scenarios for the design of both pillars, as well as pillar 2’s effects on three types of global tax revenue gains: gains from minimum tax, gains from rate increases in low-tax jurisdictions, and gains caused by reduced MNE profit shifting.
A static scenario with no behavioral reaction would lead to a 2.5 percent revenue increase from the minimum tax, while a scenario in which there is interaction with pillar 1 would result in a 2.3 percent increase.
In a scenario in which both pillars are implemented and MNEs scale back profit shifting in response, global corporate tax revenues would increase under pillar 2 minimum taxation by 1.7 percent, and reduced profit shifting would lead to a revenue gain of 1.5 percent.
In a scenario in which both pillars are implemented and low-tax jurisdictions increase their corporate income tax rates, revenues from a pillar 2 minimum tax would increase by 1.3 percent, while a corporate income tax rate increase itself would lead to a 0.5 percent revenue increase. Global tax revenues would spike to 1.5 percent if MNEs reduced their profit shifting in response to pillar 2 in this scenario, the data show. However, this fourth scenario has a higher degree of uncertainty, according to Sorbe.
Investment Effects
The OECD also estimated the effect of both pillars on investment. Implementing both pillars would lead to an expected effective average tax rate increase of 0.7 percentage points across all jurisdictions. That effect is more pronounced in investment hubs, which could see an effective average tax rate spike of 1.93 percentage points, according to the data.
Generally, the two pillars are not projected to have a major effect on investment costs and could scale back the influence of corporate taxation on investment decisions, according to Tibor Hanappi of the Centre for Tax Policy and Administration, who pointed to infrastructure and labor costs as examples of nontax factors that could motivate investment location.
Bradbury warned of the consequences if countries are unable to agree on a common approach to taxing the digital economy.
“We know the counterfactual of not reaching agreement is indeed a world with more uncertainty and future unilateral measures,” Bradbury said.
Falling Short?
Despite preliminary findings that the two pillars could lead to an annual global corporate tax revenue gain of $100 billion, “this is at the lower end of the OECD’s own estimate of corporate tax avoidance — $100 billion to $240 billion [annually],” the Independent Commission for the Reform of International Corporate Taxation said in a February 13 statement.
“As it stands, the reform proposal would fail to meaningfully address tax avoidance by multinationals and deliver minimal redistribution of taxing rights and will only achieve a small fraction of its objectives,” the commission added.
While using 2016 data was necessary because of the economic analysis project’s constraints, “it is worth considering policies that have changed since 2016 that could impact the results,” said Daniel Bunn, vice president of global projects at the Tax Foundation, pointing to the Tax Cuts and Jobs Act and the EU 2016 anti-tax-avoidance directive. “Having a result based on 2016 data is valuable, but policymakers should recognize how the world has changed since then,” Bunn said.
For its part, the OECD continues to cooperate with inclusive framework members to refine and improve the quality of the data and hopes to update the data accordingly, Johanssen said during the webcast.