The New G7 Minimum Corporate Tax Agreement is a Game Changer

The Group of Seven or G7 recently reached a potentially historic global tax agreement at a summit in Britain. This has been a personal project of Treasury Secretary Janet Yellen, who at the beginning of Biden’s term mentioned the importance of a global minimum tax rate. At the time of Yellen’s speech, progressive economists seemed impressed by the goal but distressed at the ability of the United States to get other countries on board. This agreement, between seven of the wealthiest countries on Earth, paves the way for a true global minimum corporate tax rate and goes even further. This deal also has language on taxing companies based on where their product is sold versus the location of their headquarters.

Imposing a 15% minimum global tax rate is a potential boon for the United States. The United States currently has a top corporate rate of 21%, down from 35% due to the Tax Cuts and Jobs Acts of 2017 (TCJA) enacted under Trump -- a number that Biden has said he would like to see increased to the 25-28% range. But it is important to note that what corporations actually pay is almost always much lower than the top tax rate. The effective rate is currently estimated at around 12.5%, a lower number than most individual’s income tax rate (the lowest income tax rate in the US is 10%). This effective tax is much lower than the top rate for a variety of reasons, but a significant reason is due to the very low tax rate multinational corporations pay in tax havens (between 1-6%).  Just by offshoring intellectual property and foreign profits, multinational corporations such as Apple are able to avoid the higher tax rates of either their home country or the country where point of sale occurs.

This agreement among G7 countries marks a potential shift in the narrative of race to the bottom corporate rates among nations. Between 2000-2018, 76 countries cut their corporate tax rate. With this deal, the most powerful economies in the world won’t go lower than a corporate tax rate of 15%, and that puts a lot of pressure on small countries that have been poaching taxation from the United States and European Union. Take Ireland with their top corporate rate of 12.5% and effective rate between 2.2-4.5%. Ireland has for a while been the number one tax haven for corporations from the United States to park their money and is most likely the largest tax haven in the world. Research has shown that in 2015, $1.7 trillion was accumulated by multinationals, with 40% of that total shifted to tax havens.

By picking up an address in Ireland, companies were able to move many of their foreign profits to a much lower rate than their G7 homeland. Under the new agreement, the language is in place for governments to expropriate earnings from a company up to the level of 15%. For instance, the United States would be able to recoup the difference in taxation on foreign earnings from what Apple pays and what Apple owes, around a 7-8% difference in tax rate. Countries could collect the tax on their local multinationals, regardless of any single country’s willingness to have a lower local corporate tax rate.

This significantly reduces the incentive for multinationals to book their profits in tax havens like Ireland and furthermore should reduce the incentive for tax havens to offer such low rates – or for that matter, to exist at all. This deal also includes features meant to dissuade any multinationals from jumping ship from their home country. If Apple wanted to leave the United States entirely, they may still find themselves treated with the exact same tax bill at the end of the year as if they never moved at all. It is important to note that the impact of tax havens on United States taxation has changed over time, and even in recent years inversions declined just due to minor political pressure before subsequently rising beyond prior levels.

This deal is primarily a game-changer for the United States and Europe, so it isn’t too much of a surprise that the G7 have agreed, while the G20 may be a more difficult hurdle. The Group of 20 meets in July, and then a broader coalition of 140 countries will meet later in the year. Regardless, the most meaningful work on the deal will be national governments of the G7 countries passing legislation to enact any changes to their tax codes. Conservatives in many governments are adamant about not raising the corporate rate due to the fleeing of multinationals to other countries, but thankfully this deal could solve that. The G20 and further global coalitions are important, but a few holdouts from the G20 probably won’t matter much. The key is rather can the United States and European Union legislatures pass these laws. Legislatures in these countries should be supportive because the potential consequences are low for non-tax haven countries, but conservative politicians could still side against these measures.

If this deal works out, we would be looking at 75% of the world's profits taxed at 15% or more. Literally, all profits made by the United States and European multinationals would be at this new rate, which amounts to half of all global profits. The largest winners in minimum global tax would primarily be the United States, France, and Germany – the countries with the most multinational firms with profit shifted to tax havens. The winners in the allowance of taxation on sales within a country would be those with the largest consumer bases, but the revenue impact here is much smaller than the minimum rate agreement. Essentially, countries that have foreign sales and respectable corporate tax rates should benefit under this new agreement to some degree, while the losers are limited to countries with a very low corporate tax rate meant to encourage offshore profit booking (e.g., Ireland).

This G7 agreement is far from the final step, but it also isn’t the start. Biden’s Administration originally sought a global minimum of 21%. While 21% would be much preferable for the United States, a 15% start can lead to a scaling point for additional global minimum corporate rate increases in the future. Obama’s administration actually proposed a 19% corporate minimum tax on foreign profits in 2015, but plans fell short and the administration moved to work on closing inversion loopholes. The plan fell short for numerous reasons, but primarily due to combativeness from conservatives, who held both chambers of Congress at the time.

Conservatives regularly voice two main concerns regarding raising the corporate tax rate. The most immediate fear of high corporate taxation in the United States has always been primarily that multinational firms will flee to other countries with a lower corporate rate. Essentially the free market at work – if a country can offer a lower fee, then a corporation has to think in the interest of shareholders and leave. These sorts of fears are more natural in a developing country undergoing dramatic economic changes against capital, as seen in Venezuela when rich domestic corporations literally “fled” if they could escape a future of heavy capital losses.

In a country like the United States, you can regularly ignore anyone who thinks the debate is literally about companies physically leaving the country. The debate is centered around inversions that are largely on paper, shifting profits and assets to subsidiaries or newly formed parent corporations based in tax havens. These inversions are subject to the same free-market, plenty of countries have lower top corporate rates and effective rates than the United States. Any argument centered around the United States needing to compete on minimum corporate rates on the world stage to avoid inversions is one that is okay with an effective tax rate race to minimal levels, maybe even zero.

The secondary argument is near and dear to the Reaganite heart and those who favor “trickle-down” economics – basically, higher corporate rates will lead to less economic investment. Economic investment is an important aspect of taxation, economic growth can provide higher wages and productivity. It has only been a few years since the Trump corporate tax cut, but so far there is no evidence of increased economic investment after the rate cut. Some evidence does support that the United States effective corporate rate is so low that minor adjustments such as the Trump top corporate rate slash from 35% to 21% had hardly any effect at all on the corporate investment.

So, no effect on business investment since the corporate rate decline, but there was a brief period where businesses were touting bonuses for their employees due to the Trump tax cut. However, these were likely short-lived bonuses (or less generously PR stunts) and bonuses have actually fallen below their pre-Trump tax cut levels. An analysis by the International Monetary Fund found that just 20% of the increased cash flow from 2018 was spent on business investment such as capital expenditures or research and development. The remaining 80% of added cash flow went to shareholders through the form of buybacks and dividends.

“This slowdown in business purchases of plant and equipment contrasts sharply with President Trump’s rosy forecast of a long-term investment boom that would lead to annual wage increases of $4,000 or more” – Tax Policy Center

Dividends play an important role for the middle class and even the working class that still holds a pension, but should not be a primary argument in favor of a corporate tax cut. The problem with cutting the corporate tax rate is that less revenue is generated for public utilities. The enaction of the Trump tax cut in 2017 has led to federal corporate tax receipts decreases of over 40%. Taxation is important for spending on public utility, but more realistically federal spending did not decrease, so the government was left with ever-higher deficit spending annually from 2017-2019 due to reduced tax revenue.

Part of the Trump Administration’s messaging regarding the necessity for passing the TCJA act in 2017 was that it was imperative to lower the corporate rate to reduce the incentive for companies to invert or allocate profits abroad. Early indications point to foreign investment from multinational firms actually increasing since the enaction of the TCJA. In a paper from March of 2021, the authors found that multinational firms were able to access foreign capital easier than before (a “feature” of the bill) but were using the money to invest in real assets abroad rather than in the United States. So, as a result of Trump’s TCJA, we have so far seen no impact on domestic investment in jobs or assets and instead have seen a significant impact on dividends and repurchases increasingly filling the pockets of the wealthy and shareholding class.

The opportunity for global cooperation doesn’t come along often. G7 countries are in a position to craft legislation that should add revenue to their country's bottom line while tax havens like Ireland will have to rethink their economies. There is a long way to go, but this represents a potential game-changer for large countries with a lot of multinational firms exploiting tax loopholes on foreign profits. The next challenge will be the presentation of the proposal to the G20 countries in July and the potential amendments reached. After that, the challenge will be adopting legislation through local congresses. The EU has already stated its intention to propose minimum tax legislation if the G20 can reach a deal.