Recent decades have seen a downward convergence in corporate tax regimes worldwide as economies moved to grab a bigger slice of the global investment pie. Headline rates have fallen by 20 percentage points since the early 1980s. Alongside this, special tax incentives aimed at capturing investment have emerged, further reducing the effective rates paid by multinationals. In the aftermath of the 2007-08 global financial crisis, many were compelled to slash spending and raise revenue in order to rein in large budget deficits. Even as tax revenue as a share of GDP in many economies have reached their highest levels in decades, the trend towards lower corporate tax rates has remained intact.
In the face of post-crisis austerity, however, public tolerance of corporate tax avoidance has ebbed, giving political fuel to efforts to boost transparency and limit the scope for companies to minimise their tax bills. The OECD has led the charge – alongside the G20, partner countries and emerging markets – to curb base erosion and profit shifting (BEPS). The EU has taken up parallel efforts, and continues work on a common corporate tax base that, if put in place, would have profound implications for corporate tax regimes in the region.
In advanced economies, average corporate income tax rates fell to 22% in 2015, down almost half from the early 1980s. In the latest comprehensive snapshot of changes among its 35 members, “Tax Policy Reforms in 2017”, the OECD noted competition on corporate tax rates had tightened, following a period of relative stabilisation in the early post-crisis years. In 2016-17, it said 12 countries introduced or announced reductions in headline corporate tax rates; only Chile and Slovenia raised them. Many countries phased in these changes gradually, though, in the most extreme case, Hungary cut its corporate tax rate from 19% to 9%, effective January 2017. The OECD also noted rising competition through new or enhanced tax incentives, many of which emphasise research and development (R&D) and intellectual property.
Despite its own periodic discussions on tax reform, the US resisted joining the corporate tax-cutting schemes until late 2017. With a marginal corporate tax rate of 39.1% – one of the highest in the world, and more than 10 percentage points higher than the average for advanced economies – it appeared to be something of an outlier. While campaigning for office in 2016, US President Donald Trump had called for slashing this to as low as 15%. In December 2017 the US Congress enacted a sweeping tax reform package, notably cutting the corporate rate to 21% and applying a lower 15.5% amnesty rate to historical profits in a bid to encourage repatriation of such funds. Another key change was a move towards a territorial-based corporate tax regime – aligning it with most other corporate tax regimes around the world – whereby US taxes will be levied not on global profits but on those generated in the US itself. However, this move could end up encouraging offshoring.
The downward direction of corporate tax rates, and reduction in corporate tax bases, is far from confined to the most advanced economies. The OECD also highlighted corporate tax cuts recently implemented or announced in emerging markets in Europe and MENA, notably Israel and Slovakia, as well as the Czech Republic and Slovenia. One of the main movers was Turkey, which in 2016 introduced its so-called super tax incentive model alongside specific incentives for R&D investment. Hungary, Poland and (outside the region) Mexico, have also signalled intentions to reform tax incentive offerings in 2017 or thereafter.
Such reforms in developed countries could have knock-on effects on emerging ones Mexico is likely to see pressure to improve its offering in light of the recent reforms in the US. In Argentina, President Mauricio Macri’s government introduced a tax reform that would bring the corporate rate down from 35% to 25% in October 2017. “The reform is geared more towards redistributing taxes than drastically reducing them, in order to prop up investment and job creation,” Dante Sica, CEO of ABECEB, a regional consultancy, told OBG.
This phenomenon is not new. The IMF has identified evidence of a “partial race to the bottom” in corporate tax regimes in 50 emerging and developing economies in the decade before the global financial crisis, as countries felt pressure to reduce rates to attract investment. While reductions in emerging markets in that period were on par with those in advanced ones, it found that tax competition led to a reduced tax base even where the headline rate remained unchanged. Evidence of such a race to the bottom, in which many countries established parallel systems, was found to be particularly strong in Africa, where in many countries the effective corporate rate had fallen to zero; large declines were also observed in Egypt, Ghana, Kenya and Morocco. The IMF meanwhile concluded that higher tax rates adversely affect domestic and foreign investment.
Long-term trends towards lighter corporate taxation in advanced and emerging economies have impacted developing and least developed countries. In some cases profits on activities carried out in developing countries are diverted to friendlier corporate tax regimes in advanced economies. According to Oxfam, corporate tax avoidance schemes cause $100bn in lost tax revenue for developing countries. In some cases, developing countries may lose out on revenue by following suit and introducing their own such schemes – amounting to around $138bn, according to Action Aid, a South Africa-based NGO.
One key effect of falling corporate tax rates is reinforcement of inequality, both within and between countries. When investment is diverted from emerging and developing markets, where returns should be higher, to advanced ones purely for tax reasons, the result is slower global convergence in living standards. Reduced corporate taxation further concentrates wealth in the hands of shareholders, requiring increases in other taxes or reduced spending to maintain public finances. In sub-Saharan Africa, for example, countries rely on indirect taxes for around two-thirds of their tax revenue, compared to less than one-third in advanced economies. Tax revenue in less-developed and emerging economies is generally much lower than in more advanced ones, meaning less resources are available for public investment or social spending – both of which tend to benefit the low-income and boost a country’s productive capacity.
As the IMF concluded in July 2017, “The trouble is that by competing with one another and eroding each other’s revenue, countries end up having to rely on other – typically more distortive – sources of financing or reduce much-needed public spending, or both. This has serious implications for developing countries because they are especially reliant on the corporate income tax for revenues.” It notes that efforts like the OECD-G20 BEPS initiative, despite reducing tax avoidance, could lead to more intense tax competition in other realms. Some also cast doubt on the economic rationale for cutting corporate rates. In theory, lower rates should spur productive investment, yet in the decade since the global financial crisis, investment has slowed. Rather than reinvesting earnings to expand their business, large corporates have, on the whole, been either hoarding cash or returning it to shareholders in the form of dividends or share buy-backs at historically high rates.
The big potential game-changer in early 2018 remains the tax reform in the US. While the downward trend slowed in the aftermath of the global financial crisis, such a significant reduction in the world’s largest economy would seem to confirm recent trends. Many countries have already announced, or begun, phased multi-year reductions; those moving in the opposite direction are now very much the outliers. The medium-term outlook for corporate rates therefore looks clear. Globally coordinated efforts to boost transparency and curb legal tax avoidance are changing the tax landscape, but do not appear to have slowed the emergence of new or reformed incentives in advanced, emerging or developing economies. Going forward, this appears the more intense arena for tax competition, albeit perhaps with clearer-defined rules of the game.
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