30/06/2021
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​Myths, lobbies block international tax cooperation

By Anis Chowdhury / Jomo Kwame Sundaram

Too many have swallowed the myth that lowering corporate income tax (CIT) is necessary to attract foreign direct investment (FDI) for growth. Although contradicted by their own research, this lie has long been promoted by influential international economic institutions.

'Beggar-thy-neighbor' policies

The early 1980s' economics 'counter-revolution' impacted the 'Washington Consensus' of the US federal government and the two Washington-based Bretton Woods institutions (BWIs) – the International Monetary Fund (IMF) and the World Bank.

Thus, the rise of 'supply side' economics in the US – advocating lower direct taxes on income and wealth – influenced the world. Without evidence, IMF researchers justified its policy advice thus: "The complete abolition of CIT would be the most direct application of the theoretical result that small open economies should not tax capital income."

Noting that capital is highly mobile, and can more easily evade taxes than labor, IMF economists even recommended that "small countries should not levy source-based taxes on capital income". Meanwhile, the Bank's highly influential, but dubious Doing Business Report has recommended tax incentives without evidence.

To get BWI approval, developing country governments have undertaken tax reforms, reducing progressive direct taxation. Instead, they have favored more regressive indirect taxes, such as the value-added tax (VAT), sometimes dubbed the goods and services tax.

Consequently, IMF tax policy recommendations to Sub-Saharan African (SSA) countries during 1998-2008 reduced corporate and personal income tax rates while promoting VAT. And following Bank advice, Tanzania – Africa's third largest gold producer – ended up subsidizing, not taxing foreign mining companies!

Evidence contradicts advice

World Bank research and surveys have long found that tax incentives do not really attract FDI inflows. A Bank report found no strong evidence that tax incentives attracted non-resource 'greenfield' or additional new FDI.

It also found "tax incentives impose significant costs on the countries using them", including fiscal losses, rent-seeking, tax evasion, administrative costs, economic distortions and "retaliation against new or more generous incentives" by competitors.

An earlier Bank brief noted "tax incentives are not the most influential factor for multinationals in selecting investment locations. More important are factors such as basic infrastructure, political stability, and the cost and availability of labor".

It also argued that tax incentives do not compensate well "for negative factors in a country's investment climate". Meanwhile, the "race to the bottom…may end up in a bidding war, favoring multinational firms at the expense of the state and the welfare of its citizens".

Researchers have unearthed no strong evidence that tax incentives are beneficial. While some incentives may attract FDI, they crowd out other investments; hence, overall investment and growth do not improve.

An IMF report noted, "Tax incentives generally rank low in investment climate surveys in low-income countries, …investment would have been undertaken even without them. And their fiscal cost can be high, reducing opportunities for much-needed public spending…, or requiring higher taxes on other activities."

Even Organization for Economic Cooperation and Development (OECD) research confirmed BWI findings that tax incentives hardly attracted FDI. The Economist also found a weak relationship between tax rates and business investment as well as growth rates.

A UK government report cast more doubt: "effectively attracting FDI needs public spending, so narrowing the tax base works with tax incentives for low-income countries could be contra-productive".

Race to bottom hurts all

IMF findings confirm that 'beggar-thy-neighbor' tax competition worsened avoidable revenue losses. Such ill-advised efforts to attract investment inevitably accelerated CIT rates' 'race to the bottom'.

BWI advice to governments has undoubtedly lowered CIT rates. But despite lower CIT rates, transnational corporations (TNCs) still minimize paying tax, e.g., by shifting profits to tax havens and exploiting loopholes.

CIT rate averages for high-income countries (HICs) have dropped twenty percentage points since 1980, falling from 38% in 1990 to 23% in 2018. Meanwhile, they fell from 40% to 25% in middle-income countries, and from over 45% to 30% in low-income countries (LICs).

Cut-throat competition has especially hurt developing countries, which rely much more on CIT than developed economies. IMF research found a one-point average CIT rate cut in other countries reduces a developing country's CIT revenue by two-thirds of a point.

Such tax cuts induce other concessions, further eroding the base for corporate taxation. Thus, tax revenue is doubly lost by both rate and base cuts. Fund staff estimated revenue loss at 1.3% of GDP in developing countries, due to base erosion and rate reductions – much worse than in developed countries.

The UK government estimated global revenue loss due to TNC tax minimization at US$500-650bn annually. Such adverse effects were two to three times higher in LICs than in HICs. SSA countries lost the most revenue relative to GDP, followed by Latin America and the Caribbean, and South Asia.

A third of global revenue loss – US$167-200bn – is from low and middle-income countries (LMICs), costing them 1.0-1.5% of national income. With better tax administrations and larger formal sectors, HICs can replace such losses more easily than LMICs with generally weaker tax systems and larger informal sectors.

Tax breakthrough

The IMF and others now agree that an international minimum CIT rate can stop this race to the bottom and TNC profit shifting. The group of seven largest rich countries (G7) recently agreed to a minimum 15% rate, rejecting US Treasury Secretary Janet Yellen's proposed 21%. Even The Economist agrees the G7 proposal favors rich countries.

Earlier, the Independent Commission for the Reform of International Corporate Taxation (ICRICT) had recommended a 25% minimum and fairer revenue distribution to developing countries.

Finance ministers from Indonesia, Mexico, South Africa and Germany joined Yellen in welcoming the recent G7 agreement for a minimum global CIT rate, while expressing confidence "that the rate can ultimately be pushed higher than 15 percent".

An influential piece has claimed 'A Global Minimum Corporate Tax Is a Bad Idea', again citing the myth that low taxes will attract FDI. Invoking new Cold War fears, it claimed China and Russia would also gain an unfair advantage in luring "even more" FDI.

Trump-appointed Bank President David Malpass opposes the agreement, claiming it would undermine poor countries' ability to attract investment despite Bank research showing otherwise. Pro-Trump governments in Hungary and Poland also object to the G7 deal. Developing countries cannot allow such tax-cutters to speak for them.

Developing country members of the G20 must insist on a higher minimum and fairer revenue distribution at its forthcoming finance ministers meeting. If the G7 refuses to start with anything more than 15%, an agreed rate increase schedule of an additional one percent annually would get to 25% in a decade.

International tax rules are currently set by rich countries through the OECD. Developing countries participate at a disadvantage. Instead of allowing it to control the process, they must urgently insist on an inclusive, balanced and fair multilateral process for international tax cooperation.

This article was originally published on KSJomo.org.

Related IPS commentaries:

1. Powerful States Push Tax Race to the Bottom. 15 June 2021

2. Will the New Fiscal Crises Improve International Tax Cooperation? 1 December 2020

3. OECD Tax Reform Proposal Could Be Better. 15 October 2019

4. Ensuring Fairer International Corporate Taxation. 3 September 2019

5. South Must Also Set International Tax Rules. 20 August 2019

6. 'Beggar Thy Neighbor' Policy Advice. 12 August 2019

(Anis Chowdhury is Adjunct Professor, Western Sydney University and University of New South Wales, Australia. Jomo Kwame Sundaram was an economics professor and United Nations Assistant Secretary-General for Economic Development.)

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