The Unfinished Business of International Business Tax Reform

IMF Blog, February 16, 2023

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The international tax system—shaped by the League of Nations in April 1923—has come under intense pressure in recent years due to globalization, digitalization, and tax competition.
Following a decade of debate, 138 countries recently agreed to the first major overhaul of the international tax system in a century.
The reform was agreed in 2021 by the members of the Organisation for Economic Co-operation and Development/Group of Twenty Inclusive Framework—a body with now 142 members tasked to address international tax avoidance by multinational companies and deal with the tax challenges arising from digitalization of the economy.

The reform contains two pillars:
- Pillar 1 includes a new method to allocate profits to countries where multinational companies may have significant business but few (or no) local operations, addressing cases where firms sell through digital channels and where countries have no right to tax such profits in the absence of a physical establishment.
- Pillar 2 introduces a global minimum effective tax rate of 15 percent, enforced through a set of top-up tax rules (for instance, if a country where operations take place levies taxes below this minimum, then the country where the corporate headquarters are located can collect additional taxes to reach the minimum rate).

The reform breaks with century-old norms by moving toward taxing profits in the destination country—where final consumers are located—reducing vulnerability to tax base erosion because consumers are less mobile than intangible capital such as patents or technology.
The simplified allocation of profits by a formula reduces scope for aggressive tax planning, including manipulation of transfer prices to shift profits to lower-tax countries.
The new minimum tax in Pillar 2 addresses the race to the bottom by putting a global floor on rates and raising the prospect of ending the decadelong downward trend in corporate tax rates.
The reform cuts back on profit shifting into investment hubs and reduces pressure to compete through tax incentives, enabling countries to design better domestic policies.
The paper notes that indirect effects from reduced tax competition might yield bigger gains in revenue than direct-impact estimates suggest.

Initial coverage is limited: the reform covers only the largest multinational companies—and in case of Pillar 1, just over 100 firms.
Under both pillars, relatively large chunks of profits are excluded, so the reform is unlikely to be the end point of change for the international tax system.
The reform is still quite complex, creating implementation challenges especially for developing countries; further simplification is needed, with work under way on areas important to these economies, such as simplified approaches to taxing routine marketing and distribution operations.
The global tax agreement is not yet operational; monitoring and evaluation are critical and further reforms are likely.

The additional revenue raised by the reform is welcome, but small (at initially just 0.2 percent of global gross domestic product).
The authors estimate that the reform will boost global revenue by just under 0.2 percent of GDP initially, although reduced tax competition might double the gains in the future.
These estimated revenue gains are nowhere near what developing countries need to meet the sustainable development goals.
There is potential for low-income countries to increase their tax revenues by as much as 8 percent of GDP through domestic tax increases, based on estimates of their tax capacity.

Countries need to implement the reform swiftly; the most important next step is for countries to implement it swiftly.
Other reform efforts—both international and domestic—should continue, particularly to help poorer countries raise more revenue to meet their development needs.
Low-income countries should not just rely on expected revenue from international tax agreements and should raise domestic taxes where feasible.
Options for domestic reforms include:
- Using the scope created by reduced pressures for low tax rates and tax incentives to introduce corporate tax systems with fewer loopholes.
- Collecting more from other major taxes—such as the value-added tax—where there is significant untapped potential in many countries.
- Investing urgently in revenue administration to reap the full benefits of the reform and to support tax collection more generally.

The Unfinished Business of International Business Tax Reform — Ruud de Mooij, Alexander Klemm, Christophe Waerzeggers, February 16, 2023