Behind the scenes of the G7 tax reform proposals, an old battle between states and corporations is taking place. But even if multinational corporations end up paying tax somewhere, where they pay it is still up for grabs. The battle then becomes one between rich and developing countries, Peter Dietsch argues.

The headlines from the G7 summit in Cornwall might suggest that the groundwork has just been laid for the most fundamental overhaul of the international tax regime in decades. The twin proposal accords additional taxing rights to states with large consumer markets and introduces a global minimum tax rate of 15%. It has been heralded as a game-changer to the way multinational corporations are taxed. Yet, such an optimistic reading of events would be premature.

To assess the merits of the plan tabled by the G7 as well as to evaluate its chances of success, it is useful to recall the double challenge faced by the international tax regime: first, under conditions where capital is mobile across borders, states have an interest in cooperating to make sure that capital and its returns are taxed somewhere; second, once the joint fiscal net is cast, every individual state has an interest in maximizing its individual share of the tax base. In other words, there are two simultaneous battles to catch mobile capital in the fiscal system: one to tax multinational corporations; and one to maximise one’s national tax base in doing so. The second of these battles has proven to be a formidable obstacle to states finding the consensus necessary to winning the first battle.

There are two simultaneous battles to catch mobile capital in the fiscal system: one to tax multinational corporations; and one to maximise one’s national tax base in doing so.

A long time in the making

The G7 proposal is merely a snapshot of where negotiations of the international tax regime are at after years of looking for an elusive consensus to the question of who should pay what tax and where. It is too early to tell where this process will end up in part because the members of the G7 need other nations to buy into their plan to make it reality. And other states have every reason to meet parts of the G7 plan with skepticism. While the proposal would lead to a more effective taxation of multinationals and undermine the role of tax havens, the distribution of benefits risks being skewed in favour of rich countries.

The last time the rules of international taxation were fundamentally revised to respond to these challenges was at the end of the 1920s. It was back then that the basic consensus, roughly speaking, of residence taxation for individuals and source taxation for multinational enterprises was hammered out. Arguably, the many updates to this system that have been implemented since amount to cosmetic adjustments.

The paradigm that has governed international taxation for almost a century since suffers from one important shortcoming: Designed with the primary objective of avoiding double taxation in two countries for fears this would discourage investment, the international tax regime is hindered by the problem of double non-taxation. That is, no one pays, anywhere. While evading taxes is illegal for individuals, many legal loopholes exist for multinationals to shift either their profits or their actual economic activity to low-tax jurisdictions. In recent decades, multinationals assisted by a tax avoidance industry of bankers, accountants and lawyers have continuously improved their techniques of exploiting loopholes in this system, to the point where the effective tax rate in some cases is close to zero.