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Your faithful writer,
Dr. Daniel Smith

When the clock struck midnight on New Year’s Eve, people all over the world celebrated by sipping champagne with their loved ones.

Not everyone was happy, however — some of the world’s biggest companies had to face what could be a very expensive problem when 2024 began: a global minimum tax on corporations.

Over 140 countries making up over 80% of the world economy agreed to the global minimum tax deal in 2021, and 2024 is the first year that the global minimum tax is in effect. Today’s newsletter covers:

• What is the global minimum tax?

• Why is it important?

• Will it really be effective at stopping corporate tax avoidance and boosting tax revenues for countries?

What is the Global Minimum Tax?

The global minimum tax (GMT) is an international agreement mandating that all countries institute a minimum corporate income tax rate of 15%.

The deal, which was brokered by the Organization for Economic Co-operation and Development (OECD), is designed to reduce tax avoidance by large multinational companies that used tax havens to save billions of dollars in taxes.

The rules only apply to companies generating over $820 million in annual turnover. The OECD estimated that the GMT would generate an additional $150B in global tax revenue each year, providing more funding for governments and easing the tax burden on private citizens.

How Corporations Save Billions on Taxes

Multinational corporations have long used subsidiaries, legal loopholes, clever accounting practices, and other tricks to avoid paying taxes in the Western countries they’re headquartered in.

For example, the British bank HSBC is composed of at least 828 corporate entities across 71 countries, while American beermaker Anheuser-Busch has 680 subsidiaries across 60 countries.

The global tax avoidance game isn’t just about companies and their subsidiaries; it also requires compliant countries and unscrupulous firms in order to function properly. I see it as a three-part system:

• Countries like Ireland, the U.K., and the Cayman Islands function as Offshore Financial Centers (OFCs) thanks to tax and regulatory regimes designed to attract investment from multinational companies.

• Multinational companies invest in OFCs to minimize their global tax obligations and maximize profits.

• Well-paid law firms and accountancies help companies shift their revenues from high-tax countries into OFCs.

The Race to the Bottom: Ending Tax Competition

The GMT is designed to reduce tax competition, which refers to the trend of countries lowering their corporate tax rates (or offering financial incentives to companies that effectively reduce their tax rate) in order to attract corporate investment.

When one country lowers its corporate tax rates, other countries are incentivized to follow suit if they want companies and capital to invest with them. As a result, corporations bear a smaller tax burden, and private citizens are asked to pay a higher percentage of national tax revenues for their governments.

Ireland is the best example of a country that has benefited from tax competition. Ireland has had low corporate tax rates for decades, drawing investment from leading American technology and pharmaceutical firms.

As a result, foreign firms like Apple, Pfizer, and Meta generated 80% of Ireland's corporate tax revenue by 2017. By 2018, Apple made up over 20% of Ireland's gross domestic product (GDP), effectively meaning that Apple was a fifth of the Irish economy.

Unsurprisingly, Ireland was initially opposed to the GMT. After Ireland agree to join (and raised its corporate tax rate from 12.5% to 15%), the Irish Finance Ministry estimated that joining the deal would cost Ireland up to €2 billion ($2.3B) in lost tax revenue.

Will the GMT work?

The OECD has predicted that introducing the GMT would reduce the average difference in corporate tax rates in tax havens compared to other countries by half, from 14% to 7%.

Outside of reducing tax competition and improving the effective tax rate paid by corporations, the GMT has another goal: forcing companies to allocate their capital more efficiently.

How would this work? The OECD said that corporations will focus less on tax avoidance when deciding where to invest. Instead, factors like infrastructure and workforce skills will play a bigger role in these decisions. As a result:

It’s still early days for the Global Minimum Tax, and experts will likely be watching foreign direct investment (FDI) and other data to determine whether it’s actually making a difference in the ways that companies move their money around the world.

It is promising to see that the GMT was finally implemented, after decades in which experts had warned that globalization was favoring the interests of corporations at the expense of nations.

ART OF THE DAY

Thank you for reading. Please reply to this email if you have any thoughts or feedback.

Yours,
Dan# 35