Global Minimum Tax Battles Put Emerging Economies in Crossfire

When it comes to tax policy, the goal of multilateralism is to provide more equal treatment among countries in technical policy matters, recognizing that investment and economic growth need not be a zero-sum game.

But a recent deal between the US and other G7 countries to diffuse sovereignty disputes over Pillar Two leaves emerging economies with more questions than answers about their own tax policy sovereignty.

President Donald Trump made clear that the US wouldn’t accept the global minimum tax (known as Pillar Two) from the Organization for Economic Cooperation and Development in its current form. The extraterritorial nature of the undertaxed profits rule has caused confrontation between the US and allies—including the EU and Canada, which have already adopted this new tax system into their laws.

While international tax policy is usually left to technical experts, Pillar Two has become an issue of national sovereignty and economic coercion for both Trump and Republicans in Congress. The US has threatened tariffs and retaliatory tax measures on friend and foe alike. Lawmakers have supported a provision to defund the OECD. The US walked out of tax negotiations at the United Nations.

This is bad news for emerging economies who rely on certainty for foreign direct investment. Case in point: According to the World Bank, foreign direct investment flows into developing economies have fallen to their lowest level since 2005. Major powers turning on multilateralism and starting a global economic war negatively and disproportionately affects these economies.

Therefore, a G7 side-by-side deal that excludes the foreign and domestic profit of US parented groups from Pillar Two’s undertaxed profit rule and income inclusion rule in exchange for the US dropping the Section 899 retaliatory tax provision of the Trump tax bill should be good news.

Maybe this is a sign that, despite a decades-long Republican turn against multilateralism, the right deal can keep them on board.

But there’s a catch.

READ MORE: Economies of All Sizes Need Strong Tax Policies, Each Other to Grow
Africa’s Emergence as an Energy Powerhouse Shifts Its Tax Focus
DSTs Are Double-Edged Swords in Growing Latin American Economies
Africa’s Digital Tax Patchwork Requires Comprehensive Planning

Originally, Pillar Two was negotiated and agreed to by more than 140 countries in the OECD G20 Inclusive Framework on base erosion and profit shifting. The goal was to provide emerging economies with a more equal footing at the negotiating table to increase buy-in. G7 countries realized that to change laws in non-OECD countries, those countries needed to feel like they had a vote over the future of the international system.

However, dissatisfied with the results, some countries turned to the UN in search of better representation. And that was before the G7 deal. Emerging economies understand that even in multilateral institutions, they tend to be rule takers, not rule makers.

It’s still a worthwhile compromise to have rules at all because without them, uncertainty stifles foreign direct investment and economic growth that citizens rely on.

But now, G7 countries are altering the inclusive framework-wide agreement amongst themselves, and it’s almost certain that this approach will exacerbate the disenfranchised feelings of some emerging economies. In fairness, this is not the deal they agreed to. The G7 says they will work with Inclusive Framework members to finalize the deal with their input, but the direction has already been set from the top.

Worse, the technical details of the G7 agreement could actually make things less, not more, certain for them. Pillar Two already has caused problems for these countries by forcibly changing the way they can use tax incentives to compete with larger economies for foreign direct investment and by turning tax rate competition into a subsidy race that favors the rich.

More complexity hurts those with fewer resources to comply with and enforce the rules. Going forward in a side-by-side agreement, it’s not clear what policy options are open to emerging economies nor who will decide which options are acceptable to remain compliant with Pillar Two.

So far, in the few details that have been released, there remain fundamental differences between the US minimum tax regime and Pillar Two even if they accomplish similar outcomes.

If the G7 will allow the US system to coexist without risking undertaxed profit rule liability, should any of the other 140-plus Inclusive Framework countries be allowed to adopt a US-style policy without falling foul of the Pillar Two rules? Who should make that decision? The EU or the OECD? An Inclusive Framework-wide consensus vote? Maybe even the leaders of those countries?

Then there is the possibility, albeit smaller than last week, that the G7 agreement falls apart and leaves the big economies back in a retaliatory position.

The US had its system first, and the rest of the G7 now has its own. However, the G7 agreement has the potential to split the countries into a multi-polar policy world. This could make foreign direct investment more complicated, and until the details are settled, more uncertain.

If emerging economies aren’t getting a true seat at the table nor benefiting from certainty in the international tax system, then what is the point of Pillar Two after all?

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Sean Bray is vice president of global projects at the Tax Foundation.

Write for Us: Author Guidelines