Jun 11, 2021 Macro

Tax and mend

Plans to revamp the international rules on corporate taxation are the latest sign of the political pendulum swinging in favor of labor.

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A global minimum corporate tax rate of 15%

Economists are habitually fond of competition, including on taxes. According to the traditional view, variety benefits consumer-voters. If citizens can vote with their feet, they will choose whatever combination of taxes and public services they like best.[1] It may also promote efficiency and keep overall state spending in check. Swiss cantons have been engaged in tax competition of this beneficial sort for centuries.[2]

What then, should investors make of plans by the G7 advanced economies to revamp international rules?[3] The immediate impact on company earnings at an index level is likely to be small, partly because only the world’s largest and most profitable companies would initially be targeted.[4] Take a step back, though, and the proposals look quite significant. A global minimum corporate tax rate of 15%, while taxing at least some of the profits in countries where multinationals make their sale could mark a sea change.

As our Chart of the Week shows, U.S. corporate profits after tax have been drifting upward since the 1980s, when compared to employee compensation. For almost as long, precisely how much of it was structural rather than cyclical, has been a matter of much debate among economists.[5] The same sorts of debates are likely to resurface shortly. Tight labor markets could squeeze profit margins.[6]

20210611_CotW_Global taxes_CHART_EN_72DPI.png

Sources: Board of Governors of the Federal Reserve System: Z.1 Financial Accounts of the United States, DWS Investment GmbH as of 3/11/21

Beyond cyclical fluctuations, though, the tax debate may also be the latest sign of the political pendulum swinging away in ways that have long been predicted.[7] According to long-standing critics such as Gabriel Zucman, the problem is not just tax competition as such, but the type of tax competition. Digitalization made it easier to "locate" intangibles (such as patents, logos or algorithms) in low tax jurisdictions – even as most employees, machines or research departments stayed put in higher taxed ones.[8] Ideally, the new rules would make such tax avoidance harder, while still leaving enough scope for small countries to encourage foreign direct investment through competitive tax rules.[9] One way or the other, though, governments are likely to have an easier time to tax highly mobile capital and wealthy individuals more than in recent decades.

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