Decluttering International Tax Rules | Tax Foundation
One of the Tax Foundation’s principles for sound tax policy is simplicity; tax codes should be easy to comply with, administer, and enforce.
This principle is rarely followed in tax policy, although plenty of lip service is paid to it by politicians. Simplicity is especially difficult to achieve in international tax policy, when multinational businesses invest and earn profits in multiple countries. Current global efforts to rearrange where companies pay tax and adopt a global minimum tax are making the problem worse.
The new rules are going to be layered on a variety of other rules adopted throughout the last decade. Thousands of pages of legislative documents and guidance have left many businesses with more questions than answers.
It is time to change course and make simplification a reality for taxpayers and tax collectors.
Imagine you have a garden that’s become a mix of plants you intended to be there and unwanted weeds. Then, because you want different plants in your garden, you proceed to plant new seeds without removing the other plants or the weeds. No one in your neighborhood would compliment you on your efforts. Some may even point and laugh.
That is what is happening with international tax rules. There are digital services taxes, rules for limiting interest deductions, rules about how to determine prices for items you sell between units of your company, rules that trigger additional taxes in your headquarters country, and rules about aligning your activities and your profits. The U.S. has its own special trio of minimum taxes as well. Without removing any of these rules, policymakers are trying to bring in a whole new set of rules as part of the global minimum tax.
This comes with three different costs: adjustment costs, uncertainty, and compliance costs.
Anything new will require some amount of adjusting, but the global minimum tax represents a novel set of costs for companies and governments. This includes digging up relevant data that hasn’t been used for calculating tax liability in the past, learning accounting rules that have rarely ever been used for tax policy, and keeping it all in new systems that are designed to meet the requirements of the rules.
The uncertainty partially comes from novel tax legislation that does not harmonize with existing legal frameworks and may require litigation to sort out the real meaning of the new concepts and rules. It also comes from moving targets and a lack of clarity from governing bodies. Final regulations for the new U.S. minimum tax on book income have not been promulgated even though taxpayers are liable under the new rules in 2023. The global minimum tax rules are regularly being updated even as countries try to legislate them. It doesn’t help that they include novel definitions and strange new extraterritorial rules that will lead to many legal questions down the road.
When it comes to compliance, both the taxpayer and the tax collector must be considered. A recent study for the European Parliament found that tax compliance costs run between 1 and 2 percent of business revenue; for a business making a 10 percent profit margin (many businesses would be very happy with such a margin), that suggests a compliance tax on profits of 10 to 20 percent. Relative to revenue collected, the compliance costs average 30 percent among the 27 European Union countries and the United Kingdom.
This administrative burden falls both on taxpayers and tax collectors alike. There are many skilled people working in large companies these days doing nothing but navigating through dense legislative material and ever-changing corporate tax standards. Whether their work results in significant extra revenue or not seems to be ignored. The cost of compliance crowds out other useful activities and utilizes resources that could be channeled into new investments, research, and innovation.
Some policymakers are starting to notice these costs (albeit much later than they should have). The Organisation for Co-operation and Development (OECD) has been convening many international discussions over the years, and some of their key policy staff have started noting that the international tax rules need some attention. They call it a “decluttering” project.
So, if the garden has grown unwieldy or the closet has become too cluttered, how should policymakers determine what should stay and what should go?
There are two potential paths policymakers can take. One option would be to make generous exceptions to the rules for businesses and transactions that are less likely to be a risk. This could avoid having a lot of useless paperwork activity for taxpayers and tax collectors. To be fair, this approach is already being used for some limited portions of the global minimum tax.
The second, and certainly more challenging path, would be to go in and truly simplify the policy landscape. Duplicative rules should be reviewed and only the more straightforward approach for both taxpayers and governments should be retained. The very nature of an alternative calculation for taxing (such as the global minimum tax) suggests that there is some duplication of policy, and something deserves to be in the trash pile. An eye toward rules that are more supportive of cross-border investment should win out.
Cleaning up international tax policy will require technical and political leadership. Much paper, ink, and political capital have been spent getting us into this disorderly situation, and much more will be required to get us out.
Countries that have legacy provisions for taxing multinationals (like controlled foreign corporation rules), should eliminate any duplication between those rules and their new minimum tax rules. In the European Union, this should take the form of reviewing the overlap between the global minimum tax rules and the various layers of the Anti-Tax Avoidance Directive.
U.S. lawmakers arguably have the most work to do with legacy regimes that sit alongside recent rules from 2017 and 2022. Simplification of U.S. rules would need to be prioritized even if the global minimum tax wasn’t part of the discussion.
And that’s a general lesson that should be learned here. One reason there is so much complexity in current international tax rules is because politics outpaced policy work. Politicians in Europe who were eager to tax large U.S. companies ignored the growing complexity that is now bearing down on multinationals worldwide (including in Europe).
Leaders across the globe need to see the value of simplification for it to be achieved, and they need to connect this issue to the other challenges that countries are facing across the globe. The result will be more stability in tax law, more legal certainty, and lower administrative burdens for taxpayers and tax collectors.
The 2023 UNCTAD World Investment Report noted severe weaknesses in cross-border investment, particularly for countries in Africa and developing countries in Asia. The concern among the developed world is which country is going to outpace the others with subsidies (expect them to be designed to skirt the global minimum tax rules). In 2022, that report was clear that new cross-border rules would increase the tax costs of foreign direct investment (FDI) by 14 percent globally and reduce FDI volume by 2 percent.
Simplifying international tax rules will not solve all the challenges that stand in the way of healthy cross-border investment, but eliminating unnecessary provisions would be a positive pivot relative to the trajectory of recent years. It’s high time that policymakers stopped pursuing ever more complex rules and started the hard work of simplification.
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