Tax codes should be simple to comply with, administer, and enforce, according to one of the Tax Foundation's principles for solid tax policy.
This principle is rarely observed in tax policy, despite politicians' frequent verbal service to it. It is particularly challenging to achieve simplicity in international tax policy when multinational corporations invest and generate profits in multiple countries. Current global efforts to restructure where companies pay taxes and implement a global minimum tax exacerbate the problem.
The new regulations will be layered on top of numerous other rules adopted over the past decade. Thousands of pages of legislative documents and guidance have left numerous organizations with more questions than answers.
It is time to make simplification a reality for taxpayers and tax collectors by changing course.
Imagine you have a garden that has become a mixture of desired vegetation and unwanted weeds. Then, because you desire a variety of plants in your garden, you sow new seeds without eradicating the existing plants or weeds. Nobody in your neighborhood would acknowledge your efforts. Some may even scoff and point.
This is the situation with international tax regulations. There are digital services taxes, rules for limiting interest deductions, rules for determining prices for items sold between business units, rules that activate additional taxes in your country of headquarters, and rules for aligning your activities and profits. The United States has its own unique triumvirate of minimum taxes. As part of the global minimum tax, policymakers are attempting to introduce an entirely new set of rules without repealing any of the existing ones.
There are three costs associated with this: adjustment costs, uncertainty costs, and compliance costs.
Any novelty will necessitate an adjustment period, but the global minimum tax represents a novel set of costs for corporations and governments. This includes unearthing relevant data that has never been used for calculating tax liability, learning accounting rules that have rarely been used for tax policy, and storing everything in new systems that are designed to satisfy the rules' requirements.
Novel tax legislation that is incompatible with existing legal frameworks and may necessitate litigation to clarify the true meaning of the new concepts and rules contributes to the uncertainty. It is also caused by shifting objectives and a lack of direction from regulatory bodies. The final regulations for the new U.S. minimum tax on book income have not been issued, despite the fact that taxpayers will be subject to the new rules in 2023. Regular updates are made to the global minimum tax rules, even as countries attempt to legislate them. They include novel definitions and strange new extraterritorial rules that will give rise to numerous legal concerns in the future.
Regarding compliance, both the taxpayer and the tax collector must be taken into account. A recent study conducted for the European Parliament determined that tax compliance costs account for between 1 and 2 percent of business revenue; for a business with a 10 percent profit margin (many businesses would be thrilled with such a margin), this suggests a 10 to 20 percent compliance tax on profits. The average compliance cost as a percentage of revenue collected across the 27 European Union countries and the United Kingdom is 30 percent.
This administrative burden is borne equally by taxpayers and tax collectors. There are currently a large number of competent employees at large corporations whose sole responsibility is to navigate complex legislative material and ever-changing corporate tax standards. Whether or not their work generates substantial additional revenue appears to be disregarded. The cost of compliance consumes resources that could be allocated to new investments, research, and innovation, displacing other productive activities.
Although much later than they should have, policymakers are beginning to recognize these costs. Over the years, the Organisation for Co-operation and Development (OECD) has hosted numerous international discussions, and some of their key policy staff have begun to note that the international tax rules require revision. They refer to it as a "decluttering" effort.
How should policymakers decide what should be kept and what should be discarded if the garden has become unmanageable or the closet is overstuffed?
There are two possible courses of action for policymakers. One possibility would be to grant generous exceptions to the rules for enterprises and transactions that pose a low risk. This could reduce the amount of documentation that taxpayers and tax collectors must complete. To be fair, this method is currently employed for a portion of the global minimum tax.
Second, and unquestionably more difficult, would be to genuinely simplify the policy landscape. There should be a review of redundant regulations, and only the simpler approach for both taxpayers and governments should be retained. The very nature of an alternative calculation for taxation (such as the global minimum tax) suggests that there is policy duplication, and something should be discarded. An eye toward norms that are more conducive to international investment should prevail.
International tax reform requires both technical and political leadership. Much paper, ink, and political capital were expended to get us into this disorganized situation, and much more will be necessary to get us out.
Countries with legacy provisions for taxing multinationals (such as controlled foreign corporation regulations) should eliminate any overlap between these provisions and their new minimum tax provisions. This should be accomplished in the European Union by examining the overlap between global minimum tax rules and the various layers of the Anti-Tax Avoidance Directive.
Legislators in the United States may have the most work to do with legacy regimes that coexist with recent regulations from 2017 and 2022. Priority must be placed on the simplification of U.S. regulations even if the global minimum tax is not discussed.
And this is the broader lesson to be learned here. One reason for the current complexity of international tax regulations is that politics has outpaced policymaking. Politicians in Europe who were anxious to tax large U.S. corporations disregarded the growing complexity that multinational corporations (including those in Europe) now face.
For simplification to be achieved, world leaders must recognize its value, and they must correlate this issue to the other problems countries face on a global scale. As a consequence, tax law will be more stable, legal certainty will increase, and administrative burdens for taxpayers and tax collectors will decrease.
The 2023 UNCTAD World Investment Report identified significant deficiencies in cross-border investment, particularly for African and Asian developing nations. The developed world is concerned about which nation will outpace the others with subsidies (expect them to be devised to circumvent the global minimum tax rules). In 2022, it was evident from this report that new cross-border regulations would increase the tax costs of foreign direct investment (FDI) by 14% globally and reduce the volume of FDI by 2%.
Simplifying international tax rules will not eliminate all obstacles to healthy cross-border investment, but eliminating superfluous provisions would be an improvement relative to recent trends. The time has come for policymakers to cease their pursuit of ever-more-complex regulations and begin the laborious process of simplification.
