Baba’s Explainer – Minimum Tax on Big Businesses

  • IASbaba
  • December 24, 2022
  • 0
Economics, Uncategorized
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  • GS-2: International Institutions
  • GS – 3: Economy, Globalisation and Challenges

Context: Members of the European Union agreed in principle to implement a minimum tax of 15% on big businesses.

Last year, 136 countries had agreed on a plan to redistribute tax rights across jurisdictions and enforce a minimum tax rate of 15% on large multinational corporations.

What is Base erosion and profit shifting (BEPS)?
  • BEPS refers to tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to avoid paying tax.
  • Although some of the schemes used are illegal, most are not
  • BEPS practices cost countries USD 100-240 billion in lost revenue annually.
  • Working together within OECD/G20 Inclusive Framework on BEPS, over 135 countries and jurisdictions are collaborating on
    • The implementation of 15 measures to tackle tax avoidance,
    • Improve the coherence of international tax rules
    • Ensure a more transparent tax environment.
What are the concerns with BEPS?
  • Reduced Tax Revenue: Developing countries’ higher reliance on corporate income tax means they suffer from BEPS disproportionately.
  • Disproportionately impacts domestic small firms: Such tax planning strategies undermines the fairness and integrity of tax systems because businesses that operate across borders can use BEPS to gain a competitive advantage over enterprises that operate at a domestic level.
  • Sets wrong precedent: Moreover, when taxpayers see multinational corporations legally avoiding income tax, it undermines voluntary compliance by all taxpayers.
What is OECD’s Global Tax Plan ?
  • EU members have agreed to implement a minimum tax rate of 15% on big businesses in accordance with Pillar 2 of the global tax agreement framed by the Organisation for Economic Cooperation and Development (OECD) 2021.
  • Under the OECD’s plan, governments will be equipped to impose additional taxes in case companies are found to be paying taxes that are considered too low.
  • This is to ensure that big businesses with global operations do not benefit by domiciling themselves in tax havens in order to save on taxes.
  • Pillar 1 of the OECD’s tax plan, on the other hand, tries to address the question of taxing rights. Large multinational companies have traditionally paid taxes in their home countries even though they did most of their business in foreign countries.
  • The OECD plan tries to give more taxing rights to the governments of countries where large businesses conduct a substantial amount of their business.
  • As a result, large U.S. tech companies may have to pay more taxes to governments of developing countries.
  • It is estimated that the minimum tax rate would boost global tax revenues by $150 billion annually.
Why is there a need for a global minimum tax?
  • Corporate tax rates across the world have been dropping over the last few decades as a result of competition between governments to spur economic growth through greater private investments.
  • Global corporate tax rates have fallen from over 40% in the 1980s to under 25% in 2020, thanks to global tax competition that was kick-started by former U.S. President Ronald Reagan and former British Prime Minister Margaret Thatcher in the 1980s.
  • The OECD’s tax plan tries to put an end to this “race to the bottom” which has made it harder for governments to collect revenues required to fund their rising spending budgets.
  • The minimum tax proposal is particularly relevant at a time when the fiscal state of governments across the world has deteriorated as seen in the worsening of public debt metrics.
What lies ahead?
  • Some governments, particularly those of traditional tax havens, are likely to disagree and stall the implementation of the OECD’s tax plan.
  • High tax jurisdictions like the EU are more likely to fully adopt the minimum tax plan as it saves them from having to compete against low tax jurisdictions.
  • Low tax jurisdictions, on the other hand, are likely to resist the OECD’s plan unless they are compensated sufficiently in other ways.
  • It should be noted that, even within the EU, countries such as Poland have already tried to stall the adoption of the global minimum tax proposal citing various non-economic reasons.
  • Since the OECD’s plan essentially tries to form a global tax cartel, it will always face the risk of losing out to low-tax jurisdictions outside the cartel and cheating by members within the cartel.
  • After all, countries both within and outside the cartel will have the incentive to boost investments and economic growth within their respective jurisdictions by offering lower tax rates to businesses. This is a structural problem that will persist as long as the global tax cartel continues to exist.
What are the implications of OECD’s tax plan?
  • Supporters of the OECD’s tax plan believe that it will end the global “race to the bottom” and help governments collect the revenues required for social spending.
  • Many believe that the plan will also help counter rising global inequality by making it tougher for large businesses to pay low taxes by availing the services of tax havens.
  • Critics of the OECD’s proposal, however, see the global minimum tax as a threat. They argue that without tax competition between governments, the world would be taxed a lot more than it is today, thus adversely affecting global economic growth
  • In other words, these critics believe that it is the threat of tax competition that keeps a check on governments which would otherwise tax their citizens heavily .

Main Practice Question: What do you think are the implications of OECD’s minimum tax initiative?

Note: Write answer his question in the comment section.

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