The Biden administration has proposed several changes to the US international tax system that would increase taxes on multinational corporations (MNEs). Similarly, the OECD tax proposals would increase taxes on multinationals. Together, the proposals would affect international investment patterns and potentially reduce the volume of foreign direct investment (FDI).
Under the House Build Back Better Act (BBBA) tax proposals, the Global Intangible Low-Tax Income (GILTI) deduction would be reduced to 28.5% (from the current 50%), increasing the minimum tax of 10.5% to 15%. percent (excluding the foreign tax credit discount). The change would be comparable to the OECD’s second pillar proposal, which also provides for a minimum tax of 15% on the same type of income. The BBBA would also reduce the deduction for foreign derived intangible income (FDII) to 21.85%, bringing the FDII tax rate to 15.8%.
Academic research indicates that foreign direct investment (FDI) is highly sensitive to the effective corporate tax rate (ETR); that is, the tax rate after taking into account all deductions and credits available to corporations. Using an 85-country database from PricewaterhouseCoopers, a team of economists found a significant negative effect of corporate REEs on FDI. Increasing the ETR by 10 percentage points reduced inward FDI in the first year by 2.3 percentage points.
A recent analysis by the United Nations Conference on Trade and Development (UNCTAD) examined the impact of the proposed global minimum tax, as outlined in the second pillar on FDI. Unlike the GILTI, which has a broader tax base, the second pillar minimum tax would only apply to multinationals with revenues above 750 million euros (US$763 million). However, large multinational companies alone account for two-thirds of FDI, so the economic impact could still be significant.
The report calculates ETRs under a Pillar Two regime. Most traditional estimates calculate ETR as a ratio of taxes paid in a host country to profits reported there. However, due to profit shifting, the calculation tends to overestimate the tax rates multinationals face in host countries. The UNCTAD paper instead calculates an ETR at the FDI level, defined as the ratio of corporate tax on income generated by FDI stock in the host country to FDI income. itself, although some of the income and tax may be declared in other countries. The paper finds that FDI-level EIRs for non-tax haven countries are about 2-3 percentage points lower than standard estimates.
The revisions suggest that many more countries would be affected by the global minimum tax than conventionally estimated. Using the new REE estimates, the share of developing countries with tax rates below 15% would drop from 29% to almost half. Under the second pillar, ETRs would increase by approximately 3 percentage points for non-tax haven countries, which corresponds to an increase in the tax obligations of multinational companies from 14 to 20%. Among the least developed countries, OITs would increase by 5.4 percentage points, and the increase for tax havens would be even larger, at 7.3 percentage points.
The paper predicts that the increase in corporate tax obligations resulting from the imposition of a minimum tax will cause the volume of FDI to decline by up to 4%, since the marginal return on each investment dollar will be lower. Due to the reduction of tax differentials between low-tax jurisdictions and other countries, companies would have more incentive to transfer investments from tax havens to higher-tax countries, as happened during the law on tax cuts and employment. The document estimates that FDI in tax havens could fall by 7.3%.
Since foreign direct investment (FDI) offers many benefits to both the host country and foreign countries, policymakers should continue to exercise caution when debating how to modify the taxation of cross-border investment. , avoiding proposals that would limit investment incentives.
To note: This is the fourth and final post in our blog series exploring the importance of foreign direct investment (FDI) and its relevance to tax reform. This article will assess the impact of future tax proposals on FDI.