New interesting report on the consequences of the OECD:s digital tax reform proposals

On 8 September the European Centre for International Political Economy (ECIPE) released the report “Unintended and Undesired Consequences: The Impact of OECD Pillar 1 and 2 Proposals on Small Open Economies”.

The report highlights that the OECD proposal to shift effective taxing powers away from small open economies to the world’s largest countries would undermine small countries’ relative attractiveness to international businesses and would induce domestic businesses to relocate to larger countries with the gravity of larger markets.

Matthias Bauer, the author of the report, argues that the proposals in fact would punish governments that embrace free international trade and investment by transferring fiscal funds away from small economies to many of the world’s worst-performing governments with respect to economic openness, acceptance of the rule of law, corruption, state interventionism, and the recognition of basic human rights (e.g. Argentina, Brazil, China, India, Indonesia and Russia).

Bauer contradicts the statement made by the OECD that the implementation of the proposals would improve the global allocation of capital, the reason being that trade and investment flows still would be subject to tax competition and trade and investment barriers. He claims that the proposals rather are likely to incentivize governments of large countries with protectionist institutions to maintain long-standing barriers to trade and investment.

For small research-intensive open economies, the report finds that the OECD proposals would undermine future investments in R&D, innovation and business expansion, with adverse implications for existing research clusters, education systems and high value-added jobs. From a Swedish perspective, this should give rise to concern.

In conclusion the author, Matthias Bauer, encourages policy makers to move away from corporate taxation towards greater use of VAT/sales taxes and argues that this, in time, would result in lower barriers to trade and investment and a more efficient allocation of global capital.

At the OECD, the work in trying to come up with a set of rules that could achieve international consensus on how to deal with the tax challenges of the digitalization of the economy is under extreme political pressure. Blueprints of the proposals are expected later this fall, but the project is likely to continue into 2021. Since its start as part of the BEPS project the path has clearly shifted. It is no longer about base erosion profit shifting but rather about redistribution of tax bases and tax revenues among countries with the aim to provide market jurisdictions (consumption countries) with a bigger piece of the tax pie. If some countries shall have a bigger slice, others will have to settle for a smaller one. For small open exporting countries any corporate tax system based on sales will have negative consequences.

The ECIPE report critically analyzes the OECD impact assessment presented earlier this spring and provides insightful and highly relevant comments on what implications the proposed reforms could have for international investment and tax revenues. For government representatives in small open economies, the findings in the report should give rise to concern but at the same time it provides them with relevant and important input into the OECD discussions.