The OECD Has Brokered a Global Tax Agreement – Should Asian Countries Care?

“Paris is well worth a mass.” 

Legend has it that King Henry IV of France offered this explanation for his decision to convert from Protestantism to Catholicism, which helped to end the French Wars of Religion at the end of the 16th century. Since then, countless individuals from around the world have visited the French capital to take in its grandeur. One such group of individuals flocking to Paris over the last decade are tax lawyers and accountants who congregated regularly at the secretariat office of the Committee on Fiscal Affairs at the Organisation for Economic Co-operation and Development (OECD).

This year, the world has awoken to the revelation that the visitors to the global economic policy forum’s tax arm may have been up to much more than business tourism. By many accounts, the gatherings seem to have come rather close to securing peace and religious conversion. On October 8, the OECD announced that an astounding 136 countries have struck “a ground-breaking tax deal for the digital age.” It highlighted two aspects of the agreement. First, it will “ensure that Multinational Enterprises (MNEs) will be subject to a minimum 15 percent tax rate from 2023.” Second, it will “reallocate more than US$125 billion of profits from around 100 of the world’s largest and most profitable MNEs to countries worldwide, ensuring that these firms pay a fair share of tax wherever they operate and generate profits.”

Lest the numbers seem unfathomable, OECD Secretary-General Mathias Cormann spelled out the significance of the accord: The “far-reaching agreement…ensures our international tax system is fit for purpose in a digitalized and globalized world economy.” No less extraordinarily, leading sponsors of the agreement, including US President Joe Biden and Treasury Secretary Janet Yellen declared that the “race to the bottom” of global corporate tax competition is about to end.

Do these exuberant claims from Paris and Washington resonate in Asia? Or are they distant rumbles that those in Asia can ignore at little cost? After all, the OECD made the same triumphant announcement on July 1, and markets showed no reaction. Yes, a few more countries have joined the OECD agreement since July, but if anything, international tensions, especially between the US and China, have only worsened since then. How can the apparent advances in global collective tax policymaking be reconciled with the rhetoric of “strategic competition” increasingly prevalent in global geopolitical discourse?

It is useful to begin by asking what commitments have Asian governments already made in the OECD agreement. At the moment, about half of the jurisdictions in East, Southeast and South Asia participate in the OECD’s “Inclusive Framework” (from which the new international tax agreement emerged). Pakistan and Sri Lanka are two such countries that, along with Kenya and Nigeria, declined to endorse the OECD’s proposal. However, most of the large Asian economies, ranging from China, Japan, India, Korea, Indonesia, Malaysia to Hong Kong and Singapore (but notably not including Taiwan, the Philippines, Bangladesh and Macau) have joined the deal.

What commitments have they made?

Of course, even if Hong Kong made this more limited undertaking, one would expect shocks to have coursed through the financial markets. That did not happen. So, did Hong Kong make some other kind of commitment? Here is a second way in which the OECD “agreement” is a conspicuous misnomer. The “global minimum tax” just described is optional. All that Hong Kong had to agree to is that it would not object if other countries adopted it. You read it right: If large MNEs headquartered elsewhere are subject to additional tax in their respective countries because their income earned in Hong Kong is taxed at a lower-than-15 percent rate, Hong Kong promises not to complain.

Probably few believed that Hong Kong – or Singapore or any other low-tax financial center – had a right to veto other countries’ tax policies. One reason why the financial markets did not react to the OECD’s groundbreaking agreement, therefore, may be that the waiving of such non-existent rights is simply not newsworthy. But the OECD has precisely been working hard to secure such waivers, and its main recent achievement is to convince three European low-tax jurisdictions – Ireland, Hungary and Estonia – to “give in”. A stark premise of the “global minimum tax” agreement, in other words, is that low-tax countries did have veto rights over the tax policies of others, at least if they attended the meetings in Paris.

In any case, it seems fair to say that no one is holding their breath waiting for Hong Kong and Singapore to start taxing MNEs more heavily. What about Asia’s larger economies? Republican Party politicians in the US are very worried that China would not pursue such policy. They have good reason. After all, foreign investors have fretted in the past few months about Chinese leader Xi Jinping’s “common prosperity” agenda. Yet even those who claim that Xi is a “populist” have not reported him as considering imposing higher taxes on Chinese MNEs’ income from overseas.

In fact, if China lacks zeal for the global minimum tax, it would be far from unique. A premise of the OECD global minimum tax is that most countries would like to tax their MNEs more, but they are afraid of doing so alone, because their MNEs would become “less competitive”. Yet this characterization may be accurate for far fewer countries than the OECD pretends. Most rich countries have a diverse range of tax policy instruments with which to raise revenue. They are not restricted to taxing MNEs to increase social spending as is the US. Also, many countries (Japan and South Korea might be examples) historically supported their MNEs’ foreign operations through means other than relaxing the rules of the corporate income tax, so foregone tax revenue may never have represented a high cost. In other words, through its “Inclusive Framework”, the OECD has invited countries around the world to share the parochial concerns of a few American and European countries.

“Pillar One” of the new OECD agreement makes this even more obvious. As far as the OECD is concerned, the global tax issue of the utmost importance in the 21st century is that MNEs are doing businesses remotely more often, as opposed to operating through a “bricks-and-mortar” physical presence. Therefore, the architecture of international taxation is said to require an overhaul under the OECD’s Pillar One design. What, though, is the evidence for the existence of this “global” issue? According to statistics from the World Trade Organization (WTO), for five of the world’s leading developing economies in terms of services trade – China, Hong Kong, India, Singapore, and South Korea – MNEs in fact have substantially increased their foreign operations through branches and subsidiaries in the past 15 years, leading to a corresponding large drop in the share of remotely delivered services.

A recent study by the International Monetary Fund (IMF) similarly shows that the regional differences are highly important. Many digital platform companies in Asia are large, innovative and highly profitable just like US tech giants. Unlike US companies, however, these Asian MNEs operate primarily in their domestic markets. This may be why China, Japan and other homes of Asian tech giants showed limited negative reactions when digital services taxes (DSTs) began to be introduced around the world. The DST has proven attractive to rich and poor countries alike – it is a simple tax that complements other existing taxes – but the US is vehemently against it. The IMF study warns of “trade tensions” that might arise as one downside of greater DST adoption across Asia. But as far as anyone can tell, all DST-induced trade tensions originate in Washington.

The OECD had predicted a much more disastrous outcome. In its main Economic Impact Assessment about why countries should reach a global tax agreement, the OECD provided a “model” of what would happens if no agreement is reached. In the worst-case scenario, all economies in the world except for the US, China and Hong Kong would adopt DSTs (presumably because they find them attractive). In retaliation, the US would impose import tariffs on all DST-imposing countries that are up to five times the amounts of DSTs imposed on US exports. Neither China, Hong Kong nor any other country is bothered by DSTs, but countries subject to US retaliatory tariffs impose proportional, WTO-authorized counter-tariffs against the US.

This outcome, according to the OECD, would reduce world GDP by 1 percent. Consequently, according to a leading OECD official: “Any agreement is better than no agreement.” In other words, the problem that countries need to solve by convening in Paris arises from a hypothetical situation where every economy is at peace with every other except the US, and the US is at war with every other economy except China and Hong Kong. It would seem that this is an unmitigated disaster for the US. Instead, the OECD presents it as a disaster for the world.

Nonetheless, this month’s announcements suggest that most countries in the Inclusive Framework have embraced these concerns. Pillar One will ban all DSTs forever. Should politicians, businesses and citizens in Asia care? That may depend on whether they are making a trip to Paris.