Joe Biden Versus The Developing World: The Effect of Global Minimum Tax to The Third World's Investment Attractiveness

The US has aggressively proposed the enactment of worldwide minimum tax for corporations in the last months. In the early of July, Joe Biden was able to get 130 countries around the world to set a minimum tax rate of 15 percent that all companies pay, which is known as Global Minimum Tax (GMT). For the US, GMT is a tool to stop multinational enterprises from shifting their money from US to countries with lower tax rates. The Organization for Economic Cooperation and Development (OECD) estimated the GMT would generate extra $150 billion of tax revenue for the US each year.

GMT is a scheme to reduce tax competition between countries which is expected to reduce tax avoidance of multinational enterprises. When it is implemented, the home country would be able to charge income tax at the GMT's rate when the corporation's effective tax rate is lower than the GMT rate. Effective tax rate is different with statutory tax rate, which can be seen in the domestic tax regulations. Effective tax rate is simply dividing the income tax expense by the earnings before taxes, after calculating all deductions. Therefore, effective tax rate is directly influenced by various tax incentives given by the government, yielding a number lower than the statutory tax rate. 

This GMT is effective for reducing multinational tax avoidance. Generally speaking, a tax avoidance scheme involves countries which have a lower effective tax rate than the home country's effective tax rate. Using this scheme, tax evaders pool their income in low effective tax rate jurisdictions, such as tax haven countries, to decrease their overall effective tax rate. With a GMT in place, when the overall effective tax rate of a corporation falls below the GMT, for example 15 percent, than the home country will be able to tax the difference, so that the effective tax rate of that corporation will be 15 percent. In short, GMT will prevent corporations from investing in low-tax jurisdictions just to exploit the low tax rates.

The GMT may sound a good idea to prevent tax avoidance, but it also comes in a price, especially for developing countries. Giving tax incentives to reduce effective tax rates is common for developing countries. Although the effectiveness of using tax incentives to attract foreign investment is debatable, tax incentives are still largely used by developing countries as a tool to attract investment. As reported by United Nations Conference on Trade and Development (UNCTAD), the number of countries that offer incentives and the range of the incentives have grown considerably since the mid-1980s. The reason is logical, if a firm was considering a country to invest in and all factors were the same, the firm would choose one that offers additional benefits to the firm. This has led to a global tax competition that we see now: countries are competing with each other by reducing their corporate income tax (CIT) and offering aggressive tax incentives to investors, resulting a race to the bottom.

With the GMT in place, it will reduce the effectiveness of tax incentives. Indonesia, for example, offers tax holiday that allows investors to get up to 100 percent CIT, depending on the investment amount. This tax holiday is provided to firms in pioneer industries that provide additional value and high externalities, introduce new technologies, and have strategic value for the economy. For the investors, the tax benefit that they get from the incentive also compensate the risk for investing in such industries. However, under the GMT scheme, the investors would still have to pay 15 percent CIT to their home country. With the 22 percent current statutory CIT rate, the GMT would only generate 7 percent of tax benefit for the investors, lower than the 22 percent provided by the Indonesian government. Now, the question is, is 7 percent tax benefit attractive enough for investors to invest in pioneer industries in Indonesia? 

Furthermore, tax incentives are not free. They are essentially public expenditures in a sense that they replace spending programs with the same effects on resource allocation and income distribution, since they directly erode the tax base resulting in less tax revenues. That is why, the foregone potential revenues caused by the tax incentives are part of tax expenditures. When a country is giving tax incentive to investors, it is actually transferring funds to them. In that sense, the GMT creates a scheme where the host countries transfer money to the home country through the investors. Typically, the home countries of the multinational corporations are high income countries, while the host countries are mostly developing countries. Therefore, the GMT will create cash flow from developing to high-income countries.

Aside from the pros and cons, the GMT shows us that we cannot depend on tax incentives to attract investments. With the GMT around the corner, Indonesia should focus on the other investment attractiveness factors instead of offering financial incentives. Ease of doing business, for example, is another important factor that often forgotten. Indonesia currently sits at the 73th ease of doing business rank, far below its neighboring countries such as Malaysia, Thailand, and even Vietnam. This means, we still have a lot of room to improve our investment attractiveness. Moreover, ease of doing business is a variable that influence both foreign and domestic investments. All this time, we are busy providing incentives to attract foreign investors. We should not forget that domestic investments are no less important, and can also become the backbone of our growth.