Here’s how a new tax plan affecting more than 140 countries could keep prices going up and even affect your paycheck.
A not-so-secret cabal of national leaders is working on a new global minimum tax plan based on the BEPS work of the OECD. Ah, it’s always nice to start the day with a bunch of indiscernible acronyms.
Basically, the plan will match taxes with economic activity—but its unintended consequences could affect your wallet. Oh (big) brother, now what?
Learn how this acronym you’ve never heard is going to hit your wallet.
So what’s the acronym?
Base Erosion and Profit Shifting (BEPS) is the unnecessarily vague term that the Organisation for Economic Co-Operation and Development (OECD) coined for the situation in which large businesses locate headquarters in a low-tax country to decrease their tax rate. I’ve always said that you can’t trust any organization that spells organization with an ‘S’ or cooperation with a hyphen (but maybe that’s just me?).
The OECD claims that shifting profits to locales with little or even no economic activity artificially reduces the tax bases of the locale where the economic activity occurs. For example, many companies are based in Bermuda or Ireland, where corporate tax rates are substantially lower than just about everywhere else, but actually do business in other countries.
The OECD also believes that deducting expenses such as interest and royalties (considered deductible expenses by every accountant in history) unduly erodes tax bases.
So what’s the OECD’s solution? A global minimum tax.
Tell me more about the global minimum tax
More than 140 countries have agreed to a new global minimum tax of 15%.
The clear drawback of this plan is that the countries like Ireland and Bermuda would lose out on economic activity. According to the OECD, between $100 billion and $240 billion in tax revenue would be shifted to countries where the services are being provided or goods are being sold.
Enough about other countries. How does it affect us?
How’s all this going to affect my wallet?
Like most monopolistic policy proposals, a global minimum tax is loaded with unintended consequences. Here’s how it may affect you.
Your pay may go down
One of the first concepts that you learn in finance is cost of capital. Businesses have a cost of equity and cost of debt. The cost of debt is set by the weighted average interest rate paid on the debt. The cost of equity is set by investors. Riskier businesses have to return more in cash flow to raise money from investors.
If a business’s tax rate goes up, it has to adjust other expenses to keep its cash flow at an acceptable level for investors, or even for lender covenants. Businesses may do that by freezing pay increases or cutting out bonus pools.
If businesses can’t find a good way to cut costs, they’ll need to increase their gross margin by raising prices.
Prices may go up
Supply and demand has been in the news a lot lately as inflationary pressures have ripped through the economy. Are gas prices high because the U.S. can’t produce enough? Are they high because consumers are buying too much?
Lost in this talk is the budget constraint faced by businesses. The cost of capital isn’t the only thing that makes businesses raise prices. Businesses have to find a way to meet their fixed costs obligation and then earn more than their variable costs for each unit sold. Global minimum taxes add to the variable costs and could make it so businesses have to raise prices to keep up.
Additionally, corporations are double taxed. Everyone knows about double taxation with corporate income tax and dividends, but not as many people know about geographic double taxation.
A few years ago, Apple made big news by repatriating close to $250 billion in cash and paying a reduced 15.5% tax rate to do it. Going forward, that repatriation rate will have to be tacked on top of a global minimum tax rate of 15% (or more).
Your taxes will stay high
Some pundits believe that most of the countries in the agreement joined to avoid the race to the bottom. That’s what they call tax rate competition between countries. With a global minimum tax, there is no incentive for countries to bring down their own corporate tax rates.
As recently as 2017, the U.S. had the fourth highest corporate tax rate in the world. That number is closer to the middle now, at least partially because of the race to the bottom. With repatriation taxes in full effect and less incentive for companies to leave the U.S., corporate tax rates could be back on the rise.
When analyzing any government policy, it is important to try to predict what the intended and unintended consequences are. For the global minimum tax, the intended consequences are clear:
The unintended consequences are less clear, but still derivable. Higher average tax rates will reduce corporate profits, causing corporations to adjust by cutting other costs or raising prices.
For now, keep your eyes on the news to see when and if a global minimum tax will be ratified. If it is, you’ll understand how it may affect your finances and can make changes if necessary.