By Jeffrey Owens, Senior Policy Advisor, EY
The Hangzhou G20 summit, set for 4–5 September 2016, takes place as the global economy is stuck in a cycle of low growth and confronted by financial and political uncertainties.
G20 leaders need to take robust action to stimulate investment and create new jobs. Tax must be an integrated part of these actions.
Through its past actions on tax transparency and international tax reform, the G20 has shown that it is willing to take a leadership role in tax and that it can promote fundamental changes when it speaks with one voice.
“The extraordinary G20 focus on tax — particularly the move toward greater tax transparency and the push to overhaul long-standing tax policies — is unlikely to diminish anytime soon.“
Individual countries are now adjusting their tax systems to the G20-inspired new standards.
The G20 must take the next step and seek pro-growth tax strategies. Businesses should understand what will drive this next move in the G20 agenda and how it may impact them.
‘Weaker than desirable’
The G20 has signaled that it is broadening its tax agenda to explore how tax policy can promote innovation-driven, inclusive growth, as evidenced by the G20 Finance Ministers’ communiqué released at the end of their meeting on 23–24 July 2016 in Chengdu, China.
The Finance Ministers stated that the global economic recovery continues but remains “weaker than desirable.”
Moreover, “the benefits of growth need to be shared more broadly within and among countries to promote inclusiveness,” they said.
The Finance Ministers highlighted the importance of tax policies in driving the G20’s goal of achieving strong, sustainable and balanced growth, as well as the benefit of a fair and efficient international tax environment in diminishing conflicts among tax systems.
“We emphasize the effectiveness of tax policy tools in supply-side structural reform for promoting innovation-driven, inclusive growth, as well as the benefits of tax certainty to promote investment and trade,” they said.
Given the G20’s aim of boosting growth through tax policy, structural tax reform is highly likely to become a key area of debate for governments and other intergovernmental and international organizations such as the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD), the United Nations (UN) and the World Bank.
But, unlike the G20/OECD’s Base Erosion and Profit Shifting (BEPS) project, which focused on modernizing the international framework for taxing the profits of multinational enterprises, this new tax reform effort will likely strive to be more far-reaching by encompassing all components of countries’ tax systems.
The drivers of tax reform
The G20’s inclusive growth project is likely to be driven by different factors — economic, social and political — that will vary among OECD countries, developing countries and emerging economies.
The need for revenue will undoubtedly be a major driver.
Many countries — even those that have cut back on expenditures — have significant budget deficits. Some governments will therefore look for new revenue sources through tax code changes.
Another driver will likely come from competition for foreign direct investment (FDI).
At the UN Conference on Trade and Development, held 17–22 July 2016 in Nairobi, Kenya, the attendees noted that FDI levels are still below what they were before the financial crisis.
This means that countries will continue to compete for that investment — both physical and intangible assets — by, for example, reducing certain tax rates or adding special tax regimes.
However, they will have to figure out how to use tax policy to satisfy the inclusive part of the G20’s growth agenda — that is, create wealth without exacerbating economic inequalities.
The role of tax in climate change policy could also be a factor in the tax reform debate.
Under the Paris Agreement, which was reached at the UN Climate Change Conference in Paris on 12 December 2015, 195 countries pledged to keep the increase in the global average temperature to well below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels.
Although the agreement was hailed as a breakthrough, critics have pointed out that it does not bind countries to meet their climate targets, nor does it prescribe exactly how to meet them.
Economists are in near-unanimous agreement that if governments want to seriously tackle environmental issues, they must (re)consider the merits of carbon taxes.
Given the growing attention around the concept of corporate social responsibility and the debate over what role companies should play in preserving the environment, environmental taxes could factor into tax reform debates.
Finally, discussions may arise over how governments can achieve inclusive and sustainable growth while minimizing the administrative and compliance burdens on both tax administrations and businesses.
The perception in some quarters that the BEPS project will complicate the international tax framework and ultimately lead to further disputes and uncertainty could influence the direction that tax reform takes in some countries.
How tax reform could play out
The push for inclusive growth through tax policy could see governments reconsidering how their tax systems are structured.
Developed countries may continue to move away from corporate income taxes in favor of taxes on consumption, property, capital and wealth.
In contrast, developing countries — many of which rely too heavily on consumption taxes — would likely seek a more balanced tax structure by broadening their personal income tax base and strengthening their taxation of land and buildings.
In India, for example, less than 15% of the population is in the personal income tax base.
This rate-reducing and base-broadening trend is already emerging in a number of G20 countries.
The UK has legislated to cut its corporate headline rate to 17%, which would be the lowest in the G20, with the possibility of going lower.
Other European countries are likely to come under pressure to match this rate.
In the US, one of the few points for which there seems to be bipartisan support is that the nominal corporate tax must be cut.
This trend can also be seen in emerging economies.
In the Philippines, for example, Finance Secretary Carlos Dominguez III said at a congressional hearing on 22 August 2016 that President Rodrigo Duterte’s Administration is working on a plan to reduce the corporate tax rate from 30% to 25%, as well as lower personal income rates.
The loss in revenue from the rate reductions would be offset by eliminating some value-added tax (VAT) exemptions, among other proposed measures.
Indonesian President Joko Widodo said at an event on 9 August 2016 that the Government is considering a plan to cut the corporate tax rate from 25% to 17% to match Singapore’s current rate.
The Indonesian Government also plans to change its VAT Law, Income Tax Law and General Taxation Provisions and Procedures Law.
Some governments may be looking very carefully at how India’s new goods and services tax (GST) regime plays out.
The Constitution Amendment Bill for GST was approved by both houses of India’s Parliament in early August 2016 and now needs to be ratified by more than 50% of the state legislatures before receiving presidential approval.
If the regime is enacted, it could become a game changer for India; some analysts have estimated that it could increase the country’s gross domestic product by 2%.
India’s reform could inspire a country such as Brazil, which has a complicated, multiple-rate indirect tax system with tax levied at the state, federal and municipal levels, to consider whether it, too, should pursue a coordinated consumption tax regime.
Tax certainty and competition
With the focus now on increasing growth through tax, the G20 must be careful to avoid promoting tax policies that create further uncertainty.
Given that the global environment is already characterized by high degrees of political and economic uncertainty stemming from factors such as Brexit, the refugee crisis, terrorism and downgraded forecasts for economic growth in 2017, the G20 leaders must avoid adding tax uncertainty into this mix, especially as countries go about implementing the BEPS actions.
The G20 Finance Ministers acknowledged this in their July 2016 communiqué, stating that they recognize the importance of tax certainty in promoting investment and trade.
The G20 leaders should devote significant time to the question of how tax can be used to stimulate and bring investment in the areas of innovation and R&D.
This could reintroduce the debate on patent boxes and the challenges posed by the digital economy, which could in turn revive the broader questions around tax competition posed by Action 5 of the BEPS Action Plan.
The Finance Ministers had their first discussions around innovation-driven, inclusive growth at their July meeting; those discussions will be fed into the leaders’ summit.
The leaders should give a strong mandate to the IMF, the OECD and the World Bank to propose by the time of the German summit a set of recommendations to achieve sustained and inclusive growth.
Finding the right balance
The extraordinary G20 focus on tax — particularly the move toward greater tax transparency and the push to overhaul long-standing tax policies — is unlikely to diminish anytime soon.
However, the G20’s commitment to achieving strong, sustainable and balanced growth will create new challenges for governments.
They will now have to seek to craft tax rules that bring in much-needed revenue and drive innovation and growth, while also contributing to the perceived fairness of the tax system and helping to reduce inequalities in the distribution of income and wealth