International Tax and Investment Center (ITIC) organized the inaugural Frenzel Memorial Lecture on 17 April, at the Metropolitan Club, Washington DC. The ITIC board decided to hold the lecture in memory of Congressman Bill Frenzel, former ranking member of the House Ways and Means Committee, and founder Chairman of the ITIC.
In recognition of Congressman Frenzel’s longstanding interest in international trade and taxation issues, we felt that the first lecture should examine trends in these areas, and the degree to which issues from one area affect the other. We were fortunate enough to have secured the consent of Mr Pascal Lamy, former WTO Director General, and EU Trade Commissioner, to give the lecture. Our goal was to bring together Ministers of Finance from developing countries to present their concerns on fiscal matters in the context of the global issues to be presented by Mr Lamy. Mr Bambang….., Minister of Finance of Indonesia, Mr Seth Terkper, Minister of Finance and Planning of Ghana and Ms Souda Salem, Minister of Finance of Tanzania, consented to speak as discussants.
The lecture was moderated by Ms Mary Kissel, Editorial Page board member, The Wall Street Journal.
Mr Lamy first set out the background to policy developments; for a long time, trade and tax have lived in different sides of international regulation, with the former being global and latter local, i.e. a largely national concern. The reasons for these were not difficult to understand; by its very nature, trade policy has for a long time focused on a very broad scope of reducing obstacles to trade, while international tax policy has had the very limited scope of avoiding double taxation. This divergence springs from a different relationship to sovereignty – the erosion of sovereignty in trade is a win-win, while erosion of sovereignty in tax results in a reduction of the tax base for individual nations, i.e. a win-lose. And in general trade policy has been pursued at both the multilateral and bilateral levels, while tax has been largely a case of bilateral engagement to provide solutions.
There have however been some instances of direct interaction between the two areas, when taxes have been used to distort trade. Examples of such cases come from excises on cars and tobacco, or the provision of an equivalent to an export subsidy, i.e. the FSC decision. This situation is changing under the influence of several factors; chief amongst them has been the globalization of production chains, where fragmented and “unbundled” production processes have resulted in growing trade of intermediate goods and associated services. E.g. trade in components and intermediate goods has grown from 20% of global trade to 40% in the last 20 years, and is expected to comprise 60% of global trade in the near future.
On the other hand, this fragmentation of trade has opened up new opportunities of corporate tax optimisation; interest deductions, royalties paid for intellectual property, service charges, management and technical fees, etc. are inevitably part of the transfer prices needed within global supply chains. This can create the perception of multinationals using transfer pricing techniques to reduce their tax liabilities and indulging in abusive tax practices. The focus in international tax has thus moved from avoiding double taxation to whether the tax rules facilitate double non taxation. The issue of « fairness » has also been rising with the rebalancing of the world economy, with the merits of tax competition being increasingly questioned, especially after the global financial crisis. These factors are leading to a weakening of the « tax frontier », which, like others, loses relevance with globalization.
Looking to the future, Mr Lamy highlighted the issues that he saw as increasing complexity in both trade and tax policy. In global trade, the “precautionary” principle, i.e. requirements for health and safety standards, security controls, etc. was already the largest component in regulatory costs in trade. E.g. where tariffs now constituted a 5% cost in trade amongst developed countries, the costs associated with the precautionary principle could be as high as 20%. Further, it was very difficult for companies to standardize solutions and manage costs, as these standards can often, in practice, be individually set by countries, and even competitors.
In the tax space, the issues raised by digitization and e-commerce should be seen as a precursor to the much more complex responses that will be needed to deal with digital manufactures and services. The issues around tax evasion discussed earlier would continue to be further complicated by concerns regarding surveillance for black money together with anti-corruption and the fight against drugs and terrorism. In other words, concerns regarding the integrity of global tax arrangements, and the need for information for security reasons are likely to be considered a higher priority than the need to avoid double taxation.
The ultimate consideration, therefore, for both tax and trade arrangements was to accurately identify where value was being created. Global trade rules should not move away from the principle of equal treatment and the goal of a fair and equitable trading system, while the G-20 Action Plan BEPS should be seen as a first step to address perceived flaws in international tax rules to accurately identify value addition. While it was acceptable to tax where value is created, the challenge continues to lie in identifying and allocating the shares. Also, while in principle fairness was a generally acceptable goal, agreeing what is fair will continue to be a challenge. In the taxation area, fairness would continue to be a debatable issue, as taxation presents very different collective preferences between nations in public services, levels of redistribution, etc.
Governments will continue to work to ensure that global tax and trade policies are supportive of each other, and continue to promote trade and investment in an open system. There will continue to be a need build capacity in developing countries, and to be aware of the risks of « tax protectionism », i.e. overemphasis in protecting the tax base to the benefit of a country to the detriment of the principles of an open trading system. The commonly acceptable principles continue to apply: transparency, mandatory exchange of information, non-discrimination, predictability, stability.
Mr Bambang P.S. Brodjonegoro, Minister of Finance of Indonesia raised the question of tax incentives in the context of the global tax and trade system. Investors in Indonesia have focused on the large size of the domestic market, and the open system has brought in large investment, but he was concerned that the level of value addition was not significant. In particular, his concern was that many investors request tax incentives to make the initial investment, but move away on expiry of the incentives. The head of the fiscal policy function in Indonesia, Dr Suhasil Nazara, further added that much more detailed understanding was needed by developing countries about global supply chains, and comprehensive statistics were not available.
Mr Seth Terkper, Minister of Finance of Ghana, felt that developing countries suffered from an information lag when it came to value addition by multinational enterprises. His primary concern was therefore to have good, timely information. Developing countries would feel more comfortable with allocation of value addition and related income with enhanced capacity and good information.
Mr Rashid Bade, Commissioner General of the Tanzania Revenue Authority, speaking in place of Ms Souda Salem, also emphasized the concerns tax administrations have regarding transfer pricing issues. A side by side examination of global trade figures and the actual records of gross revenue from such trade as submitted to tax administrations would show that there was a significant gap between the two. This was lost value seemed to him to have disappeared into a black hole, and developing countries would continue to have concerns about the allocation of values until they had increased confidence in the information being submitted to them.
Mr Dana Bolden, from the Coca Cola company, stressed the need for certainty and clarity in the demands for information that a global multinational such as his company had to face in the 206 countries in which it was licensed to do business. The scale of globalization and increased compliance requirements created unprecedented challenges for a business such as his company, and it was its interest to see cooperation between governments worldwide to maintain and strengthen the global trading system.
A lively panel discussion moderated by Mary Kissel included questions on whether the global corporate income tax system should be reconsidered on the basis of a VAT type, destination based tax structure, and issues around tax sovereignty, tax competition, revisions of the types of tax incentives available in developing countries and enforcement of global trading rules.