Evaluating The Economic Consequences Of UN Tax Policies

But is the UN’s approach to international tax cooperation really a win-win for everyone?

To be clear, multilateral policy conversations should aim for scenarios where everyone does win to some extent. For example, the World Trade Organisation and multilateral free trade agreements have created opportunities for such successes. But those involved efforts to reduce barriers to trade and expand the economic pie. The UN’s work is quite different.

Contra Youseff, the UN’s agenda will certainly result in winners and losers, and policymakers should recognise those tradeoffs. One such tradeoff is the risk of more gross-basis taxation of cross-border activities. This would not result in everyone being a winner. In fact, if the practice becomes widespread, many losers will emerge. Instead, policymakers should focus on policies that raise additional revenue with smaller economic costs.

Multilateral tax policy discussions have been ongoing for more than 100 years, but in the last decade, old tensions have arisen and led to rapid changes. Policymakers and taxpayers can feel the ground moving beneath their feet.

In a growing and dynamic global economy, very few economic policy debates are ever truly settled. Taxpayers desire certainty and stability—and they deserve it. But governments with longstanding policy concerns about the existing cross-border tax rules have recently seized an opportunity to shift discussions in their favour.

Throughout these developments, tradeoffs are constantly present. Some (including this author) see significant risks of moving from the status quo; fundamental change can be costly in and of itself. It is also unclear whether the potential changes will yield benefits large enough to offset the cost of the adjustment. Others see the existing system as a sunk cost. Between these two positions is the messy middle, and it is currently unclear what compromises would allow a new, stable equilibrium to be reached.

In the August vote on the Terms of Reference for a new tax treaty, 110 nations voted in favour, 44 (primarily European) nations abstained from the vote, while eight nations voted against (Australia, Canada, Israel, Japan, New Zealand, the Republic of Korea, the United Kingdom, and the United States).

The November vote to set out negotiations over the next three years fell along similar lines.

The political divide is easy to see.

Ultimately, the whole debate will eventually arrive at one question: which countries get to tax profits in a jurisdiction where sales are made? Though mostly a political question, the answer will have economic consequences.

If a political agreement changed the entire structure of cross-border tax rules such that corporate profits are only taxed in jurisdictions in proportion to the amount of sales made in that jurisdiction, the economics would be relatively straightforward. Once the tax base is defined, it is not difficult to identify the economic cost of imposing taxes on profits in this way. In fact, it could lead to a more efficient corporate income tax, since companies are more likely to manipulate where their product development and manufacturing are located than where their sales are located.

This would, however, dramatically reshape the location where tax revenues are raised by governments. Small, exporting countries would lose portions of their tax base while larger, importing countries would gain.

This is exactly why such political agreements are difficult to achieve, and part of why negotiations on the Organisation for Economic Co-operation and Development’s Pillar One have not succeeded. Any time there is a debate about where profits should be taxed, there will be winners and losers.

It’s doubtful that the UN will achieve a large and deep political commitment to adjusting tax rules in a way that fundamentally changes profit allocation rules while only taxing profits one time.

However, an alternative that would create even more losers (especially in terms of economic efficiency) would give countries the ability to unilaterally increase withholding taxes on cross-border flows, even in the context of existing tax treaties.

Governments should be taxing net profits and only taxing those profits once. Tax treaties exist to allocate taxable profits between jurisdictions and eliminate withholding taxes to achieve the outcome of taxing net profit one time.

If a country chooses to work around treaties, or if a UN Tax Convention eventually results in countries having more flexibility to impose higher gross withholding taxes than treaties currently provide, there will be significant losses in economic efficiency.

Consider a company operating in two countries earning a profit margin of 10 per cent. This means that for every one unit of revenue, there is 0.1 unit of profit. If the two countries are taxing their respective shares of that profit at 20 per cent each, then the company’s after-tax profit margin is eight per cent. The wedge between pre- and post-tax profits results in some economic inefficiency, but that pales in comparison to our next example.

Now consider that company is facing a 20 per cent gross withholding tax on its revenues instead of a 20 per cent tax on profits. The withholding tax ignores underlying expenses, and the tax bill is double the profits earned. A lower 10 per cent withholding tax would wipe out all the profits, and even a five per cent gross withholding tax would result in a 50 per cent effective tax rate.

What company would invest in a country deploying such tactics or leaning on international bodies like the UN to provide them with such tools?

In some cases, it will only be companies that are certain their profit margins will greatly exceed the tax burden such that there is still some profit leftover for investing and compensating shareholders for their risks. Even then, highly profitable businesses would still look askance at such poorly designed and targeted tax policies.

These are the economic tradeoffs that policymakers should focus on during this multilateral negotiation.

And even before firm policy proposals have arisen from the UN’s new work on tax policy, the UN’s pre-existing Committee of Experts on tax is considering adding Article XX to the UN model tax treaty that would directly give countries the flexibility to levy gross-based withholding taxes that will ruin the economics of providing cross-border services.

The risks of getting the tax treatment of cross-border activity wrong are quite serious. Even now, all is not well in the world of foreign direct investment (FDI). Globally, FDI fell by two per cent in 2023 according to the 2024 World Investment Report from UNCTAD. Developing economies saw a seven per cent decline.[1]

As we approach 2030 and review the sustainable development goals, there remains an approximately $4 trillion annual investment gap across energy, water, infrastructure, and other critical sectors.[2] Cross-border tax policy will not automatically bridge this gap, but significant harm can arise from a tax system that is punitive toward inbound investment.

This means that individuals, families, and small businesses are facing high costs, while new impediments to investment and growth are being debated.

A study from UNCTAD in 2022 noted the risks that the global minimum tax poses for cross-border investment and the tax policies that many countries rely on to attract FDI (albeit inefficiently in many cases).[3] The report identified a 14 per cent increase in the effective tax rate on FDI and an overall decline of FDI by two per cent in the presence of the global minimum tax.

This shows the need for revenue-raising efforts to focus on domestic businesses and individuals alongside more effective property and consumption tax rules.

Such an approach was echoed this spring at the UN by Benjamin Diokno, a Monetary Board Member of the Bangko Sentral of the Philippines. In his keynote remarks to the Economic and Social Council Special Meeting on International Cooperation in Tax Matters, he noted the positive development of countries shifting toward relying relatively more on consumption taxes compared to income taxes.

But the contrast between MBM Diokno’s remarks and the rest of the discussion that day was stark. Corporate income taxes were the center of attention, despite all the promising opportunities for raising significant revenue pointing away from them.

At some point, leaders who are able to reconcile these approaches will emerge. Until then, we should continue to analyse the trade-offs inherent in the negotiated terms of reference.

Neither the clean profit allocation agreement nor a widespread unleashing of withholding taxes will likely come out of the UN Convention on Tax Matters, but the current process has many miles to travel before it reaches a conclusion, and it is time for policymakers to be honest with themselves and the public about the potential winners and losers.

[1] “World Investment Report 2024,” UNCTAD, 20 Jun 2024, https://unctad.org/publication/world-investment-report-2024.

[2] “SDG Investment Trends Monitor,” UNCTAD, September 2023, Issue 4, https://unctad.org/system/files/official-document/diaemisc2023d6_en.pdf.

[3] “World Investment Report 2022,” Chapter III: The Impact of A Global Minimum Tax on FDI, UNCTAD, 9 Jun 2022, https://unctad.org/system/files/official-document/wir2022_ch03_en.pdf.

Daniel Bunn
Daniel Bunn is President and CEO of the Tax Foundation. Daniel has been with the organization since 2018 and, prior to becoming President, successfully built its Center for Global Tax Policy, expanding the Tax Foundation’s reach and impact around the world. Prior to joining the Tax Foundation, Daniel worked in the United States Senate at the Joint Economic Committee as part of Senator Mike Lee’s (R-UT) Social Capital Project and on the policy staff for both Senator Lee and Senator Tim Scott (R-SC). In his time in the Senate, Daniel developed legislative initiatives on tax, trade, regulatory, and budget policy.