Adapting the Global Tax System to the 21st Century Economy

Otto Fricke

Otto Fricke is a German lawyer, a politician of the Free Democratic Party (FDP), and a member of the Bundestag.

Since 2012, the OECD has been exploring options to prevent tax avoidance by large international corporations. These efforts were massively pushed by Janet Yellen when she called for a global minimum tax in April this year. Part of the motivation of the new U.S. Administration is to gain tax revenue. Even though it is valid for states to keep their tax revenue and their budget in mind, this is not the reason why my party, the Free Democratic Party (FDP), supports a minimum global cooperate tax in general. Concentrating only on one’s own nation’s monetary advantage will lead to a flood of national exceptions and new tax avoidance tactics. It might even deter states from joining the agreement. We must recognize that due to the rapidly changing structure of our global economy, we have to adapt the international framework to prevent a prisoner’s dilemma. If the international community fails here, states will slowly lose their legitimacy in this regard.

There are better reasons for a global minimum tax than just more resources for state spending or welfare programs. We need it because we have to adapt to a changing economic structure. We need an optimized economic framework. Setting it up is one of the most crucial tasks we have. But why is the economy changing? We can identify two major trends in the past decades. Our economies became incredibly globalized. Also, a dramatic shift occurred, away from tangible goods as the driving force of our economies to intangible goods and services, e.g. intellectual property rights like patents or licenses. Especially due to digitalization and easy and relatively cheap transportation of goods, the latter trend accelerated in the last two decades.

The future of those trends can be easily seen, for example in the shifting asset structure of the biggest companies in the United States. While intangible assets made up less than 20 percent of the market value of the S&P 500 in the 80s, their share rose to more than 80 percent by 2015. Similarly, if we look at the most valuable companies 30 years ago in the United States, they were mostly oil and gas companies. Nowadays, “FANGMAN” have taken their place.

These two major trends–globalization and the rising importance of intellectual property rights–enabled tax avoidance on a new level. Transferring intellectual property to another place, any place in the world, is possible at basically no cost. An actual office with employees is not necessary. Since most profits are made with intangible goods, profits can be shifted as well, most likely to a county or area with a tax rate near zero. This is how modern tax avoidance works in a nutshell and it is a problem for the international community.

If this tax avoidance problem is not solved, it might even hurt the legitimacy of states and their governments, especially since it violates one of the most basic contracts between a state and its citizens—citizens profit from public goods (and services) and pay taxes to keep those goods available, goods and services that are better organized publicly to achieve an efficient outcome. These goods can, in principle, be used by everyone and therefore should also be paid for by everyone. Thus, if huge corporations take advantage of public goods like administrative services, workers educated in public schools or highly developed infrastructure, but do not pay their fair share, this will lead to conflicts.

No matter how one judges the current international tax system, it is clearly not a fair competition, even within the EU and sometimes even within a single country. It does not produce the best and most reasonable solution for the vast majority. Instead, it resembles a prisoner’s dilemma for states and politicians. There is always an incentive to lower taxes and try to channel profits into one’s own country without supplying the public goods necessary. Getting the money, without investing, seems like a good deal in the short-term. However, if all states do this, the winners will be international corporations and super-rich individuals. In the long-term, everyone will lose since public goods cannot be paid for.

If large corporations do not pay taxes, others might question why they should pay theirs, especially small- and medium-sized enterprises that are the backbones of local and national economies all over the world. Politicians would have to admit that large corporations do not pay their taxes just because states cannot stop tax avoidance. This would put into question state legitimacy. Populists and their easy answers might become even more popular. Therefore, we do need a global minimum tax to provide a lower bound on taxes worldwide and the FDP will fight for it. A global minimum tax will still enable the necessary competition but also take into account the changes in our economic structure.

However, the goal has to be to stop tax avoidance without hindering innovation and competition. While the change from an economy driven by tangible goods to one driven by intangible goods and services makes adaption of our economic framework necessary, it is also a massive driver for innovation, growth, and prosperity for a growing number of people worldwide. Thus, the goal is to curb tax avoidance, not to use this change as an excuse for protectionist agendas.

Nevertheless, the idea of protecting one’s own economy seems to be a motivation for many politicians. For example, it is probably not a coincidence that the five European states that in the past introduced a digital tax dropped massively in digital competitiveness in the last decade compared to the United States. Therefore, instead of proposing more (digital) taxes, or discussing softening the protection of patents, we must set a lower but effective bound on taxes. Especially Germany must, after many years of inaction, increase the competitiveness of its economy. The FDP fights for this updated innovation promotion framework. Germany urgently needs not only fully digitalized administration, better conditions for venture capital, but also lower taxes to enable citizens and companies to invest in new technologies and business models.

Particularly now, facing the massive challenge of climate change, it is not the time to sit back and try to protect the prosperity of the past. Instead, we need to boldly enter the new world and actively shape the 21st century. The best way to do this, as history proves, is through the trial-and-error process of the market. We need competition. Not a race to the bottom, but a fair race with guardrails. That is, we need a clear framework and an innovation promotion policy.

The views expressed are those of the author(s) alone. They do not necessarily reflect the views of the American Institute for Contemporary German Studies.