The Global Tax Deal and Tax Incentives: What if the Cure Is Worse Than the Disease?

The global tax deal reached in October 2021 is a milestone in international tax coordination. With 137 out of 141 jurisdictions in the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) now participating in the agreement, there is no doubt about its significance. The new rules are designed to limit harmful tax competition through a minimum corporate tax rate of 15% for MNEs with global sales above EUR 20 billion and profitability above 10%, and are projected to increase global tax revenue by US$150 billion annually. They will also shift taxing rights on more than US$125 billion of profits each year from the low tax countries where they have currently been booked to the countries where they have been earned.

Yet, the devil is in the details, and the tax deal has not come without controversy. One crucial issue regards the use of tax incentives for investment. One of the expected outcomes of the new deal is, indeed, to discourage the use of CIT-related tax incentives since they are at the heart of harmful tax competition.

Tax incentives are one of the main instruments used by governments worldwide to attract FDI. They are also costly and often ineffective in reaching their stated goals. The new minimum corporate income tax (CIT) rate will further undermine their usefulness: MNEs that benefit from incentives such that their effective tax rate (ETR) is less than the minimum rate set at 15% will have to pay the balance to their country of residence. Although this effect is one of the stated goals of the deal, it deserves a deeper analysis.

The use of CIT-related tax incentives for investment is particularly widespread in developing economies. Most developing countries have rather high statutory CIT rates, but offer tax incentives for MNEs to attract highly mobile tax bases and FDI.

The introduction of the 15% minimum tax rate will push developing economies to repeal tax incentives to bring effective tax rates up to the minimum if they are not yet there. As some commentators have highlighted, this could lead MNEs to repatriate some of their capital to where their headquarters are, hence triggering capital flows from poor to rich economies. Accordingly, developing countries wanting to use fiscal incentives – whose effectiveness is much debated – could offer firms alternative tax benefits that are not related to corporate taxation and thus fall outside the scope of the new tax deal. As reported by the Global Tax Expenditures Database (GTED), several low-income economies already rely heavily on tax incentives for investment that are not affected by the new agreement (Table 1).

In the Democratic Republic of the Congo, for instance, two VAT-related tax incentives that are meant to “attract and promote investment” account for more than 11% and 13% of total revenue forgone.

Table 1. Examples of tax incentives for investment not affected by the new tax agreement

Source: Global Tax Expenditures Database,

The new tax deal will only affect tax incentives related to the profits of MNEs such as CITs, as well as withholding taxes on cross-border payments of dividends or interest. Hence, some governments could be tempted to compensate for the reduction in the use of profits-related tax incentives by increasing their use of other tax incentives for investment including ones related to VAT, customs duties and payroll taxes, which will not be affected by the minimum CIT rate. This would very likely add more harm than good since taxes that are not affected by the minimum rate (e.g., VAT and other consumption taxes) are often more reliable, stable and easier to collect than taxes on income. In addition, since these tax incentives would affect the ETRs paid by all businesses (not only those in scope of the new tax agreement), the revenue implications could be significant.

Limiting the use of CIT-related tax incentives would be a positive outcome of the new deal, also because it offers additional fiscal space to developing countries to invest in non-tax-related determinants of businesses’ location decisions such as infrastructure, human capital as well as political and economic stability to attract FDI. International organizations and rich countries have a key role to help lower income economies in moving in this direction, e.g., through capacity building and official development aid (ODA).

Yet, reaping what they sow might take time and developing country governments might still prioritize the use of tax incentives. If so, they should improve the design, transparency, and administration of incentives to reduce indirect costs and avoid undesired side effects. More in concrete, governments should estimate and report regularly the revenue foregone at the tax expenditure level, including tax incentives for investment and FDI. They should also design a lead agency (e.g., the finance ministry) to coordinate the tax expenditures report, which should also be scrutinized by parliament. Finally, at least the largest tax expenditures should be evaluated against their stated goals as well as in terms of the side effects they trigger. And the results of these evaluations should be used as the main input to identify which tax incentives are worth keeping in place or even being expanded and which ones should be reformed or simply eliminated.

If, instead, governments simply change the composition of the tax incentives they offer and start using more and more generous non CIT-related tax incentives, the cure might end-up being worse than the disease.