The BEPS Action Plan concluded by OECD and G20 has appeared to be ineffective in preventing global tax competition.
US is about to conduct a massive tax reform for the period 2018- 2025 following the passing of Tax Cuts and Jobs Act. Several main points of the Act are, among others, cutting the corporate income tax rate from the highest level of 35% to 21% for the income higher than USD10 million, and the individual income tax rate from the highest 39.6% to 37%.
The enactment of this Act could lead other countries to conduct similar policy, i.e lowering tax rate which eventually could drive a “race to the bottom” on tax rates.
The US individual tax cut is also accompanied by the change in the income bracket subject to the highest tax rate, from USD426,700 (single filer) and USD480,050 (married filing jointly) to USD500,000 (single filer) and USD600,000 (married filing jointly).
This new Act also states that the taxpayers repatriating the assets in the form of cash or the cash-equivalent assets from the foreign income are subject to 15.5% rate. The tax rate goes down to only 8% when the income from overseas is reinvested domestically.
Furthermore, the Trump’s administration also changes the US tax system from worldwide to territorial system and omits the provision of alternative minimum tax (AMT) for corporation (Shuster, 2017).
President Donald Trump claims this policy as the largest tax cut in Uncle Sam’s history. This US tax reform is considered as a radical and controversial breakthrough conducted by Trump to restore the US economy—which in one last decade has fallen into a recession, due to the 2008 financial crisis.
Since Subprime Mortgage crisis, the US economy has experienced a great recession. The economy dropped, the dollar suffered, and the unemployment went worse.
The first response from Barrack Obama’s administration to overcome the crisis at that time was by creating a massive stimulus policy in the form of tax rebates of USD800 per household or amounting to the total of USD150 billion. Meanwhile, the Fed as the monetary authority balanced it by cutting the Federal Funds Rate (FFR) to nearly zero percent to improve the American purchasing power.
After four years gone, the US has changed the direction of its policy by deliberately decreasing the stimulus portion (tapering off). Step by step, the Fed made financial asset purchases (quantitative easing) and increased the FFR. It took a decade to recover, even though not in full yet.
The US economy’s slow recovery, marked by a low inflation as well as a high unemployment 9 Appelbaum, 2017), became a hot issue flavouring Donald Trump’s win at the 2016 US presidential election. As if trying to compete with his predecessor, Trump also promised the biggest tax cut in the US history. Even more, he offered tax facilities for US multinational companies to bring home their capital.
Tax Battles - Risks and Sovereignty Dilemma
The tax battles issue is actually not something new. This situation has emerged for years along with the emerging tax avoidance practices through the shifting of profits to the countries with low tax rates or some tax-free jurisdictions (tax havens).
On the other side, almost all countries in the world are faced with the increasing budget to fund the development after they were hit by the global financial crisis. Tax reform, among others by lowering the tax rate, has become one of considerable options for many countries to attract investments, as well as to increase the tax base—not to mention the various tax incentives and facilities commonly implemented.
US, Australia, India, the Philippines, China, South Korea, and Malaysia are some of many countries that plan to cut their tax rates. Indonesia is also seems to be tempted to reduce its corporate income tax rate to the level of its ASEAN peer countries.
Every country has its own rights and sovereignty to manage its taxation system. However, considering the importance of economy and investment cooperation, both bilaterally and multilaterally, it is necessary to implement a fair tax system, including the tax rate matters. Tax Treaty is the example of bilateral cooperation in taxation.
Tax cut policy may give short-term positive impact towards the improvement of purchasing power, investment and economy of a country. Yet in a long run, a drastic tax cut without optimization of new revenue source may become a time bomb that can ruin the economy at any time.
In the US case, Trump’s administration should be aware of the consequences of a massive tax cut for this policy will reduce the state revenue up to USD1.5 trillion within the next decade. On the other hand, there is a need of significant budget in every year to fund the social securities and healthcare of millions American citizens that will reach their retirement ages. In 2017, approximately 45 million Americans received their pension social security cheques. The number is estimated to rise to 60 million in 2027. As a consequence, if US fiscal deficit this year is budgeted of USD487 billion, within ten years it is predicted to soar three times (Harwood , 2017). If the risk is not anticipated and wellmanaged, a huge amount of debt may once again drag the Uncle Sam down to the deeper new financial crisis.
It is just one country, yet it’s America. In view of globalization, the American economy crisis means the world’s economy crisis. Imagine if many countries are competing to apply the same (tax cut) policy. The risk must be even greater.
It is important that G20 countries should make necessary efforts to stop global (harmful) tax competition. The thing is, even an agreement or commitment to stop the tax battles will not be sufficient against a sovereignty of a country. In case of violation committed, the sanction is only an isolation from the global community, which can be removed at any time under the consideration of economic interest.
Another risk to be considered by the US is the impact of the change in taxation system, from worldwide to territorial income system. Despite encouraging the investment through the tax rate cut, it may apply the other way around which is, triggering the local investors to invest overseas instead. Since, the territorial income system will only tax the income which derives from within the country, while the income derives from overseas will be free of taxes.
Don’t Just Follow
Every policy always comes with pros and cons. In light of tax battles, Indonesia as a sovereign country has a right to either copy, follow, or implement what the US has done. The Indonesian government is now in the process of amending the tax laws. The opportunity for tax reform has now risen—including the possibility to lower the tax rate—through the revision of tax law packages that are now included in the 2018 National Legislation Program (Program Legislasi Nasional/Prolegnas).
However, we should not just follow the Uncle Sam’s tax policy. Taxpayers’ aspiration should also be taken seriously. Is it solely a high tax rate that makes them incompliant? Or perhaps, it is purely about the complexity of tax system, or the multi-interpretative tax laws that are mostly hard to digest for the majority taxpayers.
Speaking of the latter, even when the tax rate is set to the lowest, but if the tax administration and services are not simplified, we cannot expect to improve understanding and awareness of the society to pay tax.
It reminds me of this saying from a big entrepreneur, “It is not about the tax rates. What matters most are the business certainty, procedure clarity, and no multi-interpretative regulation.”
*Short version of this article has been published in www.jakartaglobe. id, Thursday, January 18, 2018.