The International Monetary Fund’s (IMF) latest World Economic Outlook found that reported profits had become less responsive to differences in corporate tax rates, while real investment had become more sensitive.
The shift suggests multinational companies are increasingly reporting profits where economic activity and investment take place.
Highly mobile intangible assets, including software, patents, data and trademarks, have historically allowed multinational companies to separate reported profits from business operations and move earnings to lower-tax jurisdictions.
Governments have responded by reducing corporate tax rates and offering incentives to attract investment and reported profits.
However, stronger international measures targeting tax avoidance, base erosion and profit shifting appear to be changing that behaviour.
The IMF found that a one-percentage-point reduction in corporate tax rates in other countries was associated with an average domestic reduction of 0.4 percentage points.
Competition was strongest among countries at similar stages of economic development, although competition over headline rates had moderated since the mid-2010s.
The IMF warned that corporate tax decisions could have significant effects beyond national borders.
A one-percentage-point increase in a country’s corporate tax rate relative to other countries was associated with a cumulative decline in foreign direct investment equivalent to about 0.5% of gross domestic product over three years.
Corporate tax cuts in major economies could also reduce economic output elsewhere because losses caused by capital moving between countries could exceed benefits from increased demand for imports.
Governments borrowing to finance tax cuts risk pushing up real interest rates and weakening investment growth across economies.
If competing countries respond with equivalent tax reductions, the initial country’s gains could also diminish.
Long-term effects depend on how governments offset lost revenue. Lower public spending or higher taxes elsewhere could weaken investment in infrastructure, education, healthcare and other services supporting economic growth.
The IMF said emerging-market and developing economies could benefit substantially from stricter anti-avoidance rules because corporate income tax remained an important source of public revenue.
Those measures could preserve funds for development while limiting artificial profit shifting.
As technology makes capital increasingly mobile, the IMF expects corporate tax systems to place more emphasis on attracting productive investment, innovation and economic activity rather than profits reported for tax purposes.
–IMF/ChannelAfrica–
