Minimizing the Minimum Tax? The Critical Effect of Substance Carve-Outs

In July 2021, 132 countries agreed to a minimum tax rate of at least 15% on their multinationals' profits. However, the joint statement includes a provision that could substantially reduce the effectiveness of this policy. Specifically, the proposed agreement allows multinationals to reduce profits subject to the minimum tax by an amount equal to 5% of the value of their assets and payroll in each country. This carve-out would allow companies to escape taxation as long as they have sufficient operations (assets and employees) in tax havens. In this note, we model how this carve-out would affect the revenues of a global minimum tax. We also discuss the economic issues raised by this type of exemption. We find that a carve-out would reduce tax revenues by 15% to 30% in the European Union relative to a minimum tax without carve-out (depending on the rate of the carve-out and the rate of the minimum tax). Moreover, this policy would exacerbate tax competition by giving firms incentives to move real activity to tax havens. More precisely, in the European Union, a 5% carve-out would reduce revenues of a 25% minimum tax by 21% from €168 billion to €132 billion; it would reduce revenues of a 15% minimum tax by 15% from €48 billion to about €41 billion. A 7.5% carve-out (which is envisioned during the first 5 years of the international agreement) would reduce revenues by 31% for a 25% minimum tax, and by 23% for a 15% minimum tax. Our analysis is based on the data sources and methodology used in the inaugural report of the EU Tax Observatory, "Collecting the Tax deficit of Multinational Companies: Simulations for the European Union" (Baraké et al., 2021). To estimate the cost of substance-based carve-outs, we additionally draw on the OECD's country-by-country data for the value of tangible assets and the number employees, and on data published by the International Labour Organization on monthly earnings.