Assessing the Flaws in the 1920s Compromise in the Times of the Burgeoning Digital Economy and the Great Lockdown
Bulletin for International Tax 2020
48 Pages Posted: 8 Nov 2020
Date Written: November 4, 2020
The COVID-19 pandemic has been described by the International Monetary Fund as the worst recession since the Great Depression. The combination of tax shortfalls, increased government spending, and the irrefutable growth in the digital economy has created a situation which means that the world arrives at the crossroads of international tax reform with a great sense of urgency. If there is political consensus, reform will be in the format proposed, or similar to, the OECD/ Inclusive Framework’s proposal (described as the 2020s compromise). In the absence of political consensus, then the world will travel down the other branch of the crossroads and we will see the introduction of a plethora of interim and unilateral domestic taxes.
The existing international tax rules are widely regarded as being “not fit for purpose”. After a brief introduction of the history of the international tax framework (referred to by some as the 1920s compromise), this paper traces the development of the current OECD/Inclusive Framework proposals as international tax policymakers grapple with the vexing problem of how to tax multinationals who do business across borders, particularly those that operate using a highly digitalised business model.
The 1920s compromise has, arguably, at least seven major problems including the vanishing ability to tax business profits, the failure of transfer pricing in certain circumstances, the inadequacy of residence-based taxation and competition between countries.
The paper identifies and then examines the proposed multilateral consensus-driven response of the 2020s compromise to these seven major challenges to the existing international tax architecture. To what extent do they provide an answer to the most significant problems in international tax?
The conclusion reached is that the most far-reaching international tax forms of the last 100 years go some significant way to addressing the challenges of the international tax framework posed by the digital economy. The effectiveness of the multilateral response may depend on the quantum of reallocated tax but the 2020s compromise does not suffer from conceptual under reach because it is much more than modest tinkering with the existing system.
Rather the 2020s compromise radically tests the existing norms of international taxation and even if not wholly adopted can still form part of a future solution to the fundamental problem of international tax in the 21st century.
Keywords: 1920s compromise, international tax, allocation of taxing rights, OECD, Pillar One
JEL Classification: K34, K33
Suggested Citation: Suggested Citation