States have always jealously guarded their powers of taxing economic activities within their respective jurisdictions, and taxation is almost synonymous with sovereignty. This is particularly important for small states, like Malta, which in a globalised world have increasingly come to rely on tax advantages as a crucial element of their pitch for international capital and investment.

The recent G7 agreement towards the adoption of a global minimum corporate tax rate, therefore, presents a significant challenge for small states. Deprived of their tax competitiveness, it is only reasonable to expect small states to struggle to compete with larger neighbours with larger populations, greater natural resources, and stronger political clout. For this reason, small states like Malta may very well be justified in vigorously resisting these developments, which could disrupt their economic models and, in turn, negatively impact education, healthcare and other essential services.

This is not to say that the status quo does not require significant reform. In fact, one would do well to acknowledge that the world has changed. In the past, wealth used to be concentrated in assets like wealth and machinery, which are immobile and easy for nation-states to govern and tax. Nowadays wealth has become increasingly concentrated in assets that are highly mobile and flighty, like intellectual property, and this combined with globalisation and technology have made it possible for corporations and individuals to aggressively arbitrage the global tax system to their advantage. Certain frustrations of the populations of big states are therefore understandable.

The recent G7 agreement towards the adoption of a global minimum corporate tax rate, presents a significant challenge for small states.

Fairness dictates that everyone should be liable to pay their fair share of tax, and this much is true. With that being said, we also acknowledge that “fairness” is a very subjective concept, especially in this regard. While it might seem fair to those hailing from larger countries to argue against their native corporations moving to Malta for tax purposes, it is also fair for a Maltese person to argue that tax sovereignty is absolutely necessary for their country to be competitive.

With both sides deeply and righteously entrenched in their positions, a prolonged and frustrating political deadlock could well loom on the horizon, particularly in Europe where small states enjoy powerful veto rights. Small states cannot be reasonably expected to concede their tax sovereignty for the benefit of some vague “greater good” that benefits only the powerful, while big states will lay claim to tax money they consider rightfully theirs. After all, every tax dollar collected by a big state is ultimately a tax dollar not collected by a small state, and vice versa.

The third way

But it doesn’t have to be this way. The much-needed reform of the global tax system does not need to be approached as a zero-sum game. With enough political goodwill, a solution can be envisaged where the gains that big states would make from a global minimum corporate tax would not necessarily mean the disruption of the economies of many of the world’s small states.

Our proposal, therefore, is for the G7’s reforms to be accompanied by a redistributive mechanism, whereby a portion of the increased tax takes that big states expect to generate would be returned to small states that agree to adopt the proposed minimum. This would have multiple benefits, including generating the sort of widespread international consensus that the G7’s plans need to achieve in order to have a meaningful impact and redirecting the economies of small states away from aggressive tax competition towards more productive activities.

Needless to say, this proposal would present significant challenges in terms of design and negotiation. A workable model would not be easy to achieve. But what are the alternatives? Neither a prolonged deadlock nor the bulldozing of small country interests by big countries would be a satisfactory or unproblematic way forward.

We would also point out that transition funds, compensation mechanisms and similar programmes are nothing new and have been deployed at scale. In fact, just last year, a political agreement was reached within the European Union on a just transition fund in relation to climate change. Just like there can be transitions vis-a-vis fossil fuel reliant economies, so too, there can be a just transition for small countries relying on low corporate tax for their competitiveness. With creativity and political goodwill, the international community can achieve tax reform that works for the citizens of all countries. 

Dr Brendan Zerafa is a lawyer and consultant specializing in politics, international relations and international law.

Dr Charles Cassar is lawyer and founder of Shoulder Compliance, an AML/CFT and anti-financial crime consultancy.