EMR August 2021
The introduction of a global minimum tax for companies is being hotly debated in OECD circles. Therefore we ask ourselves the following questions in this EMR: Which influences will it have on production, consumption and international trade? Will inflation be driven by this tax? What does a cyclical comparison say about this? What effects can be expected for large and small countries? Which asset classes are promising?
From the historic point of view, it is not surprising to understand why most commentators view as obvious immediate effects of tariffs or quotas to determine the tendency of prices to equilibrate among trading partners. With trade barriers, relative goods prices are no longer expected to be equal in the various countries. The aim of this EMR is to quantify as much as possible the impact of the global minimum tax of at least 15% now being publicly discussed. As we understand it, the proposals are to make the world`s biggest companies pay taxes in countries where they have significant sales but no physical headquarters. So far, we have not come across quantified expectations on the repercussions on equity prices.
Impacts on demand and supply
The real question is what are the repercussions of the agreement of a large number of nations to support the U.S. proposal (of Treasury Secretary Janet Yellen) to a global minimum tax of corporations? No doubt such an agreement represents a turnaround in the international tax competition. Expectations are that such a tax ought to determine or alter the relative price of the impacted goods. Respective impacts are expected regarding production, consumption and international trade. Theoretically it is rather easy to point to the respective impacts on the demand and supply curves, while empirically it remains a tricky attempt. Assuming that theoretically the amount of the “specific” good exported or imported at a given price (before the leaving of the new tax) is determined by the difference between demand and supply, what will be the impact of the 15% minimum tax deal? The available information depends on a working assumption that the demand curve either lies to the right of the supply curve (pointing to excess demand), at a given price, implying the availability of exports. On the other side if the demand curve lies to the left of the supply curve, at a given price, more of the taxed good is produced domestically than consumed, pointing to the availability of exports.
One of the major difficulties regarding the impact of the global minimum tax deal refers to disparities of the differential data basis on which the percent tax is levied. What effect will the tax have on the various countries? The immediate effect of the global deal tax is to create separate prices from country to country. The impacts are on the one hand differentiated expectations concerning the rate of inflation and on the other hand alter the trade relations. The exact change in the relative price and the level of trade depends on the slopes of the supply and demand curves, defining the marginal rates of transformation in production in the respective countries. The slope of the supply curve corresponds to the change in price necessary to induce a change in the quantity supplied. Similarly, the slope of the demand curve corresponds to the community indifference curves. These my summary comments are sufficient to explain the dichotomous interpretations available regarding the potential effects on inflation, economic activity and exchange rates. An environment speaking of sizeable volatility on the financial markets.
What are the costs of the mimnimu tax for a small country?
No doubt the proposed tax increase will change the relative price of the good on which the tax is levied. The outcome will preponderantly concern the relative price of production as well as the domestic relative price in consumption. Given that a small country has only a very limited power to affect the terms of trade the tax is expected to create a wedge between the domestic relative price in production and consumption. The result ought to be a reduction of production as well as consumption. Taxing exports raises the price of the county buying the respective good causing the relative price to be altered. A possibility that the country imposing the tax calls for an increment of the wedge for the receiving country. The wedge favors the exporting country to the detriment of the importing country. The impact of a tax is highly difficult to quantify when income, tastes and technology changes frequently, as is currently the case. A surge or decline in domestic demand must be relieved through domestic price and quantity adjustments. Domestic price fluctuations therefore must not always coincide with world price fluctuations.
The below shown charts on the monthly CPI inflation for the USA and Switzerland for the period since 1950, and the respective percent changes on a yearly basis, point to known disparities. The trend graph for Switzerland points to similar interpretative difficulties. We assume that these differences from country to country are unlikely to be significantly changed by the announced global minimum tax. This primarily due to production and consumer differences and implicit inefficiencies. It seems highly advisable to us to examine the inflation charts in greater detail. The disparities have always been sizeable not only between the USA and Switzerland but also regarding many other nations.
Examining past events, we find sizeable differences of recent developments as compared, e.g. to the late 1970´s – early 1980`s and for the years 2008 – 2009. Of forecasting importance is that the trend growth of the indexes do not point to the changes in the monthly data! In addition there are sizeable cyclical differences. 1970 and 1975 have been scary indeed. Given the above-mentioned uncertainties regarding the expected reactions of producers and consumers to the global minimum tax deal, we come to the conclusion that the outlook is somehow uncertain but not catastrophic as widely assumed.
Conclusions for investors
Our conclusions, are to be seen as a specific consequence both of a production and consumption distortion. An international trade intervention, like the global minimum tax deal, is meant to solve both distortions. The main aim is to reduce the dependence form imports from low-cost producers, mainly from China. What we know is that it will take more time than assumed by the responsible politicians, and this due to the fact that increasing domestic production will take time. Today´s setting is significantly more complex than e.g. it has been in the case of steel imports in 1977. In addition, we assume that the global minimum tax deal may not be the best way to eliminate the inequalities, given that the tax deal may reduce world welfare by reducing the level of satisfaction of foreign countries more than the satisfaction gain to the domestic country.
In terms of the investment strategy, we believe that the “political induced approach” simply calls for a prolongation of the period of uncertainty and volatility. Why, you may ask? Well, the proposed policy does not address the DISTORTIONS mentioned above. The primary purpose of levying taxes is to finance government deficits, without significantly improving output and productivity and/or to increase consumption and employment in a timely manner. Consequently, we continue to see potential in the stock markets compared to fixed income and money market investments. Currency hedging will have to be considered in the international portfolio diversification approach.
Any suggestion is highly welcome.
* Environmental influences such as heat waves, depletion of water resources and fires, or floods and storms are not taken into account.