The United States is about to carry out massive tax reforms for the 2018-2025 period, after passing the Tax Cuts and Jobs Act. This could prompt other countries to implement similar policies, such as the lowering of tax rates, which may eventually fuel a global "race to the bottom" on tax rates.
Two of the main points of the act involve reducing the corporate tax rate to 21 percent from 35 percent on income higher than $10 million, and lowering the individual income tax rate to 37 percent from 39.6 percent.
The rate cut for individual taxpayers is also accompanied by an upward adjustment in the income bracket that is subject to the highest tax rate, to $500,000 (single filer) and $600,000 (married, filing jointly) from $426,700 (single filer) and $480,050 (married, filing jointly).
This new act also states that taxpayers repatriating assets in the form of cash or cash-equivalent assets from foreign incomes are subject to a tax rate of 15.5 percent. The rate goes down to only 8 percent when income from overseas is reinvested domestically.
Furthermore, President Donald Trump's administration also changed the US tax system from global to territorial, while omitting the provision of alternative minimum tax on corporations.
President Trump claims that this policy will result in the largest tax cut in American history. This reform is considered a radical and controversial breakthrough by Trump to restore the US economy, which over the past decade, had fallen into a recession due to the 2008 financial crisis.
Tax Battles: Risks and Sovereignty Dilemma
The issue of tax battles is actually nothing new. This situation has presented itself for years, along with emerging tax-avoidance practices, such as companies moving their profits to so-called tax havens, or countries with low tax rates or no taxation.
On the other hand, almost all countries around the world have been facing the need to increase their budgets to fund development, after being hit by the global financial crisis. Tax reform, such as lowering tax rates, has become one of several options for many countries to attract investment and increase their tax bases – not to mention the various tax incentives and other measures that are commonly implemented.
The United States, Australia, India, the Philippines, China, South Korea and Malaysia are among many countries planning to cut their tax rates. Indonesia also seems to be tempted to reduce its corporate income tax rate to the same level as its peers in the Association of Southeast Asian Nations (Asean).
Every sovereign country has the right to manage its tax system. However, considering the importance of economic and investment cooperation – both bilaterally and multilaterally – it is necessary to implement a fair tax system. A tax treaty is would be an example of bilateral cooperation on taxation.
A tax-cut policy may have a short-term positive impact by boosting purchasing power, investment and the economy, but in the long run, a drastic cut without optimization of new revenue sources may become a time bomb that can ruin an economy at any time.
In the case of the United States, the Trump administration should be aware of the potential consequences of a massive tax cut, for this policy will reduce state revenue by up to $1.5 trillion over the next decade. On the other hand, there is a significant need for income to fund social security and health care for millions of citizens.
Approximately 45 million Americans received social security benefits, including pensions, in 2017, with the number expected to rise to 60 million by 2027. As a consequence, it is predicted that the US federal budget deficit will triple within 10 years from this year's $487 billion.
If the risk is not anticipated and managed properly, massive debt may drag the US economy into a new and even deeper financial crisis.
Due to globalization, a crisis in the US economy translates into a global economic crisis. If many countries decided to implement similar tax policies, the risk would be even greater.
It is important for Group of 20 countries to make the necessary efforts to stop global – and harmful – tax competition. However, even an agreement or commitment to stop such tax battles would not overrule national sovereignty. So in case of any transgressions, the only sanction would be isolation from the global community, which can be reversed at any time in consideration of economic interests.
Another risk the United States must consider is the potential impact of the change in its taxation system from global to territorial. Despite encouraging investment through tax cuts, it may also go the other way by encouraging local investors to invest abroad instead, as the territorial income system will only impose tax on income derived from within the country, while income derived from abroad be tax-free.
Don't Just Follow
Every policy always comes with pros and cons. In light of these tax battles, Indonesia, as a sovereign state, has the right to either copy, follow, or implement what the United States has done. The Indonesian government is currently in the process of amending its tax laws. The opportunity for tax reform has now risen – including the possibility to lower the tax rate – through the revision of tax law packages that have been included in the 2018 National Legislation Program.
However, we should not just follow Uncle Sam's tax policies. Taxpayer aspirations should also be taken seriously. Is it solely a high tax rate that makes them incompliant? Or perhaps it is purely the complexity of the tax system, or multi-interpretative tax laws most taxpayers find hard to digest.
Speaking of the latter, even when the tax rate is set at the lowest, we cannot expect to improve society's understanding and awareness of the need to pay tax if tax administration and services are not simplified.
It reminds me of something a big entrepreneur once said: "It is not about the tax rate. What matters most, are business certainty, procedural clarity and the absence of multi-interpretative regulations."
Wahyu Nuryanto is executive director of the MUC Tax Research Institute, a nonprofit member-supported organization dedicated to studying, informing and educating the public and stakeholders on taxation issues in Indonesia, and advising policy makers.