In an era of geoeconomic fragmentation, tax and investment policies become deeply intertwined as instruments of economic statecraft. Interestingly, this era has spurred a significant rise in discourse surrounding the nexus of tax, trade and investment. Since 2021, the Organization for Economic Co-operation and Development (OECD), an international coalition of trading partners, has been working on global tax reform, culminating in the Base Erosion and Profit Shifting 2.0 (BEPS) initiative.

This initiative is built on two pillars: the first reallocates taxing rights over highly digitalized multinational enterprises, and the second establishes a 15% global minimum corporate tax rate. Of the two, the latter has gained greater momentum and made faster progress toward global implementation in recent years.

Holding up the pillar

From a progress perspective in Pillar Two, the tax advantages that fueled the “race to the bottom” among nations no longer exist, fostering fair competition and leveling the playing field. Within the OECD-led international tax regime, China, as a strategic partner, has actively contributed to global tax reform discussions from the early days.

In broader, positive terms, China’s projected inclusion and contribution in global tax governance has pushed its interest and its global south interest, simultaneously. But, in the progress for Pillar Two, China seems relatively quiet, and is not yet taking consolidated global minimum tax (GMT) or tax legislation at home.

Politically intriguing, global tax reform faces significant complications under the Trump administration, which demands carve-outs for US multinational firms. China’s recent objections to these US tax carve-outs from the global minimum tax have not altered Washington’s position but remain noteworthy.

A global calculation

Turning to the core issue, the prospect of global tax reform, specifically Pillar Two, if fully implemented, will raise the tax burden on international investment activities and dampen the incentive for cross-border capital movements.

Under these circumstances, China’s outbound investment momentum will face a critical challenge. One of the different positions, unlike OECD-capital-exporting countries, is that China has experienced the transition from a capital-importing to a capital-exporting economy.

From China’s domestic institutional backbone, one finding warrants a stronger recommendation: China must secure a capital-related tax system. This is due to China’s growing outward investment momentum, which has coincided with the pace of international tax governance reform; China is no longer merely a destination for capital but has become a major capital exporter.

Technically speaking, China lacks the overseas income tax deferral clauses that Western capital-exporting countries usually use to help their firms remain competitive abroad. Through the lens of tax and investment relations, traditional tax incentives, under the GMT era, will be challenged, compelling developing countries and emerging markets to focus more on enhancing their nonfiscal investment capacity to attract capital.

In other words, China must be able to sustain its structural outbound investment to align with the rise of nonfiscal incentives in Belt and Road Initiative (BRI) countries, particularly in the Association of Southeast Asian Nations (ASEAN). This signals that China should pay closer attention to its outbound investment strategy in Southeast Asia, as ASEAN is a crucial partner in its capital-exporting ambitions. So, China would be wise to shift its investment orientation from tax incentives-seeking to capacity-building.

In this context, China must sustain and recalibrate its outbound investment in ASEAN by aligning its strategy with the region’s expanding nonfiscal incentive frameworks, such as energizing more investments in opportunity zones like Special Economic Zones (SEZs).

ASEAN, SEZs and economics

According to the ASEAN Investment Report 2017, Southeast Asia hosts over 1,600 diverse economic zones. From a public policy position, SEZs’ strategy must be fully integrated with national economic development, both with its regional industrial policies and its broader economic development strategies.

Consequently, it can be said that SEZs increasingly function as magnets for Global Value Chain (GVC) integration, a role underscored by a decade of political economy discourse on how multinational enterprises optimize global production. By its legal character, SEZs are designed as unilateral national economic policies that reflect core principles of international trade and investment law, functioning independently or alongside the absence of multilateral/bilateral agreements.

Unsurprisingly, through the current discourse in the international political economy of SEZ, one suggestion revealed that the big recommendation for SEZ is more in creating an attractive and conducive business environment, rather than relying on fiscal incentives like tax holidays.

Within ASEAN guidelines for SEZs Development and Collaboration, tax holidays or exemptions are common but abused and limited to profitable ventures, failing to attract innovative investments. Through these guidelines, ASEAN will harmonize its policies with the G20 Development Working Group’s guidance from the International Monetary Fund, the OECD and the UN on foreign direct investment incentive policies.

Moreover, the International Institute for Sustainable Development (IISD) recommends reforming SEZs’ incentives to better target sustainable development and clean energy goals. In that sense, countries are thus encouraged to rethink the tax incentives needed to attract renewable energy investments. In practice, green technology and strategic industries are no longer driven by a simple pursuit of low costs or tax breaks. Instead, capital is now flowing into “strategic, higher-value sectors”, specifically electronic vehicles, semiconductors and green energy systems.

The rise of geoeconomics has transformed tax and investment policies into vital instruments of regional strategy, a shift accelerated by the advancement of tax multilateralism. As China remains a primary partner for Southeast Asian economies, it must recalibrate its tax-investment relation strategy to align with this new reality.

[Casey Herrmann edited this piece]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.