For some time now, multinational companies have been gaming the
rules of the global economy to minimise their tax liability —or even
eliminate it altogether.
And for some
time now, the Independent Commission for the Reform of International
Corporate Taxation (ICRICT) has argued for the unitary taxation of
multinationals.
Fortunately, there have been some encouraging signs that the idea of a unitary tax is gaining traction.
Introducing
a global minimum effective corporate-tax rate of between 20 per cent
and 25 per cent on multinationals, as the Reform of International
Corporate Taxation (of which I am a member) advocates, would greatly
weaken these firms’ financial incentives to use transfer pricing among
their subsidiaries to shift profits to low-tax countries. Moreover, a
global minimum would end the race to the bottom in which countries lower
their national tax rates in order to attract multinational companies.
These
global tax revenues could then be allocated among governments based on
factors such as the company’s sales, employment and number of digital
users in each country — rather than on where multinationals decide to
locate their operations and intellectual property.
Although
tax experts and policymakers initially dismissed the ICRICT’s proposal
as impractical, even former naysayers now recognise the validity of this
approach.
LOST REVENUE
Most
important, it is now widely acknowledged that taxing multinational
firms based on “where value is created” encourages massive — and legal —
tax avoidance through “base erosion and profit shifting,” whereby
companies take advantage of loopholes and differences in tax rules to
move profits to low- or no-tax jurisdictions.
The
resulting revenue losses for governments are mind-boggling. The
International Monetary Fund has estimated that countries under the
Organisation for Economic Co-operation and Development may be losing
$400 billion in tax revenue each year because of profit shifting, with
non-OECD countries losing a further $200 billion.
As
the United Nations’ 2019 Financing for Sustainable Development Report
points out, tax avoidance hits developing countries particularly hard,
because their governments tend to rely on corporate tax revenues, and
because companies’ declared profits are more sensitive to tax rates than
in developed countries.
Multinationals’
tax-avoidance strategies can also distort cross-border trade
statistics. Global firms increasingly report intra-company trade and
investment in intangible assets such as intellectual property, primarily
for tax-arbitrage purposes. This creates “ghost trade flows” that have
little or no connection with real economic activity.
This
legal tax avoidance is most evident in digital companies, mainly
because digitalisation makes it hard to establish where production takes
place. As a consequence, a digital multinational’s revenues typically
bear no relation to its reported profits and resulting tax bill.
Amazon,
for example, has paid no federal tax in the US for the past two years.
In 2018, the company generated more than $232 billion in worldwide
revenue, but reported profits of only $9.4 billion, on which it could
then claim various deductions and offsetting credits. And in 2017,
Google legally moved nearly $23 billion to Bermuda through a shell
company based in the Netherlands, dramatically reducing its foreign tax
bill.
Governments are finally trying to claw back this lost revenue.
In
January, the OECD proposed standardised rules for taxing digital
companies across its member countries, building on measures already
proposed in the European Union.
The
OECD proposals go beyond the “arm’s-length principle,” which seeks to
compel multinationals to bring transfer pricing into conformity with
some market-value basis. They also go beyond current rules that limit
taxation authority to countries where a multinational has a physical
presence.
This initiative is welcome,
and not only because it could help to reduce tax competition among
developing countries. For too long, multinationals — and digital firms
in particular — have used existing tax rules to avoid paying taxes in
countries where their products are consumed.
BENEFIT
At
the moment, the various proposals to address this (from the US, the UK,
and the G24 group of developing countries) all envisage expanding these
“market” countries’ authority to tax global firms.
The UK proposal is the narrowest in this regard, while the G24’s is the broadest.
But
developing countries also want any global corporate-tax system to
recognise their increasing importance as producers for traditional
multinationals. Digital companies may be the largest and most prominent
tax avoiders, but a tax reform that focused only on these firms would
clearly not be in developing countries’ interests.
The
US government is also against changing tax rules only for (mostly
American) digital companies, because it would mean the US giving
taxation authority to other countries and receiving nothing in return.
The
geographic allocation of multinationals’ global profits and tax
payments therefore needs to reflect supply-and-demand factors. This
would take into account both sales (revenues) and employees (as a proxy
for production).
Such a system would benefit developing and developed countries alike.
The
arguments in favour of such an approach are overwhelming. But
multinationals of both the digital and traditional sort remain
politically powerful. Even – or especially – in the digital economy,
old-fashioned lobbying still counts.
Jayati
Ghosh is a professor of economics at Jawaharlal Nehru University in New
Delhi, executive secretary of the International Development Economics
Association, and a member of the Independent Commission for the Reform
of International Corporate Taxation.
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