It was a cold winter day in Washington, DC, so the ceremony took place indoors. In the Oval Office President Donald Trump signed into law the Tax Cuts and Jobs Act—“the biggest tax cut, the biggest reform of all time”—on December 22, 2017. The key feature of the bill was a cut in the corporate income tax rate from 35% to 21%. According to its proponents, the bill was going to spur growth and create jobs. But even those who did not agree with this optimistic forecast recognized that reform was long overdue. The corporate tax was broken. Between 1995 and 2017, while the federal corporate tax rate had remained constant at 35% and profits had grown faster than the economy, corporate income tax revenue (as a share of national income) had fallen by 30%. Massive amounts of profits had been shifted to low tax places. American firms had accumulated more than three trillion dollars in Bermuda, Ireland, and other offshore tax havens.1 The market for tax dodges was brimming with innovation; tax authorities were overpowered. Does this ring a bell?
For the majority of the nation’s political, economic, and intellectual elites, slashing the corporate tax rate was the right thing to do. During his presidency, Barack Obama had advocated in favor of reducing it to 28%, with a lower rate of 25% for manufacturers. Trump’s reform did not garner the same bipartisan fervor as Reagan’s Tax Reform Act of 1986: Democratic lawmakers considered 21% too low a rate, objected to the changes the bill made to individual income taxes, and did not vote for it. But most lawmakers agreed that lower corporate tax rates were in order. In holding that opinion, they were in line with most policymakers in rich countries. As Trump’s bill passed, French president Emmanuel Macron vowed to cut the corporate tax from 33% to 25% between 2018 and 2022. The United Kingdom was ahead of the curve: it had started slashing its rate under Labour prime minister Gordon Brown in 2008 and was aiming for 17% in 2020. On that issue, the Browns, Macrons, and Trumps of the world agree. The winners of global markets are mobile; we can’t tax them too much. Other countries are cutting their rates? We must cut our rates too. Google has moved its intellectual property—and thus most of its profits—to Bermuda? We must give the company tax incentives to move its IP back to the United States.
There’s a problem with this world view. If globalization means ever-lower taxes for its main winners—the owners of big multinational companies—and ever-higher taxes for those it leaves out—working-class families—then it probably has no future. Tax injustice and inequality will keep increasing. And to what end? There is a significant risk that more and more voters, falsely convinced that globalization and fairness are incompatible, will fall prey to protectionist and xenophobic politicians, eventually destroying globalization itself.
WHEN BIG CORPORATIONS PAID A LOT OF TAX
From the creation of the corporate income tax at the beginning of the twentieth century until the late 1970s, large companies did not avoid much tax. It was not for lack of opportunities—the laws that govern the taxation of multinational firms have not changed much since the beginning of the twentieth century. But two elements kept tax avoidance in check. First, as they did for individuals, Franklin Roosevelt and his successors limited corporate tax dodging with a proactive enforcement strategy, shaming tax dodgers, and appealing to morality.
But more importantly, corporate executives conceived of their role differently. In the United States today, conventional wisdom holds that the goal of CEOs must be to grow the stock price of their firms. Corporations, according to that world view, are nothing more than a conglomerate of investors pooling their resources together. Although some corporate leaders may lament being hamstrung by activist shareholders, they all consider it their duty to maximize shareholder value. And dodging taxes unquestionably enhances shareholder value. Less tax paid means more after-tax profits that can be distributed in dividends to shareholders or used to buy back shares.
But the shareholder-is-king doctrine is not universal, as evidenced by the diverse compositions of corporate boards across the world. In many countries, employee representatives make up a third of the members of corporate boards; in Germany the number is half in large companies.2 Before the 1970s US corporations, although workers’ representatives were not on their boards, were also widely considered responsible to a broad class of stakeholders beyond their owners: employees, customers, communities, and governments.3 Which, for our purposes, has one implication: company executives did not consider it their duty to dodge taxes and did not have much of a tax-planning budget. Fifty years ago General Electric, though it was already a globe-spanning conglomerate, did not employ a thousand tax lawyers as it has recently.
Let’s take a look: in the early 1950s, the federal corporate income tax collected 6% of national income, almost as much as the individual income tax! As we’ve seen in Chapter 2, up to the 1970s the corporate tax accounted for the majority of the tax payments made by the wealthy, thus playing a key role in the progressivity of the overall US tax system.
4.1 THE SLOW AGONY OF THE CORPORATE TAX
(Federal corporate and individual income tax revenue, percentage of national income)
Notes: The figure depicts federal corporate tax revenue and federal individual income tax revenue as a share of national income since 1913. Both the corporate and individual income tax increased sharply during World War II. Individual income tax revenue has stayed about stable (around 10% of national income) after World War II while corporate income tax revenue has eroded. In 2018, federal corporate tax revenue was only about 1% of national income, the lowest since the Great Depression. Complete details at taxjusticenow.org.
We should be careful not to exaggerate the contribution of the corporate tax. The high corporate tax receipts of the early 1950s were in part the result of exceptional circumstances. During the Korean War, the US government reinstated an excess profit tax (a levy it had applied during the two world wars), at a rate of 30% on top of the 47% statutory tax rate in place; this surtax boosted revenue between 1950 and 1953. After it was repealed, corporate tax revenue stabilized to 4%–5% of national income in the late 1950s and 1960s.
What’s important to realize, however, is that 4%–5% is still much more than today: in the aftermath of the Trump tax reform, the federal corporate tax now barely collects 1% of national income in revenue. It’s been reduced by a factor of four over half a century. What happened?
THE BIRTH OF PROFIT SHIFTING
The first dent occurred in the late 1960s and early 1970s, in the context of rising inflation and declining corporate profits. In the 1950s and up to the late 1960s, with virtually no competition from Europe or Japan, US corporations were highly profitable. This started to change in 1969 and 1970, when the US economy entered a recession as the government increased taxes to close the budget deficits of the Vietnam War and the Federal Reserve tightened interest rates to fight inflation. The decline in profitability continued with the Oil Shock of 1973 which led to a severe recession and the large increase in interest rates during the 1970s. Because interest is tax deductible, high interest payments reduce the tax base and hence corporate tax revenue.
These macroeconomic effects were followed, in the late 1970s and in the first half of the 1980s, by the birth of the corporate tax-dodging industry—at the same time the tax-sheltering industry swelled, and in the same ideological context.
What was the equivalent, for corporations, of the sham partnership that was all the rage for high-earning individuals? The Netherlands Antilles finance company. A US firm would set up a subsidiary on the island of Aruba, Bonaire, or Curaçao. It would then have this affiliate borrow money from a European bank at the prevailing interest rate, around 3%, and lend it back to the US parent company at a much higher interest rate, around 8%.4 The benefit of this maneuver was twofold. The offshore finance company would earn income from the five points of interest margin, and because there was no income tax in the Netherlands Antilles, this income would be tax-free. More important was the gain for the US parent: since interest paid is deductible from the corporate income tax base, the sums paid to Antilles affiliates reduced the amount of tax owed to Uncle Sam. Like sham partnerships, this was a gross tax dodge that authorities eventually shut down in the mid-1980s.
To see corporate tax avoidance in full flower, we must wait for the mid-1990s. Tax avoidance and evasion do not bloom spontaneously; as we’ve seen in the previous chapter, they’re fueled largely by the peddlers of tax dodges. And the tax-avoidance industry does not function in a vacuum: the ideological, economic, and legal context in which it operates matters. In the 1990s, all the lights turned green. The Berlin Wall had just fallen; free-market ideas were triumphing. A new generation of executives, indoctrinated into the shareholder-is-king model in the 1980s, were taking up the reins of America’s multinationals.
At the same time, globalization was opening new tax-saving opportunities. Up to the 1980s, US companies made less than 15% of their earnings abroad. When all your customers are in the United States, setting up shell companies in the British Virgin Islands can look suspicious in the eyes of the tax authorities. In the mid-1990s, however, the share of earnings made outside of the United States exploded, reaching about 30% in the first decade of the twenty-first century. The profit-shifting frenzy could start.
Here’s how it unfolded.
WELCOME TO BERMULAND
Profit-shifting exploits frailties in the legal system that governs the taxation of multinational firms. This legal system was designed in the 1920s, quickly after the invention of the corporate tax, and has remained largely unchanged.5 It embraces the notion that any subsidiaries of a multinational firm should be treated as separate entities. Apple Ireland must be considered for tax purposes as a firm of its own, distinct from Apple USA. Any profit made by Apple Ireland must be taxed in Ireland, and any profit made by Apple USA must be taxed in the United States.
The problem is simple: because the corporate tax rate in Ireland (12.5% according to the law, and in practice often much less) is lower than in the United States (21%, not including state corporate taxes), Apple is better off booking its profits in Ireland than in America, and the company has ample opportunities to do so. Of course, certain rules constrain the division of global profits across the subsidiaries of a given multinational group. In theory, firms must determine the location of their profits by exchanging goods, services, and assets internally—as if their various subsidiaries were independent entities. In each exchange, the subsidiaries must trade at the prevailing market price for the good, service, or asset—what is known as the arm’s-length principle. In practice, however, multinationals are substantially free to decide for themselves what prices they use (and therefore where they book their profits) thanks to the tax-dodging industry.
In the 1990s, the industry began selling multinationals on internally exchanging assets and services that possessed one key virtue: no market price. Assets and services such as logos, trademarks, and management services have no observable market value, thus making the arm’s-length principle impossible to enforce. What’s the price of Apple’s logo? It’s impossible to know: this logo has never been sold in any market. What’s the price of Nike’s iconic “swoosh”? What’s the price of Google’s search and advertisement technology? Since these logos and trademarks and patents are never traded externally, firms can pick whatever price suits them.
The product peddled by the tax-dodging industry is all-in: a creative intragroup transaction, and a certified “correct” transfer price to be charged for that transaction. In practice, the transfer prices used are typically those that maximize tax savings for the multinational group. The accountants that propose and certify these transfer prices are paid by the multinationals themselves. The outcome of all of this? Thanks to the proliferation of intragroup transactions conducted at doctored prices, high profits end up being recorded in subsidiaries where tax rates are low, and low profits in places where they are high.
To see how this works in practice, it’s worth considering a few examples.
In 2003, a year before it was listed as public company in August 2004, Google sold its search and advertisement technology to its own “Google Holdings,” a subsidiary incorporated in Ireland, but for Irish tax purposes a tax resident of Bermuda, an island in the Atlantic where its “mind and management” are supposedly located. The price charged for this transfer is not public information. When the US corporate income tax was created in 1909, the law provided for firms’ tax returns to be made public—with a view, precisely, to prevent tax evasion. But Congress repealed the mandatory public disclosure in 1910, and ever since the tax affairs of America’s corporate giants have remained well-kept secrets.
Nonetheless, it’s easy to conjecture that the price paid by Google Holdings to acquire Google’s technology was modest. Why? Because if it had been high, Google would have paid a substantial tax in the United States in 2003. But that year, according to the prospectus it filed in 2004 with the Securities and Exchange Commission, it paid $241 million globally.6 Even if the company’s entire tax bill resulted from the sale of Google’s intangibles to its Bermuda subsidiary (which is unlikely, as Google probably paid taxes for other reasons), it would imply a sale price for the intangibles of less than $700 million. That’s not much for an asset that has generated dozens of billions in revenue since then. In just one year, 2017 (the latest year available), Google Holdings in Bermuda made $22.7 billion in revenue. How so? Because it’s the legal owner of some of Google’s most valuable technologies. Google Holdings licenses the right to use its technology to Google’s affiliates throughout Europe. (A similar scheme is used in Asia, with Singapore in lieu of Bermuda). Google’s subsidiaries in Germany or France pay billions of dollars in royalties to Google Holdings for the right to use the so-called Bermudian technology, reducing the tax base in Germany and in France, and increasing it in Bermuda by the same amount.7
The corporate tax rate in Bermuda? Zero.
European firms do this too. In 2004, a few months after Google transferred its intellectual property to Bermuda, Skype—a company founded by a Swede and a Dane—moved most of its voice-over-IP technology to a subsidiary incorporated in Ireland. What’s interesting in the case of Skype is that thanks to “LuxLeaks”—a trove of confidential documents leaked in 2014 from PricewaterhouseCoopers—we know the details of this transaction. According to PwC, how much was the groundbreaking technology that was going to disrupt the telecommunications market worth? A grand total of 25,000 euros.8 In September 2005, a few months after this transaction, Skype was bought by eBay for $2.6 billion.
It’s not a coincidence that Google and Skype sold their intellectual property at the same time to shell companies located somewhere between Ireland and Bermuda. Around 2003–2004, this was the dodge of choice for the tax-avoidance industry. Skype, like Google, was given the same advice: move fast, before being listed as public companies or bought back by another firm. Why? Because it’s harder to pretend your core technology is nearly worthless when the market values you in the billions.
With these examples, we can see that corporate tax dodging, whatever may be said about it, is quite simple. At its core, it involves manipulating the price of intragroup transactions in goods (like iMacs), services (as when a US firm buys “management advice” from an affiliated party in Switzerland), assets (such as Google selling its search and advertisement technology to its Bermuda subsidiary), or loans (as happened during the Netherlands Antilles frenzy of the early 1980s). Variations on these schemes are made available throughout the world by the Big Four accounting firms, Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers. And they all have the same consequence: paper profits end up being recorded in subsidiaries that are located in low-tax places, employ few workers, and use little capital.
FORTY PERCENT OF MULTINATIONAL PROFITS SHIFTED TO TAX HAVENS
Thanks to a sophisticated statistical system maintained by the US Bureau of Economic Analysis (BEA), we can track the evolution of the shifting of profits by US multinationals over the last half century. United States firms are asked to annually report detailed information about their operations to the BEA, in particular the profits they book and how much tax they pay in each of the world’s countries.
Until the late 1970s, US multinationals, despite facing corporate income tax rates of 50%, barely used any offshore tax havens. Some of them did have offices in Switzerland or holding companies in small Caribbean islands, but overall the sums involved were negligible: around 95% of their foreign profits were booked in high-tax places, primarily Canada, the United Kingdom, and Japan.9 Profit shifting picked up with the Netherlands Antilles epiphany of the late 1970s; in the early 1980s the fraction of foreign profits booked in tax havens by US companies shot up to 25%. At that time, however, US companies were still making the bulk of their profits in the United States. Even though they shifted a quarter of their foreign profits to tax havens, the sums involved were small when compared to their total (US plus foreign) earnings. In the end, the Netherlands Antilles craze had little impact on the global tax bill of America’s corporate giants. It’s only since the late 1990s that profit shifting has truly become significant.
Today, close to 60% of the—large and rising—amount of profits made by US multinationals abroad are booked in low-tax countries. Where exactly? Primarily in Ireland and Bermuda. A finer geolocation is unfortunately impossible: as we’ve seen with the case of Google (now Alphabet), the frontier between these two islands is not clear, and when studying the geography of profit shifting they are better considered as a single country somewhere in the Atlantic, a place that we will call Bermuland.
In 2016, US multinationals booked more profits in Bermuland alone than in the United Kingdom, Japan, France, and Mexico combined. Considerable sums are also booked in Puerto Rico, where they are taxed at a modest effective tax rate of 1.6%. The territory is not subject to the US corporate income tax and has long been a destination of choice for tax dodgers, from pharmaceutical giants such as Abbott to tech companies like Microsoft. Next come the Netherlands, Singapore, the Cayman Islands, and the Bahamas: in each of these territories, US multinationals book more profits than in China or Mexico. Last but not least, in what is perhaps the most grotesque aspect of this farce, US firms have in 2016 (the latest year available) booked more than 20% of their non-US profits in “stateless entities”—shell companies that are incorporated nowhere, and nowhere taxed.10 In effect, they have found a way to make $100 billion in profits on what is essentially another planet.
United States multinationals are not the only ones to shift profit to low-tax locales: European and Asian firms do it too. The result of this giant free-for-all? All countries steal a bit of revenue from each other. American firms deprive European and Asian governments of tax revenues, while European and Asian firms return the favor to Uncle Sam. A recent study estimates that globally, 40% of all multinational profits—profits made by firms outside of the country where they are incorporated, such as the profits made by Apple outside of the United States, or those of Volkswagen outside of Germany—are booked in tax havens today.11 This corresponds to around $800 billion in income earned in the United States, France, or Brazil that ends up being booked and taxed in the Cayman Islands, Luxembourg, or Singapore, usually at rates between 5% and 10%. In this war of all multinationals against all states, US multinationals appear to be the boldest: they shift not 40% (the world average) but 60% of their foreign profits to offshore tax havens each year.
Multinationals from all sectors of the economy practice this profit shifting. Because they have more intangible capital—which can more easily be moved abroad—there is a view that tech giants are primarily to blame (and therefore that finding a way to tax them is all we need to do). Certainly, Silicon Valley companies make extensive use of tax havens. But tax dodging is also widespread in the pharmaceutical industry (Pfizer), among financial firms (Citigroup), in manufacturing (Nike), in the automobile industry (Fiat), and in luxury (Kering).12 Why? Because any company, properly advised by the Big Four accounting firms, can create its own intangibles (logos, know-how, patents) and sell them to itself at arbitrary prices. Any company can similarly buy nebulous services from its own subsidiaries in low- tax locales. These problems have solutions, as we will see in detail in the next chapter; but we have failed to implement them. They will require more comprehensive fixes than the taxes recently adopted in a number of European countries on the revenue of digital companies.
ARE PAPER PROFITS OR MACHINES MOVING TO TAX HAVENS?
To justify the enormous sums booked in tax havens, a frequent argument maintains that this is all an outcome of tax competition.13 Firms, according to this view, are simply responding to differences in tax rates and relocating their activities where taxes are low. They have moved their factories to Ireland, their research and development teams to Singapore, and their bank offices to George Town, Grand Cayman. It’s globalization at work.
The data, however, do not lend much support to this view. They show that by and large it’s paper profits that have moved to low-tax locales over the last decades—not offices, workers, or factories. Some 95% of the 17 million workers employed outside of the United States by US multinationals work in countries with relatively high tax rates, primarily in the United Kingdom, Canada, Mexico, and China.* Some of them—a bit fewer than a million—do work in tax havens, mostly in Europe. One hundred twenty-five thousand, for example, are employed in Ireland. This is not negligible compared to the size of the Irish labor force—about 2.3 million individuals—and the multinationals’ presence in Ireland generates real benefits for that country (above and beyond the tax revenue collected). But this population is almost fifteen times less than the number of people that work for US companies in the neighboring United Kingdom, a country whose corporate tax rate has been two times higher than Ireland’s on average since the turn of the twenty-first century.
Despite decades of tax competition, there is no evidence that production has moved to tax havens on any significant scale. Instead, US corporations have expanded their activity in emerging economies. More than a third of their overseas workers, or about 6 million people, are now employed in China, India, Mexico, and Brazil.
The conclusion is the same when we look at where firms own tangible assets including plants, equipment, and office buildings. The majority of these assets are located not where taxes are low, but where workers are. Only 18% of the stock of tangible capital owned by US firms outside of the United States is in low-tax places; the remaining 82% is in high-tax countries. Contrast that with our earlier finding that close to 60% of US companies’ overseas earnings are booked in tax havens, and the conclusion is clear: what has migrated to tax havens is not production; it’s paper profits.
No doubt taxes, along with many other factors, are considered when firms decide where to base their activity. There is even evidence that taxes may matter more today than they did a few decades ago. The capital stock situated in tax havens, as seen in Figure 4.2, is growing; it’s even growing faster than the number of people employed by multinational firms in low-tax locales. This suggests that today big companies may be more willing to move plants and offices to save on taxes than in the past. It is also clear that in certain tax havens, such as Ireland, low taxes have been instrumental in getting companies to move not only paper profits, but also real activity.
Even so, there’s one important conclusion to draw from the available data: from a global perspective, the relocation of capital to low-tax places has been much less widespread than commonly assumed. What has happened is not an upsurge of tax avoidance; it’s an epidemic of tax evasion. Prominent havens, such as Bermuda, zero-tax Caribbean islands, or Malta, only lure paper profits—nothing of substance happens there. And the movement of capital toward places like Ireland is still small compared to the enormous swing of profits to treasure islands. Even the purchase of office space in Ireland by foreign multinationals might simply be a veneer of legitimacy meant to obscure the profits artificially shifted into the island—what looks like movements of tangible capital in the data may merely serve as cover up.
4.2 PAPER PROFITS ARE MOVING TO TAX HAVENS; REAL ACTIVITY LESS SO
(Percentage of foreign profits, capital, and wages of US multinationals in tax havens)
Notes: The figure depicts the evolution of the profits booked, tangible capital owned, and wages paid by US multinationals in tax havens since 1965, expressed as a fraction of the total foreign (i.e., non-US) profits, capital, and wages of US multinationals. The share of foreign profits booked in tax havens has surged from less than 5% in the 1960s to almost 60% today but workers and capital haven’t moved to tax havens nearly as much. Complete details at taxjusticenow.org.
Today’s corporate tax dodgers defend themselves with echoes of J. P. Morgan himself: this is all perfectly legal; corporations everywhere abide by the law; governments are to blame for maintaining an out-of-sync tax code. Apple pays a 1% effective tax rate in Ireland, and is ordered by the European Commission to pay back to Dublin the billions it has dodged? It’s outrageous: “In Ireland and in every country where we operate, Apple follows the law and we pay all the taxes we owe.”14 Nike shifts billions in royalties to its tax-free Bermudian shell? Nothing to see here, “Nike fully complies with tax regulations.” Besides, global policymakers are the ones at fault: “We encourage the OECD† to actually solve these issues,” said Sundar Pichai, CEO of Google, in Davos when challenged about the tax dodging of the Mountain View, California, firm.15
It’s a weak defense: nothing of substance happens in Bermuda, so it stands to reason that Google has booked $22.7 billion in revenue in that island to avoid taxes, in violation of the economic substance doctrine. This tax evasion persists because the political will to enforce the corporate tax has declined and the resources of multinational companies swamp those of the IRS. But that does not make the activity legitimate.
THE COMMERCIALIZATION OF STATE SOVEREIGNTY
Like the tax shelters of the early 1980s, the profit-shifting business enriches the suppliers of tax schemes and their clients while impoverishing the rest of the world. There is, however, a key difference between the tax-dodging market of the 1980s and the one that serves multinationals today. In addition to the suppliers of the dodges and their buyers, another party benefits from this commerce: the governments of low-tax countries. These states sell a key ingredient, a vital input without which the scams peddled by the Big Four would be of little use: their own sovereignty.16
Since the 1980s, the governments of tax havens have engaged in a new sort of commerce. They’ve sold multinationals the right to decide for themselves their rate of taxation, regulatory constraints, and legal obligations. Everything is negotiable. Apple asks for a low tax rate to locate some of its companies in Ireland? Dublin obliges. Skype is worried that the taxman might one day contest the price at which it sold its intellectual property to its Irish subsidiary? Not to worry, the Grand Duchy sells insurance, in the form of what are known as advanced pricing agreements—contracts that rubber-stamp the transfer prices used by multinationals ahead of time. No profit shifting would be possible without the complicity of tax havens’ governments, many of which boast high statutory tax rates, but in practice grant lower rates to the companies they court and provide them with an array of schemes to duck laws and regulations imposed elsewhere.
Why do they do this? Because the commercialization of state sovereignty is, itself, quite profitable. There are nonmonetary benefits: Luxembourg, for example, derives sizable influence within the European Union from its outsized role in the financial dealings of big companies. But most importantly there are cold, hard monetary rewards for countries that conduct this kind of commerce. By applying even tiny effective tax rates to the huge amount of paper profits they attract, tax havens generate large revenues. What country has the highest ratio of corporate income tax revenues to national income? The notorious tax haven of Malta. Number two? Luxembourg. Then come Hong Kong, Cyprus, and Ireland. At the bottom of the ranking, in 2017, we find the United States, Italy, and Germany, three countries with corporate income tax rates close to or above 30% that year.17 The tax havens that impose low effective tax rates, between 5% and 10%, collect much more tax (relative to the size of their economy) than large countries that have rates in the 30s. The lower the rate, the higher the revenue!
We see here a striking illustration of “Laffer-curve” logic, named after the supply-side economist Arthur Laffer who popularized it in the 1970s. On this view, slashing tax rates boosts revenues. Even a rate of 0%, which on first blush may seem too low, can bring big bucks for small countries. The governments of the British Virgin Islands and Bermuda charge flat fees—and generate serious revenue—on the creation of the hundreds of thousands of shell companies they attract precisely because of their zero tax rate.
There is one small difference between the prosperity of tax havens and the one predicted by supply-side prophets. In Arthur Laffer’s world, people work more, businesses invest more extensively, innovators innovate more relentlessly when taxes are low—and global GDP rises. In the real world, however, any dollar of revenue gained by Malta, Luxembourg, or Cyprus comes at the expense of other countries. It’s a zero-sum transfer that does not make the world richer. When Bermuda supplies custom loopholes to big corporations, when Ireland gives sweet tax deals to Apple, when the tax office of Luxembourg works hand in hand with the Big Four, they steal the tax revenue of other nations, leaving global GDP constant. It is all zero-sum theft.
SAND IN THE WHEELS
Our intention is not to demonize this or that country, nor is it to pretend that all our problems would go away if some rogue states stopped their fiscal dumping. As globalization progresses, most countries have yielded to the temptation of selling part of their sovereignty in the hope of attracting some activity, a bit of tax revenue, whatever piece of the cake they can grab. Some—typically smaller countries, for which it’s most profitable—have gone farther down that road than others. But as the world economy becomes more integrated and as new economic powerhouses emerge in the developing world, pretty much all countries are becoming small compared to the planet as a whole. The temptation to turn into a tax haven becomes overwhelming everywhere.
There have been attempts to curtail the commerce of sovereignty. The most ambitious effort to date is the OECD initiative called “inclusive framework on base erosion and profit shifting,” or BEPS, that started in 2016. It is a coordinated effort to put sand in the wheels of the great tax-dodging machinery. It makes it harder for firms to manipulate transfer prices. It defines several harmful tax practices that countries are encouraged to abandon. It attempts to fix inconsistencies in the tax laws of various countries, and has compelled certain tax havens to abandon their most egregious schemes.
The data, however, suggest that BEPS and other efforts have been mostly unsuccessful. The share of US firms’ profits booked in low-tax locales keeps growing year after year as depicted in Figure 4.2. The evidence is less comprehensive for non-US multinationals because the available data cover fewer years, but the trend seems to be the same. How can we explain this lack of success? The BEPS initiative does not attack the heart of the tax-dodging reactor. Firms are still supposed to exchange goods, services, and assets internally. The Big Four still manufacture transactions that have no market price. Transfer pricing accountants still have incentives to please their clients and certify as correct whatever arrangement will minimize their tax bill. In need of a Copernican revolution, we’ve been busy refining the Ptolemaic model of the heavens.
THE TRIUMPH OF TAX COMPETITION
The current attempts at international coordination eventually run up against a deeper limit: the lack of any serious attempt at harmonizing tax rates. Among policymakers today, there is agreement that profit shifting should be combatted, but that tax competition—as long as countries play by the books—is not reprehensible. According to that view, it is bad if a company produces patents in the United States and shifts them to tax-free Bermuda. But it is fine if the company produces them in Ireland and if Dublin taxes profits arising from patents at 6.25%, as it does today. It would still be fine if the tax rate were 1% tomorrow. Any rate is acceptable as long as the patents were made in Ireland, by local engineers working in Irish offices—BEPS allows countries to offer legal tax breaks for revenues derived from patents, what is called a “patent box.” In addition to Ireland, the United Kingdom offers a rate of 10%, the United States 13.125% in the aftermath of the 2018 tax reform, to name a few.
International organizations such as the OECD are permitted to discuss ways to improve the definition of the tax base—but not tax rates. International coordination exists—except that countries are not coordinating on the key component of tax policy. The OECD hopes that thanks to its effort there will soon be no profit shifting: companies will be taxed in the country where they actually operate, fair and square. But the question remains, taxed at what rate? Even if BEPS eventually succeeded in curbing profit shifting, absent any coordination on the tax rates themselves, there would always be some countries for which it would be profitable to cut their tax rates. Slashing the corporate tax rate may be more transparent than signing back-room deals, more forthright than offering tailor-made loopholes, more honest than keeping one’s eyes shut on aberrant intragroup transactions. But it has the same implication: reducing the tax liabilities of big companies and of the shareholders who own them.
At its core, slashing rates is just another form of commercialization of state sovereignty. It’s a profitable business for the small countries that practice it: it boosts their revenue—and, in contrast to facilitating the pure shifting of paper profits, can even boost employment and wages. But as with other forms of commercialization of state sovereignty, these gains come at the expense of the rest of the planet. The breaks that tax havens offer to big companies impose a cost on the rest of us, a “negative externality” in economics lingo. They feed a race to the bottom, leading to a world where, to prevent capital from moving abroad, most nations are compelled to adopt tax rates that are too low—lower than the rates they would otherwise democratically choose. The fundamental problem behind the current forms of international coordination is that they do not tackle, and in fact legitimize, the undemocratic forces of tax competition.
And indeed, tax competition has intensified since the start of the BEPS process, and the global race to the bottom in corporate tax rates has accelerated. Since 2013, Japan cut its rate from 40% to 31%; the United States from 35% to 21%; Italy from 31% to 24%; Hungary from 19% to 9%; a number of Eastern European states are following the same route. Between 1985 and 2018, in what is perhaps the most striking development in tax policy throughout the world, the global average statutory corporate tax rate has fallen by more than half, from 49% to 24%. If the current trend is sustained, the global average corporate tax rate will reach 0% before the middle of the twenty-first century.