Tax Tactics Threaten Public Funds
When the European Commission charged this week that Ireland’s sweetheart tax treatment of Apple amounted to an illegal corporate subsidy, the company said that it had done nothing wrong. Apple executives might have added that whatever they did, they were not alone.
Corporate tax strategies intended to minimize global taxes, by hook or by crook, are by now standard practice. Google and Facebook move money through Ireland to lower their taxes. Starbucks uses the Netherlands, a practice that is under review by Europe as well.
“The commission picked up a case which is quite common in terms of tax planning,” said Pascal Saint-Amans, who runs the Center for Tax Policy and Administration at the Organization for Economic Cooperation and Development, the policy advisory organization of the world’s advanced nations.
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Senator Carl Levin said the European report validated a Senate panel’s finding that Apple received a tax rate of less than 1 percent.Europeans Accuse Ireland of Giving Apple Illegal Tax BreakSEPT. 30, 2014
The question is whether this sort of strategy — as common to multinational companies as filing a tax return every year — can truly be stopped. What hangs in the balance is whether governments can continue to tax corporations beyond the barest minimum. Or whether globalization will make such taxation all but impossible.
“A combination of greater economic integration and more income accruing to intangibles like intellectual property, which by nature are hard to locate, does raise profound questions for the future of taxation,” said Lawrence H. Summers, Treasury secretary under President Bill Clinton and President Obama’s first chief economic policy adviser. “It is a significant problem for the revenue capacity of states and an immense problem for their capacity to maintain progressive taxation.”
If corporations can continue to evade taxation — using strategies like sham transactions between phantom subsidiaries to shift profits to the lowest tax jurisdictions and costs to where taxes are highest — the burden of public finance will land almost entirely on the shoulders of ordinary workers, the only link in the economic chain that can’t move.
“Consider a superstar banker, an enormously valuable pharmaceutical patent, a terrific entertainer, an assembly line worker and a teacher. Of all those things, which is the least mobile?” asked Mr. Summers. “A tax system that can’t reach the mobile is a tax system that is going to burden working people.”
Some scholars — including Robert B. Reich, who served as Labor Secretary during the Clinton administration and now teaches at the University of California, Berkeley; and Greg Mankiw of Harvard, who was former chief economic adviser to President George W. Bush — have proposed abolishing the corporate income tax, replacing it with direct taxes on shareholders.
But it is highly doubtful that the American political system could raise taxes on dividends, capital gains and upper incomes enough to compensate for the lost revenue from business. Rich taxpayers also have their own sophisticated tools to shield income, including parking money in tax havens around the world.
Mr. Saint-Amans said he feared that without the corporate income tax, income taxation would fall apart entirely as the wealthy could avoid taxation by becoming companies, inserting several corporate layers between themselves and their money.
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Nobody has a confident grasp of the scale of corporate tax avoidance. Corporate tax revenue in the United States today amounts to some 2.6 percent of total economic activity, roughly the same as it did in the early 1980s, when the latest wave of globalization took off.
Across the 34 O.E.C.D. nations, corporate tax revenue actually grew from just above 2 percent of G.D.P. in the 1960s to some 3.7 percent in 2007, before the financial crisis walloped companies around the world.
These figures can be misleading, though. In the United States, corporate taxes have remained flat despite a sharp increase in corporate profits, which today take the highest share of national income since the government started measuring them in the 1920s. Profits have similarly risen in other industrial countries around the world.
Plus, there is plenty of suggestive evidence that profit-shifting has become a core pillar of corporate strategy.
In 2012 the Irish subsidiaries of American multinationals generated $120 billion in profit, according to United States government data, eight times as much as their German subsidiaries. Subsidiaries in Bermuda generated $82 billion, four times as much as subsidiaries in Mexico.
That’s not where companies make their stuff, or sell it, for that matter. According to a report from Kimberly Clausing of Reed College, the top five countries for American affiliates, measured by jobs, are Britain, Canada, Mexico, China and Germany. Measured by reported profit they are the Netherlands, Luxembourg, Ireland, Canada and Bermuda.
Americans seem to be the most nimble dodgers. The United States has a higher statutory corporate tax rate than Europe, but according to a recent study by Reuven S. Avi-Yonah of the University of Michigan Law School and Yaron Lahav of Ben-Gurion University of the Negev, European multinationals effectively pay a higher rate than their American counterparts.
The problem is global. In 2010, according to the International Monetary Fund, Barbados, Bermuda and the British Virgin Islands received more foreign direct investment combined than Germany or Japan. The British Virgin Islands was the second-largest investor in China, after Hong Kong. These fictions are possible because most of the money flows through shell corporations that employ nobody and produce nothing.
Can these problems be fixed? “I think so,” Mr. Saint-Amans said. “The golden age of ‘We plan aggressively and pay taxes nowhere’ is over.”
The European Commission’s deployment of competition policy to go after dubious tax breaks in Apple’s case is a novel and potentially powerful strategy, which could be applied to many other arrangements.
Governments in both the rich and poor world are fed up, Mr. Saint-Amans said. Having spent the last few decades drafting rules to prevent double taxation, they are now terrified that they have built a system of double nontaxation instead.
Governments that turned a blind eye to the tax avoidance of their multinational champions to give them a competitive edge against foreign rivals are now under enormous pressure from voters to prove that it’s not only workers and dupes paying taxes.
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The O.E.C.D., Mr. Saint-Amans says, has no business telling countries what tax rate they should impose. If the Irish can fund their government charging companies 12.5 percent, that’s their business.
Still, he trusts new rules developed by the O.E.C.D., if broadly adopted, could put an end to common avoidance practices, like parking valuable intellectual property in tax havens or having subsidiaries in high-tax jurisdictions, where interest is deductible, borrow from subsidiaries in low-tax jurisdictions where interest is not taxable.
Under enormous pressure from the rest of the world, tax havens might even repent. The Irish, he said, have been mulling tightening the rules unilaterally, concluding that the bad blood generated by the arrangements outweighs the modest number of jobs that they lure and the scant tax revenue that these artificial investments leave in the country.
There are reasons, however, to remain cautious that the world’s tax collectors can get ahead of its corporate tax strategists.
The trend in the United States, if anything, is going in the opposite direction. Despite the Obama administration’s new rules to prevent so-called corporate inversions, where companies move their tax residency abroad, companies like Burger King and Medtronic are still dropping their American “citizenship” to reduce their tax liability.
Ireland has based its entire development strategy on becoming a low tax base for the multinationals of the world. And until the financial crisis walloped its banks, it had been successful.
As Mr. Summers pointed out, putting a stop to the shell company shenanigans doesn’t automatically put an end to international tax competition. In fact, it might make it worse.
Today companies need move little more than a post office box to gain the benefits of a tax haven. If the rules were tightened so that a company could claim a profit only where it really made it, it might decide to move a lot of operations and jobs there.
“There is the risk that if you require economic substance, you will get economic substance,” Mr. Summers said.
