Tax avoidance is a global problem
U.S. tax law creates perverse incentives for American companies to hold cash offshore, and the U.S. Treasury recently announced proposals to deter the practice. The proposals have triggered an outcry that ranges from criticisms that the Obama administration has overstepped its authority, on one side, to criticisms that the proposals have not gone far enough, on the other.
Lost in the outcry, however, is the fact that tax avoidance represents a global problem, and therefore requires a global solution. The Treasury proposals ignore the economic dependence of some countries on their status as tax havens, and also fail to leverage the collective power of other countries that share interests with the U.S. Without addressing the push and pull factors that influence corporate behavior, the impact of any changes to U.S. tax law will be limited. International coordination is essential for preventing tax revenues from draining into countries that offer companies the most favorable tax rates.
The current Treasury proposals attempt to make it more difficult for an American company to undertake a practice known as a corporate tax inversion. In an inversion, a company moves its tax home from the U.S. to another country where its taxes will be lower. To accomplish the move, the company merges with a foreign company in order to form a new foreign company. The original American headquarters and most business operations remain in the U.S.
Inverting in this way frees a company from substantial tax liabilities in the U.S. Had Walgreens inverted by merging with Alliance Boots in Switzerland, it would have saved close to $800 million per year, according to its own estimates. It would not have had to pay tax in the U.S. on profits deemed to be profits of the newly-formed foreign company, and its remaining U.S. operations also could have reduced their tax burden.
For this reason, inverting has become increasingly common, and the nationality of American companies has become increasingly fluid. Since 2009, at least 35 American companies have moved abroad for tax reasons, while over the prior eight years, only 25 companies did so.
Meanwhile, in Europe, tax avoidance is also taking place at an accelerating rate. A 2006 decision by the European Court of Justice limited the ability of EU member states to block common forms of corporate tax avoidance. As a result, a disproportionate amount of income that companies have earned in Europe has been taxable in countries with low tax rates, such as Ireland and Luxembourg. In 2012, for example, Starbucks had sales of £400m in the UK, but paid no corporate tax there. In 2011, Amazon had sales in the UK of £3.35bn, but reported only a “tax expense” of £1.8m.
These trends are problematic for the U.S. and for Europe. Governments need tax revenues to support education, investment, and healthcare. Effective tax codes can foster poverty reduction and economic development, as well as investment and job creation. The way in which income is taxed and tax revenues are distributed shapes the relationship between citizens and the state.
In addition, tax evasion introduces market distortions. If companies in some industries can engage in inversions or funnel their profits into other countries that tax them less, they enjoy competitive advantages over companies in industries where it is more difficult to move or act strategically.
As their tax bases have eroded, many countries have grown less tolerant of allowing money to flow into countries that have established themselves as tax havens and the distortion of the location of capital and services. The executive body of the EU, the European Commission, recently launched investigations into deals that companies have struck with the governments of EU member states, including Apple with Ireland, Starbucks with the Netherlands, and Fiat with Luxembourg.
The EU approach encompassing the interactions of multiple countries better meets the challenge posed by countries that benefit from tax evasion. While the rules that the U.S. Treasury has proposed simply penalize American companies at home, without addressing the incentives of the countries where companies are moving, the spotlight that the EU has trained on dealings between Apple and Ireland already has resulted in Ireland announcing reforms to its tax law.
Last month, the international economic organization the Organization for Economic Cooperation and Development published a report that advocated coordinated actions to end tax avoidance. The report launches a new OECD initiative called the Base Erosion and Profit Shifting Project, aimed at reinvigorating tax policies to keep pace with the increasing interconnectedness of national economies.
In other areas, international coalitions have been effective in encouraging offshore financial centers to improve their regulatory environments. The establishment of the Financial Stability Forum and the Monetary and Finance Committee of the International Monetary Fund has helped to improve the transparency of financial markets. The Financial Action Task Force on Money Laundering and the UN Commission on Money Laundering have reduced the incidence of some international financial crimes.
The U.S. must coordinate its approach to inversions with other countries. Rarely has there been such significant agreement across national borders over shared interests. Together, countries can recapture their tax revenues by encouraging changes in other systems. Acting together, they can revive the effective tax law on which their governance depends.
Kirshner, formerly a law professor on the faculty of Cambridge University, is a technical adviser to the Bank of International Settlements in Basel, Switzerland and a visiting scholar and lecturer at Columbia Law School in New York.