Multinational companies have been gaming the rules of the global economy to minimise their tax liability — or even eliminate it. And 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 recent signs that the idea of a unitary tax is taking hold.
Introducing a global minimum effective corporate-tax rate on multinationals of between 20% and 25%, as the ICRICT advocates, would greatly weaken these firms’ financial incentives to use so-called transfer pricing among their subsidiaries to shift recorded profits to low-tax countries. Moreover, a global minimum would end the race to the bottom in which countries lower their national tax rates to attract investment by multinationals.
These global tax revenues could then be allocated among governments according to 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.
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 International Monetary Fund has estimated that Organisation for Economic Co-operation and Development (OECD) countries may be losing $400-billion in tax revenue each year because of profit shifting, with non-OECD countries losing a further $200-billion. Tax avoidance hits developing countries hard, because their governments tend to rely more 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 report intra-company trade and investment in intangible assets such as intellectual property, for tax-arbitrage purposes. This creates “ghost trade flows” that have little 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 United States 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. Governments are 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.
At the moment, the various proposals to address this (from the US, the United Kingdom and the G24 group of developing countries) envisage expanding these “market” countries’ authority to tax global firms.
Developing countries also want any global corporate-tax system to recognise their increasing importance as producers for traditional multinationals. A tax reform that focused only on digital companies would clearly not be in developing countries’ interests. The US government is 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).
But multinationals of both the digital and traditional sort remain politically powerful. Even — or especially — in the digital economy, old-fashioned lobbying still counts. — © Project Syndicate
Jayati Ghosh is professor of economics at Jawaharlal Nehru University and a member of the Independent Commission for the Reform of International Corporate Taxation