Multinationals’ failure to
pay is hitting governments’ ability to fight the climate crisis and inequality
Globalisation has gotten a
bad rap in recent years, and often for good reason. But some critics, not least
Donald Trump, place the blame in the wrong place, conjuring up a false image in
which Europe, China, and developing countries have snookered America’s trade negotiators
into bad deals, leading to Americans’ current woes. It’s an absurd claim: after
all, it was America – or, rather, corporate America – that wrote the rules of
globalisation in the first place.
That said, one particularly
toxic aspect of globalisation has not received the attention it deserves:
corporate tax avoidance. Multinationals can all too easily relocate their
headquarters and production to whatever jurisdiction levies the lowest taxes.
And in some cases, they need not even move their business activities, because
they can merely alter how they “book” their income on paper.
Starbucks, for example, can
continue to expand in the UK while paying hardly any British taxes, because it
claims that there are minimal profits there. But if that were true, its ongoing
expansion would make no sense. Why increase your presence when there are no
profits to be had? Obviously, there are profits, but they are being funnelled
from the UK to lower-tax jurisdictions in the form of royalties, franchise
fees, and other charges.
This kind of tax avoidance
has become an art form at which the cleverest firms, like Apple, excel. The
aggregate costs of such practices are enormous. According to the IMF,
governments lose at least $500bn (£406bn) a year as a result of corporate tax shifting. And
Gabriel Zucman of the University of California, Berkeley, and his colleagues estimate
that some 40% of overseas profits made by US multinationals are transferred to
tax havens. In 2018, 60 of the 500 largest companies – including Amazon,
Netflix, and General Motors – paid no US tax, despite reporting joint profits
(on a global basis) of some $80bn. These trends are having a devastating impact
on national tax revenues and undermining the public’s sense of fairness.
Since the aftermath of the
2008 financial crisis, when many countries found themselves in dire financial
straits, there has been growing demand to rethink the global regime for taxing
multinationals. One major effort is the OECD’s Base Erosion and
Profit Shifting (BEPS) initiative, which has already yielded
significant benefits, curbing some of the worst practices, such as that
associated with one subsidiary lending money to another. But, as the data show,
current efforts are far from adequate.
The fundamental problem is
that BEPS offers only patchwork fixes to a fundamentally flawed and
incorrigible status quo. Under the prevailing “transfer price system”, two
subsidiaries of the same multinational can exchange goods and services across
borders, and then value that trade “at arm’s length” when reporting income and
profits for tax purposes. The price they come up with is what they claim it
would be if the goods and services were being exchanged in a competitive market.
For obvious reasons, this system has never
worked well. How does one value a car without an engine, or a dress shirt
without buttons? There are no arm’s-length prices, no competitive markets, to
which a firm can refer. And matters are even more problematic in the expanding
services sector: how does one value a production process without the managerial
services provided by headquarters?
The ability of
multinationals to benefit from the transfer price system has grown, as trade
within companies has increased, as trade in services (rather than goods) has
expanded, as intellectual property has grown in importance, and as firms have
gotten better at exploiting the system. The result: the large-scale shifting of
profits across borders, leading to lower tax revenues.
It is telling that US firms
are not allowed to use transfer pricing to allocate profits within the US. That
would entail pricing goods repeatedly as they cross and re-cross state borders.
Instead, US corporate profits are allocated to different states on a formulaic
basis, according to factors such as employment, sales, and assets within each
state. And, as the Independent
Commission for the Reform of International Corporate Taxation (of
which I am a member) shows in its latest declaration, this approach is the only one that
will work at the global level.
For its part, the OECD will
soon issue a major proposal that could move the current framework a little in
this direction. But, if reports of what it will look like are correct, it still
would not go far enough. If adopted, most of a corporation’s income would still
be treated using the transfer price system, with only a “residual” allocated on
a formulaic basis. The rationale for this division is unclear; the best that
can be said is that the OECD is canonising gradualism.
After all, the corporate
profits reported in almost all jurisdictions already include deductions for the
cost of capital and interest. These are “residuals” – pure profits – that arise
from the joint operations of a multinational’s global activities. For example,
under the 2017 US Tax Cuts and Jobs Act, the total cost of capital goods is
deductible in addition to some of the interest, which allows for total reported
profits to be substantially less than true economic profits.
Given the scale of the
problem, it is clear that we need a global minimum tax to end the current race
to the bottom (which benefits no one other than corporations). There is no
evidence that lower taxation globally leads to more investment. (Of course, if
a country lowers its tax relative to others, it might “steal” some investment;
but this beggar-thy-neighbour approach doesn’t work globally.) A global minimum
tax rate should be set at a rate comparable to the current average effective
corporate tax, which is about 25%. Otherwise, global corporate tax rates will
converge on the minimum, and what was intended to be a reform to increase
taxation on multinationals will turn out to have just the opposite effect.
The world is facing multiple
crises – including climate change, inequality, slowing growth, and decaying
infrastructure – none of which can be addressed without well-resourced
governments. Unfortunately, the current proposals for reforming global taxation
simply don’t go far enough. Multinationals must be compelled to do their part.
• Joseph E Stiglitz is a Nobel laureate in
economics, university professor at Columbia University and chief economist at
the Roosevelt Institute.
