Taxing Multinationals: A Fundamental Shift Is Under Way

Faccio, Tommaso; Ghosh, Jayati Article Taxing Multinationals: A Fundamental Shift Is Under Way Intereconomics Suggested Citation: Faccio, Tommaso; Ghosh, Jayati (2021) : Taxing Multinationals: A Fundamental Shift Is Under Way, Intereconomics, ISSN 1613-964X, Springer, Heidelberg, Vol. 56, Iss. 2, pp. 62-63, https://doi.org/10.1007/s10272-021-0953-1 This Version is available at: https://hdl.handle.net/10419/247718 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Intereconomics 2021 | 2 62 Editorial Taxing Multinationals: A Fundamental Shift Is Under Way For too long, international institutions have failed to deal with one of the most toxic aspects of globalisation: tax avoidance by multinational corporations. This has reduced governments’ abilities to address international challenges such as the global pandemic, climate change, forced migration and rising inequality. It has also taken away a tool to achieve equality and distributive justice and thereby diminished citizens’ trust in the social contract. Shifting profi ts to tax havens, large companies deprive governments of at least $240 billion per year in fi scal revenues. The Global South is disproportionately affected because their revenue sources are more limited, so reliance on corporate tax receipts to fund public services is greater. In a globalised and digital economy, multinationals operate through centrally managed business models, and their global profi ts are largely the result of their global operations. Yet current international tax rules, developed nearly a century ago, treat subsidiaries of multinationals as legally independent fi rms which trade between each other using “arm’s length” or normal commercial prices to transfer goods and services. But such prices are not always easy to fi nd. Many markets are thin and dominated by the same multinationals, who then exploit this system to minimise their tax liability by shifting profi ts to jurisdictions with low or zero tax rates. This undermines the tax base of countries where real activities occur and, therefore, where the profi ts have been generated. These rules are also skewed in favour of rich countries because they help multinationals’ home countries get the biggest share of tax from global profi ts. This “transfer pricing” is exacerbated by tax competition to the point that the global average statutory corporate tax rate has fallen by more than half in three decades. Following widespread public anger at tax avoidance scandals in 2012, the G20 mandated the OECD to establish the G20/OECD Base Erosion and Profi t Shifting Project in 2013, aimed at tackling the issue. So far, reform proposals have fallen short of expectations. Comprehensive reforms have been hindered by dominant OECD member governments, which come to negotiations with the misplaced perception that national interest is served by protecting multinationals headquartered in their own countries. This has prevailed over genuine, global public interest. The negotiating process has nonetheless reached agreement that multinationals should be considered unitary businesses. This means that their worldwide profi ts should be taxed in line with their real activities in each country and allocated to different jurisdictions, based on a formula according to the key factors that generate profi t: employment, sales and assets. Many states in the United States use a similar “formulary apportionment” system to determine their taxable shares of US corporate profi ts. In 2016, the EU Commission put forward a similar proposal for an EU Common Consolidated Corporate Tax Base, but it has not yet been approved by the European Council. Formulary apportionment would remove the current artifi cial incentive for multinationals to shift reported income to low-tax locations. Tax liabilities, instead, would be allocated by measures of their real economic activity in each location. But the proposal currently being negotiated involves applying this to only a small share of a fi rm’s global profi ts (so-called “residual” rather than “routine” profi ts) and is mainly directed at mostly US-based highly digitalised multinationals. This is not suffi cient to address the problem. DOI: 10.1007/s10272-021-0953-1 © The Author(s) 2021. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). Open Access funding provided by ZBW – Leibniz Information Centre for Economics. ZBW – Leibniz Information Centre for Economics 63 Editorial Tommaso Faccio, Nottingham University Business School, UK; and Independent Commission for the Reform of International Corporate Taxation. Jayati Ghosh, University of Massachusetts, Amherst, USA; and Independent Commission for the Reform of International Corporate Taxation. Instead, we need a more ambitious and comprehensive reform that replicates the US system at the international level, without distinction between digital and non-digital businesses. This would help to establish a more level playing fi eld, reduce distortions, limit opportunities for tax avoidance, and provide certainty to multinationals and investors. To put an end to harmful tax competition between countries, this system should be supported by a global minimum tax on multinationals so as to reduce the incentive for multinationals to shift profi ts to tax havens. Until recently, negotiations on a global minimum tax were benchmarked by the existing US minimum tax on US corporations’ foreign earnings (known as “GILTI”), which has a rate of 10.5%. As a result, public discourse centred around a possible minimum tax rate of around 12.5% (incidentally, the corporate tax rate in Ireland, one of the EU’s own tax havens). Such a low minimum tax rate could in fact over time become the global ceiling, in which case the laudable initiative to oblige multinationals to bear their fair share of taxes would end up doing the opposite. Negotiations do not happen in a vacuum. The global pandemic has forced a fundamental rethink in many countries of the benefi ts of a race to the bottom in corporate tax rates. The new US administration campaigned on a manifesto to increase corporation tax from 21% to 28% and to double the current rate of minimum tax to 21%. The UK government has just announced a plan to raise its main rate of corporation tax from 19% to 25% in 2023. This shift refl ects a new understanding of the lack of positive association between corporation tax and investment decisions. The earlier belief that corporation tax cuts could help spur business investment has been contradicted by the reality that corporation tax decreases have failed to provide a step change in the level of capital investment. This is true in the UK, where the corporation tax rate was cut from 30% before the global fi nancial crisis to the current rate of 19%; in India, where the base rate was reduced to 22% from 30% in 2019; and the US, where the Trump Administration reduced the corporation tax rate from 35% to 21% in 2017. In the case of the US, instead of spurring investment, the rate cut mainly ended up funding dividend payments and stock buybacks. This lack of effect on investment should not come as a surprise, as corporate taxation is a tax on pure profi ts – also known as economic rents – and therefore, lowering or raising the rate has little effect on economic activity. Rents have been on the rise over the last decades, notably in the US, but also globally as a result of increased market concentration and monopoly/monopsony power. These have in turn been triggered by gaps in access to technology (fuelled by intellectual property rights) and a series of benefi ts and privileges not available to smaller fi rms. The increase of rents suggests that governments should consider progressive corporate taxes, with higher rates on larger fi rms (especially monopolies/oligopolies) and lower rates on smaller fi rms in highly competitive sectors. As companies return to profi tability post-crisis, this will allow governments to generate revenue without distorting investment. A more progressive corporate tax structure would also address excess profi ts enabled by crisis conditions, by raising tax revenues from companies that are thriving during the pandemic (such as some pharmaceutical and highly digitalised businesses). This shift in thinking may make a strong global agreement on an effective minimum tax a possibility and encourage countries to start a virtuous race to the top. If G20 countries were to agree to impose a 25% minimum corporate tax on the global income of their multinational fi rms, more than 90% of worldwide profi ts would automatically be taxed at 25% or more. There is broad evidence of the need for fundamental reform in the international tax system, but it requires political will to move forward. Any outcome in the 2021 international negotiations must be seen as the fi rst step towards creating a genuinely fair international fi scal architecture.