Governments who want to deter big corporations from shifting profits to low-tax countries have a carrot and a stick at their disposal.
It involves regulatory practices such as corporate inversion, aggressive transfer pricing and license fees to effectively outlaw tax avoidance. The carrot involves lowering your own tax rates so that the benefits of shifting profits abroad disappear.
One would think that the latter approach, which starves the government’s revenue, would be less attractive to politicians. Still, it is the result that a decade of international efforts to combat tax base erosion and profit shifting appears to be heading towards a decade.
President Joe Biden’s administration is proposing a worldwide minimum rate of 15% as part of its plans to reverse Trump-era corporate tax cuts and raise the US level to 28%. While this is considerably lower than the 21 percent rate proposed in the first drafts of the plan, it is probably the highest that can be achieved, given the opposition from European low-tax countries and their right to veto the European Union’s position on this issue.
The risk now is that 15% will become not only a minimum but also an anchor for maximum tax rates.
At a time when the world was allegedly focused on fighting international tax avoidance to mend the government budget holes left by the 2008 financial crisis, tax minimization has seen a boom like never before.
Follow the money
More foreign investment flows into the world’s offshore centers than into any other country
As we have written, the group of offshore centers, including the Cayman Islands, Luxembourg and Singapore, has received more FDI than any single nation in each of the past 10 years (the investments in question are mostly in the form of paper accounts) fictions leading to the Support of avoidance strategies are needed instead of physical tangible assets). International trade in royalties and royalties – the lifeblood of tax avoidance strategies – is growing faster than trade in conventional goods and services.
It is difficult to see how this situation will be reversed. The few countries that operate as offshore centers have economies based on their low corporate rates and the advantages of multinationals with “brass plate companies”. The large corporations that use the system also rely on tax strategies to maximize their returns for shareholders.
As a result, governments cracking down on profit shifting are faced with a lot of diplomatic and commercial counter-lobbying as they try to work their way through a changing legal quagmire of regulations and tax treaties. Take the EU’s attempts to use a list of tax havens to prevent such activities. The result was “confusing and ineffective,” said the chairman of the EU Parliament’s tax subcommittee in a statement in February.
The global average of statutory corporate tax rates has been falling for four decades
Source: Tax Foundation through Atlantic Council
The more likely outcome of the current round of reforms will be a continuation of the decline in corporate rates that has been observed for four decades. Despite efforts to prevent tax base erosion in recent years, 24 of the Organization for Economic Cooperation and Development’s 37 members have lowered their corporate tax rates since 2008, while only seven have increased them. Statutory corporate tax rates have decreased by around 5% per decade since 1980, to the current situation where the average is around 24%. Nations looking to compete with countries with lower taxes might find the pull of 15% irresistible.
This is bad news for the world. The availability of complex tax avoidance strategies to companies large enough to cover the legal and accounting costs required increases the power of established businesses and makes it difficult for smaller, more innovative companies to compete. With corporate profits accounting for an ever-increasing proportion of gross domestic product, the benefits of minimization do not benefit the general public but rather those rich enough to hold sizeable stock portfolios. State budgets are meanwhile being balanced by more regressive measures such as sales, wage and social security contributions.
The diversion of profits and taxes from major economies to tax havens in recent decades has fueled inequality and growing populism, as has the relocation of supply chains. If the world is unable to address it now, it shouldn’t expect these issues to go away anytime soon.
(Corrected 7th count on property, plant and equipment.)
This column does not necessarily represent the views of the editors or Bloomberg LP or their owners.
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