If you expected President Joe Biden’s administration to return to normality on trade after the drama of collective battles and tweet diplomacy of the Trump era, Treasury Secretary Janet Yellen has other ideas.
That’s because their plans to introduce a global minimum corporate tax rate, announced last week, are just as much of a shock to the international economic order as Trump’s decision to wage a trade war against China.
The two phenomena are linked as fundamental aspects of the modern world economy. Companies have reduced operating costs at the top of their income statements by moving manufacturing offshore to China and other emerging economies where labor costs are lower. At the bottom of their income statement, they did the same with tax expenses, shifting their profits to low-tax areas like Bermuda, British Virgin Islands, Cayman Islands, Ireland, the Netherlands, Luxembourg, Singapore and Switzerland.
A significant part of the profitability of the modern multinational depends on these two steps. Around a third of foreign direct investment in the ten years up to 2018 only flowed into seven offshore centers that were used to minimize taxes. According to an annual ranking by the Irish Times, the four largest companies in Ireland are the local units of Apple Inc., Alphabet Inc., Facebook Inc. and Microsoft Corp.
During the decade leading up to 2019, the British Virgin Islands and the Cayman Islands alone – with a combined population of about 100,000 – received about 76 cents of foreign investment inflows for every dollar that went to China. Such “investments” have taken the form of business reversals and intellectual property transfers rather than the creation of real new businesses. Even so, it has had a significant impact on corporate profits, as well as the revenue governments have been able to generate from taxing that income.
According to a study last year by the Organization for Economic Co-operation and Development, a group of rich nations, states would gain about $ 100 billion annually if reforms were introduced to reduce such activity. Other estimates are much higher: an influential 2018 study calculated the losses at around 10% of corporate taxes paid worldwide of $ 2.15 trillion and rose as much as 20% in the European Union.
Yellen is not the first to suggest addressing this behavior. Indeed, tackling the activity has been a major issue for international groupings such as the Group of 20 and the OECD since the early years after the 2008 financial collapse, when it was seen as a major contributor to the post-crisis deterioration in public finances.
To say that these efforts have resulted in nowhere would be a drastic understatement. While the ideas were unsuccessfully discussed in international talking shops, the real action over the past decade has been for governments to abandon attempts to prevent loss of profits and instead cut their own tax rates. Of 37 OECD members, 24 have lowered their corporate tax rates since 2008. They only raised seven.
In some ways, this offers a partial solution to the problem. If you can bring your own tax rates below Switzerland’s (like the UK, for example) did, you remove most of the incentive for multinationals to shift their profits there. The problem is that Ireland has a 12.5% interest rate and companies like the Cayman Islands and the British Virgin Islands do not tax corporate profits at all. It is a race to the bottom that the governments of rich countries can only win if they either drastically cut spending or by increasing the tax burden on the shoulders of middle and working class taxpayers.
Yellen is rightly trying to tackle this, but the challenges of achieving something remain substantial.
America has the power to assert itself on international financial matters. Every country in the world must comply with US sanctions, regardless of the rules in their own country, thanks to the way the dollar has been armed by successive governments over the past decade. Hong Kong’s sanctioned executive, Carrie Lam, receives her salary in cash because even Chinese banks in Hong Kong don’t risk getting on the wrong side of the US Department of Justice.
If there is a real will to crack down on the tax cut, it suggests that the Biden government should be able to find a way. However, the failed attempts at reform over the past decade cast doubts that change is on the way. For all the rhetoric from Washington, corporate tax rates are likely to be lower rather than higher in 2030.
David Fickling is a Bloomberg Opinion columnist who covers commodities, industrial and consumer businesses.