How to Make Sure Global Companies Pay Their Taxes
We all know by now that big multinational corporations, from Apple Inc., to Pfizer Inc., to IKEA of Sweden AB, minimize their tax bills by exploiting differences in tax rates and rules between different countries. Outrage is running high, especially in Europe, where there’s strong pressure on politicians to extract more taxes from big companies, especially the U.S. tech giants.
There’s a clean and fair solution in plain sight. It’s not even new. It’s the system that U.S. states use to apportion tax liabilities among themselves. Canada and Switzerland, which also have federal-style governments, use the same system.
The apportionment solution is considered politically unrealistic on an international scale because tax havens don’t want it. That may be true. But it’s worth understanding the system anyway—if only to see how much better things could be if politics didn’t get in the way.
As a reminder, one of the main ways that multinationals minimize their corporate taxes is by attributing as much of their profit as possible to low-tax jurisdictions, ranging from countries with genuine economies, such as the Netherlands and Ireland, to pure tax havens, such as the Cayman Islands and Jersey. Alphabet Inc.’s Google saved $3.6 billion in 2015 employing a pair of strategies called the Double Irish and Dutch Sandwich. Ireland plugged the loophole that year, but companies already using it are allowed to continue until the end of 2020.
The key to the apportionment solution is to take away multinationals’ power to attribute their profit to different geographies as they wish. Instead, governments agree on a formula by which profit will be apportioned. Revenue is one good yardstick. If a company sells only 0.01 percent of its products or services to some dinky island nation, it will not be permitted to claim that it earned, say, 20 percent of its profit there.
Other yardsticks for potential apportionment include the number of workers or the value of physical assets in each country in which a company operates, although those criteria aren’t as useful in the digital world. (Google doesn’t need a lot of people or buildings in, say, Germany to earn a lot of money from selling ads there.)
Under an apportionment system, each country is still permitted to set its corporate tax rate however it chooses. But it will be able to charge its rate only on its little slice of the company’s global profit—a slice that’s determined by an agreed-upon formula. A country can no longer grab a bigger piece of a shrinking corporate-tax pie by cutting its rate below other countries’. In one stroke, the race to the bottom in tax rates is cut short.
The U.S. version of this is called the Multistate Tax Compact, which goes back to 1966. It ensures that each dollar of profit that a company earns in the U.S. is taxed once. Not more, but also not less.
The European Commission, which is the executive arm of the 28-nation European Union, introduced an apportionment plan in 2011, calling it the Common Consolidated Corporate Tax Base. It was blocked by Ireland, the United Kingdom, and the Netherlands, among others. It reintroduced the concept with a few tweaks in 2016 and has once again run into opposition. Brian Hayes, an Irish member of the European Parliament, called it a “back door” way of forcing tax harmonization on EU members.
Nations that oppose apportionment can’t simply be outvoted because under the European Union charter, fiscal issues require unanimity. So some people have tried to get creative. In his State of the Union address this month, European Commission President Jean-Claude Juncker proposed using a so-called “passerelle clause” to make the tax apportionment idea into something that could be passed with a simple majority.
The Juncker gambit is considered a long shot. Dan Neidle, an international tax expert with the law firm of Clifford Chance in London, says “there’s no chance, none” that the EU will change its rules to something like America’s Multistate Tax Compact.
Stymied so far on the profit-apportionment idea, leaders of France and Germany, among others, are casting around for something else they can do to capture more tax revenue and assuage the public. French President Emmanuel Macron favors taxing the revenue rather than profits of digital giants as at least an interim measure. “It is impossible to convince the French people of the need to make labor market reforms if the internet giants are not paying tax,” French Finance Minister Bruno Le Maire said at a Sept. 15 press conference.
A tax on revenue might work politically, but economically it’s unsound. If you set the revenue tax rate high, it will wipe out companies that have lots of revenue but narrow profits. If you set it low to spare those companies, you won’t manage to extract a meaningful amount of tax from companies that earn huge profits on a smaller base of revenue. On Sept. 21, the European Commission promised to examine the revenue tax idea “alongside other options” but pointedly noted that “there are still a lot of questions around what the scope and basis of such a tax might be.”
J. Scott Marcus, a senior fellow at the Brussels-based Bruegel Institute who is an expert on the digital economy, says taxing revenue just because it’s easier to measure than profit is like looking for your keys under a streetlight just because the light is better there.
Meanwhile, back in the States, the Trump administration isn’t interested in arresting the race to the bottom in corporate tax rates. Just the opposite: President Trump favors a corporate income tax rate of 15 percent, which would be among the lowest among developed nations.
Kimberly Clausing, an economist at Reed College, and Reuven Avi-Yonah, a professor at University of Michigan Law School, are among the few Americans focusing on the concept of apportioning profit governmentally to minimize tax avoidance. They’ve been at it since at least 2007. Clausing presented her research this month to the Independent Commission for the Reform of International Corporate Taxation (ICRICT).
Clausing admits that in an economy dominated by intangible assets and ethereal products such as software, it’s hard to say for sure where a particular bit of profit was earned and therefore which jurisdiction should get to tax it. Using revenue as a criterion is a form of “rough justice,” she said in an interview. “It’s better than giving up and saying we’ll just tax consumption or labor.”