Containing multinationals: What can States do?
For decades, first world countries have been engaged in the race to reduce taxation on higher incomes, businesses and capital: to give an example, between 1980 and 2020 the global average corporate tax rate dropped from 46% to 26%. This trend has deep roots. The so-called “trickle down” policy has long been dominant among policy makers. The assumption is that a redistribution of capital in favour of the wealthier classes rewards those who make a more productive use of resources, thereby increasing growth and bringing benefits also to the poorer categories. This theory has systematically been disproved by data, yet it continues to have many supporters; Among them is Emmanuel Macron, who in 2017 commented his tax reform by saying it was a question of supporting “those leading the group” in order to pull the whole group up. The “trickle down” policy is firmly based on the idea that a reduction in taxes attracts talent and economic activity, increasing international competitiveness (together with wage compression it is an element of the so-called internal devaluation). This is an important topic particularly for European countries as having adopted the single currency they cannot resort to currency devaluation of the exchange rate.
In the race for fiscal dumping we forget, or pretend to forget, that reducing rates and revenues means a decreased spending capacity to support the economy and invest in social protection. For a small open economy thriving on international trade this is not an insurmountable problem; for larger countries however, where domestic demand plays an important role, this leads to the lack of an important stabilizing factor and contributes to putting pressure on public finance. Whether they launch into fiscal dumping or not, they will see their tax revenue decrease and will be forced to cut on social protection. Gabriel Zucman has estimated that tax avoidance costs countries around the world over 200 billion dollars a year in lower revenues; in the case of Italy this corresponds to 20% of the total revenue from company taxes (most of which, 17%, in favour of Europe’s tax havens, Ireland, Luxembourg and the Netherlands). It is important to note that for many this is not an unpleasant side effect of tax competition policies, but should be their guiding principle. It is the modern version of the policy of “starving the beast”, which has been carried out by American conservatives since the 1980s.
However, even from the point of view of a liberal economist, the race for fiscal dumping poses problems as it distorts competition, benefitting large multinational corporations. Unlike domestic businesses, they have always avoided much of the taxation by allocating costs and revenues between branches located in different countries to take advantage of the difference between tax regimes. The giants of the web, having largely intangible assets, have taken these practices to the extreme.
The international community has for years been trying to combat tax optimization, facing opposition from the countries that benefit from these practices. In 2021 the situation opened up, and 137 countries signed a convention negotiated by the OECD to limit avoidance (Base Erosion and Profit Shifting, BEPS). The signatory countries reached an agreement on both the pillars on which the OECD had been working for years. First, the principle that taxation must at least be partly linked to the place where the activity (production, sale) takes place and not to the tax office. The compromise is in some ways disappointing: it concerns only companies with a turnover of a minimum of 20 billion Euros and a profitability of at least 10%. Between thresholds and exemptions, 70% of profits will remain taxed according to the current regulations, which allow the use of avoidance strategies such as transfer pricing. However, some clauses of the agreement will be successful in putting a brake on the tax optimization of large corporations: the so-called “segmentation” will allow very profitable branches of large companies to be subject to the rule that even if the parent company does not meet the criteria. For example, the Amazon Cloud service, Jeff Bezos’ golden goose, will be subject to profit sharing, even if the profitability of the conglomerate is below the 10% threshold.
The second pillar is that of a minimum effective taxation rate (the key word here is “effective”, since often large corporations negotiate a preferential treatment which allows them to have much lower rates than statutory ones). Each country will be able to apply a tax rate to its corporations which is at least equal to the difference between the rate they pay in the country where they have their registered offices and 15%. This should reduce the incentive to locate the headquarters in tax havens. Each country is free to set the rate at levels above 15%, and the United States plans to introduce a minimum tax rate of 21%.
However, there is no shortage of problems. The agreement should have provided for a much more ambitious minimum rate. The European Tax Observatory recently estimated that if the rate were 21% as originally proposed by the Biden administration, EU countries would recover $100 billion ($170 billion at the 25% rate as suggested by many think tanks, and only 50 billion at the 15% rate). In addition, the agreement will allow a large part of the revenue to be recovered by developed countries. In order to benefit poorer countries, which are hardly ever multinational headquarters, the allocation should be made on the basis not only of sales, often low in developing countries, but also on the basis of capital and employment (as proposed by many NGOs but also by the European Commission). Many observers have also pointed out that the poorer countries have been offered a package that is the result of compromises in the G7 and unamendable.
In conclusion, we cannot speak of a historic agreement, given the too many watered-down compromises, the fact that a substantial part of the profits will still be able to slip through the net and that the poorer countries will only be left with the crumbs. However, it does represent a significant change of perspective: a country which tries to attract multinational corporations through tax dumping is now seen as a problem by the international community and for the first time a multilateral system aimed at limiting tax competition and combating tax avoidance has been put into place. Once the historical principle is established, it will be easier in the future to find political consensus to change the numerical thresholds and reduce avoidance. We must therefore keep our guard up to make the agreement fairer and more effective.