The usual explanation for the decline in corporate tax revenue is that globalization forces countries to compete fiercely for productive capital. To do so they offer companies tax breaks to attract plant and equipment. This makes workers in a country more productive and boosts wages.
The theory is popular among policy makers. It may have been influential in leading the U.S. this year to cut corporate tax rates from 35 percent to 21 percent.
Today, however, most of the largest multinationals do not appear to move much capital to low-tax countries. Instead, they simply shift their profits in higher tax countries to low tax havens
according to a new study.
Google and Bermuda
In 2016 Alphabet's Google, managed to make $19.2 billion in Bermuda, a small island nation in the Atlantic even though the Bermuda company has hardly any workers or assets but the corporate tax rate is zero. The appended video shows how this is done.
The decline in corporate tax rate is in large part the result of faulty policies in high-tax countries, not a necessary by-product of globalisation.
40 percent of multinational profits shifted to tax havens
New macroeconomic data enabled the study authors to make the estimate that 40 percent of multinational profits were shifted to tax havens. The authors were able to decompose national accounts aggregates and were able to make a new global database indicating where profits reported in each country by local versus foreign corporations. In turn the database enabled the authors to create the first comprehensive economic map of where profits are booked globally
Results of the analysis
In non-haven countries foreign multinationals are consistently less profitable than local firms. However, in tax havens the reverse is true and to a huge degree.
In tax havens the ratio of taxable profits to wages is typically around 30 to 40 percent but for foreign multinationals the ratio is many times higher. In Ireland for example it is as much as 800 percent. In correspondence to a capital share of corporate value-added this is 80 to 90 percent compared to just 25 percent in local firms. The statistics compiled could be used to monitor the impact of policies used to reduce tax avoidance.
The analysis shows that governments in the EU and developing countries are the prime losers of tax revenue as a result of profit shifting. It is estimated that tax avoidance by EU multinationals results in a loss of about 20 percent of tax revenue.
US multinationals most likely to shift profits
However, when the study looked at where firms that shift products have their headquarters, it was found that U.S. multinationals shifted their profits more than other countries. There are specific incentives for US companies to shift profits in the U.S. tax code and by some U.S. Treasury policies.
Tax havens flourish while non-haven countries take revenue from each other
The study argues that there are incentives in non-haven countries that have high taxes such as in Europe and elsewhere to focus on relocating profits from other countries but little incentive to combat the issue of shifting to tax havens.
Chasing profits in other countries that have high taxes is feasible and cheap since multinationals do not put up much resistance since it has little effect on their global tax bill. It can also be quick as there is already a framework in existence to settle disputes. In contrast, enforcement of tax laws on tax havens is difficult because information is lacking and hard to get. Enforcement is costly as corporations fight to keep their gains from the practice.
Not surprisingly the study found that the vast majority of enforcement effort was directed at other high-tax countries not tax havens.
The study's findings show that economic statistics such as GDP, corporate profits, trade balances, etc. are often warped because of profit shifting.
Tax havens
A tax haven is a jurisdiction with a very low rate of effective taxation although its advertised rates can be higher. Some also suggest that there should be a certain degree of secrecy. However, some jurisdictions such as Ireland with little secrecy but low levels of taxation are considered tax havens.
Some traditional tax havens such as Cayman Islands, Bermuda, British Virgin Islands and some others have taxation rates near zero. They have restricted bilateral tax treaties. However, some modern corporate tax havens have often significant "headline" tax rates and some of the broadest of bilateral tax treaties and include countries such as Ireland, the Netherlands, Singapore, and even the UK according to some studies.
Studies of tax revenue lost due to tax havens vary but the most credible range is from $100-250 billion U.S. per year. The capital left in tax havens can lead to capital base erosion. The estimates of capital held in tax havens is between $7 to 10 trillion or 10 percent of total global assets. At least 15 percent of all countries are tax havens.
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