Multinationals engage in massive tax evasion through profit shifitng

Between 1985 and 2018 the average statutory global tax rate has fallen by more than half from 49 percent to just 24 percent. A main cause of this decline is profit shifting.

Profit shifting

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.

Previously published in Digital Journal

Report: Super-rich hiding between 21 and 32 trillion U.S. in tax havens

The hidden wealth is roughly equal to the annual GDP of the U.S. and Japan combined. The report was commissioned by the Tax Justice Network based in the UK. The report claims to be the most extensive ever on the "offshore economy".
 The report was researched and written by James Henry an expert on tax havens. The tax income lost is sufficient to make a significant difference in the finances of many countries. In fact Henry claims that if these offshore funds were repatriated some debtor countries would turn out to be wealthy!
 Henry notes that the hidden assets are not held by some obscure financial institutions in small island nations. The companies holding these assets are among the biggest names in finance: UBS, Credit Suisse, and Goldman Sachs. These three handle the most assets offshore.
 The super-rich elite comprise 92,000 people or .001 per cent of the world's population are claimed to have 21 trillion in hidden assets. Henry collected data from the IMF, the World Bank, and the bank of International Settlements. Even these figures do not take into account other wealth embedded in property such as yachts and other assets. The full report can be seen here.
    Another tax expert John Whiting a UK government adviser doubted that the amount hidden was so large. Whiting who is director of the Office of  Tax Simplification said:: "There clearly are some significant amounts hidden away, but if it really is that size what is being done with it all?""  For more on the report see this article and also here