The way we tax multinational corporations is “repulsive, inequitable and inefficient,” according to Nobel Prize-winning economist and Columbia University professor Joseph Stiglitz. While big companies and their capital are global, he points out, tax systems are national. Global companies, he says, have "free rein to move their money around to the low-cost jurisdictions."
But the way to fix this problem is not through piecemeal, small-scale adjustments like making Caribbean tax havens less attractive, according to a recent proposal from a group of economists, policy experts and government officials. Rather, the Independent Commission for the Reform of International Corporate Taxation, of which Stiglitz is a member, recommends a total structural overhaul: Tax multinational corporations as single entities at a minimum rate globally, regardless of where they’re officially headquartered. Revenues would then be distributed to individual countries based on factors like sales, employment and resource extraction.
If you had to argue on principle in favor of the current system, referred to as "transfer pricing," over treating global companies as one entity and taxing them at one rate, "you'd be laughed out of court," Stiglitz says.
Major companies with headquarters in the U.S. are holding $1.95 trillion in assets offshore, “parking earnings in low-tax countries until Congress gives them a reason not to,” as Bloomberg recently reported.
The system has also lead to a boom in tax inversions, in which companies incorporate outside the U.S., recently through a wave of mergers and acquisitions that allowed them to shuffle intellectual property to new, low- or no-tax addresses. GE infamously paid zero U.S. taxes on its $14.2 billion in global profits in 2010 by employing a phalanx of tax lawyers who lobbied for tax breaks and worked to devise ways to keep profits offshore. The company instead claimed a tax benefit of $3.2 billion.
And Starbucks paid just $13.5 million in taxes in the United Kingdom between 1998 and 2012, even though its stores brought in more than $4.8 billion in revenue over that period.
Strip away the behavior of individual companies or the voguish rise of a single accounting contortion, and the trend is clear: In the mid-1950s, corporate taxes made up around 30 percent of total revenue collected by the U.S. government; in 2014, it was only about 11 percent.
In the context of that massive decline, the commission's proposal seems like a proportionate reaction. But if it still sounds outlandish, consider how similar it is to what the U.S. already does with state taxes on corporate profits. States use formulas to determine how much of a company’s U.S. profits are due to activities that take place within their borders, and apply their tax rates accordingly. The European Commission said in June that it will support a similar idea within the European Union, though the proposal still needs to get approval from member states, a significant hurdle.
Currently, multinational corporations create complex legal structures with technically separate business entities in the different countries where they operate. These entities are subject to wildly different tax laws depending on where they do business. For instance, Starbucks used a special arrangement with the Netherlands to claim a tax loss on its U.K. stores, which allowed the company to avoid paying taxes on operations that it told investors were profitable. (Starbucks ended that arrangement in 2014 after public outcry.)
But the idea that these entities are somehow independent from their corporate parents is a “legal fiction” that enables tax avoidance and evasion, the Independent Commission said in a June release.
Individual countries can’t solve this problem alone, because even when one country changes its tax system, the result is simply a “shift in tax evasion,” according to José Antonio Ocampo, Columbia economist and former UN Under Secretary-General for Economic and Social Affairs. That’s why Ocampo, a member of the Independent Commission, thinks the best way forward is an international tax treaty that can slowly but steadily expand to include more countries. That treaty would ideally begin by setting a minimum corporate tax rate and move toward the overriding principle of the commission's proposed reform: treating global companies as single entities taxed at a minimum rate.
A tax policy plan from the Organization for Economic Cooperation and Development, which acts as the de facto club for developed economies and helps set broad policy standards, has already included an international tax treaty in its list of recommendations. While that does provide a basis to begin discussions, international trade and climate negotiations show just how difficult the treaty process can be.
As an intermediate stopgap, the commission proposes a minimum tax rate in developed countries. The U.S. loses significant tax dollars when companies go offshore; if that $1.95 trillion in accumulated profits being held offshore in 2013 were taxed at a rate of 34 percent (the standard U.S. corporate tax rate), companies would be paying around $660 billion in taxes to the federal government. But the most direct harm of tax avoidance is incurred by developing countries, who are pushed to lower their tax rates to attract corporations to their shores.
That trend deprives developing countries of much-needed money for investments in basic health, education and development programs. “It undermines the social and economic fiber of a country,” Stiglitz said. Not only that, but giving tax breaks to global firms harms national companies. “If multinational companies are escaping taxation, domestic firms are put in an unfair competitive position and it distorts the economy,” he said, noting that this makes domestic companies less willing to pay taxes.
And developing nations have the least power when it comes to taking a tougher stance on corporate taxes. Global corporations are able to exert huge amounts of influence on developing nations by threatening to move their operations to another country that will meet their tax demands -- or, in the words of economist Léonce Ndikumana, a member of the Independent Commission and of the UN Committee on Development Policy, “almost blackmailing them.” For instance, Nigeria used to let companies in sectors like oil and gas pay no taxes for up to eight years. (The country now plans to boost tax revenue by reducing the tax-free period to three years, with the potential for an additional two-year extension.)
The commission did not officially put forward a specific proposal for what the minimum tax rate should be. Ocampo says it should be 15 percent, which he argues is "reasonably low.”
Powerful, developed countries like the U.S. are also playing a game with multinational tax collection, Stiglitz says, though it's a game they believe they can win: dollar by dollar and loophole by loophole, the U.S. believes it can get huge companies to pay some fraction of the American taxes they are now avoiding. At the same time, no changes are made to the overall structure that allows those same companies to shirk taxes in the developing countries where their products are made or where the resources they sell are extracted.
Stiglitz says that these issues can only be resolved by structural solutions like the one the commission is proposing, not marginal changes to the existing system. He says the U.S. Treasury "mistakenly believes that it can control the avoidance enough that we will get more revenue than if it were done on a fair and efficient basis." For instance, the Senate excoriated Apple for using a tax structure known as the “Double Irish with a Dutch Sandwich," in which profits were reallocated from the company’s California headquarters to an Irish subsidiary, moved to a Dutch subsidiary and then sent tax-free to another Irish subsidiary located in a Caribbean tax haven. In reaction to pressure from the U.S. and other European countries, Ireland will end that structure in 2018. When that happens, the U.S. will, theoretically, collect more taxes from Apple. But that change, while positive, eliminates just one of dozens and dozens of ways global companies can keep profits in low-tax countries.
There is a view among senior U.S. officials that “they can manipulate the system to divert more revenue from the developing countries to themselves,” Stiglitz says, pointing out that U.S. tax authorities currently collect some tax revenue that, under the new system his group proposes, would be collected by China, where Apple manufactures its products.
Stiglitz thinks that part of this approach is cultural, noting that a number of Treasury officials have banking backgrounds, including Secretary Jack Lew, who used to work at Citigroup. As a result, he says, the department is filled with people who have been in the “business of moving money around” their entire careers.
“To them, this is just business," Stiglitz said. "Tax evasion is just a profit center.”
The Treasury Department did not immediately respond to a request for comment.