Foreign Affairs: 100 Years
A New Americanism
Why a Nation Needs a National Story
On January 22, Google and the United Kingdom announced that they had settled a long-running dispute over taxes and that the company had agreed to hand over 130 million pounds (almost $185 million) in back payments. Rather than squaring accounts, however, the deal made people angry. Advocacy groups called it a sweetheart deal for Google, and politicians picked up the baton from there. Anger over the size of the settlement peaked on February 11, in a televised hearing that soon became personal. Pressed by members of Parliament to disclose his own income, Google executive Matt Brittin responded by saying, “I don’t have a figure.” Two weeks later, French officials said they presented Google with a bill for back taxes amounting to 1.6 billion euros ($1.8 billion dollars).
Public anger about corporate tax loopholes has not yet reached the same pitch in the United States as in the United Kingdom, but scrutiny over how much tax multinational companies pay is on the rise worldwide. Tax authorities and politicians are looking for ways to squeeze more out of them, and, in the process, are starting to clash with each other.
This friction was predictable even though most of the world’s major economic powers have already agreed on a solution to the problem, and are currently implementing it: a 15-point action plan developed by the Organization for Economic Cooperation and Development (OECD) to close loopholes and tighten the rules for global taxation. One main idea in the plan is that if tax offices have more information about companies, they will have the leverage needed to get companies to pay more in taxes. When companies file their 2016 tax returns, they will be sharing far more information than ever before with tax inspectors: instead of disclosing to national governments only what they do in those jurisdictions, they will be required to share a detailed global picture of their sales, assets, employees, profit sources, and other details. They will likely pay more taxes as a result. But the big question is to whom? Countries and their tax offices are now arming themselves with modern, digital weaponry so that they can seize as much of the new revenue as they possibly can.
DEATH AND TAXES
The pocket history of legal corporate-tax avoidance begins with the advent of the current global taxation system in the 1920s. That’s when double-taxation treaties started to emerge: agreements between two states that companies operating in both of them wouldn’t have to pay taxes on the same income in both places. Cross-border investment mushroomed as more countries signed such treaties, and countries began offering tax breaks and other incentives to multinationals to entice investment and create jobs in the process.
As a result of the competition to attract investment, corporate income tax rates have plummeted: according to a 2015 International Monetary Fund (IMF) study, in 1980 corporate tax rates ranged from 40 to 50 percent of profits; today they range from 15 to 30 percent. In the United Kingdom, Google claimed earlier this month to be taxed at the standard corporate tax rate of 20 percent, but politicians accused it of actually paying as little as three percent, once all its deductions and loopholes were accounted for. In disclosure documents filed in the United States with the Securities and Exchange Commission, Google has in the past said its global average tax rate is 6.6 percent.
Once corporations began shopping globally for the lowest tax rates, they learned that they could also legally shift their profits around the globe to pay even less tax. They do this by trading within the corporate structure. For example, one division of a multinational corporation would buy materials to sell to another division that then uses it to make the company’s products. Or the arm of the company that owns its intellectual property can make other ones pay to use those patents, branding, and methods. These kinds of exchanges within companies are called transfer pricing, and can create profitable branches in low-tax countries and loss-making ones in high-tax countries. Google, Apple, and others have done this, often locating their patents in Ireland and the Netherlands where their profits are taxed at lower rates. Transfer pricing now constitutes an estimated 60 percent of international trade.
As a result, the global system of corporate tax has now outstripped its original premise. From the starting point that it’s not fair to ask corporations to pay tax on the same income twice, the system has developed to the point where they often don’t even have to do so once. Precise estimates are difficult given the lack of data, but the OECD figures show that countries lose between $100 billion and $240 billion annually, representing four to ten percent of global corporate income tax.
In 2012, at a G-20 summit in Los Cabos, Mexico, leaders tasked the OECD with finding a solution, and a year later they signed on to the 15-point plan that the OECD designed. The OECD has provided guidelines to its members, and it is now incumbent on each country’s legislature to change laws and regulations accordingly. Once that is done, multinationals will have to share a complete set of global data. As 2016 tax returns come in, starting in early 2017, it may take some time for tax officials to absorb and digest all the information. But once they do, they will use it to make multinationals pay more.
LETTING IN THE LIGHT
The OECD’s plan has mostly unfolded as envisioned. The group set implementation dates for various elements and met them. The process involves the G-20 nations, but any country is welcome to adjust its own laws and regulations accordingly as well. That process is under way.
From the starting point that corporations should not pay tax on the same income twice, the system has developed to the point where they often don’t even have to do so once.
The pace of change, however, has not gone according to plan. The OECD urged member countries not to challenge multinationals on their taxes until the organization issued its guidelines and countries adjusted their laws and regulation, to present a united front and to remove as many of the gaps and loopholes of the past as possible.
But some countries have not been patient. Corporations are reporting more aggressive tax inspections across the globe. Digital records allow tax administrations to build databases of taxpayer information, which they can now use to check returns and capture more revenue. In a speech in 2014, Australia’s commissioner of taxation, Chris Jordan, warned multinationals’ accountants that “we will thoroughly check everything you do.”
The row over Google in the United Kingdom shows how public pressure can force governments to move before the OECD would like them to. The country has also introduced a new tax that applies to what it considers profits shifted out of the country using “contrived arrangements” (known as the Google Tax, although a Google executive said in the February 11 hearings that its accountants don’t believe the tax applies to them). The European Union is also an early mover, through hearings in which it evaluates the tax breaks its members give companies and sometimes determines that those incentives constitute unfair competition. There’s potential for friction between countries as well, and U.S. officials have already criticized Europe for its aggression.
It is also unclear if developing countries, which have more at stake, are going to be able to compete for tax revenue in this new arena. A 2015 IMF study argued that without the methods multinationals use today, developing countries would receive additional tax revenue equivalent to two percent of their GDP. For developed countries, the figure was just 0.6 percent. The G-20 and OECD contain only a handful of developing countries, but outsiders were invited to participate in the drafting of the OECD’s plan by submitting feedback as it was being formulated.
Even if the reform process doesn’t deliver a fair system that pleases everyone, it is a first attempt and it does not have to be the last. According to tax experts, several things about it are very impressive, including the speed at which the OECD created it and at which members approved it, an indication of the problem’s high priority. The idea of forcing multinationals to show all tax inspectors their global data has gone from a tax-crusader fantasy to sudden reality in a matter of years.
If this process of plugging holes and tightening rules doesn’t work, the next step could be a truly new system. The alternative mentioned the most is called formulary apportionment—a formula that would distribute a multinational corporation’s global income across countries. But it may be difficult for countries to agree to a single formula.
One smaller step could also help—making the data more accessible. The OECD’s plan forces companies to share it only with tax inspectors. But should any of those government authorities decide to make the information public, it’s easy to imagine a much bigger impact as international organizations, watchdogs, and journalists mine the data for compelling stats and sound bites. The EU is already considering publishing the tax information of multinationals if they operate in an EU country. As the United Kingdom and Google have learned, when the numbers emerge voters snap to attention—and legislators may soon follow.