About 40% of multinational profits or $650 billion are shifted each to such tax havens by multinational firms from all countries. The price tag on this type of behavior? $200 Bn. lost in global tax revenue. The reason that this behavior is possible is an antiquated tax code designed in the 1920’s. The solution will be a global overhaul of the corporate tax code: and this overhaul might not be that far away. In this article I investigate the question: What would a fair, functional global tax system look like in 2030 and how bleak is the alternative?
First things first: How is it that companies can use tax havens to avoid paying taxes all together? The answer lies in the current international tax code that treats a multinational firm not as one firm, but as a collection of national entities. For today’s global companies, each dollar of reported income in the US or Germany will be taxed at close to 30%, whereas income reported in Bermuda will be taxed at 0%. Tax minimizing strategies that shift profits to various low-tax regimes have been documented at major multinationals including Amazon, Google, IKEA, Nike and many others.
In my research with Thomas Tørsløv and Gabriel Zucman we document the global scope of this behavior. We estimate that 40% of multinational profits are shifted to tax havens based on new macroeconomic data known as foreign affiliate statistics. These statistics record the amount of wages paid by affiliates of foreign multinational companies and the profits these affiliates make. In other words, they allow us to break down national accounts aggregates (wages paid by corporations, operating surplus of corporations, etc.) into ‘local firms’ and ‘foreign firms’. We draw on these statistics to create a new global database recording the profits reported in each country by local versus foreign corporations.
Using this database, we construct and analyse a simple macro statistic: the ratio of pre-tax corporate profits to wages. Thanks to the new data exploited in our paper, we can compute this ratio for foreign versus local firms separately in each country. Our investigation reveals spectacular findings.
In non-haven countries, foreign firms are systematically less profitable than local firms. In tax havens, by contrast, they are systematically more profitable – and hugely so, as you can see in the chart below. While for local firms the ratio of taxable profits to wages is typically around 30%-40%, for foreign firms in tax havens the ratio is an order of magnitude higher – as much as 1600% in Ireland. In other words we find that enormous profits are reported by multinational firms in tax havens and that these profits do not match the actual economic activity in those tax havens.
Foreign firms are systemically more profitable in tax havens than local firms
Which countries win and lose in this game for profits?
Overall, we find that the world loses 10% of corporate tax receipts, or $200bn dollars. By going to our website, missingprofits.world, you can explore our interactive map to see which countries attract and lose profits in this shell game.
The map covers 86 countries that constitute 92% of global economic activity and more than 70% of world population. By clicking on each country you can see the amount of profits shifted to tax havens and to which havens the profits were shifted. You can also see the implied loss of corporate income tax revenue.
Some countries are marked in green; these are tax havens. For the tax havens we report how much profit they attract from high-tax countries and what the effective corporate income tax rate is. To name a few examples: Germany loses $20bn each year, corresponding to 29% of their corporate tax receipts. Similarly, France loses 24% of its corporate tax return and the United States loses 17%.
Which countries lose the most corporate tax revenue because of tax havens?
Image: The Missing Profits of Nations
Interestingly, the corporate tax havens of the world are also the biggest tax collectors of the world. That is, countries like Ireland, Luxembourg and Puerto Rico, despite applying effective tax rates of less than 5%, manage to attract such large artificial profits that they end up collecting more tax revenue than any other country. This displays the perverse incentives of the current corporate tax code and helps to explain how countries have entered into a race-to-the-bottom of cutting corporate tax rates.
Which firms are the most aggressive profit shifters?
Based on corporate tax returns from South Africa and public annual reports from Bureau Van Dijk, a publisher of business information, my co-author Hayley Reynolds and I investigate what characterizes a profit-shifting firm. We find that the majority of multinationals firms do not shift any profits to tax havens, but that this is dwarfed by the enormous amounts shifted by very large multinationals. As a result, we estimate that 98% of profits shifted to tax havens are shifted by the 10% largest multinational firms, as below.
An estimated 98% of profits shifted to tax havens are shifted by the 10% largest multinational firms
Furthermore, as documented by Zucman (2014), US-owned firms seem to be particularly aggressive – shifting 60% of their foreign earned income to tax havens, as opposed to the global average of 40%. Despite the frequent focus on “digital” firms, my research with Thomas Tørsløv and Gabriel Zucman does not suggest there are any systematic differences in profit shifting across industries.
How do we fix this?
When your car doesn’t start, you have essentially two options: fix it or scrap it and get a new vehicle. So far, the world as a whole has been scrapping corporate tax, albeit in a very gradual way. As a response to globalism and the issues that this has brought to corporate taxation, countries have cut tax rates and instead relied more heavily on consumption taxes. In the last 40 years, we have hence seen the global average corporate tax rate fall by more than 50%.
What would it take to change this trajectory? What would a fair, functional global tax system look like in ten years from now, in 2030?
The root cause of profit shifting is 1) the incentive to shift profits (differences in corporate tax rates) and 2) the possibility to do so (the separate tax accounting of multinational entities). To solve the problem, these two root causes have to be eliminated.
Let’s start with the easiest: corporate tax harmonization. If countries could agree on a global minimum corporate tax rate of say 25%, the problem of profit shifting would largely disappear, as tax havens would simply cease to exist.
This was already suggested by the EU Commision’s Ruding Committee in 1992, which proposed a minimum EU corporate tax rate of 30%. Skeptical readers might have a hard time seeing tax havens such as Malta, Hong Kong or Luxembourg agree to this and kill a major revenue source. And the failure of any global agreement suggests that these readers are right.
There is, however, a solution to that also. Say Google reports $22bn dollars of profits in Bermuda to be taxed at 0%. The US tax authority can in this case choose to cash in the residual tax payment of 25% by itself. A version of this model was implemented with the Trump tax reform – the only problem being that the minimum tax rate imposed was only 13% (with loopholes built in) and hence still left firms with an incentive to shift profits.
The second solution: formula apportionment. Instead of treating the multinational firm as a collection of national entities we need to treat them as one firm. Concretely, if, for example, Google reported $30bn in consolidated global earnings, and 10% of its revenue comes from France, then France should get to tax 10% of Google’s global earnings ($3Bn). In order for the company to shift their earnings to Bermuda, they have to ask their customers to move.
The likelihood that these two solutions will see the light of day? Surprisingly, not completely impossible. OECD’s secretariat’s recent proposal indeed suggests similar (diluted, but similar) solutions. The timeline for 137 member countries agreeing on this is end of 2020. The public pressure has never been higher to fix the corporate tax and a trade war looms if countries fail to collaborate. If a global agreement is reached, it is very conceivable that new and bolder global reforms can be made. In other words – a fair and effective corporate tax system is in no way out of reach.
Ludvig Wier, Postdoctoral researcher, UC Berkeley