In a column written five years ago, I had argued for a laissez-faire approach to eliminate tax havens — Reduce tax rates on the richest individuals and corporations to levels so low that they would have little incentive to cheat. Then, they would willingly comply and pay, and Panama-papers-like scandals will become history.
Two weeks ago, in London, the powerful G7 nations (Canada, France, Germany, Italy, Japan, the UK, and the US) went diametrically the other way, proposing a series of overhauls that would increase taxes on the world’s wealthiest corporations, levy crushing penalties on companies and countries for non-compliance, and establish a global minimum corporate tax of 15 per cent.
To enlist the rest of the G7’s support, America resorted to an old trick that always works — bribes. Europe has been furious that it can’t get the big tech companies such as Google, Facebook, and Apple to pay sufficient taxes to their ever-hungry coffers.
Taxing tech behemoths
So America offered them a deal. If a company has a profit margin above 10 per cent (read tech companies), 20 per cent of the excess profit would be taxed in every jurisdiction in which a company operates. Suppose a company has $10 billion in revenue and a profit of $2.5 billion, that is, a profit margin of 25 per cent. It would automatically fall victim to the new scheme.
- The 10 per cent profit floor equals $250 million and would be taxed in its home country as has always been the case. The profits above this floor are $2.250 billion.
- 20 per cent of the excess, that is 20 per cent of $2.250 billion, $450 million, would be subject to taxes in each jurisdiction that the company operates based on a percentage of sales. If the company generated 5 per cent of its global revenue in Italy — even if Italy has no manufacturing facilities or a physical presence for the company — Italy would still get to collect 5 per cent of $450 million, or $22.5 million in taxes.
- The remaining 80 per cent of the excess, $1.8 billion, would again be taxed in its home country as before.
In exchange for such a lucrative deal, the G7 nations agreed to establish a global minimum corporate tax rate of 15 per cent. Many countries with few natural resources or an insufficiently deep reserve of human capital (think Bermuda, Panama, Ireland, Luxembourg) have become enormously wealthy by lowering their corporate tax rates to attract large companies to relocate to their tax havens. Ireland has a corporate tax rate of 12.5 per cent. The US has a rate of 21 per cent.
Tax plan’s flaws
A big American technology company opens up a small office in Dublin and transfers most of its intellectual property to the Irish subsidiary. When filing US taxes, the company claims a large deductible expense for royalties paid to its Irish subsidiary, a fully legal manoeuvre. In so doing, it lowers its net income in the US substantially, paying the US a lower amount in taxes. The Irish subsidiary earns a large royalty income, but pays a much lower 12.5 per cent tax rate on it, saving the global corporation 8.5 per cent of its income in taxes.
Credit Janet Yellen, the US Treasury secretary, former Fed Chairperson, and a star economist, for promoting the global minimum tax, a bizarre idea that has been in the works at the OECD since 2016. Under this proposal, all countries would enforce a minimum tax rate of 15 per cent. America would be legally allowed to “top up” the 2.5 per cent difference on all technology companies with tax havens in Ireland bringing in an estimated $50 billion in additional corporate tax revenue each year.
Yellen’s plan is to eliminate tax competition among countries altogether. She actually said so in April, advocating for “renewed international engagement, recognising that it is important to work with other countries to end the pressures of tax competition and corporate tax base erosion.” An independent watchdog estimated that Ireland would lose $4.24 billion a year in corporate taxes because of the 15 per cent global minimum tax rate. Worse, companies could begin leaving Ireland. If the top five US companies in Ireland were to move, Ireland could face an additional shortfall in tax revenue of $4 billion. What gives the G7 nations the power, by diktat, to pass a death sentence on these countries?
Nobody argues that governments want to raise sufficient revenue to pay for expenses, but for over 100 years, decisions about how much to tax and how fairly the burden of government has to fall on citizens, have distinguished one country from another. It is this distinction that makes a company locate in the Netherlands and not in France. Indeed, in America, individual states, as the laboratories of democracy, devise tax and spending policies to differentiate themselves from other states. This is why companies decide to relocate out of New York or California and move to Texas and Florida.
A group of bureaucrats should not have the power to eliminate the consideration of tax implications of business decisions, a pillar of corporate strategy, over clinking wine glasses.
If private companies had engaged in price collusion to thwart other companies, these very governments would have pursued antitrust cases against them. But because governments are cooperating for the so-called public good, engaging in a collusive approach regarding taxes somehow excuses them?
Skin in the game
The economics profession is strange. Extraordinarily gifted individuals think, analyse, number-crunch complex data, debate among themselves on elite college campuses for how the world ought to work and publish theories conjured up in hallways. Government leaders incorporate these proposals as policy, impacting billions of people, although the ideas themselves are not test-driven, and once deployed, are rarely withdrawn.
Contrast this approach with what works in the private sector. Amazon, Google, or Facebook market their ideas to stakeholders, continuously fine-tuning them to become and stay successful, all the while gaining a share of markets and minds. If an idea fails, the companies change it or, in extreme cases, drop it altogether. Companies have to earn your business every day, but governments have the power to force you, under powers of penalty, to obey tax laws passed.
Government officials get paid no matter if their ideas work or not — before they retire riding into the sunset, pensions fully protected, and their individual futures secure. And while companies launched by flawed ideas fail all the time, governments continue to double down on failed policies. The Global Minimum Tax is one such and will have devastating consequences on ingenuity, creativity, drive, and hard work — the engines of capitalism — not only in one country but around the world.