Corporate tax planning is undoubtedly part of the fiduciary duties owed by corporations to their shareholders, and the largest corporations are extremely good at it, particularly those with global operations and a heavy reliance on intangible assets. Nevertheless, experts disagree over the precise amount of tax that corporations successfully avoid as a result of these efforts. One estimate for 2012 suggests that 50 percent of all foreign income of multinationals is reported in jurisdictions with an effective tax rate below 5 percent; another suggests it’s more like 40 percent. The OECD estimates that governments worldwide are missing out on anything between four and ten percent of global corporate income tax revenue every year, or US$100–$240 billion. While the accounting varies, one fact is clear: this is an unacceptable level of corporate tax for governments to miss out on, no matter how you do the math.
The 2019 World Development Report on the Changing Nature of Work highlights the challenges of corporate tax avoidance in Chapter 2 on the “Changing Nature of Firms”. Many asked why; what’s the link? For starters, tax avoidance is easier and more common in the new world of work, even if it isn’t new. The digital economy expands firm boundaries. Physical presence is no longer a prerequisite to doing business: digital platforms generate income from the capital of others; companies provide online services from abroad or profit from intangible assets such as software and intellectual property; and identifying where value is created is not always straightforward, particularly when it comes to user data. Under these circumstances, it has become easier for companies to locate assets (and subsequently profits) in tax havens—countries with preferential corporate tax frameworks.
Second, and related, the notion that billion- and trillion-dollar companies syphon off large portions of their profits to reduce their tax burden is a moral problem for many citizens, and particularly those who work. While effective corporate tax has gone down in many countries, over the same period, a portion of the fiscal burden has been transferred to workers through increases in personal income tax. For example, since 2008, countries have cut headline corporate taxes by 5 percent, while increasing personal taxes by 6 percent. Minimizing one’s tax burden is understandable, but the latitude to do so is decided by governments. Public acceptance of the situation is waning.
Third, tax avoidance contributes to tighter government budgets. The less fiscal space governments have in which to maneuver, the more limited they are in their response to labor market disruptions driven by technology. Lower skill workers are losing out in the face of automation, because their skills do not complement new technologies. Job tenure is decreasing and work in the digital gig economy often has no social protections. These trends are more pronounced in advanced economies, where technology is more widespread. However, this situation is not dissimilar to that of the 2 billion people who work in the informal sector, predominantly in low- and middle-income countries. Worldwide, governments need bigger budgets to invest in expanded social protection and better education that enables people to compete in the global economy. Aggressive—albeit legal—tax planning is the last thing governments need in this environment.
Ensuring governments capture a meaningful portion of corporate gains needs to become a development priority, particularly as large digital companies move into emerging markets. Low income countries on average collect the least amount of tax as a proportion of GDP. They also, however, have the greatest financial burden when it comes to financing the human capital and social protection investments needed to adjust to the changing nature of work.
The international community has taken great strides in recent years to reduce opportunities for tax avoidance. The OECD Base Erosion and Profit Shifting (BEPS) initiative, launched in 2013 and involving more than 115 countries, negotiated the most comprehensive package of measures to reduce profit shifting to-date. Certain measures, if fully adopted by governments, would better align profit and taxes with the location where value is created, and the package includes guidelines on transfer pricing. However, the initiative has put off solutions for the digital economy until 2020.
Multilateral, or at least regional, solutions to corporate tax avoidance are the best option to deal with digital business, if consensus on the details is possible. But while we wait, people are getting impatient and governments are getting desperate. The United States’ 2017 tax reform included a minimum tax on intangible assets and the United Kingdom announced late last month that it will target “established tech giants” through a tax on digital services revenues if the BEPS initiative fails to deliver in 2020. Several countries, including India, Italy, and Spain have plans to do the same. Many more countries may follow suit before BEPS can produce a solution.
This shouldn’t come as a surprise. The political economy surrounding global corporate tax reform presents major challenges. In the meantime, however, unilaterally imposed digital taxes represent a potentially significant revenue stream for governments. What’s more, in targeting only the largest of digital firms, just like UK, politicians risk very little—for most countries, those firms are foreign. The political economy of unilateral digital tax seems far easier for governments to deal with.