It's easy to be outraged about multinational corporations' shifting of profits to tax havens, but much harder to figure out how to stop them from doing it without hurting the economy. Evidence exists that curbing tax avoidance opportunities makes these firms move actual jobs, not just accounting profits, overseas.
In a recent paper, Thomas Torslov, Ludvig Wier and Gabriel Zucman argued that governments throughout the world are cutting corporate tax rates (to an average of 24% today compared with 49% in 1985) simply because they've given up on trying to fight profit shifting, defined as the recording of accounting profits in low-tax jurisdictions. "Machines don't move to low-tax places; paper profits do," the economists wrote, estimating that about 40% of multinational profits were artificially shifted to tax havens in 2015.
The authors used an ingenious device to describe the scale of the profit-shifting: They calculated the profit recorded by multinationals and local firms in a country per dollar of wages paid. On average, a company makes 36 cents in taxable profit for every $1 of wages in a non-haven country. In low-tax jurisdictions, the ratio soars -- to more than 100% in Singapore and Hong Kong, to more than 200% in Ireland, Luxembourg and Puerto Rico.
The example of that US territory is used in another recent paper, by Juan Carlos Suarez Serrato, to study what happens when a government tries to curb profit-shifting. Between 1921 and 2006, US multinationals were exempt from taxes on income earned by their Puerto Rican affiliates under a regulation known as Section 936, after the relevant section of the US tax code. In 1996, the exemption was repealed with a 10-year phaseout because legislators decided it was doing more harm in the mainland US than good in Puerto Rico -- essentially the same argument Mr Torslov, Mr Wier and Mr Zucman make concerning the shifting of paper profits.
The repeal of Section 936 contributed to Puerto Rico's financial crisis. But it also caused large profit drops for the 682 US firms, including major ones such as General Electric and most of the US pharma industry, that were using the loophole in 1995. Mr Serrato calculated that the effect on their income was equivalent to that of losing $232 billion in combined sales.
That, according to Mr Serrato, triggered a decrease in US investment and the shifting of actual production to cheaper countries. The repeal of Section 936, according to Mr Serrato, cost the US economy a million jobs.
Causality, of course, is always a concern in studies of this kind. Mr Serrato checked his findings against data on firms that weren't exposed to Section 936's repeal and confirmed they were robust.
Based on both Mr Zucman and Mr Serrato's research, one might conclude that letting firms shift accounting profits allows them to keep more money for investment and job creation, while at the same time supporting the low-tax countries with extra revenue. The problem is corporations end up sitting on huge piles of cash they do not invest or pay out as taxes. As of March 31, Apple was holding $267.3 billion of cash and equivalents. Even though the company distributes much of that to shareholders, it still has more than it knows what to do with.
The 2017 US corporate tax reform, which allowed firms to repatriate overseas cash piles formed by profit-shifting at the cost of a 15.5% one-time tax payment. Quite a few multinationals have done so and followed Apple's example in showering shareholders, and sometimes staff, with the cash. And yet they're left with huge, ineffectively used war chests.
Policymakers should still keep looking for ways to tax the excess profits -- but without creating unwanted effects like those caused by Section 936's repeal. Mr Serrato cautions that moves to curb profit-shifting shouldn't be unilateral.
The best approach to profit-shifting would involve all countries agreeing on certain taxation principles, a project on which the OECD works with more than 100 jurisdictions. But in a world where the US prefers to take unilateral action, its multinationals are vulnerable to all kinds of one-sided tax actions.
Both Mr Zucman and Mr Serrato believe it could be reasonable to tax profits according to where they were earned. If the EU, whose economies, according to Mr Zucman, lose the most tax revenue thanks to profit shifting, applies this approach unilaterally, US tech and pharmaceutical firms could experience a shock similar to that of Section 936's repeal. Then, their US investment and job creation would suffer, contrary to the intentions behind President Donald Trump's tax and trade policies. - Bloomberg Opinion
Leonid Bershidsky writes for Bloomberg Opinion.
