The Raging 2020s

by Alec Ross

  Tax policy is complicated, quantitative, and mind-numbing. No less than Albert Einstein said, “The hardest thing to understand in the world is the income tax,” speaking to the accountant who prepared his taxes. Very few people understand it, and the ones who do often work as accountants, bankers, and lawyers for multinational corporations and wealthy individuals. However, taxes are a skeleton key for unlocking the problems that emerge out of using a 20th-century set of policies to solve 21st-century problems.

  Ninety-nine percent of the people reading this book could pay less in taxes and our governments would have more to spend if we fixed a system where trillions of dollars in tax go missing each year and entire nations have been captured by outside interests. Tax serves as a microcosm for many of the global issues by which governments are divided and conquered.

  The story of its complexity and importance can be illustrated by something as simple as buying a new belt.

  Marco was out to dinner with Giulia, a writer he met at the supermarket. It was a perfect date: a plate of spaghetti alla carbonara, a fantastic conversation, even a slice of tiramisu to top it all off. But by dessert, Marco had begun to feel a little snug around the waist. When he leaned forward to grab the bill, the buckle of his belt popped off and tumbled to the floor. He managed to keep his cool, put on his coat, take Giulia by the arm, and walk her home without any first-date disaster stories. But now their second date was coming up, and Marco’s trusty leather belt was out of commission.

  Back in his flat in central Rome, Marco opened up his laptop and typed “men’s Italian leather belt” into Google. The people of the Italian peninsula have been working with leather for thousands of years, and their craftsmanship, through brands like Gucci, is among the world’s best. On Marco’s screen, a series of ads appeared above the organic search results. At the top was an ad for Gucci. But Marco was not a designer-label guy, and the €360 cost was not in his budget. One link down, he saw an ad for Pelletteria Artigianale Firenze della Famiglia Ascani (which roughly translates to “the Florentine artisanal leather maker of the Ascani Family”). Like Gucci, the Ascani family had spent a century crafting fine Italian leather in Florence, but unlike Gucci their belts cost only €40.

  Marco loved the belt that appeared on the screen. It was black, glossy, and functional. And for genuine Italian leather, you could not beat the price. Marco clicked on the ad and made the purchase online through Pelletteria Artigianale Firenze della Famiglia Ascani’s website. The belt arrived just in time for his second date, and it served him well, through dates two and three and four, until there was no point counting anymore.

  Marco bought his belt in the kind of routine online transaction that happens tens of millions of times per day around the world. It would not have been possible before the internet and e-commerce. Years ago, Marco would have needed to walk to a store, select a belt from whatever they had available in stock, and pay the cashier. Years ago, it would also have been an all-Italian purchase. Italian buyer, Italian seller, plus a portion pulled out as tax for the Italian government.

  Now, of course, there’s a fourth party in the mix. Marco might not even have heard of Ascani if not for Google, after all. Ascani pays for the service, at a rate of approximately €0.11 per click on its ads. On average, it takes about thirty-six clicks to drive a single sale. So, for each belt purchase, Ascani ends up paying Google €3.96, roughly 10 percent of the belt’s cost. When you zoom out, Google—and its peers such as Apple and Amazon—have set themselves up as tax collectors on the traffic that runs through their online fiefdoms. It’s virtually impossible to operate a business in the 21st century without making regular payments to at least one of the tech giants.

  Smaller businesses have been pushing back against this form of rentier capitalism and making noise about the monopoly power that comes with owning an online marketplace like the App Store or Google’s “Search” pages. Others argue that this is just the inevitable cost of doing business online.

  But whatever your position, fishier than the cut that Google takes out of Marco’s purchase and billions of other daily purchases is what Google pays in taxes. Each party in Marco’s transaction is paying taxes: Ascani is still paying the 22 percent in value-added tax (VAT) that it would have before the digital age. Marco is still forking over 41 percent of his own income in tax as well to the Italian government. But the biggest player of all—trillion-dollar Google—has managed to slip out of the deal with a shocking 0.7 percent tax rate. The slimmest of slivers.

  That is not because Italy has given Google a special exemption. By Italian law, all corporate income in the country is taxed at 24 percent. But the catch is that Google has assembled a complex set of levers and transfers to shift its profit off its Italian books. That €3.96 is collected by a subsidiary in Ireland, where Google faces a much lower tax rate—and that’s just the first trick.

  This kind of loophole might look irrelevant or eye-glazingly boring to the average citizen—especially one who’s in a hurry to dress himself up for his second date. But when you zoom out and understand the scale of these maneuvers, when you start to see how central they are to the workings of the world’s wealth, you begin to understand that Google’s trick is less like a loophole and more like a wormhole in the global economy—one that has steadily eaten into the power of social contracts around the world for decades, and shows no sign of stopping.

  When Marco buys his belt online, 10 percent of an otherwise all-Italian transaction just vanishes. And once that money slips away into Ireland, it does another disappearing act, followed by another. The full chain of transactions, through which Google has transferred billions of dollars, reveals one of the greatest engines of corporate power and inequality in the globalized world.

  Extrapolate that €3.96 over the billions of ads Google serves every single day and you are dealing with big money, both in gains for Google and in losses for the countries where it does business. The tax laws we have today were written for commerce that occurred in the physical world, with tangible goods and national borders. But these rules begin to fall apart when businesses go digital and spread their operations across a global chessboard. Economists estimate that governments around the world lose more than $500 billion each year due to corporate tax avoidance. Even more is lost through the further tax evasion by wealthy individuals, often through many of the same tricks that multinational corporations have mastered.

  Of course, tax might seem like a dirty word to you. Who cares? Maybe if Marco had a choice, he’d be doing the same thing, and then he’d be able to afford Gucci. But taxes are at the very core of government and what we rely on it for. Without revenue, governments cannot defend the nation, educate their citizens, build public infrastructure, support the economy, or fund social programs. People can debate the scale and scope of the government’s responsibilities—but no matter its mandate, a government needs money to carry it out. A fair and just tax system is one that requires everyone to pay their fair share. People of different political stripes can debate what constitutes a “fair share,” but when any party pays less than that amount, it undermines the greater good and puts a tear into the social contract. Either the government receives less than it’s owed, or somebody else pays more than they should.

  Today, we live in a society in which FedEx pays less money in federal taxes than one of its delivery drivers and Starbucks pays less than one of its baristas. Over the last fifty years, a massive proportion of global corporate income has begun to route through tax havens rather than to the countries where major corporations do the bulk of their business. Yet how far would FedEx have gotten without public roads to deliver its packages? How valuable would Google be without a steady stream of technologists graduating from universities with federally funded research? Would the company even exist were it not for the federal grant that enabled its founders to develop their famous search algorithm? And where would any of these companies be without strong courts to defend their intellectual property and effecti
ve militaries to protect their physical assets? As US Supreme Court Justice Oliver Wendell Holmes Jr. put it, “Taxes are what we pay for civilized society.”

  I do not like paying taxes any more than anybody else, and the 41 percent of his €55,000 annual income that Marco pays to the Italian government must sting. If Google, FedEx, Starbucks, and their peers paid anywhere close to the level of taxes that you, Marco, I, and everyone else reading this book paid, we could pay much less.

  Each transaction has real-world consequences, even the €3.96 Google gets from a belt. Every dollar that multinationals or wealthy individuals keep from tax authorities is a dollar that is not being spent on infrastructure, health care, education, public safety, and other government programs that benefit not only society but the companies themselves.

  Yet the bulk of the tax avoidance we see is not obviously illegal. As major corporations have become larger and larger, they’ve become ever more capable of gaming the tax policies of any individual nation and finding the best deals by shuttling money around the world. As they’ve done so, they’ve been able to accelerate their own growth and then put pressure on nations to loosen their tax mandates even further. This cycle has been going on for at least a half century, in a long-running race to the bottom.

  We are nearly at rock bottom. And the only fitting response will need to be global: a worldwide effort to remove incentives for companies and wealthy individuals to dodge billions of dollars in taxes, leaving everyday citizens to come up with the balance.

  TAX HAVENS 101

  Tax avoidance is not a new phenomenon. People have found ways to avoid paying taxes for as long as their sovereigns have been collecting them.

  The merchants of ancient Sumer avoided their kings’ extensive tax regimes by working through an equally extensive black market, smuggling cows, sheep, and grain. In medieval Japan, landowners lobbied the emperor’s government to extend a tax exemption created for Buddhist temples to their own private estates. Later, these tax-free estates, called shōen, became so large that the imperial court ran out of land to tax and went bankrupt.

  Tax avoidance is a game historically mastered by society’s elites. With money and political connections, they can push for laws that work in their favor and circumvent the laws that do not. Just as the aristocrats of Japan leveraged this power to acquire massive, tax-free estates, today’s elites use it to operate through an opaque, lightly regulated financial system that lets capital dart around the globe out of the reach of authorities.

  The jurisdictions that cater to the offshore world are known as tax havens.

  Tax havens as we know them emerged in the early 20th century. They proliferated after World War I as stashes for Europe’s wealth, then started to become a staple of the global economy in the 1960s and ’70s. They come in all shapes and sizes: tax havens can be countries (Ireland and Luxembourg), individual states (Delaware and South Dakota), or semi-sovereign territories (Bermuda and Hong Kong). They might specialize in certain areas: hedge funds like the Cayman Islands, insurance companies prefer Bermuda, Wall Street financiers gravitate to Delaware, and their European counterparts flock to Jersey, Ireland, and Luxembourg. They often target certain geographies: elites in the US and Latin America funnel their money through Panama and the Caribbean; the Chinese send theirs to Hong Kong, Singapore, and Macau. Wealthy Europeans and Gulf royals are serviced by the famously secretive banks of Switzerland, though reforms in the Swiss system bringing more transparency have pushed those really seeking to hide their wealth into Singapore and the Cayman Islands. And as we will read, the United States is as big a culprit as the Caymans.

  But no matter their status or specialty, all tax havens offer their clients one thing: an escape from the laws of someplace else.

  For instance, when Google received €3.96 from the Ascani family, it likely would have avoided paying a dime to the Italian government. As soon as the transaction was completed, that money departed the country. The payment did not go directly to Google LLC, the corporation headquartered in Silicon Valley, nor to Alphabet Inc., the company that owns Google and its various side projects for self-driving cars, drone delivery, biotechnology, and the like. Instead, the Ascanis’ €3.96 worked its way through a chain of corporate entities scattered across three different countries, none of which played any role in getting Marco his belt.

  The reason Google and other multinational firms shuffle their money around the map in this way is to minimize their taxes, allowing them to generate billions of dollars from customers around the globe without giving a cut to the countries where they do business. Tax havens like the Cayman Islands, the Netherlands, Bermuda, Luxembourg, and Ireland offer drastically reduced tax rates and regulations to lure in foreign businesses or wealthy individuals. Following a model set by Switzerland in the wake of World War I, most tax havens also promise secrecy, outlawing even officials from prying into the details of offshore accounts.

  HOW IT WORKS

  There are countless financial hoops that companies can jump through to ensure the money they make in one country appears in a tax haven. Corporations generally pay taxes only on profits. Thus, they can save a lot of money by reducing profits in countries with high tax rates and increasing profits in jurisdictions where they pay little or no tax.

  The strategies for moving earnings from one country to another fall under the broad umbrella of “base erosion and profit shifting.” And as convoluted as these maneuvers may sound, most of them do not blatantly violate the law.

  One of the most common techniques companies use to shift their profits around the globe is called transfer pricing. In short, this allows one branch of a company to pay another branch of that same company for goods and services that it provides, at a price basically set by the company itself. For multinational corporations, that often entails a subsidiary in one country making a payment to a subsidiary in a different country. Today, these sorts of intra-company payments are extremely common—about one-third of all international trade happens within the same company.

  Transfer pricing has many legitimate applications. If you are a multinational citrus producer and your Brazilian subsidiary sends ten tons of oranges to the US, it is reasonable for the American subsidiary to pay its Brazilian counterpart for product and shipping costs. That said, transfer pricing can easily be abused.

  In 2019, American corporations reported earning $577 billion in profits outside the United States. Nearly 60 percent of that money—some $330 billion—was “earned” in just seven low-tax jurisdictions: Ireland, Luxembourg, Switzerland, the Netherlands, Singapore, Bermuda, and the British Caribbean (the Cayman Islands, British Virgin Islands, Turks and Caicos, and Montserrat). Only 7 percent of that profit was reported in Germany, France, Italy, India, Japan, and China.

  In other words, on paper, US multinationals “earned” nine times more profit in seven small jurisdictions than in six of the world’s largest economies. That is not because the customer base in Bermuda is nine times bigger than the one in China. It is because transfer pricing allowed them to move profits to tax havens and lower their profits in high-tax jurisdictions.

  To explain how this works, let’s imagine what this kind of profit shifting might look like in a conventional business using analogous tricks of creative but legal accounting.

  Imagine you were hired as a delivery driver for a local pizza shop. Each delivery comes with a tip, but you have to share 20 percent of your tips with the owner of the restaurant. Before the owner takes her cut, you are allowed to deduct any job-related costs. At a basic level, this is how corporate taxes work. Your company earns a profit (revenue minus costs), and a portion of the proceeds goes to the government.

  We will say on your first night, you made $25 in tips and spent $5 on gas. You would immediately get back the gas money, and then the remaining $20 would be divided between you and the owner. She would get $4—20 percent of the total—and you would pocket the remaining $16. In this situation, you are the multinational corporatio
n and the pizza shop owner is the government.

  Now imagine you wanted to game the system through transfer pricing. The car that you use to deliver pizzas belongs to your parents. Normally they let you drive it whenever you want, but you could instead ask them to charge you $1,000 to “lease” the car for pizza deliveries. Your mother drafts an invoice and you bring it into the shop. The owner allows you to count that $1,000 as an operating cost, which you can deduct from your profits.

  Now the next night that you make $25 in tips and spend $5 on gas, you get to keep the whole thing. You would get $5 back for the gas just as before, but you also count the remaining $20 toward the car lease. Your “profit” is zero on the night; you’re still $980 in the red on that car lease. So there is nothing for the pizza shop owner to tax.

  In this case, your mother is acting as an offshore subsidiary of your multinational company. You would “pay” your parents the $20, and because you live in their house (a jurisdiction with no taxes), nobody else takes a cut. In reality, your parents would never even need to touch the money.

  After that first shift, the balance on the car lease is knocked down to $980. The same thing happens the next night, and now the balance is $960. After the next night, it drops to $940. At that rate, it would take fifty shifts to pay off the lease. That is fifty shifts in which the pizza shop owner is not getting 20 percent of your tips.

  By the time the lease is paid off, you will have successfully transferred $1,000 in profit from a high-tax jurisdiction (the pizza shop) to a tax haven (your home). The pizza shop owner did not take a single penny.

  The lease was a purely paper transaction—neither you nor your parents spent any extra money—but it nonetheless eliminated the “taxes” you would otherwise have owed. Without the lease, you would have taken home only $800 in profits. With the lease, you made an extra $200.