The Raging 2020s

by Alec Ross

  Armed with those two numbers—total profit and proportional allocation—countries can determine how big their slice of the pie should be. Theoretically, if 15 percent of Google’s overall business were conducted within the borders of Germany, then the German government would apply its taxes to 15 percent of the company’s total profit.

  Under this system, countries still get to decide how to tax corporate income, but the race to the bottom would end. The Cayman Islands could still offer companies a 0 percent corporate tax rate, but no matter how hard they try, multinationals can conduct only so much of their business in a territory with seventy thousand people. Similarly, a company can decide not to pay the 30 percent corporate tax rate in Germany, but that would mean forgoing one of the world’s largest markets.

  Unitary taxation with formulary apportionment is not without kinks. In the words of economist Austan Goolsbee, “There’s no system of tax policy that’s un-gameable.” Depending on the definitions of profit and formulas for apportionment, companies could find ways to reduce their tax bill, and countries could undercut each other’s tax laws to compete for business. We have already seen this competition play out in the United States, where the fifty states use formulary apportionment to tax interstate companies. The system uses three metrics for apportionment—sales, payroll, and property—but states can give different weights to each factor. Companies take advantage of differences to lower their tax bills. As a result, you see firms concentrating employees in states that underweight payroll and buying buildings in those that underweight property.

  Under a global formulary apportionment system, companies might also drive up sales in low-tax countries by expanding their offerings, but that can go only so far.

  “Grocery stores in Bermuda suddenly become very valuable, because you’ll increase your sales in Bermuda and thereby dilute the amount of tax you pay,” said economist Brad Setser. “But there’s sort of a limit to how many supermarkets you can buy in Bermuda.”

  While companies will always optimize their tax bills, unitary taxation with formulary apportionment would eliminate most of the profit shifting we see today, said Setser. That means global governments would get hundreds of billions of dollars in additional revenue every year.

  Beyond tax revenue, the system also forces companies to be more open about their operations.

  When companies report their profits on a country-by-country basis, and that information is made public, every government official, journalist, academic, and everyday citizen knows exactly where their business is being done. This transparency would lead to more effective business strategies, more informed government policies, and more responsible corporate behavior. To paraphrase US Supreme Court Justice Louis Brandeis, sunlight is the best disinfectant.

  John Christensen, the Jersey whistleblower, thinks investors also have a lot to gain from this transparency. Aggressive corporate tax structures carry a lot of risk, leaving companies vulnerable to changing laws and international investigations. “Not many people … understand that there is a risk attached to tax policies. Yes, investigations can damage your reputation, but also if you have a full-blown investigation leading to a court trial, it might very seriously materially affect your balance sheet.”

  The thirty-seven-nation Organisation for Economic Co-operation and Development (OECD) has already paved the way for these reporting standards.

  In 2015, the OECD released an action plan for reducing profit shifting, which included a framework for country-by-country reporting standards. The problem is that the rules apply only to the companies that earn more than €750 million per year. These companies are also required to file reports only with their home government, and those governments can share the information only with countries that meet minimum standards for information security. Most developing countries do not.

  In other words, the measure lets wealthy countries observe the behavior of wealthy companies, but neither developing countries nor the public gets to see anything.

  “Even if [countries] are able to get ahold of this, they’re only getting information on the largest companies—there may or may not be any of those operating in your country,” said Clark Gascoigne of the FACT Coalition. “Those thresholds have been set at a level that doesn’t work for developing countries.”

  This underscores a key point. In international tax, as with every other area of policy, it matters who writes the rules.

  Though every country loses revenue to tax avoidance, developing nations suffer a disproportionate amount of the loss.

  “The folks that are oftentimes making the rules about the international system, it’s generally the G20 or the OECD … the largest economies in the world. So you end up with a bunch of rules that are very skewed towards thinking about the world as if the world were all wealthy developed countries,” Gascoigne said. “Oftentimes, developing countries don’t have a seat at the table. If you’re going to enact something that takes into consideration the concerns of developing countries, then developing countries should be at the table on equal footing.”

  He and Christensen both believe the proper forum for reforming international tax is the United Nations, not an exclusive group like the OECD or G20. In a more representative body like the UN, it will be harder for the United States and United Kingdom to stonewall or water down tax reforms. The G77, a coalition of 135 developing countries, regularly speaks out against tax havens and voices its support for reform. However, it has yet to take any actions that have produced a real result.

  Some members of the OECD are pushing the organization to take stronger action against tax avoidance. Today, the group is updating its original framework to curb aggressive profit shifting by technology platforms like Google, Apple, and Facebook. The Base Erosion and Profit Shifting Project or “BEPS 2.0” initiative was still in development at the time of this writing, but it is expected to focus on two policies.

  The first policy, called the Unified Approach, would create a formula for dividing the profits of multinational technology companies among the different jurisdictions where they operate. The calculation would take into account different types of profit. This should sound familiar to you: it is formulary apportionment.

  Gascoigne thinks the final scope of the Unified Approach will be narrow, applying to only a small fraction of the profits from a small fraction of companies. Nevertheless, it is the first time countries have entertained the idea of formulary apportionment, Gascoigne said, and it has “enormous potential” to push the international community toward a more holistic system of unitary taxation with formulary apportionment.

  The second policy is even more radical: a global minimum tax. This measure guarantees that all companies pay a minimum tax rate no matter where they do business—if a company’s offshore profits are undertaxed, its home country can step in to make up the difference.

  The OECD has yet to finalize the rate, but Gascoigne said it will likely be between 10 percent and 15 percent. For the purposes of this book, we will say it is 10 percent. This is how it would work.

  Let’s say you own a German company that recorded $1 million of profit in Bermuda. You do not pay any taxes in Bermuda, because the corporate rate is zero. But under a global minimum tax, the German government could step in and take $100,000 in tax (10 percent of your profits). If the profits were made in Hungary, where the corporate tax rate is 9 percent, you would owe $90,000 to the Hungarian government and $10,000 to the German government—a combined tax rate of 10 percent. If they were made in Canada, where the 26.5 percent corporate tax rate exceeds the global minimum, you would pay $265,000 to the Canadian government and owe the German government nothing, because you already hit the global minimum. In effect, a global minimum tax sets a floor on what companies must pay and helps direct those taxes to the real centers of economic activity.

  “Currently, the global minimum tax is 0 percent—countries can set tax rates as high or as low as they want to. What that has led to is a global race to the bottom on ta
xes. It’s just bringing everybody down, and … we get to the point where we bankrupt ourselves,” Gascoigne said. “Now, I’d say 10 to 15 percent is a pretty pathetic corporate tax rate. That said, the current floor is 0 percent. If we can raise the floor to 10 to 15 percent, well I mean, that’s an enormous shift.”

  The idea for the global minimum tax came from an unlikely source: the United States.

  In 2017, the US Congress passed the Tax Cuts and Jobs Act, which cut the country’s corporate tax rate from 35 percent to 21 percent and lowered taxes on offshore assets that companies bring back to the US. In many ways, the Tax Cuts and Jobs Act was one more descent in the race to the bottom, another tax cut in a long line of cuts to try to stay “competitive.” But the act also contained a brand-new provision.

  It placed a 10.5 percent tax on so-called global intangible low-taxed income, or GILTI. Supporters hoped that the provision would serve as a minimum tax, capable of incentivizing multinationals to bring their foreign cash back home, while landing a blow against tax havens. The GILTI essentially guarantees that all companies pay a minimum tax rate (in this case 10.5 percent) no matter where they do business. If a company’s offshore profits are taxed below that rate, the US would step in to make up the difference. And while it was a first step toward a global minimum tax, it ended up being just a half measure that allowed multinationals to lower their tax bill.

  Before the 2017 law, the United States taxed offshore profits and onshore profits at the same rate—the only difference was that companies did not owe taxes on foreign profits until they were returned to the US. This is why companies like Apple, Pfizer, and Google stored trillions of dollars in tax havens: as long as the money was offshore, they did not need to pay the US corporate tax rate.

  But while the GILTI was great in theory, it served as a major tax cut in practice, reducing the tax rate on foreign profits by half. Profits made in the United States are taxed at 21 percent, while profits made abroad are taxed at only 10.5 percent. If you make $1 million from a patent in the United States, you pay the US government $210,000. But if the patent is in Bermuda, you owe only $105,000. After the GILTI is paid, you can move the money back to the United States without owing another penny. So a dollar made overseas becomes more valuable than a dollar made back home.

  Through this mechanism and a handful of other loopholes, GILTI ended up rewarding companies for basing their operations abroad, rather than convincing them to come home. Even so, it represented a step toward a new approach to tax abuse. When Congress enacted the GILTI in 2017, it made the United States the first country in the world with a global minimum tax. Yes, “it’s like a Swiss cheese of a global minimum tax,” said Clark Gascoigne, but “if you plugged those holes … it could mean you’d pay the same rate whether you book your profits abroad or domestically.”

  Like the Unified Approach, any global minimum tax the OECD agrees to will likely be modest at the beginning, Gascoigne said, “but I would say it’s an enormous step that over the long term is going to be hugely impactful. And it’s a completely unintended consequence of the tax law in 2017. Even two years ago, I would have told you that we are thirty years off from discussions about a global minimum tax, and yet here we are.”

  Even if the OECD’s programs go through, the measures will only address the behavior of corporations. Wealthy individuals, who are responsible for the majority of global tax avoidance and evasion, will remain largely untouched.

  The way to help governments spot individual tax evaders is through transparency, specifically international information-sharing programs. Under such programs, countries agree to share foreigners’ financial information with their home country. If a Brazilian citizen opened a bank account in Germany, the German government would share their financial activity with Brazilian tax authorities.

  Both the OECD and the United Nations endorse information-sharing agreements as a key tool for dealing with tax avoidance and evasion. The OECD created standards for reporting financial information to international tax authorities. The group also created a portal for countries to share this information with one another. Some 160 countries have either adopted or committed to adopting the framework, called the “common reporting standard.”

  It is important to note that not all information-sharing agreements are alike. Countries can choose to share foreigners’ financial information with tax authorities automatically or on demand. Automatic exchanges promote more transparency—authorities do not request information unless they already suspect bad behavior.

  As of November 2019, nearly one hundred jurisdictions have adopted automatic information-sharing programs. The list includes Bermuda, the Bahamas, the Cayman Islands, Jersey, the British Virgin Islands, Ireland, and other top tax havens, as well as the vast majority of the world’s largest economies. However, the United States is conspicuously absent.

  The United States has agreed to share information with certain countries that comply with FATCA, but only on request. Clark Gascoigne said that the position of the US is that it wants to share sensitive information only with countries that “have the technology and rule of law to protect that information as sacrosanct.” But the result is that its agreements exclude most of the developing world. “The countries that are losing the most from tax evasion from their own countries … they’re not getting information back from the US. [The United States is] getting information from everybody else in the world, but we’re not sharing it with the vast majority of the rest of the world.”

  Again, the United States is fighting foreign tax havens while serving as a tax haven for non-Americans. The US opposition to automatic reporting reinforces its role as one of the world’s top secrecy jurisdictions. The door is open for foreigners to set up anonymous shell companies or bank accounts knowing that information will likely never make it back home. Until the United States gets on board, meaningful solutions to tax abuse are going to sputter out. And all the while, the US loses billions per year in taxes.

  To significantly reduce tax evasion, the international community needs to chip away at banking secrecy. Economist Gabriel Zucman thinks he knows the place to start.

  In his book The Hidden Wealth of Nations, Zucman proposes creating a “global financial register,” a consolidated log for “recording who owns all the financial securities in circulation, stocks, bonds, and shares of mutual funds throughout the world.” Using the registry, international tax authorities can verify that banks are reporting all the information they have at their disposal. Similar registries already exist, but they are privately controlled and only cover individual countries. By combining these disparate logs into a single repository, Zucman said, countries can build a system that does not “exclusively rely on the goodwill of offshore bankers.”

  The policies needed to build a coherent international tax system are straightforward: treat each multinational as a single unit, let countries tax their share of profits, and automatically share information about individuals who bank across borders. But bringing the entire international community on board is a much heavier lift.

  “In terms of what needs to be done, none of it’s rocket science,” said John Christensen. “The problem lies entirely with political will.”

  Making real progress on international tax reform requires buy-in from many different stakeholders, both developing countries that lose the most to tax avoidance and wealthy nations where the global economy is concentrated. Among the latter is a handful of countries that are either tax havens themselves or direct supporters of the offshore system: Ireland, Luxembourg, Switzerland, the United Kingdom, and the United States.

  Countries that oppose global tax reform are finding themselves at odds with the rest of the world. Amid growing economic inequality, recent backlash against globalization, and modest yet noteworthy steps by the OECD, change seems inevitable. What remains unclear is how it will come. Small countries might bend under enough international pressure, but forcing the United Kingdom and United States to reverse course
could get messy.

  Considering the United States remains the biggest roadblock to global information sharing and the United Kingdom controls the world’s top tax havens, they could bring about change almost unilaterally. “You can’t have a global norm without the United States being on board, and likewise if the United States acts, they can pretty quickly make something a global norm,” Gascoigne said.

  But if the US and the UK refuse to lead, it will likely take a global effort. The Group of 77, led by emerging global powers including China, India, Brazil, and South Africa, would have an enormous amount to gain if it could force global tax reform through the United Nations. Creating this unified bloc would be a logistical challenge, Gascoigne said, but “with enough political will, they could absolutely do it.”

  This highlights another key point. There are both moral and economic arguments for building a cohesive and fair tax framework: more tax revenue benefits democratic societies, and international competition on tax leads to economic inefficiency.

  Creating elaborate, globally optimized tax structures is costly, and more and more companies are having a difficult time defending them in court. For example, Google’s Double Irish with a Dutch Sandwich did not escape the attention, and anger, of European tax authorities. The company has been sued in several jurisdictions, and in 2017, Google settled a $335 million tax bill with the Italian government following an investigation into its Irish arrangement. In 2019, it reached a similar settlement to pay the French government more than $1 billion in back taxes after a four-year fraud investigation.

  Though the existing global tax system benefits multinationals in the short term, it creates a significant amount of uncertainty in the long term. Every country that a company routes its money through is an additional variable the company must consider in its long-term planning. When laws change or government investigations launch, companies are left scrambling.