The Hidden Wealth of Nations

by Gabriel Zucman

  The issue is growing, as a rising number of international transactions within international divisions of a single company—such as the sale of proprietary trademarks, logos, and algorithms—are not replicated between third parties, hence have no reference price. Firms can sell themselves bananas or shovels at exorbitant prices—we’ve seen this—but the risk is high for companies that engage in such obvious fraud, as they can find themselves caught by the tax authorities. There is nothing less risky, by contrast, than manipulating the prices of patents, logos, labels, or algorithms, because the value of these assets is intrinsically difficult to establish. This is why the giants of tax avoidance are companies of the new economy: Google, Apple, and Microsoft. Taxing companies wanes to the same extent as immaterial capital gains in importance.

  Tax Avoidance by US Firms: $130 Billion a Year

  Quantifying the government revenue losses caused by profit shifting to lower-tax jurisdictions is not straightforward and, as with personal wealth, involves some margin of error. My approach relies on national accounts and balance-of-payments statistics, focusing on US firms.32 Consider the basic macroeconomic aggregates of the US economy in 2013. Corporate profits (net of capital depreciation and interest payments) account for 14.5% of US national income, or $2.1 trillion. This figure includes $1.7 trillion of domestic profits, plus $650 billion of profits made by foreign firms owned by US residents (mostly subsidiaries of US corporations), minus $250 billion made by domestic firms owned by foreigners. Close to a third of US corporate profits (650/2,100), therefore, are made abroad.

  Where do the $650 billion of foreign profits come from? The balance of payments provides a country-by-country decomposition of this total: according to the latest available figures, 55% is made in six low- or zero-tax countries: the Netherlands, Bermuda, Luxembourg, Ireland, Singapore, and Switzerland (fig. 8). Not much production or sale occurs in these offshore centers; very few workers are employed there—profits appear in Bermuda by sheer accounting manipulations. Since foreign profits account for a third of all US corporate profits, and tax havens for 55% of their foreign profits, the share of tax havens in total US corporate profits reaches 18% (55% of a third) in 2013. The use of tax havens by US firms has steadily increased since the 1980s and continues to rise.

  By my estimate, the artificial shifting of profits to low-tax locales enables US companies to reduce their tax liabilities, in total, by about $130 billion a year. Surveys of US multinationals conducted by the Bureau of Economic Analysis show that US firms pay a negligible 3% in taxes to foreign governments on the profits booked in the main low-tax jurisdictions displayed in figure 8. In the United States, contrary to what happens in most other countries, profits become taxable at a rate of 35% when they are repatriated (with a credit for all foreign corporate taxes previously paid). But in practice, there are few incentives to repatriate. The funds retained offshore can be used to purchase foreign companies, secure loans, pay foreign workers, and finance foreign investments, all of this without incurring US taxes. An even more extreme scenario is possible: firms that would like to use their accumulated earnings trapped offshore as they so wish can merge with foreign companies, in order to change their tax residence and avoid the US law, or what is known as a “tax inversion.”

  Figure 8: The share of tax havens in US corporate profits made abroad. Note: The figure charts the share of income on US direct investment abroad made in main tax havens. In 2013 total income on US direct investment abroad was about $500 billion, 17% coming from the Netherlands, 8% from Luxembourg, and so on.

  Source: Gabriel Zucman, “Taxing Across Borders: Tracking Personal Wealth and Corporate Profits,” Journal of Economic Perspectives 28, no. 4 (2014): 121–48.

  In 2004 Congress granted a repatriation tax holiday, letting multinationals bring their foreign profits back home if they paid a rate of 5.25%. The holiday failed to increase domestic employment, investment, or R&D;33 it also boosted the foreign profits retained by US firms in tax havens. Today only a tiny fraction of the profits recorded by US firms in Bermuda and similar havens are brought back to the United States, and this share is falling with expectations of new holidays. In the end, not only do the profits made in the main havens bear negligible foreign taxes; they also mostly go untaxed by the Internal Revenue Service. Since they account for almost 20% of all US corporate profits, profit shifting to low-tax jurisdictions reduces the tax bill of US companies by close to 20%—or $130 billion annually.

  The Decline in the Effective Corporate Tax Rate of US Firms

  A direct consequence of the increased use of tax havens is that the effective tax rate paid by US firms is declining fast. The effective corporate tax rate is the ratio of all the corporate taxes paid by US firms (to US and foreign governments) by US corporate profits. Despite the fact that the nominal income tax rate in the United States has remained constant at 35%, the effective rate has fallen from 30% in the late 1990s to barely 20% today (fig. 9).

  Figure 9: Nominal and effective corporate tax rates on US corporate profits. In 2013 of $100 of corporate profits earned by US residents, on average $16 is paid in corporate taxes to the US government (federal and state) and $4 to foreign governments.

  Source: Gabriel Zucman, “Taxing Across Borders: Tracking Personal Wealth and Corporate Profits,” Journal of Economic Perspectives 28, no. 4 (2014): 121–48.

  Granted, not all that decline should be attributed to increased tax avoidance. Some changes in US laws have narrowed the tax base, like the introduction of a deduction of manufacturing income, or “bonus depreciation” during and in the aftermath of recessions; there is also a growing number of businesses in the United States, known as S-corporations, which are legally exempt from paying any corporate tax at all. But after factoring in all these changes, about two-thirds of the decline in the effective corporate tax rate since 1998 can be attributed to increased tax avoidance through low-tax jurisdictions.

  The cost of tax avoidance by US firms is borne by both the United States and other countries’ governments. Much of Google’s profit that is shifted to Bermuda is earned in Europe; absent tax havens, Google would pay more taxes in France and Germany. On the other hand, some US corporations also use tax havens to avoid taxes on their US-source income. With national accounts data, it is hard to know which government loses most. In both cases, US shareholders win. Since equity ownership is very concentrated, even after including the equities owned by broad-based pension funds, so too are the benefits.

  Accounting manipulations do not just cost governments a lot. They also cause basic macroeconomic statistics to lose significance, with adverse consequences for financial regulation and stability. The national accounts of Ireland, for example, are seriously contaminated by the trickery of multinationals. First, in the balance of payments: to shift their profits to the island, where they are taxed at only 12.5%, companies have their Irish branches import at low prices and export at artificially elevated prices—which results in an amazing trade surplus for Ireland of 25% of GDP! This surplus has nothing to do with any sort of competitive advantage; it doesn’t benefit the Irish population at all: it is entirely paid back to the foreign owners of the firms that operate in Ireland, so that Irish national income is only 80% of Irish GDP. Manipulations of transfer prices then massively distort the share of each factor of production (capital and labor) in corporate value added: the artificially elevated profits booked by foreign-owned firms make the capital share rise to more than 50% in sectors where immaterial capital is large, as in the pharmaceutical industry.

  A Twenty-First-Century Tax on Companies

  What is to be done? The current approach of the OECD and G20 countries consists of trying to reform the existing system by strengthening transfer-pricing regulations.34 The first efforts began in the second half of the 1990s, and yet the trend toward more widespread use of tax havens by US multinational companies has shown no particular sign of slowing down since then. The current approach, therefore, does not seem very promi
sing. When it comes to manipulating transfer prices, companies will always be far ahead of the controllers, because their means are greater: the tax department of General Electric alone employs close to a thousand individuals. More resources granted to tax authorities might help curb tax avoidance. But in the United States, IRS funding is actually on a downward trend, and, besides, there is a real risk that increased spending by tax authorities would trigger even bigger corporate expenses, leading to no extra revenue and a true loss for the collectivity.

  We need a radical reform of corporate taxation. A promising solution consists in starting from the global, consolidated profits of firms, which cannot be manipulated. To attribute profits to the different countries necessitates the use of an apportionment formula, perhaps some combination of sales, capital, and employment. For instance, if Starbucks makes half of its sales, has half of its capital and workers in the United States, then half of its profits would be taxable there. Ideally, the formula should be such that the location of profits cannot be manipulated. One way to achieve this is to attribute a substantial weight to the amount of sales made in each country, because companies have no control over that: they cannot move their customers from the United States to Bermuda! Once the profits are attributed to various countries, each remains free to tax them at the rate it wishes.

  Even if the magical formula has not yet been invented (and probably doesn’t exist), we can still understand the advantage of such a system: a tax that starts for the worldwide, consolidated profits of firms and apportion them to each country would render the manipulation of transfer prices meaningless. According to the estimates we have, we can thus expect an increase of 20% of the taxes paid by US (and probably other countries’) companies. And multinationals themselves would save a lot of money, as they would no longer have to pay billions of dollars to find out how to make their profits appear in Ireland or Singapore while minimizing the legal risks. Only the firms specialized in tax optimization would lose in this; they would have to convert themselves into socially useful entities.

  Is a tax on global profits utopian? Not at all. Comparable systems already exist on a regional level. This is how the state corporate taxes work in the United States: profits of US firms are calculated on a national level, then attributed to the different states using a formula that is difficult to manipulate—each state is then free to choose the rate at which it wishes to tax. The European Commission proposes an analogous solution for the EU, through its CCCTB (Common Consolidated Corporate Tax Base) project. Brussels has retained a simple apportionment formula, in which sales, salaries, and capital each count for a third. The Commission has had the good idea to exclude immaterial capital from its formula, to the great distress of consulting companies that specialize in optimization, and which thus see themselves deprived of their favorite pastime, the sending of patents, labels, and logos to offshore centers. The formula penalizes tax havens—where there are few sales, workers, or material capital—to the benefit of the large countries of continental Europe. The main problem is that at this stage the proposed plan is optional—each company may choose, if it wishes, to remain subject to the existing national taxes, whereas the plan should be made obligatory.

  The United States and Europe will thus soon each have their own tax on companies that will function on a consolidated base, and not state by state. There is nothing unrealistic in envisioning their fusion. The EU and the United States are currently discussing the establishment of a zone of transatlantic free trade. The creation of a common base for the taxation of companies should appear at the top of the agenda in these negotiations. To prevent accounting manipulations and widespread avoidance, we must put fiscal questions at the center of trade policies.

  There is no reason to wait: while the creation of a global financial register requires a high degree of cooperation, the United States and Europe can advance alone in reforming the taxation of companies. It is up to them to choose the way in which they wish to tax multinationals. An EU-US accord would build the foundation for a global base of taxation that would put an end to the large-scale shifting of profits to tax haven countries.

  Conclusion

  This book brings to light the concrete ways in which tax evasion by wealthy individuals and multinationals takes place. It calculates the cost for governments—that is, for us all—and above all proposes means to put an end to it.

  Europe is in the midst of an interminable crisis. Many believe that they see in it the sign of an irreversible decline, but they are wrong. The Continent is the richest region in the world, and this is not going to change anytime soon. The private wealth there is greatly superior to the public debt. And, contrary to what we often believe, that wealth is taxable. The profits go to Bermuda, but the factories do not. The money hides in Switzerland, but it is not invested there. Capital does not move; it can simply be concealed. Europe is stealing from itself.

  But this spiral can be reversed. Thanks to a global financial register, to an automatic exchange of information, and to a new way of taxing multinational companies, fiscal dissimulation can be stopped. Is this utopian? This is what most experts said of automatic exchange only five years ago, before rallying for it as a single voice. There are no technical obstacles to the measures I propose. The resistance from tax havens is not insurmountable, either: it can be broken by the threat of proportional trade sanctions.

  Although solutions exist, governments have not been stellar up to now in their boldness or determination. It is thus high time to make them face up to their responsibilities. It is up to the citizens to mobilize, in Europe and perhaps above all in the tax havens. I don’t believe that the majority of the inhabitants of Luxembourg—hardly 50% of which voted in the last elections—approve of the capture of the Grand Duchy by offshore finance. Nor do most Swiss accept the active aid that their bankers provide the billionaires who go there to avoid their fiscal obligations. To turn the page on large-scale fraud, the battle that must be fought is not just a battle between governments. It is above all a battle of citizens against the false inevitability of tax evasion and the impotence of nations.

  Notes

  1. These data are gathered on the website www.gabriel-zucman.eu. This site provides details on all the calculations on which the results presented in this book are based. Numbers, tables, graphs: all can be verified and reproduced to the letter. This work is largely the result of four years of rigorous, but certainly not definitive, research, which formed the basis of my PhD dissertation: Gabriel Zucman, “Three Essays on the World Distribution of Wealth” (PhD diss., Paris School of Economics, EHESS, 2013). I thank in advance readers who wish to send me their reactions, criticism, and suggestions to improve my approach.

  2. See Malik Mazbouri, L’Émergence de la place financière suisse (1890–1913) (Lausanne: Antipodes, 2005).

  3. Thomas Piketty and Gabriel Zucman, “Capital Is Back: Wealth-Income Ratios in Rich Countries, 1700–2010,” Quarterly Journal of Economics 129, no. 3 (2014).

  4. “Keeping Mum,” Economist, February 17, 1996, p. 90.

  5. Sébastien Guex, “The Origin of the Swiss Banking Secrecy Law and Its Repercussions for Swiss Federal Policy,” Business History Review 74, no. 2 (2000).

  6. Marc Perrenoud et al., La place financière et les banques suisses à l’époque du national-socialisme: Les relations des grandes banques avec l’Allemagne (1931–1946), publication of the CIE, vol. 13 (Paris: Chronos/Payot, 2002), p. 98.

  7. Janick Marina Schaufelbuehl, La France et la Suisse ou la force du petit (Paris: Presses de Sciences Po, 2009). On false certificates, see pp. 274–90 in particular.

  8. Michael Findley, Daniel Nielson, and Jason Sharman, “Global Shell Games: Testing Money Launderers’ and Terrorist Financiers’ Access to Shell Companies,” working paper, Centre for Governance and Public Policy, Griffith University, 2012, http://www.gfintegrity.org/wp-content/uploads/2014/05/Global-Shell-Games-2012.pdf.

  9. Gabriel Zucman, “The Missing Wealth of Nations: Are Euro
pe and the U.S. Net Debtors or Net Creditors?,” Quarterly Journal of Economics 128, no. 3 (2013).

  10. The estimate of $2.5 trillion includes $100 billion incorrectly recorded by the SNB as belonging to Switzerland. The exact figure could be much higher, on the order of several hundreds of billions of dollars.

  11. All details are available online in the appendix to chapter 1 at www.gabriel-zucman.eu.

  12. For a detailed description of my method, see Gabriel Zucman, “The Missing Wealth of Nations: Are Europe and the U.S. Net Debtors or Net Creditors?,” Quarterly Journal of Economics 128, no. 3 (2013), and the online appendix at www.gabriel-zucman.eu.

  13. Philip Lane and Gian Maria Milesi-Ferretti, “The External Wealth of Nations Mark II: Revised Estimates of Foreign Assets and Liabilities, 1970–2004,” Journal of International Economics 73 (2007).

  14. Ferdy Adam, “Impact de l’échange automatique d’informations en matière de produits financiers: Une tentative d’évaluation macro-économique appliquée au Luxembourg,” Statec working paper no. 73, 2014.

  15. James S. Henry, “The Price of Offshore Revisited: New Estimates for ‘Missing’ Global Private Wealth, Income, Inequality, and Lost Taxes,” Tax Justice Network, July 2012, http://www.taxjustice.net/cms/upload/pdf/Price_of_Offshore_Revisited_120722.pdf.

  16. Ruth Judson, “Crisis and Calm: Demand for U.S. Currency at Home and Abroad from the Fall of the Berlin Wall to 2011,” IFDP working paper of the Board of Governors of the Federal Reserve System, November 2012, http://www.federalreserve.gov/pubs/ifdp/2012/1058/ifdp1058.pdf.