Four Futures for International Tax Rules

This post was first published on Views from the Center.

Consensus on the reform of international tax rules may be splintering under the combined pressures of post-crisis austerity and revelations about cut-throat tax ‘competition’ (see my discussion on thishere). In light of this, I sketch out four possible directions for international rules and one major trend common to all, and then assess the likely implications for developing countries.

1. Staying the BEPS course

The Base Erosion and Profit Shifting initiative (BEPS), led by the OECD at the behest of the G-8 and G-20 countries, aims to create better alignment between multinational profits and the location of their actual economic activity. The OECD’s remit, set out in a detailed action plan, is to deliver progress in a set of largely discrete areas to make the current system function better.

The BEPS approach rests on a commitment to “arm’s length pricing” (ALP) for transactions among members of the same multinational group, which is intended to give rise in turn to the real (market-equivalent) distribution of profit across the group. Setting aside whether this is an economically sensible way of looking at a group of related parties with common control, the approach simply may not be consistent with the aim – there is no evidence to suggest that ALP, if effective, would necessarily align profit with economic activity.

The UK’s proposed ‘diverted profits tax’ embodies the challenge for BEPS. Despite playing an important role in bringing BEPS into being, the UK government’s frustration with the inability of ALP to deliver politically acceptable taxation of major multinationals has led it to take a quite different tack: in effect, to require explicitly some degree of alignment of profits and activity (sales).

Will leading states maintain their commitment to the OECD approach? The answer may depend on a return to stronger economic performance, and the easing of broader fiscal pressure. Continuing anaemic growth may lead to continuing political pressure and proliferation of work-around measures like the Google tax that cut across the ALP by requiring some alignment of profits and activity.

2. A bigger fix for BEPS

A more consensual future for BEPS can also be envisaged (hat tip to a necessarily anonymous official at a major ministry of finance), involving a rather broader fix but maintaining the fundamental nature of the current system.

This would involve countries signing up to three basic principles, which it has been suggested could eliminate 90 percent of the BEPS problem in one stroke:

  • A common tax base (so there is no incentive for arbitrage on the base)
  • Minimum tax rates (limiting, though not eliminating, the incentive for arbitrage on rates)
  • Elimination of preferential regimes (such as the patent box)

This would require a substantial shift in perceptions of the problem. Since some policymakers see this type of harmonization as a threat to sovereignty, progress seems likely only if such a view is eclipsed by the perception of tax ‘competition’ as the greater threat.

3. Unitary tax revolution

The most dramatic change conceivable would involve broad agreement to adopt the major alternative to the ALP, which is unitary taxation with formulary apportionment. In other words, the new approach would take the multinational group as the unit for taxation purposes, rather than individual companies within it, and apply a formula based on the location of economic activity to apportion the group’s tax base between different jurisdictions, where each may apply whatever level of tax they choose.

Given this approach is explicitly designed to align profits with economic activity, progress towards the agreed aim of the BEPS initiative is highly likely, and would benefit lower-income countries. While pressure for lower rates might build over time, the increase in tax sovereignty – the ability to make policy changes that matter – would remain.

However, political opposition has hindered the prospect of a global agreement to rip up the rules and start afresh. EU attempts to move towards an apportionment basis under the Common Consolidated Corporate Tax Base project appear stalled, and major powers like the US (despite its largely positive experience using unitary taxation among its own states), and the vast bulk of the multinational and accounting sectors continue to oppose, rendering a revolution unlikely in the medium term at least.

4. Unitary tax evolution

A more likely scenario is one where the current system evolves gradually towards something more consistent with unitary taxation (UT). There are two main, complementary channels through which this could occur.

First, continuing dissatisfaction with the ALP – and the sense that developing countries’ concerns are not well reflected in BEPS – may give rise to a breakaway. Developing countries will soon be able to examine country-by-country reporting from multinationals operating in their jurisdiction, which will highlight the misalignment between the shares of activity hosted and shares of profits declared.

A single developing country or a regional grouping could reach a tipping point and decide to switch unilaterally to taking as tax base some formulary apportionment of the global profit. The demonstration effect could be powerful and drive others to follow suit.

The second channel is even more gradual. It involves the ongoing growth in the diversity of methods allowed under OECD rules and the use of methods that include some profit attribution on the basis of activity, as distinct from any ALP or other pricing decision.

Between the two channels, the world seems likely – ceteris paribus – to move at least a little further in this direction over time. Again, this scenario would offer the possibility of greater tax sovereignty for many developing countries.

Development prospects and a common trend

Lower-income countries obtain, on average, much smaller shares of GDP in corporate tax revenue. In no small part this is due to a combination of limits to states’ technical capacity and negotiating power with large multinationals, and to the incentives that the international system provides for profit-shifting. As such, the four futures can be considered in terms of their likely impact on these two factors.

Source (columns A and B): McNabb & LeMay-Boucher, 2014; data from ICTD Government Revenue Dataset.

The BEPS course (future 1) address specific weaknesses in the rules, which may reduce profit-shifting incentives somewhat, but at a broader level will do little to diminish the complexity of rules that make technical capacity such a constraint. The ‘bigger fix’ (2) offers the possibility of greatly reduced incentives for multinationals, and so could have an appreciable benefit.

The unitary revolution (3) could change the power dynamic for lower-income countries entirely, both in relation to multinationals but also vis-à-vis higher-income countries – but partly for this reason is an implausible scenario. Evolutionary steps towards UT (4), however, seem likely, and have the potential to sharply reduce the importance of capacity constraints and to change the balance of negotiating power also.

In fact, the common trend in all four futures is in this direction. The presence of country-by-country reporting information, now established as OECD standard, provides a simple risk mechanism by allowing a check on the profit misalignment of each taxpayer. Any tax authority requiring this information from multinationals will be in a position, regardless of the range of possible outcomes under ALP (or directly under UT), to set effective limits on the extent of profit misalignment that they are willing to accept. This has the potential to change the relative negotiating power of even the least well-resourced tax authorities.

Publishing the data would provide a powerful accountability mechanism for both multinationals and tax authorities, in respect of each other and for civil society; but even held privately, this is information that can support substantial change. Not all transparency is equal; in this particular case, information is indeed power.

#Luxleaks: The Reality of Tax ‘Competition’

This post was first published on Views from the Center.

Aside from lurid revelations about individual companies and the big four accounting firms, the leaks of multinationals’ tax deals with Luxembourg confirm­—and expose to a wider audience­—the true nature of the tax ‘competition’ that prevents the emergence of effective international rules.


The International Consortium of Investigative Journalists published the second tranche of leaked files, showing tax agreements the big four accounting firms reached, on behalf of their clients, with Luxembourg. The general pattern is of establishing internal corporate finance companies in Luxembourg and using these to shift in billions of dollars of profits earned elsewhere, after obtaining confidential rulings from officials that ensure a very low effective tax rate — in many cases less than one percent.

The ICIJ’s reporting and detailed analysis of documents on individual companies from Disney to IKEA is outstanding. It clearly shows a systematic pattern of behaviour in Luxembourg, and adds to a range of other evidence suggesting the pattern is systematic across multiple jurisdictions.

Widespread tax base poaching

Several recent examples show other countries doing deals knowingly to shift in, and not (fully) tax, profits that arose elsewhere. The European Commission has initiated proceedings against Ireland for allegedly providing “State Aid” to Apple since the 1990s through unjustifiably beneficial tax treatment. This had effectively capped the level of profit Ireland would recognize as tax base, leaving untouched the vast majority of profit shifted in. Meanwhile, a more formalized version of this approach dating back 10 years, Belgium’s system of ‘excess profits rulings’, has also come under scrutiny.

In all three cases­—Luxembourg, Ireland, and Belgium—the pattern is consistent. Companies, through their big four accounting firm advisers, have obtained advance agreement not to tax profits that arise, but are not taxed, elsewhere.

A less blatant but increasingly common instrument is the patent box, or knowledge box, which provides a very low tax rate in relation to R&D. There are already generous tax breaks for R&D in most countries. A patent box can, controversially, allow one country to capture the tax base associated with the R&D that was supported by taxpayers in another.

Such tax incentives for intellectual property exist in Belgium, Cyprus, France, Hungary, Ireland, Luxembourg, Netherlands, and Spain.  In addition, the UK, which had introduced the measure from 2013, recently bowed to German pressure to phase it out (albeit not fully until 2021). The decision came after initially resisting, along with Luxembourg, Netherlands, and Spain, the suggestion that the tax break should only apply to R&D actually carried out in the country offering the patent box.

Google tax

Less than a month after its compromise over the patent box tax break, the UK government proposed a measure designed to protect its own tax base against similar poaching. The ‘diverted profits tax’ (DPT), now subject to public consultation, seeks to ensure profit arising from sales in the UK do not escape taxation by claiming to have no permanent establishment in the UK, nor through ‘certain arrangements which lack economic substance’. Perhaps unsurprisingly, given criticism of theapparent disconnect between Google’s UK profitability and tax payments, media are calling the measure the ‘Google tax’.

The expected revenue impact is small. Despite a marginally penal rate of 25 percent (compared to a standard 21 percent), the forecast is to raise around £1.3 billion over five years. The highest forecast annual take of £350 million implies a base of £1.4 billion of ‘diverted’ profits, which is equivalent to just 1.4 percent of the most recent quarterly UK corporate profits. (The basis for these estimates hasnot been published.)

The change of direction may nonetheless be important. During his announcement of the DPT, UK Chancellor George Osborne stressed “the government’s commitment to an internationally competitive tax system.” However, the DPT reflects an understanding that, too often, countries are competing not to attract real economic activity but only the taxable profit that arises from activity taking place in another jurisdiction.

The tension between playing this game, while trying to limit the counter-success of others, in large part explains the failure to develop more effective international rules – and hence the tilting of benefits towards multinationals rather than to (especially lower-income) states. Still, pressure is growing, and the eventual direction of travel will have important implications for developing countries. A companion post explores future scenarios for international tax rules, and the implications for developing countries.

Welcome to Uncounted

Film trailer voiceover voice:

Imagine a world of such structural inequality that even the questions of who and what get counted are decided by power.

A world in which the ‘unpeople’ at the bottom go uncounted, and so too does the ‘unmoney’ of those at the very top. Where the unpeople are denied a political voice. Public services. Opportunities. And the unmoney escapes taxation, regulation and criminal investigation, allowing corruption and inequality to flourish out of sight.

This is the world we live in. This is Uncounted.

What links a samizdat publication in turn-of-the-century Khartoum, the liquidation of a Scottish football club, a Burmese mobilisation for the US census, the Swiss role in supporting apartheid, a campaign around UK learning disabilities and Thomas Piketty’s proposal for a global financial registry? The common thread is the relationship between power, inequality and being uncounted – a relationship that demands we pay much more attention to who and what are counted and not.

We may pride ourselves on being the generation of open data, of big data, of transparency and accountability, but the truth is less palatable. We are the generation of the uncounted – and we barely know it.

Counting is fundamentally political. Decisions about what and who to count not only reflect unequal power, they are also a major driver of inequalities. Our failure to acknowledge and challenge these automatic tendencies means that we unthinkingly facilitate them.

There are two major elements to the uncounted: that which is uncounted because of a lack of power, and that which is uncounted because of an excess of power. In addition, the category of that which is only counted in private has its own power dynamics. Policy implications vary according to the context and the type of uncounted – but there are some very clear channels if we decide – as we surely must – to address the problem head-on.

This site will include semi-regular blogging (that may eventually result in a book) on these issues and others, along with related publications and data as they appear. There’s also a particular space for the Palma: a measure of inequality, developed with Andy Sumner on the basis of Gabriel Palma‘s analysis of the income distribution.

[NB. This post will also live at ‘About Uncounted‘, for ease of location.]