The inaugural Tax Justice Research Bulletin

January 2015. Over at the Tax Justice Network, we’ve just launched the inaugural Tax Justice Research Bulletin, the first of a monthly series dedicated to tracking the latest developments in policy-relevant research on national and international taxation.

This issue looks at a new paper using the longest series of tax data that exist for any one country (challenges to this very welcome!), and an article on property taxation in Africa. The Spotlight section focuses on inequality and redistribution – including an important study from UN-DESA, Joe Stiglitz’s take on Piketty, and answers to that question you’ve been quietly pondering: just how much could you tax the 1%?

It’s a work in progress so any comments on the format, content etc, or suggestions for future research to include, would be most welcome.

30/01/2015

150 years of tax data!

Republished from the Tax Justice Research Bulletin – find it all there, with added blues.

Sweden’s IFN (the Research Institute of Industrial Economics) has undertaken a fascinating project, to bring together and to analyse what seems to be the longest single-country span of tax data ever compiled. Published this month is the overview paper, by IFN researchers Magnus Henrekson and Mikael Stenkula. There’s a wealth of insight in it, and the individual papers that it draws upon, so I’ll just pick out a couple of points here.

First, the Swedish system has seen major swings over time in both structure and scale. The authors identify three major stages: a low and stable tax-to-GDP ratio until around 1930, with consumption taxation the major component; sharply increasing tax-to-GDP to around 50% and then stable until 1990, with income taxes important, and VAT and social security contributions increasingly so; and then a declining tax-to-GDP ratio post the 1990–1991 reforms, with income taxes decreasing, wealth and inheritance and gift taxation abolished, and a growing relative reliance on consumption tax and social security contributions.

The second broad point that emerges very clearly is that the type of tax headings I’ve just used are not always helpful, especially in long-term analysis. The consumption tax revenue pattern in figure 3 conceals the same shift seen in most developing countries, albeit compressed into the last few decades, of customs duties being less than fully replaced by general consumption taxes (with possible though uncertain regressive impact). In Sweden’s case, there has also been a major reduction in revenues from ‘specific’ consumption taxes (sin and luxury taxes in particular).

Two areas in which the research could be usefully extended are to consider the associated developments in inequality (see Spotlight below), and in political representation. The latter is a slightly odd omission, where the authors motivate the work by setting out the other four of the five Rs of taxation.

But this is quibbling, of course. The paper, and the project, represent exactly the type of work that, as Morten Jerven has pointed out, is necessary to complement the improvement in cross-country data represented by the ICTD’s Government Revenue Dataset. It would be valuable for the authors to share further details on the process and resource demands of the project, as an input to others considering the same in other countries.

30/01/2015

Inequality: How much to tax the 1%?

Republished from the Tax Justice Research Bulletin – find it all there, with added blues.

UN-DESA’s Pierre Kohler has produced a really useful and broad – yet far from shallow – overview, ‘Redistributive Policies for Sustainable Development: Looking at the Role of Assets and Equity’. Part of the basis is figure 3 on the left, which shows the extent to which redistribution has remained relatively static in the facing of rising market inequality – leaving final inequality to mirror that rise. But Kohler’s real focus is on the distinction between stock inequality (in e.g. land and capital), and flow inequality (in derived income streams). The paper draws on the work of Piketty and related researchers, and the main distributional databases, to establish the base from which a relatively comprehensive analysis of main policy areas is then constructed. Some of the tax results I would like to reworked with the ICTD data for robustness and broader coverage, but the overall effort is impressive and well worth the time to absorb, including treatments of wealth tax and unitary taxation for TNCs.

The paper also goes beyond the increasingly criticised Gini measure of inequality, making me happy with references to the Palma ratio and also covering some of the literature on the top 1%. The latter’s correlation with top marginal tax rates, and the absence of correlation between those rates and growth, is striking. Indeed, it begs the question, how highly could the top 1% be taxed without negative economic effects? A life-cycle model published last year concluded that “significant welfare gains [arise] from increasing top marginal labor income tax rates above 80%… and that these gains outweigh the macroeconomic costs” (Kindermann & Krueger, 2014: 19).

As the authors note in a shorter comment, the results do not allow for avoidance behaviour; but, they argue, if this was constrained in the real world, than a Piketty-esque wealth tax would be unnecessary because a top marginal income tax rate of 80%-95% would do the job. Of course, Piketty’s own paper (with Saez and Stantcheva) does allow for avoidance, and uses detailed empirical work on elasticities to find that the revenue-maximising top tax rate for plausible scenarios ranges between 62% (full tax avoidance scenario, where any e.g. policy-led reductions in avoidance change the elasticities and raise the optimal tax rate) and 83%.

Finally, Joe Stiglitz has taken on Piketty from a progressive perspective, arguing that the latter’s analysis of growing wealth concentration fails to capture a major part of the dynamic: not increases in capital but rather rises in the value of existing assets urban land, driven by factors outside the owners’ control (i.e. rents). [I have a hard copy of the paper from December’s fantastic Columbia conference, and it is referenced in interviews – but I haven’t found a published version online yet; will link when I do.]

30/01/2015

Property tax potential

Republished from the Tax Justice Research Bulletin – find it all there, with added blues.

In a new article for the Africa Research Institute, ‘How Property Tax Would B e nefit Africa’, Nara Monkam (ATAF) and Mick Moore (ICTD) provide a useful overview of the current state of play, while making the case for a greater role for property tax – not least because of its potential in respect of accountability. Unsurprisingly, the continent contains a ‘spaghetti soup’ of different approaches to property tax, operated by various tiers of government, and with widely varying revenue importance. The ‘soup’ includes specifically land value taxes (LVT), as well as those focused on buildings, and many combinations thereof. Property tax potential

Two complementary avenues for improvement are identified. Investment in administrative capacity, most obviously through (re)building cadastres, digitising ownership records and harmonising with other databases such as utility company records, is vital. (And far from being a low-income country problem only – see for example Andy Wightman’s sweeping work on Scottish land, The Poor Had No Lawyers.) But also necessary is a hefty dose of political will. The authors compare 3 Sierra Leone city councils to illustrate the point:

In Bo, 93% of business owners surveyed in 2012 were able to produce a property tax receipt and 87.5% believed that local elites were successfully prosecuted for non-compliance. In Makeni and Kenema, however, only around 40% were able to produce a receipt, and just 30% were confident of successful prosecution. All three cities had demonstrated rapid revenue gains, but in Makeni and Kenema annual increases stagnated as elites proved resistant to the tax, while the municipal authorities in Bo made further progress due to sustained political will.

Monkam and Moore conclude: “The future of African national and municipal governments will depend on institutions and tax policy that are equitable, improve local service delivery and encourage compliance through establishing a social contract between taxpayers and the state. Property tax is one of the more effective means of realising these goals.”

I tend to agree, though I think we’re still short of definitive evidence for that last statement. In some ways this article highlights the dearth of rigorous research on which to draw – but it’s certainly building, and the case for greater research focus (at least) on property tax is clear. One area of particular caution: there is evidence that property taxes at sub-national levels are often regressive (see e.g. ITEP’s report this month on the US), albeit less than consumption taxes. Issues of political commitment therefore go beyond whether elites comply or not, to whether a progressive design (quite possibly LVT) can be put in place and maintained.

17/12/2014

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.

17/12/2014

#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.

#Luxleaks

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.