international tax – Page 3

01/06/201501/06/2015

Tax professionals: Who makes the international rules?

From the Tax Justice Research Bulletin 1(5).

Last month, TJRB 1(4) looked at the OECD’s review of research on base erosion and profit-shifting (BEPS) by multinational enterprises (MNEs). That review revealed a dearth of findings in a number of areas, as well as broad consensus on the importance of the problem. Untouched in that review, and little researched in generally, is the process by which policy on BEPS is made.

The historical record, back to the League of Nations and beyond, has been laid out by Prof. Sol Picciotto. Sol, one of our senior advisers, now leads the BEPS Monitoring Group, the hub for technical submissions to BEPS from civil society. And the BEPS process itself has now been subject to a detailed process analysis, in a seriously impressive Copenhagen Business School Master’s thesis by Rasmus Corlin Christensen.

The main focus is on BEPS 13, which deals with transfer pricing documentation including country-by-country reporting (CBCR), and the findings reflect many interviews as well as analysis of submissions and consultations. The summary of literature, and detail of the methods, are well worth the time.
Figures 1 and 2 show the simple range of submissions to BEPS 13, in terms of organisation type and geographical origin. There’s little surprise to find that less than 10% of submissions came from academia and civil society; and even less from South America, Africa and Asia combined.

Similarly, figures 3 and 4 confirm that business groups and professional services firms expressed preference for much more restricted transfer pricing documentation than did academia or civil society. Figure 5 shows tax practitioners with the greatest intra-group variation of views expressed, compared to other private sector groupings, with business lobbies the least; while academia provided the most varied range of views, and civil society the least. The latter point is perhaps unsurprising given the technical nature of the process (hence relatively limited engagement); and that BEPS 13 addresses an area in which civil society consensus has emerged over a decade or so. {Indeed, the content of BEPS 13 is in good part a product of successful influence by civil society in non-specialist, political processes, not least in the UK – but that would be a whole other study.}

The analysis goes to a much more detailed level, tracing the paths of leading individuals in the process, identifying ‘professional competition’ as a key factor, where “influence in highly technical policy discussions is contingent upon expertise (being able to speak authoritatively) and networks (being listened to)… I distinguish two types of influential professional: career diverse professionals (“octopuses”) and well-connected specialists (“arrows”). The former are influential because of their varied expertise, the latter because they are respected through key tax/transfer pricing networks.” In figure 16 (click to expand, as ever), the red dots indicate organisations with a ‘managing professional’ who is influential in the process.

The full thesis contains a great deal more, including on the career paths of influentials. These are just some of the broad conclusions:

[A]nalysis of the BEPS Action 13 consultation shows that it was dominated by Western tax advisers and business representatives, that there was a general preference for a limited [transfer pricing documentation] package, and that there was significant variation in attitudes between similar participating organisations. Furthermore, the discussions were highly complex, requiring substantial technical expertise, and thus limiting the range of participating organisations… Looking at the pool of BEPS Action 13 professionals’ expertises, I find that while legal and private sector views are important in the reform, several other expertises are also relevant, signifying the need for varied expertise in order to obtain policy influence…

Finally, the significance of access to the right expertise and networks is visible in another articulation of professional competition in BEPS Action 13: lobby centres. Lobby centres are specific interest groups where different professionals and organisations collectively engage the policy process, spearheaded by one particular professional, who most often is influential. Peripheral professionals and groups without access will use this lobbying strategy to leverage the expertise and networks of influential professionals. This strategy highlights the importance of being able to access the right professional expertise and networks in order to make engage successfully in policy debates. However, this importance is not sufficiently recognised by the interest group literature, which emphasises organisational finances or issue attributes.

01/06/201501/10/2015

IMF: developing countries’ BEPS revenue losses exceed $200 billion

Update 1 October 2015: A revised version of the IMF paper has now been posted – see additional discussion at the bottom of this piece.

From the Tax Justice Research Bulletin 1(5).

For as long as there has been civil society attention to issues of tax justice, there have been calls for the international financial institutions to provide analyses of the scale of various aspects of the problem. Raymond Baker has been particularly heroic in pursuing the World Bank and IMF to produce estimates of illicit flows to complement or challenge those of Global Financial Integrity. Long-term leader among bilateral donors, Norway even managed to seal a deal with Robert Zoellick to pay for his World Bank to produce such an estimate – only for a senior Bank staff revolt led him to reverse course and deliver only a volume of work by outside authors.

While there are still no takers for estimates of the full breadth of illicit financial flows, the last year has seen a growing willingness to come up with big numbers for the scale of revenue losses due to the tax behaviour of MNEs. In addition to unpublished estimates by OECD researchers (I could tell you but…), UNCTAD have prepared an estimate that one type of tax dodge (thin capitalisation via a small number of opaque jurisdictions) resulted in the manipulation of declared returns in developing countries, producing a revenue loss of around $100 billion p.a. (see also the critique suggesting the estimate should perhaps be nearer $300 billion).

The IMF – where the sole leadership of the OECD in the BEPS process still rankles – has been increasingly active in this area. Its 2014 spillover analysis began by emphasising “the IMF’s experience on international tax issues with its wide membership”, and concluded with the finding that developing countries (i.e. those within the IMF’s remit but not the OECD’s) suffer from spillovers (i.e. tax losses due to behaiour of other jursidictions, and in particular revenue losses due to profit-shifting) that are “especially marked and important.”

In terms of the prospects for BEPS, the IMF was unequivocal: “At issue here are deeper notions as to the ‘fair’ international allocation of tax revenues and powers across countries (which current initiatives do not address)” (p.12); and “Current initiatives, which operate within the present international tax architecture, will not eliminate spillovers” (p.35).

Now researchers at the IMF’s Fiscal Affairs Dept (FAD) have published a new study. Where the 2014 paper relied primarily on data on US MNEs, the currrent analysis uses the internal FAD dataset on tax revenues (unpublished, but thought to be not a million miles, at least in the approach used, from the ICTD Government Revenue Dataset). Figure 2 shows we’re on course for a near-halving of corporate income tax rates over 35 years.

The aim of the analysis is to understand the impact of CIT rates (domestic and foreign) on individual countries’ corporate tax base. The authors use the difference between ‘tax havens’ and non-havens to shed a little light on the relative importance of base effects that stem from shifting of real economic activity, as against profit-shifting. An interesting additional result, a ‘horse-race’ between the base effects of GDP-weighted and ‘haven-weighted’ tax rates of other jurisdictions, sees only the latter emerge as significant – suggesting “the primacy of avoidance over real effects” (p.18).

The authors also consider the question of the relative scale of effects between developing countries and OECD members (make of that choice of comparator groups what you will). Results for developing countries only suggest that both real effects and profit-shifting “matter at least as much”. And finally, a “simple, albeit highly speculative” revenue assessment produces table 6.

In line, as the authors note, with Gravelle’s (2013) study of US losses, they find a long-run revenue loss for OECD countries of toward 0.6% of GDP (some $500 billion). For developing countries however, the losses are nearly three times as high in GDP terms, exceeding $200 billion. This doesn’t immediately seem inconsistent with the UNCTAD findings of $100 billion lost through thin capitalisation alone – although would certainly seem conservative if there is merit to the critique mentioned that revises this number towards $300 billion.

I’m hoping the authors will be happy to share the code, and to be able to consider a couple of extensions. One could be to use actual effective rates from the US MNE data (which tend to show a sharper fall than other sources find); another to complement the tax haven list approach using the – ahem – Financial Secrecy Index.

Update 15 June 2015: the authors have very kindly shared the code – I’ll update if we get anywhere in extending the approach.

Update 1 October 2015: having been the withdrawn since June, a revised version of the paper has now been posted (hat-tip to Petr Janský). In terms of the summary here, the main changes relate to the calculation of revenue loss estimates. These are now somewhat lower, and expressed with substantially more caution – figure 3 here (click for full size version) effectively replaces table 6 above. Subject to caveats, c.$200 billion revenue losses for developing countries remains the spot estimate.

19/05/201519/11/2018

New publication: The Financial Secrecy Index

The Financial Secrecy Index is the Tax Justice Network’s flagship index of secrecy jurisdictions, or ‘tax havens’. The idea emerged from discussions at the World Social Forum in Nairobi, in January 2007.

In part, it came from frustration with a popular view of corruption as a ‘poor country’ problem – when all the analysis of experts in the Tax Justice Network showed high-income countries as central to financial crime.

And in part, it stemmed from recognition that the lists of ‘tax havens’ compiled by the OECD, IMF and others would never solve the problem – because the subjective, political nature of their processes meant that the jurisdictions left on the list were not the most dangerous, but merely the least powerful (the least able to negotiate their way off).

Since 2009, the Financial Secrecy Index (FSI) has been published biennially as a ranking of major secrecy jurisdictions. It combines a ‘secrecy score’ with a measure of global scale. The secrecy score reflects around 50 measures of financial secrecy, most compiled by international organisations. The scale measure reflects the importance of each jurisdiction in providing financial services to non-residents around the world.

Figure 1 shows how the main lists used have failed to capture the bulk of this activity – in most cases, including jurisdictions which in total account for a smaller share of global activity than the top ten by scale. Indeed, list-based approaches would in general have been more encompassing, and of equivalent financial secrecy, if they had simply listed instead the top ten of the FSI (by the combination of secrecy and scale).

The 2009 G20 was probably the final high point for international policymakers trying to use tax haven lists to make progress. The one attraction was that it used an objective and relevant criterion (number of tax information exchange agreements), but set the bar so low that it was almost immediately depopulated, with no discernible impact – hence the academic assessment as a fairly dismal failure.

Since then, the importance of specific policies as required for progress on the FSI has come to dominate the international agenda (in rhetoric, if not yet in practice) – from automatic information exchange, to public registries of beneficial ownership.

The FSI itself has been used in a whole range of ways, including by central banks and international organisations, by rating agencies and in risk analysis, in a number of other indices, and now increasingly in academic studies.

Now a full paper on the FSI is being published for the first time in a leading academic journal, Economic Geography. To learn more, you can visit Sambla here, but here’s the abstract:

Both academic research and public policy debate around tax havens and offshore finance typically suffer from a lack of definitional consistency. Unsurprisingly then, there is little agreement about which jurisdictions ought to be considered as tax havens—or which policy measures would result in their not being so considered. In this article we explore and make operational an alternative concept, that of asecrecy jurisdiction and present the findings of the resulting Financial Secrecy Index (FSI).

The FSI ranks countries and jurisdictions according to their contribution to opacity in global financial flows, revealing a quite different geography of financial secrecy from the image of small island tax havens that may still dominate popular perceptions and some of the literature on offshore finance. Some major (secrecy-supplying) economies now come into focus. Instead of a binary division between tax havens and others, the results show a secrecy spectrum, on which all jurisdictions can be situated, and that adjustment for the scale of business is necessary in order to compare impact propensity. This approach has the potential to support more precise and granular research findings and policy recommendations.

I was working at the Center for Global Development when this paper was being written, and the ungated version is published in their working paper series.

We hope that the FSI continues now to be used increasingly in research. We know of one major paper on the FSI which is forthcoming, and a number of applications are under discussion. These include the creation of measures of vulnerability to financial secrecy index, which were piloted in Thabo Mbeki’s high level panel report for the Economic Commission for Africa (the figure shows the relative intensity of financial secrecy of the partners for bilateral trade and investment for each country).

We plan a major evaluation of the index after the 2015 edition comes out in November, so we would warmly welcome comments and criticisms of the methodology.

We’re grateful to all who have contributed to the creation and construction of the index over the years, not least John Christensen, Moran Harari, Andres Knobel, Richard Murphy, Nick Shaxson and Sol Picciotto (who may have had the idea first, and certainly provided the whisky that drove the discussion).

And we’re grateful also for important funding to this work from the Ford Foundation, the Joffe Trust, Misereor and Oxfam-Novib; as well as broader support for dissemination and mobilisation from Norway and Christian Aid.

It’s not necessarily easy to fund work that challenges accepted intellectual positions directly. But it can be the only way that policy errors are undone.

18/05/2015

Uncounted: has the post-2015 data revolution failed already?

This was originally posted at the Development Leadership Program. I’m grateful to Cheryl Stonehouse for patient(!) editing.

Counting matters. As the Stiglitz-Sen-Fitoussi report puts it:

What we measure affects what we do; and if our measurements are flawed, decisions may be distorted…. [I]f metrics of performance are flawed, so too may be inferences we draw.

The UN Secretary General was told two years ago by the 2012–13 High Level Panel of Eminent Persons on the Post-2015 Development Agenda that any follow-up to the Millennium Development Goals (MDGs) had to include adata revolution.

In common with the UN global thematic consultation on inequality earlier in 2013, the High Level Panel recognised that challenging inequalities and better data collection are inextricably linked – because better data make it clear which goals are and are not being met, and because with better data we can all demand answers and action.

So the data revolution can only be about changing the balance of power. Yet much of the current discussion emphasizes purely technical reforms instead. Whilst there is nothing wrong with bringing in these new systems, such as those created by Couchbase and similar companies, it is how these technologies are used that should be considered.

I use the term ‘Uncounted‘ to describe a politically motivated failure to count that reflects power. It ignores people and groups at the bottom of distributions whose ‘uncounting’ adds another level to their marginalisation. It ignores people at the top whose uncounting hands them even greater power.

Why do we fail to count well at the bottom? This figure shows three different series for primary school enrolment in Kenya. One comes from the Kenyan National Bureau of Statistics (KNBS); one from the Demographic and Household Surveys (DHS); and one from the Ministry of Education (MOE). MOE data come directly from schools and are used as the basis for funding decisions.

Now, MOE trends tell you that progress is rapid and unsustained, while surveys look static. Which do you believe? If your children are in Kenyan state education, how well counted do you feel?

Not that survey data are perfect either. Six groups are systematically excluded from most household survey and census returns. Excluded by design are the homeless, those in institutions and nomadic populations. Ignored by undersampling are those living in fragile, disjointed households, in areas facing security risks and in informal settlements. In any research survey, there should be careful consideration of the demographic and picks for sampling. A study of various sampling methods, along with ample research into other areas of surveying, can help improve results. A large part of the populace that usually gets overlooked can then be better helped. These groups, thought to amount to around 250 million uncounted people – roughly 3.5% of today’s global population – obviously contain a disproportionate share of the world’s poorest people. They are being systematically failed even in the ‘best’ counting approaches we have.

It’s no coincidence that people in poverty are excluded. Nor is it because of technical problems that Sudan’s government in Khartoum suppresses publication of data on regional development outcomes. Or that the deaths of those living with disabilities in the UK go uncounted.

As for counting at the top, it’s equally no coincidence that high-income households are undersampled in surveys. Or that even when tax data are used to adjust the picture, major wealth – $8 trillion? $32 trillion? – remains uncounted. Or that the OECD, charged with measuring the ‘misalignment’globally between the profits of multinational companies and the actual location of their economic activity, has so far been unable to lay its hands on the necessary data.

Our choice of measure is also important – and also political. Take a look at this chart which shows how two measures, the Gini coefficient and the Palma ratio, come up with radically different answers to the same question about income distribution. Has UK wealth inequality been flat across the crisis? Or did it fall sharply, then immediately rebound even more dramatically?

The Gini coefficient embodies such strong normative views (pp. 129–144) that it doesn’t capture well changes in the top 10%, or in the bottom 40% where most poverty lies. It is very encouraging (to me!) that instead the Palma ratio has featured in recent drafts of the post-2015 indicators.

The Palma – which expresses the ratio of income shares of the top 10% to the bottom 40% – also embodies a normative view, but it’s absolutely explicit about it. The chart of UK wealth distribution across the financial crisis shows why the Gini gave rise to so many congratulatory headlines about stable inequality, and why they’re wrong.

What might an actual ‘data revolution’ look like? If there’s no recognition of the political nature of the problem, then we’d be fooling ourselves to expect any great change: the same people and the same things will continue to go uncounted.

What’s noticeable in the discussion so far is that there has been a great deal more attention paid to the uncounted at the bottom than at the top. There’s been precious little mention of Piketty’s proposal for a global wealth register, for instance, or of specific measures that would eliminate anonymous company ownership, require states to exchange tax information with each other (think SwissLeaks), or multinational companies to publish country-by-country reporting (think LuxLeaks). Yet if we don’t start counting things that make elites uncomfortable, then we’re not doing it right.

Data reforms are, broadly, welcome; but a revolution remains far off. People and things go uncounted largely for political, not technical reasons.

That’s why a data revolution is so badly needed. And revolutions aren’t technical: they’re political.

13/05/201513/05/2015

Measuring tax avoidance: What data for BEPS 11?

Update 13/5/15: OECD has released all the public comments on BEPS 11. See end for encouraging business support for use of country-by-country reporting data…

—

Don’t look now, but the OECD may just have realised that public country-by-country reporting is necessary to meet their Base Erosion and Profit Shifting commitments…

The OECD has a mandate from the G8 and G20 to measure and track the extent to which the profits of multinational enterprises (MNEs) are ‘misaligned’ with the location of their real economic activity – Action Point 11, out of 15, of the Base Erosion and Profit Shifting initiative, or BEPS 11 if you will.

Why this is exciting – no, really

Now BEPS 11 is not only the top action point for geeks. It may also be the most important overall. Other BEPS measures can change the dynamic in a particular part of the problem of applying international tax rules. Some of those changes will reduce avoidance over the medium-term. And some may even benefit lower-income countries outside of the OECD, to some extent at least.

But BEPS 11 could change the whole landscape in which tax rules are applied. BEPS can, and should, deliver public data, on an annual basis, which shows the following:

The current degree of profit misalignment globally (which the whole BEPS initiative is aimed at reducing);
Trends over time, i.e. how well the BEPS initiative is performing on its sole aim; and
Regional and national BEPS patterns, i.e. which countries receive disproportionately large or small shares of the MNE tax base – and how this is changing over time.

This is Uncounted‘s type of data – not transparency for its own sake, but transparency that shifts the balance of power. In this case, OECD country tax authorities can, and quite often do, demand sufficient data to see their piece of the story.

The biggest shifts in power if this data was made available would be (i) from MNEs to tax authorities in lower-income countries, that have not hitherto been able to make such demands; and (ii) towards civil society, who have not to this point been able to hold MNEs or tax authorities fully responsible, because of a lack of public information.

Additional benefits would be for all tax authorities (and national civil society) to compare their own performance with others globally; and for MNEs to do the same.

Where are we now?

The new OECD discussion draft on BEPS 11 covers a lot of ground. It surveys the academic literature (as reviewed here), including kind treatment of some of our work. It sets out some potential BEPS indicators. In both cases, the results are somewhat hamstrung by currently available data.

The most exciting discussion is of course on the data itself. And as the response of the BEPS Monitoring Group (to which I contributed) shows, the OECD document really has only one logical conclusion: country-by-country reporting data offers the only serious prospect of creating a baseline on the extent of BEPS, and of tracking it consistently over time.

These are the key points from the BEPS Monitoring Group response – well worth reading in full:

Thorough, timely or comprehensive analysis of BEPS is currently not possible due to data limitations. The discussion draft provides a very useful discussion of data sources and methodologies and rightly concludes that availability of comprehensive and reliable micro data is a major constraint. Additional disclosure requirements for MNEs are crucial to ensure that such data become available. The same applies to bilateral macro data; these require primarily an effort by governments to collect and report better statistics.

Enhancing possibilities for analysis of BEPS requires revisiting the implementation of country-by-country reporting requirements under Action 13. We understand that the OECD is committed to ensure that the final set of BEPS Actions, to be presented towards the end of the year, will be a coherent package. There is an urgent need to enhance coherence between Action 13 and Action 11 in the final package. We discuss this in more detail below.

Now there is a possible halfway house. If policymakers are committed to progress against BEPS, but for whatever ~~lobbying~~ reason cannot accept public country-by-country reporting, then this is the get-out.

In our previous submission we already mentioned second-best alternatives, such as storing all country-by-country reporting data in a secured central data system. Staff from the OECD CTPA, IMF FAD, UN Tax Committee, regional tax forums and external researchers could then have full access to all micro data, bound by confidentiality agreements, and be able to publish partially aggregated statistics. It is worrying that the February 2015 guidance on implementation does not even provide for second-best approaches to make the data available to researchers. If some countries continue to block the OECD and G20 from endorsing public country-by-country reporting, the OECD should urgently work on a second-best approach.

Absent immediate agreement on public CbC, there must be – at a minimum – some process in place to collate all the data, to analyse it, and to publish results of that analysis along with partially aggregated statistics to allow further analysis by others. (There’s some discussion of the likely very high benefit-cost ratio involved, in my Copenhagen Consensus piece on post-2015.)

Otherwise we’d be accepting the failure of BEPS 11 – and with it the failure to demonstrate any progress of the whole BEPS initiative. Not to mention that all the CbC compliance costs still be incurred, while we leave all sorts of potential benefits on the table.

Watch this space

So it’s very welcome indeed to see the OECD draft appear to point to the inescapable logic of using CbC data.

But it’s also noticeable that they stop short of an explicit demand of this type. So we may assume the politics remain tricky, even if the logic is clear.

Watch this space.

—

Update 13/05/15: the public comments on BEPS 11 have been published. Many, including from business, raise interesting questions about specific possible BEPS indicators – a subject to which further attention will be given, not least when some new work on misalignment is ready in a month or two.

For now, note this interesting feature of the comments: there is broad business support, where data availability is addressed, for the use of country-by-country reporting data to monitor BEPS. This includes:

British business group, the CBI:

These documents should provide tax authorities with significantly more information that they currently possess and therefore we would suggest that analysis is also carried out on the new information that tax authorities will have to monitor BEPS before any additional burden is created for business under this Action.

Big 4 accountants EY:

The country-by-country report will require that MNEs gather information of a type and in a manner that it are not required for any other accounting or tax purpose. The master file/local file framework for transfer pricing documentation will require extensive quantitative and qualitative information about the MNE group and about the individual entities in the group. We would urge that the OECD look first to the data that will be collected through this new information reporting before considering any new reporting requirements.

TD Bank sum up the general view, which seems to be that CbC data should be used for BEPS rather than imposing any additional compliance requirements:

‘Moreover, the compliance burden on multinational corporations will increase significantly with the new country-by-country reporting and master file transfer pricing documentation contemplated under BEPS Action 13. We do not believe further additions to the reporting requirements for corporate taxpayers should be the answer. Rather, we believe it is important for tax authorities to work together to share the information that already is provided and, as the Discussion Draft notes, to use the available data more effectively. One key use of the available data is to better measure the incidence of BEPS.

08/05/201513/07/2015

UNCTAD’s big number: A critique

Update 2: 8 May 2015, a slightly tweaked version of the blog is now back up, and the UNCTAD study authors will provide a comment which I’ll add at the start of next week.

A critique of the UNCTAD analysis of corporate tax avoidance suggests things may be (even) less rosy for developing countries.

It is a mark of the importance of UNCTAD’s study on corporate tax avoidance in developing countries that it is provides the first numbers mentioned by the World Bank’s MD and COO Sri Mulyani in a major speech last month:

A recent UNCTAD study indicates that about $100 billion in annual tax revenue is lost to developing countries in transactions directly linked to offshore hubs. The total “development finance” loss – counting both revenue and reinvested earnings – is estimated in the range of $250 to $300 billion. This prevents developing countries from stopping the outflow of money – which thus bleeds them of essential resources.

For the schoolchild in Haiti, the new mother in Malawi, or the farmer in Bangladesh, these losses have a real impact: They result in classrooms that are overcrowded, health clinics that are never built, and water that is never delivered. People’s opportunities are being stolen from them – because tax revenues are not collected.

But there is a critique of the UNCTAD report, which also found that multinational enterprises (MNEs) may be paying developing countries around $700bn in revenues.
The import of the critique is that, rather than multinationals in developing countries avoiding a dollar of tax for every seven they contribute, they may by one form of avoidance alone be avoiding a dollar of tax for every three or four they contribute. Total revenue losses to avoidance might even stack up against the total contribution made… but I’m getting ahead of myself.
There are two main elements to the critique being advanced, one conceptual, the other practical. I should repeat my disclosure from the earlier blog that I’m part of the expert group that has fed in views about drafts of the study, so I’m probably not neutral.

The role of investment

The conceptual critique concerns whether the UNCTAD study appropriately captures the role of investment in development.

One risk is that a policy of avoidance might somehow be seen as an acceptable tool to encourage investment, that a tradeoff might exist (p.5):

The dilemma is clear: how can policymakers take action against tax avoidance to ensure that MNEs pay “the right amount of tax, at the right time, and in the right place” while avoiding excessive tightening of the fiscal regime for MNEs which might have a negative impact on investment.

Three main criticisms are made.

First, the study concentrates on FDI rather than the total of investment. But it’s conceivable that reducing multinational tax avoidance could (i) increase revenues for public investment, (ii) reduce the unfair competitive disadvantage faced by domestic firms (and more compliant multinationals), and through the combination of (i) and (ii) actually increase overall investment.

Second, any possible tradeoff hinges on assumptions of the importance of tax for investment (that is, for FDI). Namely (p.5, emphasis in original):

Tax is a key investment determinant influencing the attractiveness of a location or an economy for international investors.

Taxation, tax reliefs and other fiscal incentives are a key policy tool to attract investors.

The criticism is that these statements are undercut by the evidence – for example, TJN research (PDF) drawing on the IMF and McKinsey’s inter alia has long highlighted the non-importance of tax in locational decisions. [Such overall findings do not necessarily rule out any potential role of well-administered tax incentives as a possible lever of industrial policy, however.]

The third element of the conceptual critique is that while FDI inflows might fall in the event of targeted reduction in MNE tax avoidance, it is unlikely that a fall in FDI stock would occur – and highly unlikely that such a fall would be of sufficient scale to reduce overall revenues. The strongest impact of the financial crisis came in 2009, which saw positive inflows continue, albeit with a 20% fall in volume.

My take on this, for what it’s worth: the suggestion of a tradeoff is far from prominent in the paper, and UNCTAD exist in part to promote FDI (benefits), so the framing is not particularly surprising.

And nor need it be particularly damaging, if the dominant discourse is reflected by the kind of remarks that James Zhan (Director of the relevant UNCTAD department) made at the UNECE Financing for Development consultation about the importance of MNE tax avoidance, and the need to maximise not investment per se but the broader sustainable development benefits thereof – so that there’s no immediate, actionable avoidance/investment tradeoff as such, but a more holistic conception of the potential for FDI to influence multiple channels of a (much wider again) development strategy.
I don’t think anyone would argue – and the UNCTAD study does not – for promoting avoidance as an investment attraction mechanism (although that is in a sense the game for those jurisdictions that seek to capture the tax base of others.)

Methodological critique: Varying the assumptions

The methodological critique is multifaceted, and I will set aside much of it. Suffice to say, I think there are reasonable criticisms to be made – as with any regression analyses, and any attempt to estimate hidden financial flows on the basis of limited public data – but that the central approach is quite reasonable, and represents a valuable innovation to add to existing work.

A broad point is that the revenue loss number for one form of avoidance alone has been presented as the number for all avoidance – ignoring, for example, transfer pricing abuses of the sort that a Banque de France researcher has estimated to cost France alone tax base of around $8 billion a year. We certainly need to find ways to construct broader numbers of that type, but it’s not what the authors were about here.

The more specific criticisms of the UNCTAD study calculation are interesting, however, and worth showing in order to think about where one should imagine the probable range of MNE revenue contributions, and so the relative scale of avoidance – for the ‘contribution method’ and the ‘FDI-income method’, which are the two complementary approaches proposed and used in the UNCTAD study.

Contribution method

This approach uses countries’ revenue values from the new ICTD dataset, and allocates a proportion of each revenue type from 0-100% to MNEs in order to assess their total contribution.

The critics highlight a range of decisions as potentially difficult to justify (e.g. that MNEs contribute 50% of tax paid on property, or 100% of taxes on imports), and make some different proposals (‘Alternative 1′ in the table). This additionally includes a relaxation of the UNCTAD study’s assumption that MNEs’ share of taxable profit will be equivalent to their share of operating surplus, which will be violated when methods like thin capitalisation are used for profit-shifting. There is also a somewhat arbitrary reduction (by the critics) of the MNEs’ share of corporate tax revenues, apparently to reflect the original study’s recognition that ‘generous discounts on tax rates’ may lead to bias here.

This reduces the total estimated MNE contribution from $723 billion to $391 billion. In addition, the critics point out that the UNCTAD study uses a reference year from the crisis period. Choosing a different reference year (‘Alternative 1b’) leads to a total contribution of $399 billion, but where the share due to corporate income tax is now 43% of revenue contribution, as opposed to 30% in the original.

Here I have to put my hands up – the UNCTAD study (very wisely) uses the ICTD Government Revenue Dataset, as a better source of tax data, and until the upcoming release, the present edition contains only data to 2009/10.

FDI-income method

In this method, the UNCTAD study takes balance of payments data on FDI income, and applies an average effective tax rate to estimate a revenue outcome. Good data on MNEs’ foreign tax payments, never mind effective tax rates, is notoriously difficult to come by – and especially so for lower-income countries.

The critics re-engineer the data in the UNCTAD study to show that an effective rate of 11% is not unreasonable, but more generously apply 15% (compared to nearer 20% and 25% in the original).

The overall effect, combined with the above finding that income tax produces a higher share of the total contribution, is to reduce the estimated total contribution to $291 billion.

Implications?

It is true that the UNCTAD study considers only one form of avoidance – so as they themselves say, one might reasonably add to their $100 billion an estimate of transfer pricing avoidance (for example).
[The reason not to, I imagine, is that there isn’t as rigorous an estimate of this as their estimate of the thin capitalisation avoidance, due to the failure to make available more widely the type of trade data used in the Banque de France study which explicitly contrasts real arm’s length pricing with related party trade prices.]

This is not a criticism of the UNCTAD study – just a caution against presenting the $100 billion as if it were an assessment of all avoidance.

A genuine, but as yet untested criticism relates to the potential sensitivity of the assessment of the revenue contribution of MNEs in developing countries, to the necessary set of assumptions made.

Is MNEs’ revenue contribution $300 billion or $700 billion?

You wouldn’t stand full square behind either, it seems to me, but that feels a more or less inevitable result of current data problems (yet one more that would be solved, of course, by public country-by-country reporting).

The UNCTAD study provides justification for the various choices it makes. It would be useful to have a broader discussion of these, and to onsider the range of movement in the estimate level of contributions.

What does this all mean for policy? One response to the UNCTAD study would be to acknowledge that it provides confirmation, at a minimum, of the ‘scale-reasonableness’ of NGO estimates of revenue losses of this scale. Another would be to note, as I did in the previous post on this report, that $100bn is small in relation to total revenues.

If the critics were right, and the total MNE contribution is half of what we thought, perhaps this whole area of tax should be even less of a priority. Alternatively, if the MNE contribution could be doubled from what it is – without any unreasonable impositions – that would suggest a much bigger prize…

The one form of avoidance (thin capitalisation) in the UNCTAD study seems likely to be joined by several significantly sized other mechanisms – as the evidence for Europe suggests fairly strongly may be the case; and see also the new OECD survey paper on evidence on an even broader range of BEPS channels.

So the total developing country revenue losses to MNE avoidance could be several times that $100 billion – which could be half of, or the same as MNEs’ total contribution, if the original or the critics’ assumptions are used.

The authors of the study have very kindly agreed to provide a response to some of the points raised, which I’ll post here when I have it. I think it will help the rest of us to understand more about the range of possible revenue contributions we should consider reasonable.

06/05/201513/07/2015

Base erosion and profit-shifting: What do we know?

[From the Tax Justice Research Bulletin 1(4)]

The OECD was mandated by the G8 and G20 to revise its international tax rules in order to combat multinational corporate tax dodging – known in OECD jargon as “Base Erosion and Profit-Shifting (BEPS). The final deliverables due later this year, and because of the complexity of international tax, it has been broken down into 15 “Action Points.” (On Monday, TJN blogged Action Points 3 and 12, as discussed by the BEPS Monitoring Group, or BMG.)

The geeks’ Action Point of choice has always been number 11, which requires the collation of baseline data on how far profits are misaligned away from genuine economic activity: e.g. by being shoveled into tax havens where nothing really happens. Action Point 11 also involves continuous tracking of progress in this area.

The team working on BEPS 11 has now published a discussion draft, which sets out not only their thinking on questions of data and measurement (check back later with the BMG for our response to these) but also a broad survey of the literature on the scale and channels of BEPS.

A Banque de France researcher found that measured deviations from the Arm’s Length Principle may have cost France $8 billion of its ~~revenue~~tax base in 2008 alone – and this is just one aspect of profit-shifting

Some of the main findings:

There is broad consensus (regardless of time period, country or data source) that there has been widespread tax-motivated BEPS activity by multinationals — though the intensity varies.
BEPS via manipulation of debt and interest payments is particularly important (and relatively well-studied: e.g. Huizinga, Laeven and Nicodeme (2008).)
Transfer pricing studies of various kinds show consistently, again, that prices are manipulated for tax reasons; and that intangible assets are important here. We might also point to the more recent study by Banque de France researcher Vincent Vicard, finding that the deviation between intra-firm pricing and true arm’s length prices may result in a ~~revenue~~tax base loss to France of $8bn in 2008, having grown over the decade – and this remains just a part of estimated total profit-shifting. [Phew!]
Treaty shopping is estimated to reduce withholding tax rates ‘by more than five percentage points from nearly 8% to 3%.’
Transparency: evidence on the role of disclosure and transparency – i.e. measures such as BEPS 11 itself – is limited but striking. Most obviously, Dyreng, Hoopes and Wilder (2014) found that ActionAid’s revelations about FTSE100 companies failing to meet a rule on disclosure of subsidiaries resulted in greater disclosure, a reduction in ‘tax haven’ subsidiaries and a reduction in avoidance [Kudos to Actionaid!].

ActionAid’s revelations about FTSE100 companies failing to meet a rule on disclosure of subsidiaries resulted in greater disclosure, a reduction in ‘tax haven’ subsidiaries and a reduction in avoidance

Developing country scale: only two studies provide a comparative assessment of the likely scale of BEPS in developing as opposed to higher-income countries. The first, by authors including long-standing critics of NGO estimates in the broad area, finds that profit-shifting (in this case, only that of German multinationals and via debt manipulations) is roughly double the size in developing countries. The IMF, meanwhile, recently presented evidence that the revenue losses of developing countries may be several times higher than elsewhere (as a share of corporate tax revenue).

Without wishing to prejudge the BEPS Monitoring Group’s analysis (oh go on then), it is clear even from this chapter of the OECD study alone that the authors have reached a point very similar to that which motivated Richard Murphy to elaborate the first TJN proposal for country-by-country reporting back in the day: namely, that existing data sources can only provide parts of the picture, and to develop a comprehensive understanding of BEPS will require consistent and comprehensive data on global multinational activity. [Well done Richard!]

To this we might add, in the spirit of Uncounted, that current data availability has “non-random weaknesses” which will systematically result in disproportionately lower tax revenues in lower-income countries. BEPS 11, if it delivers that comprehensive data, might just be the greatest contribution to fairer international tax that is compatible with the insistence on separate accounting.

26/03/201520/07/2015

UNCTAD study on corporate tax in developing countries

UNCTAD, the UN body that tracks trade and investment with the aim of improving development impacts, has published a major new study on corporate tax. [Link broken as at 20 July 2015, thanks Lisa, so see World Investment Report 2015 chapter 5 and annexes instead – this is the updated version.] Much attention will go to the estimate of $100 billion in developing country revenue losses due to MNEs’ tax avoidance, but the study contains much more of value:

The first comprehensive overview of MNEs’ revenue contribution in developing countries;
A relatively detailed overview of the use of ‘offshore hubs’ as conduits for investment;
Regression analysis of the profit-shifting impact of conduit use, and an estimate of the revenue losses; and
A discussion of potential policy responses that emphasise the value of investment but also recognise the damage of tax avoidance.

This (long) post will summarise each area in turn, then offer a few thoughts on the importance of the study, and future research directions. [Full disclosure: I’m on the expert group for the upcoming World Investment Report, of which this study is a part; which is to say that I may be biased, but certainly not that I can take any credit.]

MNEs’ revenue contribution

The first major element of the paper consists of creating a baseline for the revenue contribution of (the foreign affiliates of) MNEs, drawing primarily on the ICTD Government Revenue Dataset.

The authors break down the pattern of revenues overall (figure 3 – click for full size), and then focus on the contribution of MNEs.

Figure 6 shows the results of the ‘contribution method’, where each component of revenues is decomposed into a corporate and a non-corporate element, and the former again into a domestic and foreign affiliate element (see Annex I for full details). This allows an overall estimate of the contribution of MNEs’ foreign affiliates, of around $725 billion or 10% of total revenues. Around 3% of revenues derives from MNEs’ corporate income tax.

As a cross-check, the authors use balance of payments data to construct the ‘FDI-income method’ which involves estimating the total revenue contribution from both unctad draft fig7 corporate income taxation and non-income items. Per figure 7 (click to enlarge), this yields an overall contribution of $730 billion. There is perhaps more uncertainty in this approach, since it rests on the estimated tax rate and on the extrapolated rate of other (non-income tax) revenue contributions. Nonetheless, the full approach (again detailed in Annex I) is plausible, and the cross-check on the contribution approach is valuable.

The investment role of ‘offshore’

The second contribution of the study is to assess the (jurisdiction) sources of investment. 42 jurisdictions are identified as either ‘tax havens’ (“small jurisdictions whose economy is entirely, or almost entirely, dedicated to the provision of offshore financial services”) or ‘SPEs’ (jurisdictions offering SPEs or other entities facilitating transit investment. Larger jurisdictions with substantial real economic activity that act as major global investment hubs for MNEs due to favorable tax and investment conditions”).

This might be considered a rather blunt approach; as I’ve written elsewhere, there are serious issues with any ‘tax haven’ definition, and the intuition of the Financial Secrecy Index is that it makes more sense to think of jurisdictions on a spectrum, rather than being either ‘havens’ or not. Nonetheless, it’s clear that the approach here identifies the major players one way or another.

Figure 13 (click to enlarge) shows the specific picture in the US. The difference in relative tax rates is striking: averages of 3% (‘tax havens’) and 2% (‘SPE countries’) versus 17% elsewhere.

In this light, the growth in use of these conduit jurisdictions for investment in developing countries which figure 17 illustrates is of clear concern.

Estimate of MNE tax avoidance

The logical next step of the paper is to consider the likely effect of using conduit jurisdictions for investment into developing countries on MNEs’ revenue contribution. It seems inevitable that this calculation will draw the most attention.

The estimate is based on (fixed effects OLS) regression analysis of the relationship, at the national level, between the aggregate use of investment conduits and the rate of (taxable) return on the investment stock. On the basis of a variety of specifications, the authors conclude that

“an additional 10% share of inward investment stock originating from offshore investment hubs is associated with a decrease in the rate of return of 1-1.5 percentage point” (p.34).

Extrapolating to all (non-haven) developing countries generates a range of revenue loss estimates from $70 billion to $120 billion. Figure 20 shows the central estimate of $100 billion in revenue losses: towards half of the actual tax paid.

The $100 billion is also around a tenth of the ‘potential value at stake’ – in effect, the total development finance associated with the activities of MNEs’ foreign affiliates. As an earlier draft had noted, the leakage of development resources is not limited to the loss of domestic fiscal revenues but it also affects overall GDP (as the profit component of value added is reduced) and potentially the reinvested earnings component of FDI. As companies shift away profits from the recipient country they may also undermine the development opportunities related to reinvestment of those profits for productive purposes.

Applying an average reinvestment rate of 50%, for example, to the calculated (after-tax) profit shifting of $330 – $450 billion would yield lost reinvested earnings in the range of $165- $225 billion. Summing up the revenue loss component and the reinvested earnings component the total leakage of development financing resources would then be in the order of $250 billion and $300 billion – in other words, between a quarter and third of the potential value at stake.

The pot of gold, however, should not be overstated: although this is likely to be a lower bound, since it does not capture all forms of corporate tax reducing behaviour, we’re talking about something like 1.5 percent of developing country government revenues on average. The absolute amount involved is clearly worth pursuing, and can have a substantial benefit in revenue terms and beyond; but the tax justice agenda cannot be boiled down to this alone. Much broader improvements, with both domestic and international components, are required to achieve a step change in effective taxation for development.

Policy recommendations

The study concludes with a range of policy recommendations, focused on improving the sustainable development impact of investment into developing countries. These are summarised in figure 21.

Multiple measures are set out, each worthy of more detailed discussion. A particular strength is the clarity of intent to ‘Ban tolerance or facilitation of tax avoidance as a means to attract investment’. If such an aim could be made operational and effective, it would imply an end to ‘competition’ among jurisdictions to take the tax base arising from economic activity elsewhere, of the type so clearly exposed in LuxLeaks.

I would have liked to see more emphasis on transparency measures – including, crucially, public country-by-country reporting – that would not only make the analysis here much more of a calculation and less of an estimation, but also provide an ongoing tool for accountability to ensure progress in reducing avoidance.

Summary

The UNCTAD study marks a major step forward in our understanding of the scale and nature of multinational tax avoidance in developing countries. Both the baseline for multinationals’ revenue contribution, and the assessment of the losses to avoidance, are likely to become part of the literature and the policy discussion for a good time to come.

No doubt some of the approaches will be challenged, including the regression results (when aren’t they?); and data will evolve over time (for example, the updating of the ICTD dataset in a few months’ time). But the pioneering approaches in the contribution method and the FDI-income method, as well as the model for the avoidance estimate, are likely to endure.

The policy recommendations are likely to have influence, perhaps including in the FfD process, and provide a valuable reminder of the importance of maximising not investment, nor revenues, but the development benefits that result. Better tools to resist avoidance will improve the ability of governments to make any necessary trade-offs.

26/03/2015

An African civil society perspective on FfD

The African regional consultation on Financing for Development (FfD) took place at the start of the week (like the European one). The submission from TJN-Africa puts particular emphasis on inequality, including women’s rights, and on global data issues.

Summary of CSO Recommendations to African governments

African countries should push for the centrality of taxation as both the most important source of financing for development needs and the key lever to fight inequality.
African countries should call for the establishment of a new intergovernmental body on tax matters with a clear mandate.
African countries should stand together to ensure that FfD process not only recognises the importance of measures to increase transparency and accountability within the private sector as it does in Article 25 of the Zero draft but also that it commits the countries to act.
African countries should implement the recommendations contained in the AU/UNECA high level panel (HLP) on IFF report.
African countries should push for the integration of women’s rights into the FfD agenda as an important issue which has relevance for tax policy.
African countries should push for commitment to the principle of redistribution via taxation and ensure the global data collection effort envisaged within the SDGs includes tracking the equity implications of tax policy
African countries should call for the recognition of international cooperation on tax as a key priority related to financing within the new global partnership for sustainable development.
African countries should make an explicit statement that MNCs paying their share of tax will be a major means of financing the SDGs.

The full document (with thanks to Savior Mwamba) can be found here.

23/03/201524/03/2015

3 ways to remove obstacles to effective taxation: #FFD3ECE

Update 24 March:

An interesting conference, including Amina Mohamed’s stressing of the urgency for development finance of tackling tax evasion and illicit financial flows. Of the three elements I discussed, it was governance that generated the most interest (perhaps in part because the suggestions on norms and transparency fall more clearly under post-2015 targets).

There felt to be quite broad consensus that simply upgrading the UN tax committee to intergovernmental standing would not do – resources are crucial if this is to become the globally representative, rule-setting body. To think about how much resourcing is required, think of the OECD’s current capacity on tax – and then scale up to global level.

But much supportive capacity already exists, if so mandated – for example, James Zhan of UNCTAD was on the same panel and spoke impressively about the work they have done on ensuring investment is not pursued for its own sake, nor maximised in terms of quantity, but rather seen as an important tool in the pursuit of the sustainable development. UNCTAD’s expertise in, for example, assessing investment and tax treaties in terms of their overall development benefit can be of value.

Is the required level of resourcing realistic? I’m not sure. But one suggestion from IBIS seems the right starting point: to hold a ministerial panel on the subject during the Financing for Development summit in Addis in July. If there is sufficiently broad desire to address the failed international governance of taxation, it should start in Addis – and if nobody turns up, I guess that’s the signal that the same failure will be accepted for the next wee while…

The pdf of my slides, in case the viewer below is too fiddly.

—–

Here are the slides I’m presenting at the UNECE regional consultation on Financing for Development in Geneva today (click on them to see the controls to move forwards). I’m arguing for a bit of focus in FfD on changing norms, governance and transparency at the international level, in order to open up space for effective taxation at the domestic level.

The slides are a little basic, because (a) I am, and (b) I’ve only got 7 minutes. With those excuses in place, comments are very welcome. And the hashtag is #FFD3ECE…

Alex-Cobham-UNECE-Geneva-FfD-230315

A couple of bits of related reading:

A paper on three zero targets for financial opacity;
A post on possible tax targets; and
Eurodad’s FfD briefing, which calls for an intergovernmental tax body.