New study destroys claims of company tax competition

A new study from the US discredits the argument that corporate tax rates are falling because of countries trying to lure precious capital. Instead, it's because of multinational tax avoidance.

Grant King, president of the Business Council

A new research paper from the National Bureau of Economic Research — the most prestigious independent economic research organisation in the US — has discredited the central argument of company tax cut advocates, that international tax competition has driven down tax rates around the developed world. Instead, they show it has been driven by multinational tax avoidance.

“The Missing Profits of Nations” by Thomas R. Tørsløv, Ludvig S. Wier and Gabriel Zucman examines the claim “that globalization makes countries compete harder for productive capital, pushing corporate tax rates down”. “Global economic integration has made capital location more sensitive to differences in taxes and led to a more perfect competition between nations. This theory provides a consistent explanation for the global decline in tax rates observed over the last twenty years.”

This has been the basis for the Turnbull government and the Business Council to claim that Australia, in order to compete effectively with our countries for flighty international capital, must cut its company tax rate. The paper, however, shows that there is little evidence for this “standard claim”:

Machines don’t move to low-tax places; paper profits do. By our estimates, close to 40% of multinational profits are artificially shifted to tax havens in 2015. This tax avoidance and the failure to curb it are the main reason why corporate tax rates are falling globally—not tax competition for productive capital. The decline in corporate tax rate is the result of policies in high-tax countries—not a necessary by-product of globalization.

The researchers note that large multinational corporations:

… don’t seem to move much tangible capital to low-tax places—they don’t even have much tangible capital to start with. Instead, they avoid taxes by shifting accounting profits. In 2016 for instance, Google Alphabet made $19.2 billion in revenue in Bermuda, a small island in the Atlantic where it barely employs any worker nor owns any tangible assets, and where the corporate tax rate is zero percent.

This is not productive capital, but profits shifted from higher-tax companies. Trying to compete for multinational corporate profits by lowering company tax rates risks merely attracting the paper profits of a company, not productive capital that will drive growth and jobs. Just ask Bermuda.

But how does this drive lower company tax rates in developed countries? The paper shows how tax havens or low-tax countries generate significant levels of corporate tax revenue by attracting paper profits from higher-tax countries. It is easier to in effect steal company tax revenue from higher-tax countries than actually stop profit-shifting to tax havens:

… the fiscal authorities of high-tax countries do not have incentives to combat shifting to tax havens, but instead to focus their enforcement effort on relocating profits booked by multinationals in other high-tax countries. Chasing the profits booked in other high-tax places is feasible (the information exists), cheap (there is little push-back from multinationals, since it does not affect much their global tax bill), and fast (a framework exists to settle disputes between high-tax countries quickly). This type of enforcement crowds out enforcement on tax havens, which is hard (little data exists), costly (as multinationals spend large resources to defend their shifting to low-tax locales), and lengthy (due to a lack of cooperation between haven and non-haven countries).

In essence, authorities have an incentive to pursue company tax obtained by other developed countries that are not tax havens, rather than make the effort to compel multinationals and tax havens to stop ripping them off.

The data accumulated by the researchers also shows “close to 40% of multinational profits are artificially shifted to tax havens in 2015.” For Australia, their estimate was that of the US$179 billion or corporate pre-tax profits in Australia in 2015 (from domestic and international companies), some 7%, or US$12 billion, was shifted to tax havens.

“This tax avoidance and the failure to curb it are the main reason why corporate tax rates are falling globally — not tax competition for productive capital.”