Profits of foreign firms in Ireland (mainly of US global multinationals) are almost 800% of their payroll costs in the country, according to a new academic paper that also says “close to 40% of multinational profits are shifted to low-tax countries each year.”
Thomas Tørsløv (University of Copenhagen), Ludvig Wier (University of Copenhagen) and Gabriel Zucman (University of California Berkeley and National Bureau of Economic Research) in their June 2018 paper, ‘The Missing Profits of Nations,’ write that “Between 1985 and 2018, the global average statutory corporate tax rate has fallen by more than half, from 49% to 24%. In 2018, most spectacularly, the United States cut its rate from 35% to 21%.” The authors say that the redistributive consequences of the process of shifting huge paper profits rather than actual productive capital “are major, and different than in the textbook model of tax competition. Instead of increasing capital stocks in low-tax countries, boosting wages along the way, profit shifting merely reduces the taxes paid by multinationals, which mostly benefits their shareholders, who tend to be wealthy.”
Ireland’s 800% profits ratio corresponds to a capital share of corporate value-added of 80%-90% (vs. around 25%–30% in local firms). “By contrast, and strikingly, in almost all non-haven countries foreign firms are less profitable than local firms.”
Coupled with the massive gains from tax avoidance, I highlighted here last week IMF research on the super profits made in advanced economies, mostly driven by “superstar” firms, dominating markets, that managed to increase their market power further, while markups — the ratio between the cost of a good or service and its selling price — in other firms have essentially been flat. The IMF says markups among advanced economies have significantly increased since the 1980s, by 43% on average, and this trend has accelerated during the present decade.
The economists estimate that tax avoidance by multinationals reduces EU corporate tax revenue by around 20% and by tracing where firms that shift profits are headquartered, they found that US multinationals shift comparatively more profits than multinationals from other countries. Global annual revenue losses are about $200bn. They say that despite anti-avoidance measures, companies can still lower their tax bills significantly by shifting profits to places with effective tax rates between zero and 10% — the paper relies on 2015 data from countries such as Ireland, Luxembourg and the Netherlands that hadn’t previously been collected.
Based on an analysis of data on tax disputes between tax authorities, the economists say that tax authorities in high-income countries tend to focus on transactions with other high-income countries rather than work on profit shifting trails that end in such island havens as Bermuda. “This policy failure is reinforced by the incentives of tax havens. Although some of them like Bermuda have 0% corporate tax rates, most, like Ireland and Luxembourg, have low but positive rates. By lightly taxing the large amount of profits they attract, they have been able to generate more tax revenue, as a fraction of their national income, than the United States and non-haven European countries that have much higher rates. The low revenue-maximizing rate of tax havens can explain the rise of the supply of tax avoidance schemes documented in the literature — such as favourable tax rulings granted to specific multinationals — and in turn the rise of profit shifting since the 1980s. The incentives of tax havens, however, are not enough to explain the persistence of this shifting — to understand it, one has to understand why high-tax countries’ fiscal authorities have so far failed to curb it.”
Last December’s US corporate tax reform lowered the domestic tax rate to 21% and also proposed to tax US companies’ foreign profits by setting a floor and a ceiling the range is set at 10.5%-13.125%.
The Congressional Budget Office has estimated that the new law would cut the $300bn in annual profit-shifting out of the US by only $65bn. Gabriel Zucman told The Wall Street Journal that it would take two or three years before it is clear how the new law affects profit shifting.
“It’s a very complex piece of legislation, and I think it’s just very hard to guess what’s going to happen,” he said.
The New York Times reports that Kimberly Clausing, an economist at Reed College who has written and researched extensively about the scope of shifting profits to tax havens, said the research demonstrated that “the decline in the corporate tax is a result of policy, not an inevitable feature of the global economy. This implies that policymakers have the ability to address this problem without losing out in a tax competition game against other countries. But they must have the will to tackle tax havens themselves, instead of directing their fire at other non-haven countries.”