Spring is in the air, which can only mean one thing: discussion of a “common consolidated corporate tax base” by the International Monetary Fund (IMF). This year’s IMF Spring Meetings included ample discussion of international taxation and attempts to make multinationals pay a “fair share” of earnings to local host governments. The simple question of “Where should corporations pay their taxes?” has no easy solution, as experts debate competing models of revenue collection.
For many experts at International Governmental Organizations (IGOs) such as the IMF and the Organisation for Economic Co-operation and Development (OECD), the current system of transfer pricing is simply too fragmented to work. IGO officials insist that replacing this decentralized model with a common international system of “formulaic apportionment” (for at least some profits) would lead to more fairness and simplicity. Beneath all of this bureaucratic jargon, however, lies a plan to stifle tax competition across the globe. Punishing entrepreneurs of the Global South to prop up corrupt governments is not a recipe for prosperity.
The current system of international tax collection for multinationals has no shortage of critics. To understand the status quo, it is helpful to flesh out the inner-workings of multinationals. Businesses located in multiple countries are headquartered in one place, and often have subsidiaries in strategic markets.
An international car manufacturer located in the United States may wish to “sell” auto parts to its subsidiary in Thailand as a part of a broader strategy to sell cars in that country. But part of the goal of this arrangement may also be to shift as much taxable income as possible to Thailand, a country with a lower corporate tax rate than the United States. To prevent this sort of tax gaming, countries pretend that a sale to a subsidiary is a sale to another company entirely. Thus, the car maker would have to report a “fair value” for the goods sold to the subsidiary and pay tax on that value. Obviously, estimating the value of goods being shifted around is not fool-proof, and companies have some leeway in low-balling the stated value when the taxman comes knocking.
To centralization advocates, however, this system goes too far in allowing companies to minimize their taxes. There is a knowledge gap between businesses and governments on the true worth of assets being sold to subsidiaries, which is especially large when considering intangibles such as intellectual property. And since a large “fudge” factor exists, companies are able to move into a low-tax jurisdiction.
To stem the (alleged) bleeding, OCED researchers and officials have all but called for a system of apportionment, in which factors like sales and property holdings are weighted by formula in determining tax burden. This formula, which would need to be agreed upon by all participating countries, would mean that simply holding property in a higher-tax jurisdiction would set a company up for higher taxes. In order to take advantage of that low Thai corporate rate mentioned earlier, property, sales, and capital would all have to be based in the Asian nation.
This solution may make sense if corporations were indeed minimizing their tax bills through artificial business arrangements. The limited data available, though, does not bear this out. Mercatus Center senior fellow Jason Fichtner and Heritage Foundation policy analyst Adam Michel find that, over the past fifty years, corporate tax revenue as a percent of the economy across the OECD has increased despite the widespread implementation of transfer pricing norms.
Amongst U.S. states, which largely have apportionment formulas and the world’s highest rates until tax reform, corporate tax revenue as a percentage of all tax revenue has declined over the past fifty years. This is consistent with the academic literature, which implies that a fine-tuned system of transfer pricing can actually be better at collecting revenue than a system of apportionment.
This evidence supports the idea that centralization is a solution in search of a problem. Maintaining a system of transfer prices promotes tax competition, without leading to large revenue swings via loopholes in fair value accounting. With this in mind, it is hard to know what the OECD researchers mean by “harmful tax practices” and “harmful tax competition.”
Countries like Thailand know that, without the bounds of reason, reducing their corporate taxes will lead to companies based in the developed world to ramp up sales in their country. If that incentive went by the wayside due to fixed formulas, developing countries with corrupt governments would have little incentive to slash rates. The poorest residents of the Global South would see fewer opportunities, and the pockets of corrupt public officials would be further padded.
So, for the sake of the most vulnerable taxpayers worldwide, it is time to embrace the best system we’ve got.
Ross Marchand is the director of policy for the Taxpayers Protection Alliance.
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