How to tax business in a global world

The International Monetary Fund recently asked a slate of experts for their views on the future of corporate taxation and tax competition. Most of the Fund’s interlocutors answered that tax competition was “likely to intensify” in the foreseeable future. Since each nation has a sovereign right to set its own taxation, who could possibly force tax havens to stop? Some countries, the experts agreed, will always offer lower tax rates than their neighbours if it’s in their interest to do so. Mobile profits will seek the lowest tax burden. There may be ways to fix egregious forms of abuse. But taxing multinational companies at high rates? In an ever-more tightly integrated global economy? Hopeless.

As we move forward into the 2020s, we need the confidence to say: this view is wrong. There is nothing in globalisation that requires corporate tax to disappear. The race to the bottom that rages today is a decision we’ve collectively made—perhaps not fully consciously or explicitly, certainly not a choice that was openly debated or voted on, but a choice nonetheless. We can make other choices. And we have to make other choices, because the current trend looks unsustainable. If globalisation means ever-lower taxes for its main winners (the big multinationals) and ever-higher taxes for those it leaves out (working-class families) then it probably has no future. Tax injustice and inequality will keep increasing. And to what end? Voters, falsely convinced that globalisation and fairness are incompatible, will be in danger of falling prey to protectionist and xenophobic politicians, eventually destroying globalisation itself.

Fortunately, there are other, equally feasible paths. An effective action plan has three pillars: “exemplarity,” coordination and sanctions against free riders. Exemplarity means that each country should police its own multinationals. For instance, the United Kingdom should make sure that UK companies, if they don’t pay enough abroad, at least pay their fair share at home. To understand how this could work, imagine that, by manipulating intra-group transactions, a British oil and gas company had managed to book $1bn in profits in Ireland—taxed at, say, 5 per cent—and $1bn in Jersey—taxed at, say, 0 per cent. There’s a problem here: the company pays much less tax than it should overall if (for illustration) London would otherwise have levied it at 25 per cent; we call this a tax deficit. The good news is that nothing prevents the UK from curbing this deficit itself, by collecting the taxes that the tax havens choose not to levy. Concretely, the UK could tax the company’s Irish income at 20 per cent and its Jersey bounty at 25 per cent. More generally, it could easily impose remedial taxes such that its effective tax rate, in each of the countries where it operates, equals 25 per cent.

Such a reduction of the company’s tax deficit would not violate any international treaty. It does not require the cooperation of tax havens. It doesn’t even require new data: the necessary information already exists. But if Britain did that, wouldn’t companies move their headquarters to tax havens? This threat, too, can be addressed. The first way to do so is to strengthen the regulations that determine where a company is headquartered; for instance, a firm with most of its activities in Britain could be automatically considered British. Another solution is international cooperation. The world’s largest economies could all agree that they will apply, say, a 25 per cent minimum tax rate to their multinationals, wherever they operate. From there it would be easy to pressure tax havens to join such an agreement—with the threat of sanctions if need be.

Each country is of course entitled to its laws, but when these laws spill over negatively on to others, the victims are entitled to retaliate. Refusing to take part in a minimal global standard such as an effective corporate tax rate of (an unexceptional) 25 per cent, should be seen for what it is: an extreme form of dumping that fills the coffers of some small states (and more importantly of global shareholders) at the expense of everyone else. Such practices must be discouraged.

Contrary to what the experts polled by the IMF might believe, globalisation does not prevent countries from taxing corporations at high rates. Those who profess that the race to the bottom in corporate tax rates is natural, that taking on tax havens is a crime against free trade, are not the defenders of globalisation. What will make globalisation sustainable is not the disappearance of capital taxation, but its reinvention. Not tax competition, but tax coordination. Not free-trade agreements that ignore fiscal issues, but international deals that advance tax harmonisation. When people embrace these ideas, it will become apparent that progressive taxation is not doomed to disappear—but that it can be reinvented and expanded in a globalised economy.