Sometimes my mind wanders to think about the mountain of debt the UK and most other countries across the globe have accumulated. The UK national debt was already nearly £2 trillion and now, with a much-needed estimated £330bn to fight the pandemic, the debt will exceed UK GDP for the first time since 1964. There’s also little prospect that this gargantuan sum will diminish significantly.
I have an additional reason to worry: I’m Greek, and have seen first-hand how economic crises easily lead to political ones. I experienced the disastrous effects of a nation accumulating vast amounts of debt and then failing to service it. I remember lenders demanding over 30 per cent in interest and the painful austerity that followed. The nation saw cuts in hospitals and education; unemployment rates of over 25 per cent; civil unrest; the rise of a neo-Nazi party in Greece, and a society in collective depression. Ten years later, the Greek economy is still struggling.
But who is responsible for all this debt in Greece, the UK and many other countries? Unlike some of my colleagues I don’t blame welfare recipients, a supposedly inflated state apparatus or the cliché of inefficient civil servants. In fact, if it were up to me, I’d invest even more money on social services, particularly in education, health and infrastructure. Spending more to prop up the economy in times of crisis seems like common sense to me. I certainly don’t blame the little guys like me and you for not paying enough taxes. If anything, we already pay too much tax: income tax, national insurance, council tax and VAT on most products. Historically, people revolted against their governments for much less tax than we pay these days.
I blame the legal loopholes and practices that allow corporations to pay much less than their fair share of tax. The IMF has estimated that tax havens—typically an offshore country or area that allows registered companies there to pay very little tax—cost governments a gargantuan $500-600bn per year in lost taxes. In fact, about a fifth of the biggest companies in the UK regularly avoid paying any tax whatsoever. Tax Watch UK estimated that the big tech firms—Apple, Cisco, Facebook, Google and Microsoft—made £30bn of profit in the UK in the years 2012-2017, but shifted most of these profits offshore for tax purposes, paying just £933m in UK tax between them. This is a rate of about 3 per cent. We can understand how little that is if we compare it with what you and I pay: direct taxes cost the richest one fifth of the population in the UK about 31 per cent of their income while the poorest one-fifth pays “only” 15 per cent of their income in direct taxes.
How to hide profits
If you’re big enough, there are many ways to manipulate the system but a widely used and relatively simple one is to artificially shift your revenue to a tax haven. This is called fraudulent transfer pricing or transfer mispricing. It’s very simple. Take a (fictional) company that mines diamonds in Sierra Leone and sells them in the UK. If this company decides to stop paying taxes, all it needs to do is to set up a couple of subsidiary companies that act as “intermediaries” in the buying and selling chain. They set up subsidiary Y in Sierra Leone and subsidiary Z in a tax haven. The company that mines the diamonds—subsidiary Y—sells the product to the company in the tax haven—subsidiary Z—at an artificially low price.The result is that the company in Sierra Leone shows minimal profits, or even losses, and therefore pays little tax in that nation. Then, company Z sells the diamonds to the UK retailer at a high price—a price almost as high as the retail price that diamonds will be sold later on. The result is that the UK-based company also pays minimal tax there: since they have sold the diamonds at the same price they were bought for, they can show they've only made minimal profits as well. All the profit has shifted to the tax haven company Z. But as this company is based on a tax haven, it will also pay minimal tax by default. University of Massachusetts Amherst’s Political Economy Research Institute estimates that approximately $1.4trn of capital left African countries between 1970-2015. The African Union estimates that transfer mispricing is responsible for a substantial portion of that staggering amount.
The problem of the digital economy
Looking into the future, the rise of the digital economy—a process that Covid-19 has accelerated further—makes tax avoidance even easier. It’s easy to set up a company in a tax haven online and pretend that your offices and production are based there. It’s even possible for big companies to negotiate an exceptionally favourable tax treatment from a government by promising to shift their headquarters there. For example, the European Union is trying to claw back hundreds of millions of dollars in taxes from companies such as Facebook and Amazon, arguing that these companies have benefitted from exceptionally generous deals from Ireland and Luxembourg respectively. Ireland and Luxembourg may have benefitted individually but other EU members and the European Union as a whole have lost out.In addition, in a worrying sign of our times, the government of the Barbados seeks to extend their services to individuals as well. Under this scheme, for a fee of £1,590 any Briton earning over £39,760 can work remotely from that island and—provided they’ve registered to stay for at least six months—their income will be taxed there, even if the income received was for services provided in the UK. Barbados recently reduced its top rate of income tax from 33.5 to 28.5 per cent. As for those of us who can’t declare that we’re working remotely from a tax haven, we’ll simply need to pay higher income taxes in the UK. Naturally, the more businesses and individuals set up base in tax havens, the more our governments will have to borrow to make up for the shortfall.
Proposal: a unitary tax
All this can’t go on. I believe that a reset of the international taxation system is urgently needed, and it’s feasible too. A method that could cut tax havens out of the picture is a so-called unitary tax. This tax divides the global profits of a multinational between each country where the company operates. So, Facebook can still claim that it’s based in Ireland but it won’t be able to benefit from its ultra-low corporation tax rates for its global income. Facebook’s profits would be allocated to each country it operates in, based on a formula that could take into account metrics such as advertisement revenue, number of customers or actual physical presence in each country. Then, each country can decide how to tax the portion of profits made within its border. Running a one-person booking office in Barbados or a limited crew in Ireland won’t cut it anymore.A unitary tax is not without its issues of course: countries will certainly bicker over how a multinational’s profits should be divided. Countries with bigger populations will be pushing for a formula that prioritises the sheer number of customers that a firm has in each country. Other governments will be advocating that the key metric should be spending per capita, where the goods/software are actually made or where key raw materials come from. The US government—the real home to some of the biggest multinational corporations—has threatened to retaliate if the EU taxes US companies. The UK is also home to, or has close ties to, four of the ten tax havens where most global profits are shifted and unfortunately the country’s knee jerk reaction would be to protect places like Jersey’s status as a tax haven. Yet, despite its complications, a unitary tax or a similar form would be a great step towards a fairer tax treatment of global corporate profits.
The tax treatment of big corporations goes deeper than bolstering our national finances and reducing our debts. It’s about reassuring increasingly disaffected citizens that democracy and an open society are worth having. In recent years, reactionary and populist politicians and thinkers have advanced considerably across the world. Economic insecurity, diminishing state support due to austerity and rising inequality have boosted nationalism, xenophobia and anti-globalisation. Now, more than ever, the world needs to act. The UK government needs to think if it’s worth maintaining the country’s role as a key enabler of global tax avoidance or if it should lead this global drive for fairness.
