Taxing Global Businesses: The Imperfect Choices



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But the situation of large firms has changed dramatically in at least two ways: 1) they have become much more likely to cross national borders in their inputs, production, customers and owners; and 2) they are more dependent on intellectual property, which means that the profits come from something that is not of a physical nature.

Alan Auerbach outlines the issues and reviews the solutions that have been tried in “The Taxation of Business Income in the Global Economy“, presented at the 2021 Martin S. Feldstein lecture at the National Bureau of Economic Research (NBER journalist, September 2021). Here’s Auerbach on how the nature of America’s largest corporations has changed (footnotes omitted):

Fifty years ago, the top five companies by market capitalization were IBM, General Motors, AT&T, Standard Oil of New Jersey (Esso, the predecessor of today’s ExxonMobil) and Eastman Kodak. … These were companies that “made things” in identifiable places, much of it in the United States. If we turn to today, we see five more familiar names, all giant companies: Apple, Microsoft, Amazon, Alphabet (Google’s parent company) and Facebook. These companies are global multinationals, relying very heavily on the use of intellectual property in the goods and services they provide …

Over the past half-century, the share of intellectual property measured in the assets of U.S. non-financial firms has more than doubled, according to the U.S. Fed’s financial accounts. This is probably a conservative estimate, as the measure of intellectual property here is quite narrow. The share of U.S. corporate pre-tax profits from overseas operations has almost quintupled, according to data from the Bureau of Economic Analysis. American companies have become much more multinational, not only by selling products abroad, but by manufacturing them abroad as well. And the share of cross-border ownership has continued to increase, to the point that individuals and foreign companies represent a significant fraction of the shareholding of American companies.

When production, customers and owners are spread all over the world, when the “product” can be a digitally delivered service, and when the ultimate source of profit is closely tied to intellectual property, the taxation of large global corporations becomes complex. . The idea of ​​corporate profits itself is far from a clear idea in a world of powerful accountants and finance, operating against the backdrop of different national tax codes. Each country would prefer to establish rules to attract companies that it can tax. Companies that operate across national borders in a number of ways have the opportunity to move from country to country and pretend that the profits are actually being made in one place rather than another. What could we do. Auerbach discussed the possibilities, which I summarize here.

  1. Establish corporate tax rules that seek to prevent businesses from avoiding taxes. This has been the main strategy for the past few years, and the whole point of the previous discussion about the changing nature of big business is that it can be difficult to make this work in the modern economy.
  2. Patent boxes are a way to encourage companies with intellectual property to claim residency in your country, so that your country can tax the company. But to attract business, the “patent box” approach often promises a reduction in corporate taxes. As Auerbach writes: “One of the problems with patent boxes is that, in a sense, they deal with tax competition by just giving up.
  3. Tax global businesses based on their users, not their profits. For example, European countries where a company like Google or Facebook has virtually no employees might seek to tax these companies because the locals use the services of these companies. The idea is that a part of the profits of the company goes back to the users of a certain country, so that the country should be able to tax the profits of the company. But of course, drawing a straight line from users to profits for these companies is a huge simplification. Their profits are based on many factors including advertising revenue, operating costs, intellectual property, and other factors. The United States is generally not happy if foreign countries try to tax companies based in the United States.
  4. Use a “destination-based tax,” which means taxing businesses in proportion to where their sales are located. This approach requires detailed analysis, and Auerbach reviews variants of a destination-based tax, such as the allocation of residual profits by income (RPAI) and a destination-based cash flow tax (DBCFT). Given the international cooperation, this approach seems largely feasible. But note that this is a fundamental shift from the idea of ​​taxing corporate profits to the idea of ​​taxing corporate sales: that is, two companies with equal sales would pay equal taxes, even if one made positive profits and the other lost money. When people argue over whether companies are paying their fair share, I don’t know if this approach fits their intuition.
  5. Mix all of these approaches together, don’t worry too much about the contradictions and do a little of each. As Auerbach points out, this was essentially the approach of the 2017 Tax Cuts and Jobs Act.

The current international negotiations on global corporate taxation are essentially based on two “pillars”, as they are often called. A “pillar” would take a certain share of the profits of large digital service companies and let other countries share those tax revenues. Since these big companies are mostly American companies, the rest of the world likes this idea, but it is not clear that the United States Senate will approve it. The other “pillar” would be a minimum tax rate of 15% on the profits of large companies. The problem with this approach is that it essentially ignores the underlying issues. As Auerbach writes:

But beyond the immediate barriers to adoption, there is also a more fundamental, longer-term challenge that stems from trying to preserve a taxation based on concepts that no longer really work, that are poorly defined and endogenous: the residence of the business and the location of production and profits (what tax authorities have come to call the location of value creation). Because it is based on these ill-defined concepts, the two-pillar system will not be sustainable unless countries adopt and adhere to similar rules that reduce the incentives for companies to shift production, profits. and residence.

Auerbach is a proponent of a destination-based approach to taxation and believes that economic and political forces will tend to push in this direction over time. Maybe he’s right. But another possibility is that the nature of business continues to change, the importance of intangibles like intellectual property continues to grow, and the long-term argument about what it means for businesses to pay their fair share continues to grow. ringing much the same, even if the underlying conditions keep changing.

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