It is important to note that disparate environmental regulations do not necessarily trigger a race to the bottom. For example, a multinational company that needs to comply with a higher-standard jurisdiction may find it more cost-effective to use one uniform production method throughout its operations. By employing the cleaner production method in lower-standard jurisdictions, it helps to spread cleaner technologies and methods throughout the world. In just this way, higher clean air standards in California caused US automotive companies to improve their environmental performance throughout the entire US market. It was more efficient to adopt cleaner technologies for all vehicles sold in US states than to use a more “dirty” technology for less stringent states.
Another example concerns global shipping. While it is easy to register a ship in many jurisdictions, and some locations provide options with scant regulation and very low fees, shipping standards have nonetheless not collapsed. Ships registered with stricter rules receive benefits that those sailing under “flags of convenience” do not: fewer port detainments, more fish market access, and smoother labor relations with dock workers. This has caused a “race to the middle” in shipping standards, as low-standard registries have raised their standards to give registered ships the same benefits.22
Concern 4: Can National Governments Tax Global Firms?
The possibility of a race to the bottom in corporate tax policy is also a very real concern. In response to the mobility of multinational corporate investment, many governments have sought to create more attractive tax environments to lure investments, jobs, and tax revenues to their jurisdiction. These efforts have led to steady declines in corporate tax rates in recent decades (fig. 7.5).
Despite the declining tax rates, corporate revenues have been relatively flat in many peer countries, leading some to suspect that tax competition is not a concern. However, it is important to remember the very large rise in corporate profits over this period, which would otherwise imply that corporate tax revenues should be increasing.
Figure 7.5: Corporate Tax Rates Are Falling Across Peer Countries
Note: The figure shows the average OECD-country corporate tax rate at the central government level. Data source: OECD Statistics.
While there is evidence that investment and employment are sensitive to tax rate differences among countries, their responsiveness to favorable tax environments is far less than the responsiveness of the corporate tax base itself. For US multinational corporations, the location of economic activity across countries is primarily determined by the sorts of factors that should matter: market size, customer purchasing power, educated workforces, and well-functioning institutions.23 For example, when looking at where U.S. multinationals locate jobs, whether measured in terms of payroll or job headcount, the biggest markets in the world are the ones that attract activity (fig. 7.6).
Countries like the United Kingdom, Canada, Germany, and China are economic powerhouses; it is not surprising that they attract substantial US multinational activity. For similar reasons, the United States has also, in recent years, received more foreign direct investment than it has sent abroad.
Figure 7.6: Where Are the Jobs for US Multinationals? The Usual Suspects: Big Markets
Note: Calculations are based on data for US multinational companies. This figure shows the eleven countries with the biggest job and payroll shares. Data are for 2014, the most recent year with available data. Data source: US Bureau of Economic Analysis.
When it comes to the distribution of the corporate tax base, however, US multinational companies are extremely tax-sensitive. Over half of all foreign profits are earned in just seven tax havens with effective tax rates under 5 percent: the Netherlands, Luxembourg, Ireland, Bermuda, the Cayman Islands, Switzerland, and Singapore. These countries have a combined population smaller than that of California. Of the top ten affiliate-profit countries, only three (the solid bars in Figure 7.7) are not tax havens.
How is it that a country the size of Bermuda, with a population of about 65,000—roughly the same size as the student body of Ohio State University—ends up with $94 billion in profits, representing 7 percent of all foreign profits of US multinational firms, and about $1.5 million per resident?24 The profits of US multinational affiliates in Bermuda are sixteen times the size of Bermuda’s economy.25 It is simply implausible that such profits were truly “earned” in Bermuda; instead, they were shifted to Bermuda for tax purposes, since Bermuda has a 0 percent corporate tax rate. Similarly implausible levels of profits are reported in the other tax havens on the list: the Cayman Islands, Luxembourg, the Netherlands, Switzerland, Singapore, and Ireland.
Figure 7.7: Where Do US Multinationals Book Their Profits? Tax Havens
Note: Calculations are based on data for US multinational companies. This figure shows the ten countries with the biggest income shares. Data are for 2014, the most recent year with available data. Data source: US Bureau of Economic Analysis.
Multinational corporations shift profits abroad through a variety of mechanisms. For example, they can underprice goods sold from high-tax affiliates to low-tax affiliates, and overprice goods sold from low-tax affiliates to high-tax affiliates; this makes the low-tax affiliates appear more profitable.26 They can also transfer intellectual property to affiliates in tax havens through cost-sharing agreements or other mechanisms; the profits from utilizing the intellectual property then accrue in the haven jurisdiction. Another method is to change the structure of financing across a company’s affiliates such that the high-tax affiliates have more interest deductions and the low-tax affiliates have more interest earnings. Finally, complicated chains of ownership and hybrid corporate structures can be used to create income that goes untaxed in any jurisdiction; recent press accounts have described many instances of companies creating “stateless income” using such techniques.27
In my research, I find that profit shifting by multinational corporations is a large and pervasive problem, costing the US government over $100 billion per year at present, and other governments collectively about $200 billion per year.28 Corporate tax base erosion has not gone unnoticed by governments, the press, and the international non-governmental organization (NGO) community. One response was the recent “Base Erosion and Profit Shifting Project” of the OECD and G20 countries, which produced nearly two thousand pages of suggested guidelines for governments seeking to stem the profit shifting problem. While this attempt to tackle tax avoidance should be commended, it is unclear that these efforts will be enough to stop tax base erosion. A more systematic overhaul of company taxation is likely necessary. Below, I suggest how we might modernize the US tax system to make it more suited to the global economy.
Modernizing Economic Policy in a World of Global Companies
Multinational corporations are successful in generating value, innovation, and activity, often to the benefit of larger society. Yet international business also creates policy concerns in the four areas just discussed. This section will consider ways to modernize economic policy to adapt to the sophistication and international mobility of today’s global companies.
Many useful policy responses are unilateral; as the next section will show, they do not require cooperation with other countries. But other good policy responses involve combined efforts. For example, international agreements can help governments counter the pressures of policy competition. By agreeing on frameworks of core labor and environmental standards, and by working together to stem tax base erosion and tax competition, countries can avoid the downsides of competitive pressure. Rather than face a prisoner’s dilemma, where everyone suffers by acting individually, they can reach binding commitments that produce better outcomes for all.29
Working together on international agreements need not imply policy harmonization. For example, countries can, and likely should, choose different minimum wage rates and tax rates. Poor countries cannot afford rich-country minimum wages, and citizens may have different preferences regarding the size and role of gov
ernment. But there are still substantial gains to be had from avoiding beggar-thy-neighbor policies; often, there are situations where agreements can improve outcomes for all participants.
Britain’s decision to leave the European Union and Donald Trump’s election on a platform of isolationist policies were both steps in the opposite direction. International trade agreements like the proposed Transatlantic Trade and Investment Partnership (T-TIP) and supranational arrangements like the European Union are just the sort of institutions and agreements that work against policy competition.
The T-TIP, now indefinitely stalled, was intended to be a high-standard trade agreement between the United States and the European Union. There was an emphasis within the agreement on ensuring high labor standards, environmental protections, and consumer protections.30 Given recent political developments on both sides of the Atlantic, the likelihood of this agreement going forward is remote at best. Meanwhile, the European Union has recently reached a trade agreement with Canada; this agreement is noteworthy for fostering cooperation in several areas, including competition policy, regulatory cooperation, sustainable development, labor rights, and environmental policy. The agreement has provisions specifically prohibiting either side from lowering its labor or environmental standards to boost trade.31
In the future, agreements like T-TIP can do much to modernize economic policy to suit a global economy. The world’s largest businesses have globally integrated operations that span borders. Governments need to acknowledge that reality, and adjust their policy choices accordingly.
While some environmental problems can be addressed effectively at a national or subnational level, others require larger, international efforts.32 The largest and most important example concerns the world’s greenhouse gas emissions, which drive climate change and profound damage to the planet’s ecosystems. The Paris Agreement of 2016 was a crucial step, as countries worked together to set policy goals toward addressing this problem. (Chapter 10 will discuss why a carbon tax is a useful way for the United States to respond to the world’s largest environmental problem, while also raising essential tax revenues that allow for lower tax rates elsewhere in the tax system.)
Labor issues are also of concern. There is substantial evidence that the share of world economic output accruing to capital has increased dramatically in recent decades. Rising corporate profits and corporate savings are an important part of that story, as are labor unionization rates, which have been steadily falling throughout the world (fig. 7.8).
How globalization will affect workers’ rights in developing countries is uncertain; global influences can help as well as hurt. Economic growth typically leads to higher wages and greater labor rights. For example, child labor tends to fall dramatically as countries become richer, regardless of their political commitments to ending child labor.33
In many areas—labor rights, environmental policy, and tax competition—there are common concerns associated with competitive pressures across jurisdictions. What if mobile firms move their operations toward those countries with the lowest standards and lowest tax burdens? What prevents a race to the bottom? International agreements can be a key part of the toolkit.
Also, some purely domestic policy responses affect other countries in positive ways. For example, antitrust laws provide a useful way for governments to counter excessive market power in the hands of too few companies, helping to protect consumer interests and to provide a healthy, competitive market for smaller firms. US and EU antitrust laws affect both domestic companies and companies from other countries that want to serve their markets. Effective antitrust enforcement benefits other countries, since ensuring competitive outcomes in large markets will also have broader pro-competitive effects in the larger world economy.
Figure 7.8: Steady Declines in Union Jobs in the United States and Abroad
Data sources: OECD Statistics; Jelle Visser, “Union Membership Statistics in 24 Countries,” Monthly Labor Review, January 2006; Lyle Scruggs and Peter Lange, “Where Have All the Members Gone? Globalization, Institutions, and Union Density,” The Journal of Politics 64:1 (2002), 126–153; David G. Blanchflower, “A Cross-Country Study of Union Membership,” Dartmouth College Working Paper, March 2006.
It is also possible for one country’s corporate tax base protections to have positive effects on other countries’ tax bases, as well. For example, a minimum tax on income booked in tax havens reduces the incentive for multinational companies to shift profits away from higher-tax jurisdictions toward tax havens.
An Agenda for Unilateral Action
Even absent international agreements, there is much that can be done by the United States on a unilateral basis—and, given the size and power of the United States, these actions can be quite effective. The following agenda is built on three key items.
Item 1: Do Not Resort to Tax-Cutting and Regulation-Gutting
The threat of international competition is often held up as a rationale for reductions in tax rates or regulatory burdens. Yet, in the United States, we should avoid the pressure to lower our regulatory and environmental standards. While standards should be efficiently designed and continuously streamlined, there is no reason to roll them back. The United States has a long history of successful global corporations that continues to the present day. Even before the tax cuts of 2018, there was no need to ease tax or regulatory burdens to attract investment or economic activity. For example, across fifteen years of Forbes Global 2000 rankings, the United States is consistently home to a disproportionate share of the world’s largest corporations. Our economy is about one-fifth the size of the world economy—16 percent in purchasing power parity (PPP) terms and 22 percent in US dollar terms—yet we have larger fractions of the world’s top two thousand firms: 28 percent by count, 33 percent by sales, 37 percent by profits (consolidated worldwide), 24 percent by assets, and 44 percent by market capitalization (fig. 7.9).34
Some observers caution about the threat of corporate inversions, which occur when companies restructure to change their headquarters locations for tax purposes. Despite a few highly publicized instances of corporate inversions, however, there is little evidence that corporate inversions are a sizable problem. The US-headquartered share of the Forbes Global 2000 (in terms of sales, profits, assets, or market capitalization) has been increasing slightly in recent years, despite the growth of China and India. Recent US Treasury regulations in 2015 and 2016 were effective in reducing tax-motivated inversions, although some of these regulations have been challenged, and the current administration is rethinking this regulatory stance.35 Nonetheless, there are easy legislative solutions to corporate inversions that do not require a race to the bottom in corporate tax rates.36
Figure 7.9: US Share of Forbes Global 2000 Firms (and World GDP), 2016
Note: Data on top companies are for 2016; the Forbes 2017 Global 2000 list reports 2016 data. The first two columns show the US share of the world economy; the following columns show US shares of Forbes Global 2000 companies, by different measures. Data sources: World Bank; Forbes 2017 Global 2000.
Further, it is important to have adequate tax revenues to ensure that the United States remains an attractive place to invest. Good public infrastructure, good institutions, the rule of law, well-educated workers, and investments in research and development are all important foundations for the economic success of US companies, and they all require tax revenues to sustain. And while regulations can always be improved, lax regulation is not a recipe for economic success. On the contrary, there is substantial evidence that insufficient financial market regulation was instrumental in generating the Great Recession of 2008.
Further, our corporate tax system was already competitive, even before the rate cuts enacted in 2018 due to the legislation commonly referred to as the Tax Cuts and Jobs Act (TCJA).37. Our corporate tax system most certainly had serious problems, but a high tax burden on multinational corporations was not one of them. While it is true that the US statutory rate of
35 percent was indeed high relative to peer nations, this is not the relevant measure of multinational corporate tax burdens. Due to their aggressive use of corporate loopholes, many US multinationals had effective tax rates in the single digits, far lower than that statutory rate. Also, US corporate tax revenues are consistently lower than the corporate tax revenues of our peer trading partners, by about 1 percent of GDP. Part of the revenue shortfall is explained by profit shifting to tax havens, and there are also other reasons for weak US corporate tax revenues.38
Trying to Take a Bite Out of Apple
The European Commission’s ruling against Apple provoked strong feelings in Ireland, with news headlines like “If Apple won’t pay tax what hope is there for civilisation?” and worries about sovereignty among Irish members of parliament. In August 2016, EU Competition Commissioner Margrethe Vestager ordered Apple to pay the Irish government €13 billion ($14.5 billion); she and the Commission claimed that “sweetheart deals” struck in 1991 and 2007 allowed Apple to escape taxation on the billions of profits earned by Apple’s Irish subsidiaries. The corporation had an effective tax rate of 0.005 percent on its European profits in 2014.
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