The Case For Real Tax Justice

TJN arrives at the figure by multiplying its estimate of annual tax losses ($472 billion) by 10. It’s unclear why it does this, other than to create a bigger number, but on that basis, TJN could have said that the world would lose $9.4 trillion over the next two decades. Or $47 trillion over the next century. My guess is that TJN felt a bigger number would attract more attention and a decade seemed like a reasonable timescale.

There are only two small problems with this $4.7 trillion figure. The first is that it is based on dubious assumptions about the extent of “corporate tax abuse” and “offshore wealth tax abuse.” The second is that, even if the annual tax “loss” figure were correct, it ignores the dynamic effects of these “losses.” I’ll address each of these in turn, and then turn to the problems with a global tax treaty.

Corporate Tax Abuse

TJN states that “by placing holding companies and important value-creating assets in corporate tax havens, large corporations can shift their profits to low tax or no tax jurisdictions, in order to artificially drive down their tax obligations elsewhere and pay little to no tax on the profits they shift into tax havens.” TJN calls this “corporate tax abuse.”

The practice of shifting profits from high-tax to low-tax jurisdictions to reduce current tax liabilities has been widely recognised for decades. A key requirement for such practices is the ability for parent entities to exclude profits made by overseas subsidiaries from inclusion in the amount of profit on which tax is to be paid by those parent entities. Clearly that is, first and foremost, a determination made by politicians and tax authorities in the parent entities’ jurisdictions. For example, those governments can and do put rules in place limiting the ability of domestic corporations to use agreements with subsidiaries and other related parties in other jurisdictions to shift profits, and thereby reduce the amount of tax they pay in the parent jurisdiction.

To the extent that foreign governments directly facilitate tax avoidance, it is through the application of double taxation treaties (DTTs), which specify the circumstances under which profits made by an entity in one jurisdiction are to be taxed in the other jurisdiction.

Caribbean jurisdictions such as Cayman, BVI and the Bahamas, which have no corporation tax and no substantive double taxation treaties, cannot directly influence the rate at which corporations are taxed in other jurisdictions, so it is more than a little odd to accuse these jurisdictions of causing “corporate tax abuse.” Indeed, it is a category mistake. Just as numbers aren’t colours, and two can’t be blue, so jurisdictions cannot cause “tax abuse” when they have no corporation taxes and no say over the rate or method of taxation of other jurisdictions.[2]

Nonetheless, under the auspices of the OECD’s Base Erosion and Profit Shifting (BEPS) programme, Caribbean members of the “inclusive framework”, including Cayman, BVI, and the Bahamas, have introduced many measures specifically intended to assist other jurisdictions in collecting their taxes. These measures include the implementation of tax information exchange agreements, the Common Reporting Standard, Country by Country Reporting (CbCR), various intergovernmental agreements (for example in relation to the implementation of the USA’s FATCA), and so on. As such, and for better or worse, it would be more appropriate to describe them as “corporate tax enablers.”

The Scale Of Profit Shifting

The phenomenon of corporations shifting profits to low-tax jurisdictions has been well documented for decades. In the academic literature, there are debates over the scale of profit shifting, with some estimates suggesting that in the late 2010s it was in the range of $500 billion globally per year, while others put it at perhaps one tenth of that. (Aparna Mathur’s recent article for IFC Review contained an excellent summary of this debate.[3])

TJN asserts that corporations shifted $1.1 trillion in profits, reducing government revenue of $301 billion. Its estimates were based on publicly available CbCR data for 2018, which are aggregates based on information provided by companies with annual revenue in excess of €750 million.

By contrast, a recent study by a team led by professor Clemens Fuest, one of the world’s foremost authorities on profit shifting and President of the prestigious CESIfo Network, used entity-specific CbCR data for 2018, made available by the German federal finance ministry on a confidential basis, to calculate the extent of profit shifting and associated tax avoidance.[4] Fuest’s team found that the 3,513 qualifying MNEs operating in Germany shifted a total of €242 billion in profits and avoided €53 billion in taxes. The authors note that not all MNEs operate in Germany so they have missing data points, but even if they missed half of all the profits shifted (which seems unlikely), that would mean a global aggregate of around €500 billion in shifted profits and €106 billion in avoided taxes.

So, compared with this more credible estimate, TJN seems to have overestimated the amount of profit shifting by between two and four times, while it has overestimated the amount of taxes avoided by between three and six times.

The Effects Of Profit Shifting

While there is no question that corporations shift profits to reduce their tax liabilities, such actions are not necessarily harmful; indeed, they may be beneficial. In a seminal 1994 paper, economists James Hines and Eric Rice argued that by shifting foreign profits from high-tax to low-tax jurisdictions, U.S. corporations are able to increase the profitability of overseas activities, and thereby increase the amount of tax they pay upon repatriation of those profits.[5]

In addition, by shifting profits from high- to low-tax jurisdictions, corporations can accumulate profits overseas, enabling them to make additional investments. This increases the supply of capital and reduces its cost, leading to higher levels of investment, innovation and economic growth. That, in turn, leads to higher levels of employment and consumption, with associated increases in taxation.

Harmful Tax Avoidance

If TJN was actually concerned about tax losses, it might turn its attention to the main and most harmful sources of such avoidance, which are the discriminatory “expenditures” permitted by nearly all tax systems. For example, since the 1950s, the US government has permitted companies to provide health insurance as an untaxed perquisite benefit to employees (that is, the employee does not pay tax on the benefit and the company is able to treat it as an expense, thereby reducing its taxable profits). In its latest assessment, the US Treasury estimates the cost of this perk to the federal government in foregone taxes at 3.4 trillion over the coming decade.[6] In other words, the US alone expects to lose nearly as much tax from this single permitted expense as TJN “claims” the whole world will lose from all corporate tax avoidance and personal tax evasion.

Offshore Wealth Tax Abuse

The second category of “tax losses” estimated by TJN are those it claims are related to “financial secrecy,” which it alleges underpins enormous amounts of tax evasion by wealthy individuals. It asserts that this evasion is facilitated by “secrecy jurisdictions” with significant “abnormal bank deposits.” But a closer look at the basis upon which TJN makes this claim suggests it is simply barking up the wrong tree.

Secrecy Jurisdictions

TJN defines “secrecy jurisdiction” as “those that have high Secrecy Scores on the Financial Secrecy Index for the category of ownership registration.”[7] But TJN’s metrics for “secrecy” are highly dubious.[8] For example, 54 jurisdictions meet the arbitrary criterion TJN uses in the State of Tax Justice – a “secrecy score” of more than 70 on the category of ownership registration – but if that criterion were changed to a secrecy score of more than 66, then 72 jurisdictions would be so classified. Among the jurisdictions that are currently excluded are Nigeria (67), Russia (68), and the Maldives (69).

Aside from being arbitrary, TJN’s criterion for a “secrecy jurisdiction” fails to consider some important characteristics that likely prevent many jurisdictions from facilitating tax evasion.  For example, Cayman has a verified beneficial ownership registry, has implemented the OECD’s Common Reporting Standard (CRS) under which all financial institutions in the jurisdiction are required annually to report information on accounts held by foreign nationals, and it automatically shares this information with authorities in over 100 jurisdictions.[9] Cayman has a similar agreement with the USA, under which it shares information for the purposes of facilitating compliance with FATCA.[10] These actions strongly disincentivise individuals from attempting to use Cayman to engage in tax evasion. The same is surely true for other Caribbean jurisdictions with similar measures in place.

Abnormal Bank Deposits

TJN asserts that jurisdictions with “abnormal” bank deposits are more likely to facilitate tax evasion. There are several significant problems with this approach. First, TJN’s criteria for “abnormal” captures about 50 per cent of all foreign bank deposits in the world, which suggests that TJN has a poor grasp on the term “abnormal.” Second, the reason such a high proportion of bank deposits are classified as abnormal is most likely that the data TJN uses, which is from the Bank for International Settlements (BIS), does not distinguish between deposits held by corporations and deposits held by individuals.

In Cayman’s case, 99.97 per cent of deposits are classified as “abnormal” but this almost certainly has nothing to do with secrecy or tax evasion. As the world’s largest domicile for funds (including hedge funds, PE funds, etc.), it is hardly surprising that most of the bank deposits attributable to the jurisdiction are held by foreign entities. In other words, there is nothing inherently “abnormal” about the large foreign deposits in Cayman, and they certainly provide no evidence of tax evasion.

TJN co-founder Richard Murphy makes similar points, noting “the main flaws” in SOTJ 2023:[11]

“First, that all deposits held in tax havens are assumed to be illicit. That is not true. Second, it is assumed that little or none of the income earned on the sums saved in tax havens is declared to appropriate tax authorities with the right to know about this income. Again, this is not true. There is strong evidence to suggest that at least 80 per cent of that income is declared to the authorities that have the right to tax it. Third, the rate of income earned on offshore investments is assumed to be higher than that available onshore, which is simply untrue.”

There Is No Tax Crisis

TJN’s contentions regarding the alleged effects of tax avoidance on government revenue are contradicted by the evidence. Put simply, there has been no race to the bottom. As Figure 1 shows, over the past half century, tax revenue as a percentage of GDP has increased in OECD countries. Moreover, these increases are mainly driven by countries with the lowest tax to GDP ratio. In other words, in terms of taxes as a proportion of GDP, there has been a race to the top.

Figure 1: Tax Revenue as a Percentage of GDP, OECD countries (Source: OECD)

Similarly, as can be seen in Figure 2, average corporate tax revenue in the OECD as a percentage of GDP shows a general upward trend, with peaks and troughs corresponding to the business cycle, and does not seem to have been significantly affected by the reduction in average headline rates.

Figure 2: Corp Income Tax Revenue (% GDP, Right) & Statutory Rates (%, Left), OECD Countries (Source: OECD)

Meanwhile, as can be seen in Figure 3, average corporate income tax revenue in Non-OECD countries follows a very similar pattern to that of OECD countries, contradicting claims that such revenue has been disproportionately adversely affected by profit shifting.

Figure 3: Average Corp Income Tax as a Percentage of GDP, OECD and Non-OECD Countries. (Source: OECD)

Finally, in the UK and elsewhere, the proportion of tax paid by those on high incomes has been increasing over time. Consider the following figures from a recent House of Commons Library report, which shows that the proportion of total tax receipts paid by the top one per cent of taxpayers increased from 21.3 per cent in 2000 to 29 per cent in 2020, while the proportion of tax paid by the top 10 per cent increased from 51.3 per cent to 60.3 per cent.

Source: House of Commons Library[12]

The Case For Shifting Taxes Away From Personal And Corporate Income

Taxes on income and capital gains are effectively taxes on productive economic activity. It is perhaps no surprise that in 2008, when five OECD economists produced a report on the relationship between taxation and economic growth, they concluded: “Corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxes. Recurrent taxes on immovable property appear to have the least impact. A revenue neutral growth-oriented tax reform would, therefore, be to shift part of the revenue base from income taxes to less distortive taxes such as recurrent taxes on immovable property or consumption.”[13]

Many other studies have come to similar conclusions.[14] Indeed, this finding is among the most universally accepted in all of economics. As such, governments should ideally seek to switch away from a reliance on corporation and personal income taxes and towards less harmful forms of taxation, such as sales taxes, VAT, and property taxes. Until recently, competition has been driving this process. However, the introduction of a global minimum tax for corporations could seriously impede this process, even if it is limited to MNEs.

Is There Need For A UN Tax Convention?

TJN begins and ends SOTJ 2023 with a plea for the United Nations to establish “a UN tax convention and a new framework under UN auspices.” Given that government revenue as a proportion of GDP has been increasing, that the proportion of income attributable to those on high incomes has been increasing, and that there is good evidence the actions taken by the OECD and members of the Inclusive Framework are reducing both corporate tax avoidance and individual tax evasion, there is no obvious need for a new UN tax convention.

Indeed, to the extent that such a convention reduces tax competition and leads to greater reliance on personal and corporate income tax, it would lead to lower rates of economic growth, thereby hindering the sustainable development it is intended to promote.

1 Tax Justice Network, State of Tax Justice 2023, hereinafter SOTJ 2023.

2 https://plato.stanford.edu/entries/category-mistakes/

3 https://www.ifcreview.com/articles/2023/june/profit-shifting-let-s-define-the-problem-before-we-rush-to-the-solution/

4 Clemens Fuest, Stefan Greil, Felix Hugger, Florian Neumeier, Global Profit Shifting of Multinational Companies: Evidence from CbCR Micro Data, CESifo, Munich, 2022. https://www.cesifo.org/DocDL/cesifo1_wp9757.pdf

5 James R. Hines, Jr. and Eric M. Rice, “Fiscal Paradise: Foreign Tax Havens and American Business,” The Quarterly Journal of Economics 109 (1), 1994, 149-182. https://www.jstor.org/stable/2118431

6 https://home.treasury.gov/policy-issues/tax-policy/tax-expenditures

7 SOTJ 2023, at 41

8 See: Julian Morris, A Review of TJN’s Financial Secrecy Index, Cayman Islands: Cayman Finance, 2021. https://caymanfinance.ky/wp-content/uploads/2021/09/A-Review-of-TJNs-FInancial-Secrecy-Index-September-2021_FINAL-9356284.pdf

9 http://gazettes.gov.ky/portal/pls/portal/docs/1/13258584.PDF

10 https://home.treasury.gov/system/files/131/FINAL-US-Cayman-Islands-Cayman-alternat.pdf

11 https://www.taxresearch.org.uk/Blog/2023/07/25/the-tax-justice-networks-state-of-tax-justice-report-is-hopelessly-misleading-yet-again/

12 https://commonslibrary.parliament.uk/research-briefings/cbp-8513/

13 Johansson, Å., et al., Taxation and Economic Growth, OECD Economics Department Working Papers, No. 620, OECD Publishing, Paris, 2008.https://doi.org/10.1787/241216205486.

14 See e.g. https://taxfoundation.org/blog/reviewing-recent-evidence-effect-taxes-economic-growth/

Julian Morris FRSA
Julian Morris has 30 years’ experience as an economist, policy expert, and entrepreneur. In addition to his role at ICLE, he is a Senior Fellow at Reason Foundation and a member of the editorial board of Energy and Environment. Julian is the author of over 100 scholarly publications and many more articles for newspapers, magazines, and blogs. A graduate of Edinburgh University, he has masters’ degrees from UCL and Cambridge, and a Graduate diploma in law from Westminster. In addition to his more academic work, Julian is an advisor to various business and a member of several non-profit boards.