(Business Insider Nordic) -- The sun rises behind the Tower of Refuge on November 7, 2017 in Douglas, Isle of Man. The Isle of Man is a low-tax British Crown Dependency with a population of just 85 thousand in the Irish Sea off the west coast England. Revelations in the Paradise Papers have linked the island to tax loopholes being used by Apple and Nike, as well as celebrities such as Formula One champion Lewis Hamilton.
Economists find that 40% of the profits of multinational corporations are shifted to tax havens. The volumes are increasing.
The EU and developing economies are the biggest losers. US companies are the biggest profit shifters.
Tax authorites in high-tax countries are focusing enforcement on other high-tax countries - leaving tax havens unassailed.
A unilateral policy of distributing profits in proportion to regional sales could increase EU and US corporate tax income by 20% and 15% respectively.
A working paper called The Missing Profits of Nations, co-authored by economists Thomas Tørsløv and Ludvig Wier of the University of Copenhagen, along with the renowned Gabriel Zucman, sheds new light on the magnitude of tax evasion schemes globally.
The paper uses improved methodology to show that 40% of the profits made by multinational corporations are shifted to tax havens – using methods like manipulating transfer prices in sales between group companies, exploiting tax deductibility of interest payments within group companies, and relocating intangible assets.
The pattern is obvious: multinationals are abnormally profitable in tax havens, while they are abnormally unprofitable in non-havens. Profits are shifted to low-tax countries while losses are kept in high-tax countries.
The EU is estimated to lose 20% of its corporate tax revenue through profit shifting. Similarly, despite US corporations being the biggest tax evaders, the US is estimated to lose 15% of its corporate tax revenue on profit shifting.
EU countries are ‘stealing from each other while letting tax havens flourish’.
The authors argue that the EU particularly is the loser when it comes to profit shifting because tax authorities are perversely incentivized. Pursuing cases of profit shifting to tax havens is difficult in comparison to going after profit shifting to other non-haven economies.
Tax haven cases are more difficult to prove because of less access to financial data, more aggressively disputed by companies because there is much more money at stake, and are not facilitated by cooperation agreements.
The result is that tax authorities in the countries most adversely affected by profit shifting predominantly focus enforcement on other high-tax countries – effectively “stealing from each other while letting tax havens flourish”. Ironically, increased cooperation between OECD countries will only aggravate these perverse incentives.
Tax havens are becoming increasingly profitable.
The data shows that the corporate tax incomes of tax haven economies has increased dramatically with globalization. The tax base continues to grow as the corporate tax rate is successively decreased. Ireland is the biggest tax haven and a clear example of how tax income has increased as the tax rate decreases.
Proportional profit allocation could be a policy solution.
The paper does offer a solution, however: A unilaterally imposed policy of distributing total profits in proportion to regional sales would make profit shifting ineffective, thereby returning the EU’s and US’ lost corporate tax revenues of 20% and 15% respectively.
Better collection of data could also mitigate the problem by facilitating enforcement by tax authorities.