Yellen’s new alliance against the leprechauns – 06/08/2021 – Paul Krugman

Over the weekend, largely at the urging of US Treasury Secretary Janet Yellen, finance ministers from the Group of 7 (G7) – the big advanced economies – reached an agreement on a 15% minimum tax rate on the profits of foreign subsidiaries of multinational corporations. You may not know what this means, or why you should be interested in the subject.

So I’m going to tell you the story of Apple and the leprechauns.

Apple has a vast international reach. Their products are sold almost everywhere; it operates subsidiaries in several countries. And it is, of course, very profitable.

But where are these profits made? Apple does not have large industrial activities, and basically outsources its production to other companies, most of which are in China. Much of its profit comes from licensing fees, which reflect the company’s intangible assets — patents, trademarks, trade secrets and other marks. And where are these intangible assets located? From an economic point of view, this question is of no importance.

For tax purposes, however, Apple needs to declare profits somewhere. At the moment, that means it’s the company that chooses to declare where it earns its money — and what it does, of course, is declare that profits are earned by subsidiaries located in countries that levy low taxes on those profits, especially Ireland.

In fact, until 2014, it was even more than that. A large proportion of the company’s worldwide profit was attributed to Apple Sales International, registered in Ireland but, for tax purposes, located nowhere. In 2015, however, a combination of pressure from the European Commission and changes in Irish tax laws induced Apple to allocate much of its profits to its regular Irish subsidiary.

How important was that? On Paper, Ireland’s GDP (Gross Domestic Product) suddenly grew by 25%, though nothing in reality had changed — a phenomenon I dubbed the “leprechaun economy”, a nickname that has caught on (the Irish, luckily, have a sense of humor).

The truth is, Apple is far from the only company to exploit its multinational status to avoid taxes, and Ireland is far from being the most infamous tax haven, even in Europe.

According to figures from the International Monetary Fund (IMF), Luxembourg – whose population is similar to the state of Vermont [600 mil habitantes] —has attracted more than $3 trillion in investments from foreign companies, a total comparable to the United States as a whole. What does that mean? The actual investment involved is almost non-existent. Instead, the tiny duchy offers many companies agreements that allow them to file their taxes there, paying next to nothing.

So what do we learn from these stories? First, that the current international tax system offers immense scope for tax evasion by large corporations.

Second, we’ve learned that when countries try to compete in cutting corporate tax rates— chamadathe so-called “race to the bottom”—they aren’t actually struggling to determine who will get jobs and investments that will raise their productivity. There is little indication that profit tax cuts induce companies to effectively build factories and expand employment.

The real dispute is to determine where the profits will be declared, and therewith taxed. And with tax rates falling further and tax evasion flourishing, the result is that tax revenue continues to decline.

In the 1960s, federal corporate taxes were equivalent to 3.5 percent of US GDP; now they average 1%. That’s a revenue loss of more than $500 billion a year, enough to pay for a lot of infrastructure, children’s services, and more.

Which brings us to that G7 agreement. How would the 15% minimum rate work? Here’s how Gabriel Zucman —who has probably done more than any other economist to highlight the importance of tax evasion by multinationals— sums up the situation: “Imagine a German multinational that accounts for income in Ireland, taxed at an effective rate of 5% . Germany will now collect 10% more tax, to reach 15% — and the same applies to profits declared by German multinationals in Bermuda, Singapore, etc.”

This would, of course, immediately reduce the amount of taxes that multinationals could escape by transferring declared profits to tax havens. It would also greatly reduce the incentive for countries to serve as tax havens in the first place. And if you believe companies could avoid the problem by moving their headquarters to, say, Bermuda, the big economies have the ability to make those moves more difficult.

To put the situation in a broader context, what we are seeing here is the beginning of an attempt to fix a system that harms workers and benefits capital. Workers have few ways to escape income taxes, payroll taxes and sales taxes unless they move to another country. Multinational corporations, which are ultimately controlled by a small moneyed elite, can pursue low-tax jurisdictions without doing anything real except hiring talented accountants. The G7 plan would contain this practice.

So far, it’s true, we only have an agreement between finance ministers, and some important details have not been resolved. Large companies can hire lobbyists, not just accountants.

But the deal remains a victory — an important step towards a fairer world.

Translation by Paulo Migliacci

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