It’s legal, but should it be?

Corporations, especially multinational large caps, have historically shifted more and more of their profits to subsidiaries located in tax havens. This is perfectly understandable and legal. But as a shareholder, I am of two minds about these practices. On the one hand, I am glad whenever a company makes more profits and thus has more money to invest. On the other hand, by starving the government of tax revenues, key infrastructure deteriorates, and government investments are starved of funding.

Ludvig Wier and Gabriel Zucman have tried to track what share of corporate profits globally has been booked in low-tax countries and tax havens and tried to estimate what share of corporate tax revenue the governments in developed countries are losing due to these practices. The chart below shows the global average going back to the 1970s. Starting in the 1980s, there has been a constant increase in the use of tax havens to reduce corporate tax liabilities. This accelerated in the 2010s which led to the backlash in the form of a global agreement to introduce global minimum corporate tax rates as a result of the OECD BEPS talks. Since then the growth of profit shifting has markedly slowed down.

Share of corporate profits booked in tax havens and government tax revenue lost

Source: Wier and Zucman (2022)

But even so, profit shifting still can deprive countries of a large portion of corporate tax revenues. While the global average is estimated to have been 10% in 2019, the UK government loses about one-third of its corporate tax revenues to tax havens, while the German government loses close to 30% and France and Spain both lose about 20%.

Corporate tax revenue lost to profit shifting

Source: Wier and Zucman (2022)

That is a lot of money. And if you are wondering why governments don’t have the money to pay nurses, renovate decrepit infrastructure, or fund their military properly even though the risks of military conflict with Russia and China are rising, I would suggest looking at corporate profit shifting for a start.

As I said, I am sympathetic to corporate profit shifting because it is legal and it is in the best interest of shareholders, even though it is arguably not in the best interest of other stakeholders such as employees or society at large because it forces us to drive on bumpy and jammed roads and face unreliable train service and long lines at airports. In fact, profit shifting by corporations hurts the companies themselves because the poor infrastructure means that they face higher costs and delays for distribution as well as getting inputs for the goods they produce. To get an idea of how much is lost economically, just read this old post of mine where I discuss the economic benefits of infrastructure investments.

So what to do? Demanding minimum corporate tax rates globally is a step in the right direction but it won’t solve any problems because corporations will always find loopholes to reduce their effective tax rate. Just look at how profit shifting has slowed down but not stopped after the BEPS talks started.

The US Tax Cuts and Jobs Acts (TCJA) tried to go down the route that other countries like Italy have taken before: tax amnesties that incentivise companies to repatriate foreign profits. But many corporations might argue that they have no incentive to repatriate profits even at a lower tax rate because the money will just be wasted on a bloated government apparatus.

So here is my compromise. Introduce a tax amnesty for companies that allows them to repatriate profits at a lower tax rate (say half the regular corporate tax rate). These tax revenues will be separated from general tax revenues and paid into a ‘future fund’ that only invests in infrastructure. Thus, these tax revenues are earmarked for investments in the country's future. Companies that have foreign profits but do not repatriate at least half of them will be publicly named on a government website and face additional penalty taxes on their domestic profits. Maybe that will set the right incentives for companies to pay taxes and for governments not to waste these tax revenues.