On Thursday, March 25, Alan Auerbach joined Markus’ Academy for a lecture. Auerbach is director of the Robert D. Burch Center for Tax Policy and Public Finance at the University of California, Berkeley.
There has been a steady downward trend of G-7 corporate tax rates in the last 25 years. There has been a change in the nature of economies. In the US, the top five companies in the 1960s made tangible items whereas the current top companies are associated with intangible assets. In addition, there has been a rise of multinational companies and increased foreign holdings of US corporate stock.
These changes increase the likelihood of inversion — reorganizing corporate structure to change corporate residence, relocating production to low-tax jurisdictions, and, beyond the relocation of production, shifting profits to low-tax jurisdictions. Inversion is easier because companies operate and have shareholders in many places. The location of production is easier to modify due to multinational supply chains and low transportation costs. In addition, profit shifting is easier when companies have foreign operations and have less concrete IP based profits.
The newest challenge is with companies that provide digital services (like Google, Facebook). These companies provide substantial benefits to users in countries where they do not pay corporate income tax. In response, some countries have implemented special digital taxes.
There are multiple solutions to this need for reform: Countries can enact patent boxes that tax IP at a lower rate. One rationale is that this would encourage IP R&D. In addition, the income associated with intellectual property is more mobile. Countries can also tighten tax rules to limit profit shifting and tax avoidance. They can also try a hybrid approach — the US, for example, adopted a territorial tax but also introduced the GILTI provision, which is a worldwide accrual-based minimum tax. A fourth approach focuses the tax base on destination, or the location of final consumers. This leads to incentive compatibility where the countries are willing to adopt the systems on their own, without the need for international cooperation or enforcement.
A RPAI reform is an incremental approach and is good when the public is less comfortable with a major tax change. This would allocate earnings on routine operations under the current system whereas residual earnings would be taxed based on the location of revenue. This reduces incentives to shift profits and production although does not completely eliminate tax avoidance opportunities.
The DBCFT is a more revolutionary approach which implements a cash flow tax on domestic operations with border adjustments. This would shift location of tax from production to consumption, eliminating profit shifting opportunities.
In conclusion, we are moving towards destination-based taxation through digital taxation, unilateral partial actions, and attempts at cooperative approaches.