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Below explore the dynamics of Taxation:
International Taxation of Companies
The multinational enterprise is on the rise; in the last three decades, the share of overall corporate profits garnered by the foreign-owned affiliates of these firms has more than tripled. Meanwhile the increasing importance of multinationals to the global economy has sparked increased awareness of their behavior when it comes to taxes. Public outrage over a broken system has forced policy-makers to try to come up with fairer solutions.
By artificially attracting huge sums of corporate profit, tax havens end up collecting more tax revenue than relatively higher-tax countries - despite having effective tax rates of less than 5% (the average combined statutory corporate tax rate as of 2018 was 21.4%, according to the OECD). Failure to reach a global agreement might simply mean the end of the corporate taxes, as countries try to defend their tax base by cutting rates. In the last 40 years, corporate tax rates dropped by 50%; in the last 20 years alone, they have dropped by 30%.
Multinationals stand in a unique position - able to exploit international tax differences, by redistributing reported profits from high-tax countries to countries with low tax rates.
The root cause of this behavior is the multinational firm’s ability to intentionally misprice internal trades and reallocate ownership of tangible and intangible (such as patents) assets among affiliates, in order to minimize global tax payments - a technique often termed "profit shifting." Recent research suggests that 40% of all multinational profits are shifted to tax havens every year, causing a collective loss of $200 billion in global tax revenue. Criticism of certain large multinationals (such as Amazon) for paying nearly no taxes in their home markets has caused public outrage and forced policy-makers to look for new, fairer solutions.
Solutions proposed by the Organisation for Economic Co-operation and Development (based on public consultations) aim to change the tax code by introducing a global minimum tax rate - thereby harmonizing disparate rates and removing the incentive to shift profits. They also propose abandoning the principle of internal transactions in multinational firms, and instead allocating the firms’ taxable income based on their sales. However, there remains the enormous task of obtaining agreement among countries to jointly implement meaningful reform. This has so far proven difficult, as countries that have established themselves as tax havens profit enormously from the current system.
International Taxation of individuals
Following the advent of globalization, however, and the rise of an entire tax avoidance industry in the 1980’s, we have seen a sharp increase in the share of wealth that is hidden offshore. By the 2000’s, the wealthiest 0.01% were hiding an estimated 30% to 40% of their wealth offshore. The total estimated tax loss resulting from this behaviour amounted to $200 billion in 2012 (an amount roughly equivalent to the current GDP of Greece). In order to curb this phenomenon, tax authorities need access to more information about foreign bank accounts, ideally through automatic exchange-of-information agreements (recent developments such as the US’s Foreign Account Tax Compliance Act are evidence that this is starting to happen). Above and beyond the simple exchange of information, we need to create a global wealth registry that records the beneficial owners of the world’s assets. This could enable governments to not only curb tax evasion - but also impede the ability to stash the proceeds of criminal activity abroad.
Globalization and the tax avoidance industry have enabled increasingly illicit behavior
Recent public disclosures have cast new light on the old saying, “the poor evade, the rich avoid.” By using the information on the wealth hidden in tax havens by the 0.01% wealthiest individuals in the world (uncovered thanks to the Panama Papers and Swiss Leaks disclosures, and via various tax amnesty programs), economists from the University of California, Berkeley, have been able to estimate the total amount of taxes evaded globally by the ultra-rich - and the findings are astounding.
One-quarter of all taxes owed by the wealthiest 0.01% are never paid, compared with tax evasion rates that are as low as 3% amongst taxpayers in the bottom 90% of the wealth distribution. It seems that the old saying should be updated to, “the poor evade, the rich evade a lot.” The sharp increase in tax evasion and avoidance at the very top of the wealth pyramid is a new phenomenon. In the 1950s, when the world was less globalized, it was harder to move assets to tax havens - and as a result, a negligible amount of wealth was stashed offshore.
Taxation and Economic Growth
A traditional part of the standard curriculum for students of economics has been that there is a trade-off between economic growth and equality. As the theory goes, higher taxes discourage people from working, and as a result any redistribution of resources to the poor via higher tax revenue comes at the cost of lower economic activity.
This theory has now been tested empirically for decades, and as it turns out the story is a bit more complicated than the textbooks make it seem. If we compare the world’s countries, a blunt relationship between inequality and economic growth simply does not appear. In fact, the cross-sectional relationship between tax rates and labor participation rates goes in the opposite direction of what standard theory predicts - as a matter of fact, countries with higher tax rates have higher labor participation rates.
It is accepted wisdom that higher taxes hinder growth, but the truth may not be so simple. The effect of tax hikes must therefore be measured not only in relation to how they lower the incentive to work, but also to how the newly-enabled government spending that results from a hike can foster economic growth. Natural experiments do tend to show that people enduring a tax increase work less hours in its immediate aftermath.
One recent example was a tax holiday implemented in Switzerland in the late 1990s, which led to significant (albeit small) increases in labor supply. However, similar natural experiments have documented how improved access to childcare made possible via greater tax revenue and spending can boost growth. An example of this is access to public childcare in Germany, which has been shown to increase the maternal labor supply as many women suddenly find themselves with more options. The exact right level of taxation is therefore a function of not only how people respond to higher taxes, but also how well governments can spend tax revenue.
The reason is that tax revenue is (generally) not poured into the gutter, but is instead often used in ways that support economic activity through the building of infrastructure, generally improving institutions, and lowering the ultimate cost of work by providing things like child care.
Inequality and Taxation
As the wealthy pay a smaller share, the poor pay more. Some economists believe the corporate tax is actually partly paid by the poor, through low wages and high consumer prices - and so low corporate taxes benefit the poor. Still others argue that corporate taxes are being paid by shareholders. Almost everyone, however, agrees that documenting effective tax rates across all income levels is necessary in order to drive an informed discussion.
One of the main objectives of taxation is to reduce inequality by collecting from the rich and distributing to the poor. This is how welfare states work. However, recent research from economists at the University of California, Berkeley has cast doubt on the progressivity of the global tax system. That is, while the public transfer system is progressive, the overall system is becoming less so.
The global erosion of capital taxes and the rise of consumption taxes (like sales tax and VAT) in the last 50 years implies that the tax burden has gradually shifted from the wealthiest (who own assets) to the poorest (who tend to own no assets and consume most of their income). This shift is in part a result of globalization, which has pressured capital taxation as people and corporations can move capital earnings to tax havens. On top of this, the progressivity of income and estate taxes has declined dramatically; the top marginal tax rate in the US, for example, was cut from close to 90% in the 1960’s to around 40% by 2018. The rationale for this has largely been a perceived need to lessen the incentive for tax avoidance and evasion.
The consequences of these developments are remarkable: Since the 1930s, the tax rate for the bottom 50% of American earners has effectively doubled, while the effective rate for the top 0.01% has fallen by more than 50%. In 2018, for the first time on record, the richest 400 Americans paid a lower effective tax rate than everyone else. Such developments are not unique to the US - around the world, we are seeing regressive consumption taxes increase, capital taxation fall, and the overall progressivity of systems eroded.
These findings have stirred debate about the fundamental fairness of the global tax system; while some economists argue that it does not need progressivity, as long as the transfer system disproportionately benefits the poor, others argue that a lack of progressivity will lead to mass accumulation of wealth among the richest - undermining the social contract.
Mobilizing Resources for Development
A combination of new data sources (such as satellite images, digitized tax records, and automated information on bank transfers) and low-cost, automated algorithms means that both the efficiency and efficacy of tax enforcement can increase dramatically. Early results of missions undertaken by the IMF, OECD and the World Bank suggest that the rollout of big-data analytics can increase tax revenue, and at limited cost. Other low-cost compliance measures include behavioral “nudging” through taxpayer communication and the simplification of tax codes. One way to increase tax revenue would be to limit the losses that result from illicit financial flows - that is, financial flows related to illegal gains, or flows intended to avoid taxation (such as hidden payments to entities based in tax havens).
Bolstering tax revenue will be essential for achieving the Sustainable Development Goals. In fact, the taxation of international illicit financial flows related to corporations and individuals is thought to be so important that it has its own designated Sustainable Development Goal target: significantly reducing illicit financial and arms flows by 2030. The elevated focus on illicit financial flows is based on a growing awareness that they undermine both the credibility of institutions, and the fairness of tax systems.
But in order to deliver on these goals, everyone agrees that sufficient tax revenue is necessary and should, to a large extent, be collected in the developing countries that are the focus of many of the goals. SDG 17 in particular targets an increase in domestic resource mobilization - explicitly measured by the ratio of tax-to-GDP.
Tax collection is generally thought to be more difficult in developing countries, which tend to have large informal sectors (gray economies) and relatively little third-party reporting of income. Added to this is the difficulty tax authorities in many developing countries face in terms of resource constraints, limiting their ability to audit taxpayers. In light of these constraints, governments and development organizations such as the International Centre for Tax and Development, the Organization for Economic Co-operation and Development, the International Monetary Fund, and the World Bank are trying to implement solutions that can raise tax compliance even with limited resources.
Taxation and Climate Action
By putting a price on carbon emissions with a tax, producers will increase prices on emission-heavy products, and consumers will respond by shifting towards low-emission consumption. In fact, William Nordhaus won the 2018 Nobel Memorial Prize in Economics by estimating what the optimal tax on greenhouse gas emissions should be. In a world of carbon pricing, all consumers would be as climate aware as they are economically aware of what they need to pay for the things they want - a Thailand vacation, for example, would become far less attractive if the price of the trip quadruples as a result of carbon taxes - no additional moral imperative required.
If the means to curb emissions is so obvious, why aren’t we implementing it?
From an economist’s point of view, the solution to the climate crisis is pretty straightforward: carbon taxes.
Emission taxes come replete with an implementation efficiency aspect: the carbon footprint of every product and service in the economy is priced automatically by the free market. Governments in this carbon-pricing world would simply need to tax the first link of production (such as fuel consumption, deforestation, or agricultural emissions) in order for the tax to automatically pass through to all other related services and products.
In time, low-emission alternatives may appear - though there will be a period of transition to lower consumption. Added to this, people with low incomes will pay the highest price, as they spend a larger part of their income on consumption - making the carbon-tax solution appear unfair to many. To limit this inequality effect of the tax, solutions have been proposed including progressive climate taxation (which would imply low emission taxes for those who consume less) and green dividends that transfer carbon-tax revenue back to low-income individuals. Ultimately, corresponding efforts to fight inequality may be a prerequisite for a carbon tax to be politically viable.
For example, if a rubber band is made using oil and the price of oil triples, so will the price of rubber bands. No need for endless discussions about what type of consumption is most polluting - we will know by simply looking at price tags. So, if economists agree on the solution, why isn’t it being implemented? The short answer is that transitions are painful, and politically difficult. Because a carbon tax is effective, it means people will actually have to adjust their emission-heavy consumption by doing things like using less private transportation and eating less meat.
TAXES
Taxation provides the foundation of any well-functioning society and is the potential solution to many of the weightiest issues of our time. However, globalization has pressured tax systems and caused a shift in tax burden from the richest to the poorest. Some 40% of the profits earned by multinational corporations are moved to tax havens every year, at a cost of about $200 billion to public coffers. And, one-quarter of the taxes owed by the wealthiest 0.01% of people are never paid, as assets are stashed offshore.
In order to deliver on the Sustainable Development Goals, sufficient and stable tax revenue is necessary. Taxing carbon emissions could meanwhile help curb global warming, and tax hikes may actually bolster inclusive growth if spent appropriately. A smartly-reformed tax system can embrace globalization, as it delivers shared and sustainable prosperity.
