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a blog from young economists at Nova SBE

Base Erosion and Profit Shifting: Light at the End of the Tunnel?

On Monday (5th Oct.), the OECD are releasing the outputs of their joint project with the G20 on Base Erosion and Profit Shifting (BEPS). This is a phenomenon with a lot of history. Already in 1961, J.F. Kennedy spoke of “artificial arrangements between parent and subsidiary (…) in order to reduce sharply or eliminate completely their tax liabilities both at home and abroad.” Yet, they are all the more relevant today as repeated scandals emerge of near-zero tax bills for immensely profitable household names, such as Google, Starbucks and Amazon.

Beyond the difficulties it raises for public financing, and the equity concerns of firms not paying their fair share of organizing society, BEPS means unfair competition, as multinational firms pay 5% tax while smaller businesses pay up to 30%. This raises a (further) barrier to entry and generates inefficiencies. For this reason, governments should combat BEPS, if not to optimize taxation, then in their role as ‘hosts of efficient markets’.

The reality of BEPS is startling. Barbados, Bermuda and the British Virgin Islands – three small Caribbean islands – received in 2010 more foreign direct investment (5.11% of global FDI) than Germany (4.77%) or Japan (3.76%). Not only that, but they made more foreign investments (4.54%) than Germany (4.28%) – home to several of the world’s largest firms. Luxembourg and the Netherlands also manage huge inward and outward stock investments, at over $2 trillion in-and-out and $3 and $4 trillion in-and-out respectively. Of these, 83% are made by special purpose entities which are “entities with no or few employees, little or no physical presence in the host economy and whose assets and liabilities represent investments in or from other countries and whose core business consists of group financing or holding activities.” These examples are, in and of themselves, huge and only give us a glimpse to the bigger picture. With 60% of world trade taking place within (not between) multinational enterprises, the problem is likely to be of far greater magnitude.

cartoontaxesIt is clear that the most effective solution to this problem is international. This is why the G20’s participation in this project is so significant. Nevertheless, observers should be cautious in their optimism. Tax havens are not in the G20. Mostly, they are small economies, inflated by these capital inflows, and otherwise incapable of attracting investors. To persuade them to abandon their competitive advantage in tax will require more than grand pronouncements and soft power.

Furthermore, given ample criticism of the OECD’s programme by tax justice experts, (for detail, go here) even in the unlikely event of an international agreement, policy entrepreneurs should be prepared to find creative solutions to base erosion and profit shifting.

While policy solutions are far from easy (you only need take a look at the OECD’s first batch of proposals), tweaks and patches are destined to die in the bureaucratic cesspits of oblivion, inefficacy or fatal disagreement on the details. In any case, solutions are essential to fix not only fiscal crisis (through additional revenue), but (by making taxes progressive again) the crises of economic inequality and (by tax justice) post-democracy.

Miguel Costa Matos – 25220 / 872

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Author: studentnovasbe

Master student in Nova Sbe

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