If you think US President Joe Biden’s administration will return to normalcy on trade issues after the Trump era tariff wars and tweet diplomacy, Treasury Secretary Janet Yellen has other ideas. Because, Trump’s decision to wage a trade war on China with her plans to introduce a minimum corporate tax rate for China comes as a huge shock to the world economic order.
These two phenomena are intertwined as fundamental elements of the modern world economy. Corporations have reduced operating costs on top of their revenue statements by sending manufacturing offshore to China and other emerging economies where labor costs are lower. At the bottom of their income statements, they did the same with tax expenses by sending their profits to a lower-tax jurisdiction.
An important part of the profitability of a modern multinational corporation (MNC) depends on those two movements. One-third of foreign direct investment in the decade from 2018 went through seven offshore centers used for tax minimization. According to the Irish Times annual ranking, Ireland’s four largest companies are Apple, Alphabet, Facebook and Microsoft’s local units. In the decade from 2019, only the British Virgin Islands and the Cayman Islands – with a population of just 100,000 – received 76 cents of foreign investment for every dollar that went to China.
Such ‘investments’ came more in the form of corporate inversions and intellectual property rights than the establishment of real new businesses. However, this makes a significant difference to corporate profits, as well as what governments are able to collect from taxing that income.
According to a 2020 study by the Organization for Economic Co-operation and Development (OECD), states would receive $ 100 billion a year if reforms were introduced to reduce such activity. Other estimates are very high: an effective 2018 study calculated losses at 10% of the 15 2.15 trillion in corporate taxes paid worldwide, up 20% in the EU.
Yellen was not the first person to suggest that this behavior be curtailed. In fact, since the early years after the financial collapse of 2008, since it appeared to be a significant contributor to the post-crisis decline in government budgets, addressing the G-20 and OECD has been a major factor in addressing the issue.
It is common to say that those efforts were in vain. True, while ideas around international talking shops are batting in vain, the real action over the past decade has been for governments to abandon efforts to prevent profit leakage and instead shift their own tax rates. Of the 37 OECD members, 24 have reduced their corporate tax rates since 2008. Only seven raised them.
In a sense, it provides a partial solution to the problem. If you can lower your own tax rates than Switzerland (as the UK does), you will eliminate much incentive for multinational corporations to convert their profits there. The trouble is that Ireland is running at a rate of 12.5% and the Cayman Islands will not tax corporate profits at all, which is a burden on middle- and working-class voters that only wealthy country governments can win by drastically reducing spending or changing their finances.
Yellen is right to try to fix this, but the challenges of doing anything are substantial. Major companies and corporate lobbies have had a harder time dealing with China compared to Bermuda, the Netherlands and Singapore — but even there, the Trump trade war with Beijing has provoked a significant pushback. The richest corporate donors in every developed economy stand to gain greatly from the world’s failure to address this issue collectively. Bringing low-tax jurisdictions on board can be very difficult, given how basic tax minimization strategies are for their economies.
America has significant muscles in international economic affairs. Every country in the world must abide by U.S. sanctions regardless of the regulations in their own country, thanks to the policy of acquiring dollar weapons through successive administrations over the past decade. Hong Kong-sanctioned chief executive Carrie Lam receives her salary in cash because even Chinese-owned banks in Hong Kong are not at risk of going to the wrong side of the US Department of Justice.
If there is a real will to curb tax minimization, the US should be able to find a way. However, the failed reform efforts of the last decade cause us to suspect that change is on its way. For all of Washington’s rhetoric, corporate tax rates are likely to be lower than higher in 2030.
David Fickling is a Bloomberg opinion columnist who covers industrial as well as consumer and consumer organizations.