Let’s do something about tax avoidance

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J. Soedradjad Djiwandono Emeritus Professor in Economics, University of Indonesia and Professor of International Economics, S. Rajaratnam School of International Studies (RSIS), Nanyang Technological University (NTU), Singapore.

IO – It is noteworthy that the Organization for Economic Cooperation and Development (OECD) recently reported it was preparing a proposal to extract more corporate tax from large multinationals and highly profitable global brands. The idea arose from concern about clever tax avoidance manipulation that many big corporations have notoriously been resorting to with different transnational mechanisms to avoid or minimize their tax obligations: deftly shifting profits around, exploiting transfer pricing loopholes or even resorting to miraculous “accounting engineering”. Among suspect digital corporations, Facebook, Apple, Amazon, Google, Netflix and others of their scale have been fingered as guilty of such [legal] shenanigans. Of course, their defense is always that they have broken now laws nor violated any regulations – true enough, since most tax regulations are based on the outdated practice of levying taxes on corporations based on their physical presence.

I must admit that I have never made any effort to question whether there is in fact any impropriety on the part of those multinational companies – or standing policy of host countries regarding the operations of these companies – and what might be done to deal with this issue more fairly. I have basically been counting on the conscience of these companies to acknowledge their social responsibility, something a number those billionaire business – philanthropes might eventually accept.

 I do not claim to yet understand the details very clearly as to what would be the direction or and how it would be implemented or accepted as a general norm. However, a movement could follow the reportage of one Chris Giles, carried on the front page of the Financial Times, (10/10/ 2019): the proposed OECD proposal on overhauling corporate taxation looks promising to me. Let me explain what this means and why.

OECD Proposal

The international tax rule is apparently based on a regulation that was introduced in the 1920s, whereby tax levies are based on the physical presence of a given enterprise, i.e. where the company is incorporated and/or the location of its headquarters. This does however give rise to challenges for present-day operations of mega-multinational companies, doing business at a variety of locations all around the world, and selling their products and services also globally.

Tax systems differ for different countries; some famously levy a very low level with less stringent tax laws; these are politely known as “tax havens” and include the British Overseas Territories, like the Bahamas and Cayman Islands. Others, however like Ireland, Luxemburg and the Netherlands encourage globalized business practices, allowing multinationals to easily relocate their headquarters and production bases, listing them on paper to whichever countries offer the sweetest tax deals. This includes the legerdemain of transfer pricing in recording transactions among their own subsidiaries, to decide on prices that would result in the fattest profits with minimal tax obligations.  They even resort to accounting engineering to achieve this objective. Actually, all these practices are aimed at tax avoidance – and consequent loss of revenue to governments. Prof. Stiglitz in his recent writing in Project Syndicate (07/10/2019) cited an IMF report which estimated that governments lose at least USD 500 billion per year in income as a result of corporate tax shifting. The US government also complained that such mammoth concerns as Amazon, Netflix and General Motors paid zero in US taxes (2008).

The argument of the OECD proposal on reforming tax rules starts off by stating that tying corporate tax rates to the physical presence of a company is no longer appropriate in the current multinational corporate environment. This elderly rule gives corporations the impetus to shift profits around to countries with lower tax rates or/and looser regulations, always to minimize tax obligations. In the meantime, numerous countries attempt to attract businesses by resorting to temptations of lower tax rates. Facing slower growth during the great recession, countries competed with one another to cut tax rates in a race to the bottom as “competitive devaluation” (echoing a “beggar thy neighbor” policy of the 1930s). 

According to the Editorial in the Financial Times the new proposal is basically “to give governments a ‘tax right’ over the profits of consumer-oriented businesses, indexed to the share of sales within their territory”. The objective of the proposed rule is to fairly extract more corporate tax from large multinationals, digital enterprises or owners of profitable brands – as in the case of luxury goods makers, clothing or cars or food & drink, or IT companies. Currently they can zip their profits around to minimize their tax bill via different means of transfer pricing, accounting tricks and others. According to Chris Giles, the aim of OECD is to create a new and stable international tax system, because the current rules are no longer applicable to provide a fair allocation of taxing rights in an increasingly globalized world. The newly-giant companies, whose operations and expansion depend on intangible investments, would be more heavily affected by this proposal.

At a time when most countries see increased leveraging – covering developed, emerging or developing economies, the result of harsher budget deficits or shortfalls in tax revenues from locked expenditures, everybody really needs to raise tax revenues; this OECD proposal thus seems to be a welcome relief from their burden. This would in fact be good news for countries like the US, France, China, U.K. or Germany, as well as many emerging economies, Indonesia included.

However, the big countries involved have something to lose as well. Countries that at present hosting those big corporations, wooing them with low corporate tax rates or less stringent tax law (including Ireland, Luxemburg, the Netherlands and British Overseas Territories, Bahama and Cayman Islands) would no longer look very attractive to those big multinationals.

At the same time, they and other countries could champion a fairer “level playing field” for their local SMEs, to date outcompeted by these monster companies. This is really a healthier development, since there will be no more incentive for companies to profit from magical accounting engineering – and they must face the responsibility for their real economic activity.

Meanwhile, according to Professor Stiglitz’ recent writing (as referred to above) this measure is still but a partial solution or half-measure. He seems to be very concerned about the problems that naturally arise from the practice of transfer pricing, which could be as easily practiced by multinationals – and that ultimately would still result in much-reduced value of taxable corporate profits. This must be true. However, I still think that if this proposal could be accepted globally, a fairer corporate tax right would result and many countries would benefit from its implementation.

Its relevance for Indonesia?

Some may question the relevance of what I discuss here for Indonesia and its economy. For sure, this is very relevant. Indonesia, as an emerging economy, would certainly benefit from the adoption of this corporate tax proposal. As a country with more than 270 million populations, still enjoying a demographic dividend, with a huge number of millennials as fast-growing users of smartphones and internet service, Indonesia has been a very good market for any consumer goods and services, including those provided by huge multinational digital corporations. As it stands now, our Government has no right to tax the profits of those Facebook, Google and other big players. But if this regulation is adopted, Indonesia should receive revenue from taxes on corporations who benefit from the sale of their services in Indonesia. How much would of course depend on the way the regulation is configured.

This would not simply take place as a miracle. It would still need considerable effort to make the proposal acceptable. Could Indonesia play some role here? Of course. According to the report of the Financial Times mentioned before, the OECD will seek agreement from the G20 meeting. This should be a very good chance for Indonesia, as a member of the group, to voice its strong support for the proposal, in the name of emerging economies and of itself.

In my take, this is certainly a much better idea than hiring debt collectors to collect arrears of social insurance administration service (BPJS) fees in order to cut budget deficits. I tend to view the business model that digital corporations rely on as moving in the direction of conglomeration, or ‘big is beautiful’.  Even though my field of interest is monetary and international economics, I also am a development economist who prefer a model of ‘small is beautiful’. As mentioned above, the adoption of this tax rule would tend to offer a level playing field to SMEs. For sure I like the idea.