With the publication of the Paradise Papers the public has once again been shocked by the extent of tax cheating by the wealthy elite. But precious little of the coverage has focused on what needs to be done stop it happening. Where there is such discussion, it has almost exclusively focused on closing loopholes. Whilst this is important, in the context of the billions siphoned off to tax havens every year, it amounts to rearranging the deckchairs on the Titanic. The problem is that the system is broken.
I’m not talking about capitalism itself, but rather the system of international tax law that was created by the League of Nations in the 1920s. The system operates by the Arms-Length Principle, according to which sister companies of transnational corporations are supposed to behave as though they were separate entities, for example, by trading goods at market prices. The problem is that the world of the 1920s is very different from the world of the 2010s. Technological connectivity and globalised finance has rendered the Arms-Length Principle impossible to police and profit shifting is rampant. By paying extravagant fees for use of trademarks, or by paying interest on huge loans, a company in one location – say, Britain – is able to move profits to its sister company in a low-tax jurisdiction – say, Ireland. In reality, these “two” companies are not distinct entities but our tax laws allow them to behave as though they were. The result is that profits generated in Britain are booked for taxation in Ireland, or shifted on to another tax haven. Economists at the University of California, Berkeley, have estimated that six European tax havens alone (Luxembourg, Ireland, the Netherlands, Belgium, Malta and Cyprus) shift €350bn of profits every year.
In broad outline, the solution to this problem has been known to both political scientists and policy makers for some time, but in the absence of pressure from the public progress is slow. The first priority is greater transparency: profit shifting thrives in a climate of secrecy. More specifically we need Automatic Exchange of Information – whereby countries are legally obliged to share all of their tax information with each other – and Country-by-Country reporting – whereby a transnational corporation is obliged to give a single figure for their worldwide profits and a breakdown of how much was generated in each country of operation. With such increased transparency, the public would be able to see the system for what it is, and demands for change will grow.
The ultimate goal is to move to a system of Unitary Taxation, which would ensure that transnational corporations are taxed in each jurisdiction in which they operate according to the real economic activity they conduct in that area. This would end once and for all the farce of companies such as Starbucks and Amazon being able to pay miniscule levels of corporation tax that bear no relation to their sales or employment figures. This is not Utopian. Such a system is used within federal countries such as Canada, Switzerland and the United States. And the EU has worked out a proposal for a Common Consolidated Corporate Tax Base, which would go a long way towards a system of Unitary Taxation within the EU. So far implementation has been blocked not only by the countries most guilty of systematic profit shifting, but also by the neo-liberal government of the UK.
With the political will, profit shifting could be resigned to history. Labour should rise to the challenge and pledge that in government they will lead negotiations towards a new system of global tax law fit for the realities of the 21st century. It’s time to make globalisation work for everyone.