Profit taxes are rising everywhere, but the tech giants could reverse that

Continental concerns about losing profit taxes have long been misplaced — but that could now be changing, writes Dan O’Brien

CONVERSATIONS with continentals these days invariably include the topic of the taxing of multinational companies. For some people in some European countries it is almost an obsession.

That is because it has come to be widely believed that corporate behemoths are dodging tax on an epic scale and that this is reducing the revenues of many governments.

As many of the world’s largest multinationals do a lot of business in Ireland, the country is frequently accused of facilitating dodging.

But while there is no doubt that aggressive tax avoidance is commonplace, and it is almost certainly becoming more so, the evidence, as discussed below, does not provide much support for the narrative that it is leeching exchequers dry.

But before getting to the facts, it is important to understand why so many people, including many well-informed people, believe that profit taxes are evaporating at an alarming rate across the world.

There are two interrelated reasons: falling rates of corporation tax and a huge proliferation of multinationals.

Over recent decades, the rate at which profits have been taxed in most countries has been falling. Ireland was an early mover, bringing the rate down to 12.5pc (for most profits) two decades ago. The US has been the slowest mover, only a few weeks ago cutting its federal rate from 35pc to 21pc. Every single developed country has a lower rate today than 30 years ago. It makes intuitive sense to conclude that if corporation tax rates are falling everywhere, less profits tax is being paid.

The reason rates are falling is the second reason to believe less profit tax is being paid.

Globalisation has been a defining feature of recent decades.

More and more human activity takes place across borders. At the centre of the economic strand of the globalisation process is the internationalisation of the firm.

As more companies are locating operations outside their home countries, competition to attract them has heated up. This competition has driven down tax rates.

The explosion in the number of foreign subsidiaries has also allowed clever and creative accountants greater scope to devise ever more sophisticated ways of exploiting loopholes between different jurisdictions.

The decline in headline corporation tax rates and the increase in the number and size of globalised companies would lead reasonable people to conclude that there must be more avoidance happening. It is a small step from that conclusion to the view that more avoidance means less revenue.

Even if it is very likely that there is more avoidance going on, detailed tax data from the OECD show that there has been no downward trend in profit taxes in the era of globalisation.

In every OECD country, revenues have been trending upwards over decades even after allowing for inflation. Corporation tax as a percentage of national income has also been increasing. In the 1980s, before the current era of globalisation really got going, corporation tax revenue averaged just under 2.5pc of GDP in the OECD. It trended upwards thereafter, peaking at 3.6pc of GDP in 2007.

The Great Recession clobbered profits, as recessions always do, and revenues fell sharply.

They have since recovered. In 2015, the most recent year for which full OECD figures are available, profit tax revenues were equivalent to 2.8pc of GDP.

The same trend has been in evidence when corporation tax as a share of all government revenue is considered. In the 1980s, just under 8pc of the cash going into the coffers of OECD governments was accounted for by taxes on profits.

Again, that rose gradually during the 1990s and 2000s, reaching more than 11pc in 2007. As of 2015 it stood at 9pc, higher than in the 1980s when headline rates were much higher than they are today.

While the importance of corporation tax to governments differs across the world, there has not been much difference in the trends in OECD member countries over the past four decades. That is also true of France and Germany, the two countries most exercised about Ireland’s tax policies.

Over decades, neither country has seen a loss of corporation tax, either as a percentage of GDP or as a percentage of their respective government revenues.

If industrial scale avoidance was going on, with companies using lower rate jurisdictions, such as Ireland, to the detriment of higher rate ones, such as France and Germany, it would be showing up in the receipts. But it is not. It is less than clear why Irish ministers and officials do not make this point when they are being berated on the issue in Brussels, Berlin and Paris.

But if the evidence to date of industrial-scale avoidance by multinationals is scant, change could well be afoot. That is because of the rise and rise of the tech giants. Last week saw the biggest five reporting their final quarter accounts.

Amazon, Apple, Facebook, Google and Microsoft are now the most valuable companies in the US (as measured by market capitalisation), the first time ever that the top five positions have been held by companies from a single industry.

What’s more, analysis by PWC and ZEW, an accounting firm and a German research institute respectively, has found that across the bloc companies in the tech sector — both national and multinational — pay an average effective tax rate half that of non-tech firms.

If more and more economic activity moves online, and if this gap is not closed, there is a real risk that tax revenues could start to fall.

It is for this reason that France and Germany, along with Italy and Spain, have put their weight behind a tax on the revenues of tech companies, a levy more akin to VAT than a tax on profits.

The European Commission is drafting legislation to put to the 28 member countries. This is an entirely new idea, in contrast to proposals on changing the way profit taxes are levied in Europe which have been around for many years.

What are the implications for Ireland? It is well known that last year, Irish corporation tax receipts exceeded €8bn and that in recent years, just 10 companies paid around 40pc of all profit taxes. It is less well known which sectors do the paying.

In 2016, the hospitality sector, including hotels, restaurants and pubs, paid €84m in profit tax. Financial companies paid 25 times more, and that is despite the homegrown banks using past losses to offset paying tax on their now multi-billion profits.

The manufacturing sector was in second place, paying €1.9bn. The tech sector was third, coughing up €1.2bn. That is not chicken feed, but a sharp decline would not cause fiscal mayhem. More serious would be a big decline in tech companies’ foreign sales.

It is surprisingly little known that Ireland is the biggest exporter of computer services in the world. According to World Trade Organisation data, Irish computer services exports exceed those of France, Germany, the US and Israel combined. They are set to top €75bn in 2017.

The recent announcement by Facebook that it would stop booking international sales in Ireland is likely to impact on these export numbers. If other companies follow suit, tens of billions of computer services exports could disappear.

If that happened, the economy could experience a “reverse leprechaun”, whereby GDP suddenly shrinks by a huge amount, just as it suddenly expanded by 26pc in 2015 because of multinational accounting changes.

A double digit decline in GDP would make headlines in the international financial press. Such an event might have little real impact if the current good economic times across the world continue.

If it happened in less auspicious moments, things could turn out differently.

I have tweeted a thread of data and graphics on corporation tax issues at @danobrien20 for those seeking additional detail.

‘Amazon, Apple, Facebook, Google and Microsoft are the most valuable firms in the US’