U.S. President Joe Biden is calling for a minimum corporate tax rate of 21 percent for companies. But countries like Ireland and Luxembourg have established a lucrative revenue stream through big breaks for multinationals. A number of EU countries could soon feel the pinch.
If you want to know why a company should have its headquarters in Ireland these days, the best place to ask is IDA Ireland, the government’s foreign direct investment agency based in Dublin.
The Emerald Isle, their lobbyists rave, has a “great density of data centers.” It advertises the country’s large pool of young talent with above-average qualifications as well as international and innovative companies, ranging from Microsoft and Facebook to German corporations such as Allianz, Zalando and SAP.
But when asked if perhaps the real attraction for investors is the extremely low corporate tax rate of 12.5 percent, the IDA declines to answer. For that, the agency says, it is best to contact Paschal Donohoe, the Irish finance minister and chair of the Eurogroup.
The man currently finds himself facing a problem that has become a concern for all of Europe. Since U.S. President Joe Biden presented his groundbreaking proposal for a global minimum tax on corporate profits, old rifts have ripped open again on the Continent. Whereas large member states such as Germany approve of the move, it would hit smaller EU members like Ireland, the Netherlands and Slovakia hard.
For years, they have lured international corporations into their countries with the promise that they will be largely spared from the grasp of the domestic tax authorities. If the U.S. gets its way, that could be the end of it.
Numerous EU countries would not only have to reckon with revenue losses in the billions, but also with the loss of corporate headquarters and thousands of jobs.
Countries like France or Italy, on the other hand, would feel vindicated. Out of anger with corporations like Amazon that have barely paid any taxes at all in Europe in recent years, they enacted their own digital taxes – and drew the ire of Donald Trump by doing so. The former U.S. president even threatened retaliatory tariffs on German cars, Italian cheese and French handbags.
Now, the U.S. has performed a spectacular about-face – and raised difficult questions for the Europeans: How seriously must pledges from Brussels to fight tax evasion be taken? Would it just be the tax havens that have to reckon with losses or would they also be painful for large exporting countries like Germany?
And, more importantly: Will the Europeans manage to find a common line with the U.S. in the tax negotiations that have been going on for years in the OECD club of industrialized nations?
At issue here is the safeguarding of public finances, the power of global digital corporations and the West’s ability to take action. Since Biden moved into the White House, high-ranking EU politicians like European Commission President Ursula von der Leyen have promised a “re-energizing of trans-Atlantic relations.” But now she has to prove that she can back up her eloquent formulations with concrete steps.
“The Europeans are being called upon to take Biden’s outstretched hand,” says Sven Giegold, a budget expert with the Green Party in the European Parliament. And Guntram Wolff, head of the Brussels think tank Bruegel, says: “It wouldn’t be the first time the U.S. has nudged reforms in Europe that the union of nations can’t push through on its own.”
A Decades-Long Downward Trend
The time to do so is ripe, too. Leading up to Biden’s call for a reversal, corporate taxes worldwide only seemed to know but one direction: downward. Over the past 40 years, the global average corporate tax rate has fallen from 40 to 24 percent. The first step was taken in the 1980s by Ronald Reagan, who sought to stimulate the economy with a radical tax cut.
Whether he succeeded in doing so is still the subject of dispute today. But there is little doubt about the damage the reform has done to the government’s coffers. The share of corporate taxes in the U.S. has since fallen to less than one-tenth of federal revenues, while taxes on labor now account for more than 80 percent.
Globalization has accelerated that trend. In the 1980s, American corporations still generated less than 15 percent of their sales abroad. By the 2000s, that figure had risen to 30 percent. Increasingly, multinational corporations could choose where they paid taxes – and how much.
Digitalization made that game even easier. Companies like Facebook, Apple and Google don’t even have to build new factories in a country to enjoy its tax benefits. Given that their businesses are based on data and technology, they can distribute profits around the world through simple transfers that are done in ways that leave little for the taxman.
Executives aren’t generally plagued by bad consciences for doing so. When Facebook opened its European headquarters in Dublin, for example, deputy company head Sheryl Sandberg wrote to her colleagues with the utmost matter-of-factness that it was basically the same process as at her former employer Google: It was about “tax breaks” to “put international revenue through.”
For years, the world has marveled at the chutzpah corporations have used to push their taxes down to levels lower than ordinary citizens could only dream of. According to the European Commission, iPhone manufacturer Apple, for example, at times paid taxes of only 0.005 percent on its profits in Ireland and should therefore pay 13 billion euros in back taxes. Apple CEO Tim Cook described the demand as “political crap,” and the government in Dublin has so far successfully resisted collecting those billions.
Politicians have long looked on as multinational tech giants played tricks, and in some cases even encouraged them through their tax laws. But since the publication of massive data leaks, such as the “Panama Papers,” public outrage has grown. Activists have long been beating the drum for corporate tax reform. They are supported by scholars like University of California at Berkeley economists Gabriel Zucman and Emmanuel Saez, who decry the current tax system as a “triumph of injustice.”
Under Joe Biden, those voices have now made it to the Treasury Department, where the tax analysis office has been headed since February by economist Kimberly Clausing, who previously made a name for herself with research into the tax-motivated shifting of corporate profits to offshore havens. Treasury Minister Janet Yellen also considers the global tax competition to be “self-defeating” and announced, “We want to change the game.”
The Americans have also become more involved in OECD negotiations that the Trump administration had only recently torpedoed. The Biden administration believes that the corporate tax rate should be at least 21 percent worldwide, the same level it is seeking for the U.S. If other countries fall short, the U.S. Treasury would be allowed to book the difference for itself. Biden’s people want to use it to prevent U.S. corporations from moving profits or jobs overseas.
The American plan, though, has a second component that is particularly complicated for Germany. The taxes of the biggest and most profitable multinationals would be redistributed under the plan. In the future, the number of products a company sells in a particular country would play a role in the tax calculation – and not just whether it operates a factory there.
This kind of idea has been under discussion for some time, but it was initially aimed primarily at large American digital giants. Now, the U.S. wants to apply it to export-strong industrial companies as well – and thus to major European corporations from Volkswagen to L’Oréal.
Saint-Amans believes the demand is justifiable. “The question of profit allocation goes beyond digital companies,” he says. Starbucks, for example, has also saved on taxes by shifting around profits it earned through its global network of cafés.
Calculators Under the Table
Thomas Rixen, a tax expert at the Free University of Berlin, also believes that the U.S. approach makes sense, even if Washington benefits from the fact that the tax burden is based on sales. “In negotiations, of course, everyone sits with their calculators under the tables,” he says. The Americans have a large market with many consumers. “That’s why they are likely to be allocated a large portion of the taxes,” Rixen says. Major successes in international tax policy have always been achieved at the instigation of the U.S., Rixen says.
The Europeans, on the other hand, have stood idly by in recent years as the multinationals have funneled billions in profits past their state coffers and their tax systems became ever more divergent. Official tax rates on the Continent vary from 9 percent in Hungary to 31 percent in France.
The differences are greater, of course, when the many tax breaks that countries use to lure companies are factored in.
According to an analysis conducted by the parliamentary group of the Green Party in the European Parliament, effective tax rates range from about 2 percent in Luxembourg to 30 percent in Italy. In the Netherlands, which has become famous for it’s particularly tricky “Dutch Sandwich” tax-savings scheme, corporations only have to hand over about 10 percent of their profits to the tax authorities.
All attempts to at least partly mitigate the differences have been unsuccessful. For more than 15 years, German and French experts have been searching for common principles for corporate taxes on both sides of the Rhine, and so far they haven’t borne any fruit. And when Ireland received billions from the European bailout fund in the wake of the financial crisis, the government in Dublin rebuffed all demands to raise corporate taxes in return.
Not even the Luxleaks scandal, which exposed the Luxembourg government’s cronyism with the tax avoidance industry, could usher in a turnaround, as the European Commission recently noted in a damning review of European tax policy. The “patchwork of corporate taxes,” the paper says, has led to a “downward spiral,” created “new loopholes for the highly mobile corporate sector” and piled up “hurdles to cross-border investment.” The rather resigned conclusion drawn in the report is that tax competition within the EU has “intensified further.”
Finance Minister Scholz was all the happier that the U.S. has now taken up his minimum tax proposal, and even surpassed it with a rate of 21 percent. The Social Democrat considered a rate of 14 percent at best to be enforceable. If the U.S. proposal moves ahead, the German treasury would also benefit, according to an internal estimate at the Finance Ministry – raking in an addition sum in the low billions.
The ministry also doesn’t believe the new tax claims being discussed for export-rich multinational companies will be a drag on German tax revenues. One reason is that many globally positioned medium-sized companies that are the backbone of the German economy remain below the turnover thresholds that are the focus of debate in the OECD. Furthermore, only the most profitable companies are included: Only those companies that earn between 15 and 20 percent profits on their sales in a country would have to hand over part of their proceeds to the tax office of that land. There aren’t that many German companies that hit that threshold.
On top of that comes the fact that Germany isn’t only home to export-strong corporations – it’s also its own market with more than 80 million inhabitants. This means that the German treasury stands to benefit not inconsiderably if international tax revenues are redistributed.
All in all, officials at the BMF are convinced, a global tax reform would not be a losing proposition for Germany. The story is different for the multinational corporations for whom the Biden plan would arguably usher in the end of the digital zero-tax era. Tommaso Faccio, head of the secretariat of the Independent Commission for the Reform of International Corporate Taxation, is convinced that “the biggest resistance” to the reforms will come from multinationals. “We already saw that during the OECD consultation process.”
Countries that build their financial systems on low taxes will face losses.
Publicly, the bosses at Facebook and Google are not expressing their annoyance, with some even pretending to be chastened. A while back, they even declared their willingness to pay more taxes. The week before last, Amazon founder Jeff Bezos announced his support for Biden’s plan – despite the fact that the U.S. president had branded the online retailer a tax evader just a short time before.
While the tech multinationals can easily absorb reasonable amounts of tax, those countries that have based their economic model on low tax rates, not least in the EU, must expect to lose out. “We still have to convince many partners that a comparatively high minimum tax rate is necessary,” says an official in Scholz’s Finance Ministry.
The coronavirus pandemic has also provided them with additional arguments: The bailout effort has torn deep holes in the government budgets and higher tax revenues would make debt repayment easier.
Scholz and his staff will have to prevent Europe’s low-tax countries from blocking a compromise. Key here is the level of the minimum tax rate. It is likely to be below what the Americans want, but above the 14 percent that has been under discussion in the OECD negotiations so far. In the end, 140 countries have to agree. Tax expert Faccio sees the Germans in a key role: “Now that the U.S. is convinced, can Germany convince Europe?”
The U.S. is in a comparatively comfortable position. They could simply enforce their plan by siphoning off corporate profits through national law.
The tax authorities in Germany or France, on the other hand, would have a more difficult time because Europe’s corporations can invoke the right to freely set up their headquarters anywhere in the EU.
As long as they’re not operating pure letterbox companies in Ireland or Luxembourg and maintain offices and employ their own staff, the German tax authorities “cannot simply skim off the profits there,” says University of Mannheim tax professor Christoph Spengel. He even considers it conceivable that European corporations could “shift additional business from international tax havens to Europe’s low-tax locations.”
On the other hand: Who likes tangling with the Americans? Irish Finance Minister Donohoe apparently does not. He recently announced that the U.S. plans would lead to an annual shortfall of around 2 billion euros in Ireland’s national budget. But there was no talk of outright rejecting the Biden plan. He said he merely had “reservations.”