Global fight against tax optimization evasion

Globalization has become a boon for rich people who want to avoid being taxed. U.S. companies place about half of their overseas profits in offshore tax havens, a significant increase since the late 1970s. About $12 trillion of global financial wealth is offshore. Financial centers such as the British Virgin Islands are an integral part of the global economy, as are manufacturing centers such as Shenzhen.

But how much longer will this last? Over the past decade, there have been impressive global efforts to close tax loopholes. In 2017, governments introduced the Automatic Exchange of Banking Information, which requires offshore financial centers to inform the tax authorities of the account resident's country of banking transactions. In 2021, more than 140 countries and territories, coordinated by the Organization for Economic Cooperation and Development, reached an agreement to impose a 15% minimum tax on international profits and redistribute tax revenues to countries where products are actually sold or used.

A new report by the European Tax Observatory at the Paris School of Economics provides the first detailed look at the work that has been done. The authors may be overly enthusiastic about the idea of a perfectly fair tax system that will bring rich people and tax evading companies to order. However, they also provide important data generated by what they call the "information Big Bang" to improve the global tax system. While they may be over zealous, they are right that we need to do everything we can to reconcile globalization with justice if we are to save the global system from self-destruction.

The campaign has been a great success: the automatic exchange of banking information has reduced offshore tax evasion by rich people by about three times. Until 2017, about 90% of financial capital held offshore was not reported to tax authorities. Today, while the same percentage of global GDP is offshore, only about a quarter of it is unreported.

But even here success is limited: it is estimated that about a quarter of the offshore wealth formerly held in the form of financial assets may have been converted into real estate. About $500 billion of real estate is owned by foreign owners, often companies rather than individuals, in six locations: London, Paris, Singapore, Dubai, Côte d'Ajour and, surprisingly, Oslo. That's equivalent to about 10% of the total real estate in those areas.

And when it comes to tackling profit shifting, the situation is even more complex. In 2022, $1 trillion in profits were recorded in tax havens - that's about 35% of all profits of multinational companies outside their home countries and about the same as before the legislation was introduced. This is not to say that nothing has been achieved - the growth in profit shifting has slowed - but exemptions and caveats are rapidly eroding the impact of the legislation.

Ireland

Ireland is an example of a ruthless country's ability to play by its own rules. (Ireland has been far more successful as a corsair state within the EU than Britain has been outside it.) In 2022, Ireland collected the equivalent of 4,500 euros ($4,770) of tax on stock gains per resident - almost five times as much as France or Germany, which have much higher corporate tax rates. Ireland's introduction of a particularly low tax rate (6.25%) on royalties (under the so-called "patent box" regime) has led to a surge of global companies locating their "intangible assets" there.

Globalization is not the only villain in the Observatory's story: one of the most serious distortions in the global tax system occurs at the national rather than the global level. American billionaires have an effective tax rate of 0.5% of their wealth, while French billionaires have an effective tax rate of zero. American billionaires accomplish this, in many cases, by making their companies retain profits; French billionaires accomplish this by transferring their dividends to intermediate companies. The Observatory believes it has a global solution to these national problems: a global minimum tax for all billionaires of 2% of their wealth.

This idea strikes me as misguided and counterproductive.

It was the US that pioneered the fight against tax havens with the passage of the Foreign Account Tax Compliance Act (FATCA) in 2010, which required all banks to report the bank accounts of US citizens. It is the US that has a key role in countering profit shifting. U.S. multinationals place nearly half of their overseas profits in tax havens, compared to about 30% for non-U.S. multinationals. Congressional opposition to the new profit-shifting regime is growing, with the chairman of the House Tax and Revenue Committee, Jason Smith, vehemently declaring that "global technocrats negotiating in the shadows seek to attack the United States." The likelihood of this legislation passing will not increase because of calls from an EU-related organization for a global minimum tax on billionaires.

Many conservatives will undoubtedly go further and condemn the entire premise of the report—that global technocrats should limit the freedom of nation-states to set their own tax rates. What is the point of sovereignty if not to give you the ability to decide on tax and spending issues? And how are developing countries supposed to grow if they cannot compete with already established countries in attracting mobile companies and talented individuals? This is absolutely true. However, closing tax loopholes and preventing profit shifting do not hinder genuine competition between countries. They simply prevent companies from playing hide and seek, which has nothing to do with wealth creation.

A deep objection to the argument is perhaps that it doesn't go far enough: it considers the old world of free globalization rather than the new world of state activity and trade barriers. The race to subsidize green energy suppliers—a race initiated by China with its generous treatment of state-owned companies, but which was then intensified by Biden's Inflation Reduction Act—more than offsets the benefits of a global minimum corporate tax. The next important tax battle is about how to prevent countries from distorting economies through subsidies, rather than how to uncover hidden wealth.

However, it would be foolish to despair over global tax policy. Automatic reporting of bank payments indicates that progress is possible in this complex area: reducing tax evasion by about three times is no small achievement. It also shows that we have a formula for success: to require financial authorities in tax havens to register financial transactions as a condition for continued participation in the global financial system. Tax reformers should now make it their top priority to apply this same principle to international real estate transactions.

Progress matters if we want to reconcile globalization with political legitimacy. Globalization is hard to sustain if it means tax cuts for the winners who can hide their income, and tax increases for ordinary people who have no choice but to pay payroll and consumption taxes. It is even more difficult to sustain globalization if successful people, especially the young, find it increasingly hard to live in big cities because tax evaders are turning urban real estate into a kind of Swiss bank account. There is no point in hiding your wealth from the tax authorities if you are simultaneously undermining the foundations of the capitalist system.