Sometimes only a severe shock can fix a broken system. The time is ripe for applying this principle to cross-border corporate taxation and Donald Trump, the US president-elect, is perhaps the man to do it.
In the corporate taxation game, some countries compete for genuine business by lowering their tax rates. Many more seek to raise revenues by attracting fake profits with low rates. Tax havens compete most ferociously of all to the detriment of everyone else. The outcome is a race to the bottom. In large economies, corporate tax rates have fallen from an average of nearly 50 per cent in 1983 to below 30 per cent in 2015. The system promotes dishonesty and encourages tax avoidance. It results in nations unable to collect sufficient revenues and inadequate taxation of profits. The international community has agreed steps to counter such erosion of the corporation tax base through profit shifting. It is well meaning but likely to be as effective as using a sticking plaster to repair a broken bone. A better solution would come from adopting destination-based cash flow taxation. Emerging from non-partisan think-tanks, this idea is promoted by congressional Republicans and is likely to underpin the corporate tax reform, even though Mr Trump worried publicly about its complexities this week. Destination-based cash flow taxation represents a fiscal revolution. Taxes are no longer levied on the profits earned where operations are based. Instead, they are levied on profits earned where products are sold. The location of a company’s operations no longer matters. This move eliminates the artificial incentive to locate operations and profits in low-tax jurisdictions. A company could not lower its tax liabilities unless it changed the location of its sales. A multinational would not pay less tax if it shifted headquarters or located lucrative parts of its business in tax havens. There would be clear national winners and losers if all countries adopted the destination principle. Tax havens and countries that make a living from companies locating profits in their jurisdictions would lose revenue. Sorry Luxembourg; sorry Ireland. At a global level, the relative revenue winners would be countries where sales exceed production: those with trade deficits.
Countries with large and persistent trade surpluses – Germany, Japan and China – would lose. This is another welcome side effect, providing for the first time a fiscal incentive for surplus countries to rebalance their economies. No longer would pressure for adjustment rest solely on those with deficits, a problem outlined by John Maynard Keynes almost a century ago. Organising a concerted international move to a better system is impossible. It is further complicated by the likelihood that destination-based corporate taxes run counter to the World Trade Organisation’s rule book, even though they do not distort trade if implemented everywhere. This is where it is helpful to have a president-elect who cares little for international norms and wants to shake up the world. Alone among nations, the US could unilaterally move to a new corporate tax system. If it does so, regardless of whether it sparks a long dispute at the WTO, other countries will fall into line, for it would be a highly aggressive act. It would give companies every incentive to shift their profits to the US. Their US corporate tax bills would be unaffected because any move would not change their sales locations, but revenues elsewhere would take a hit. If the US moves, the world will follow. Rapidly. You might bridle at such Trumpian aggression; you might hate his sleaze and his conflicts of interest. But do not let those feelings lead you into knee-jerk opposition to the Republicans’ corporate tax plans. They have the potential to create order from chaos.