7. How is the world different today than when the dominant tax rules were created?
Most of the existing country-to-country tax rules were created in the 1920s, in a world where tangible capital was paramount: factories, warehouses & physical goods. Two major developments have combined with a situation whereby the current tax rules have not kept pace with said developments, and because of this, companies can now take advantage of global tax rules in order to minimise how much tax they pay & maximise how much profit they earn.
The first development was the removal of capital controls in the 1970s & 1980s. This allowed corporations to easily move their operations & capital between countries. For the first time after WWII, corporations could threaten sovereign nation states with their departure if the terms were not favourable, threatening a sudden stop to that flow of revenue & the associated employment etc. They were able to hit two birds with one stone; they could get the highest profits possible without regard for the needs of the country in which they were based, & they could dictate the terms of their investment to the nation-state. This reduced & continues to reduce the state’s policy space, resulting in diminished revenue via corporation tax for the state.
The removal of capital controls also sparked the emergence of the ‘race to the bottom’; competition between countries on the rate of corporation tax they charge corporations. Since capital became more mobile, nation states have tried to attract Foreign Direct Investment (FDI) through low tax rates, financial incentives & even financial secrecy. The IMF, the WB, regional development banks & the EU have all been part of promoting this developmental strategy known as the ‘tax consensus’.
An outcome of capital mobility is capital flight. Capital flight denotes money leaving a country rapidly, & is defined as the transfer of assets abroad to reduce loss of principal, loss of return, or loss of control over one’s financial wealth due to government-sanctioned activities. This can be in response to many stimuli; & is not always illegal. However one key reason capital flight takes place is for the asset-holder to escape paying tax. As Nicholas Shaxson summarises “To escape rules you don’t like, you take your money elsewhere, offshore, across borders.”
The second development is that today in our highly digitised & financialised world, MNCs can conduct their business in a jurisdiction in which they have little or no physical presence. The existing rules say that the profits of a company can only be taxed in a country different to that in which it is headquartered if the company has a physical presence there. However this is often not the case when it comes to intangible items, for example intellectual property. What’s more, a country which headquarters a particular company, for example country A & the global HQ of Tech Company Inc., does not tend to tax the income on foreign activities of that company, as it assumes that the country in which the company is operating, i.e. Country B will receive the tax. However that is not always the case, in particular for intangible goods.
