Tax avoidance and tax arbitrage by multinational corporations undertaking cross-border trade should be getting much more importance that it deserves. They are a cause for major distortions in the world economy, besides perpetuating illegal business practices and money laundering.
Brad Setser has two excellent tweet threads (HT: Ananth) highlighting their role in globalisation and distorting services trade.
Brad Setser points to the role of tax avoidance in questioning the premise of deglobalisation. He argues that world will deglobalise only when...
American pharmaceutical firms stop taking drugs developed, sometimes with support from the NIH, in the US, and then entering into R&D cost shares and other tax arrangements with subsidiaries located in offshore financial centers with favorable tax rates, and then and producing patent protected drugs in Ireland, Switzerland, Singapore and Belgium for sale back to the US. With the majority of their global profits, of course, booked outside the US even though the majority of their sales are in the US...When the world’s most profitable firm no longer produces the bulk of its consumer products in a few cities in China, using chips produced mostly in Taiwan using intellectual property often licensed from a US firms' tax subsidiary in say Singapore. And then notionally sells its consumer goods to its subsidiary in Ireland before reexporting those goods globally -- and, of course, booking the majority of its global profit outside both the US and China...Chinese support of global manufactures is no longer at a record level relative to global output – and when China no longer needs to draw a record amount of net demand from the world to sustain its unbalanced economy... And when Ireland is not the United States biggest export market for a range of services – from software to research and development… and when Caribbean tax centers aren't the biggest US export market for financial services ...
This is a definitive graphic
It's hard to not feel that China never deglobalised.
Now to services trade. Let's start with some basics - US software exports.
If there's an award for the biggest distortionary public policy impacting world trade, Ireland's corporate taxation policy should be among the strongest contenders. It's inconceivable that a country of 5 million people consumes a quarter of US software exports.
In order to benefit from its ultra-low corporate tax rates, it has become standard practice for US software businesses to transfer IP to shell entities in Ireland, export software to Ireland, add their royalty margins, have it re-exported to other countries, and (minimise taxes and) maximise profits.
Ditto in R&D services, where in contrast to six tax havens, US has a deficit with the rest of the world. Tax havens distort US R&D services, big time.
And this is the summary, from a slightly dated, but still very relevant paper by Setser
This article explains the tax avoidance (through profit shifting) strategies of US pharmaceutical firms.
1. Identify a valuable drug by testing it in the United States market;2. Transfer the right to exploit the pharmaceutical product to a subsidiary in a low or no tax jurisdiction like Bermuda;3. Set up a manufacturing subsidiary in another low tax jurisdiction (Ireland, Singapore, and Switzerland are common—but Puerto Rico also works, as it is outside the scope of U.S. corporate income tax for complex historical reasons);4. Import the active ingredient into the United States at a high price.
Firms generally prefer to avoid exporting active ingredients from the United States and paying U.S. tax and instead prefer to produce for the European market in Ireland and the Asian market in Singapore and book their “export” profits offshore.
However way you see it, tax avoidance through tax arbitrage is a massive distortion in the world economy.
As an aside, can we imagine a developing country pursuing Ireland's beggar-thy-neighbour policy and getting away?
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