InvestMacro

By Ludvig Wier, University of Copenhagen and Gabriel Zucman, University of California, Berkeley 

About a decade ago, the world’s biggest economies agreed to crack down on multinational corporations’ abusive use of tax havens. This resulted in a 15-point action plan that aimed to curb practices that shielded a large chunk of corporate profits from tax authorities.

But, according to our estimates, it hasn’t worked. Instead of reining in the use of tax havens – countries such as the Bahamas and Cayman Islands with very low or no effective tax rates – the problem has only gotten worse.

By our reckoning, corporations shifted nearly US$1 trillion in profits earned outside of their home countries to tax havens in 2019, up from $616 billion in 2015, the year before the global tax haven plan was implemented by the group of 20 leading economies, also known as the G-20.

In a new study, we measured the excessive profits reported in tax havens that cannot be explained by ordinary economic activity such as employees, factories and research in that country. Our findings – which you can explore in more detail along with the data and an interactive map in our public database – show a striking pattern of artificial shifting of paper profits to tax havens by corporations, which has been relentless since the 1980s.

Global crackdown

The current effort to curb the legal corporate practice of using tax havens to avoid paying taxes began in June 2012, when world leaders at the G-20 meeting in Los Cabos, Mexico, agreed on the need to do something.

The Organization for Economic Cooperation and Development, a group of 37 democracies with market-based economies, developed a plan that consisted of 15 tangible actions it believed would significantly limit abusive corporate tax practices. These included creating a single set of international tax rules and cracking down on harmful tax practices.

In 2015, the G-20 adopted the plan officially, and implementation began across the world the following year.

In addition, following leaks like the Panama Papers and Paradise Papers – which shed light on dodgy corporate tax practices – public outrage led governments in the U.S. and Europe to initiate their own efforts to lower the incentive to shift profits to tax havens.

Profit-shifting soars

Our research shows all these efforts appear to have had little impact.

We found that the world’s biggest multinational businesses shifted 37% of the profits – or $969 billion – they earned in other countries (outside the headquarter country) to tax havens in 2019, up from about 20% in 2012 when G-20 leaders met in Los Cabos and agreed to crack down. The figure was less than 2% back in the 1970s. The main reasons for the large increase were the growth of the tax avoidance industry in the 1980s and U.S. policies that made it easier to shift profits from high-tax countries to tax havens.

We also estimate that the amount of corporate taxes lost as a result reached 10% of total corporate revenue in 2019, up from less than 0.1% in the 1970s.

In 2019, the total government tax loss globally was $250 billion. U.S. multinational corporations alone accounted for about half of that, followed by the U.K. and Germany.

Global minimum tax

How do policymakers fix this?

So far, the world as a whole has been trying to solve this problem by cutting or scrapping corporate taxes, albeit in a very gradual way. In the past 40 years, the global effective corporate tax rate has fallen from 23% to 17%. At the same time, governments have relied more heavily on consumption taxes, which are regressive and tend to increase income inequality.

But the root cause of profit-shifting is the incentives involved, such as generous or lenient corporate tax rates in other countries. If countries could agree on a global minimum corporate tax rate of, say, 20%, the problem of profit-shifting would, in our estimation, largely disappear, as tax havens would simply cease to exist.

This type of mechanism is exactly what more than 130 countries signed onto in 2021, with implementation of a 15% minimum tax set to begin in 2024 in the EU, U.K., Japan, Indonesia and many other countries. While the Biden administration has helped spearhead the global effort to implement the tax, the U.S. has notably not been able to get legislation through Congress.

Our research suggests implementing this type of tax reform is necessary to reverse the shift of ever-greater amounts of corporate profits going to tax havens – instead of being taxed by the governments where they operate and create value.

About the Author:

Ludvig Wier, External Lecturer of Economics, University of Copenhagen and Gabriel Zucman, Associate Professor of Economics, University of California, Berkeley

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By Dan Steinbock

The year 2023 represents a turning point. If economic realities guide global prospects, it will be a positive turnaround. If geopolitics will continue to penalize economic prospects, a negative inflection point is more likely.

Recently, Kristalina Georgieva, Managing Director of the International Monetary Fund (IMF), suggested that the year 2023 could “represent a turning point, with inflation declining and growth bottoming out.” She based the prediction on economic assumptions. Unfortunately, we no longer live under an economic status quo.

Since the mid-2010s and the advanced economies’ trade protectionism, sanctions and militarization, geopolitics has driven global prospects, as it did in the interwar period. As long as these underlying conditions prevail, so will persistent inflation.

The year 2023 could represent a turning point. Not the kind Georgieva had in mind – but a negative reversal.

Poor economies driving global growth

While the latest IMF projections show global growth slowing to 2.9 percent this year, the IMF anticipates a modest rebound to 3.1 percent in 2024. But it is the emerging and developing economies that are providing the momentum.

In 2021-24, the share of global growth by the largest emerging and developing economies will climb from 63 to over 80 percent. Accordingly, the share of the advanced economies will almost halve to less than 20 percent (Figure 1).

Figure 1 Global growth, 2021-E2024

Source: IMF

Starting from a low base, India’s GDP is still barely an eighth relative to the US and its growth is now slowing from the 7% growth projected to 6.8% in the 2023/24 fiscal year, as the global slowdown is likely to hurt exports. However, China’s GDP is already three-fourths of that of the US and this year growth in the mainland (5.8-6.5%) could prove almost as fast as that of India (6.0-6.8%).

Together, China and India are likely to account for almost a third of global growth in 2023, as the major advanced economies are coping with recessionary conditions. Furthermore, the share of emerging and developing economies of global growth will progressively increase, whereas that of advanced economies will continue to fall as secular stagnation is spreading among them.

The Fed as a global risk

Global economic prospects have been further penalized by the US Federal Reserve’s ill-advised monetary policies, particularly since fall 2021. After years of easy money and rounds of quantitative easing, the Fed misread the market signals after mid-2021, when inflation started to climb rapidly, and Fed chairman Jerome Powell downplayed the threat of soaring prices calling them “transitionary.”

It was a fatal policy mistake, which a year ago led to my warning that US inflation was the global risk of 2022. With the onset of the proxy war only a month later, I predicted that the world economy would have to cope with the risk of stagflationary recession, compounded by energy and food inflation. The rest, as they say, is history.

In its February 2023 meeting, the Fed raised the interest rate to 4.5-4.8 percent, pushing borrowing costs to the highest since 2007. Recently, Powell warned of more rate hikes and seems to be aiming at a rate of 5.25 to 5.5 percent, thus flirting with a recession.

Rather than transitionary, inflation has proved sticky and persistent. Thanks to America’s central role of the US in the world economy, what happens in America won’t stay in America.

Rich economies’ geopolitics penalizes global growth

Recently, US stocks sank to their lowest levels in a month, with the S&P 500 Index dropping under 4000. Despite interest rate at almost 5 percent, the inflation rate, which soared close to 10 percent in summer 2022, slowed only to 6.4 percent in January.

After the US hit its $31.4 trillion debt limit set by Congress, Treasury Secretary Janet Yellen warned that a failure to make payments that are due “would undoubtedly cause a recession in the US economy and could cause a global financial crisis.” New debt limit can be enacted, but not without unsustainable debt-taking.

In January, euro area bank lending fell again amid downturn, while cash and liquid deposits declined for the first time ever, thanks to rapid rate hikes by the European Central Bank (ECB). The ECB analysts stressed that the euro area has “ shown remarkable economic resilience to the effects of the war [in Ukraine].” But that resilience is elusive because it’s also based on massive debt-taking.

Consumer price inflation was revised slightly higher to 8.6 percent year-on-year in January. That’s significantly below the peak of 11.1 percent in November, yet remains far above the ECB’s target of 2.0 percent. It is likely to result in half a percentage hike at the Bank’s mid-March meeting.

In Japan, inflation was negative until fall 2021. By January, it soared to 4.2 percent; the biggest increase since September 1981. Core inflation has been well above the Bank of Japan’s (BOJ) 2% target for nine months in a row. This is largely attributable to continued increases in the cost of fuel and raw materials. Hence, the market’s rising concern about global bond market spillovers if and when the BOJ’s new chief Kazuo Ueda will hike interest rates (Figure 2).

Figure 2 Inflation and interest rates: US, euro area, Japan, and China

Source: Tradingeconomics, Difference Group

China’s rebound offsets the Fed’s risks

When Chinese policymakers began to prepare the reopening of the world’s second-largest economy, many international observers warned it would unleash inflationary headwinds. But numbers do not back up the story.

China’s annual inflation rate rose to only 2.1 percent in January. Expectedly, prices of food jumped and those of non-food gained further on the back of the Lunar New Year festival and the removal of pandemic measures. Nonetheless, the inflation rate remains only half relative to Japan, a third to the US and a fifth compared to the euro area. 

At the eve of the Two Sessions, Chinese leaders pledged stronger growth. Recovery is taking hold and economic activity picking up pace with the country’s reopening. China’s GDP growth could soar to 5.5 to 6 percent in 2023, or over 6 percent on a quarter-to-quarter basis.

Internally, China’s emphasis on social policies promoting a moderately prosperous society supports rising purchasing power among new middle-income groups. External risks have been in part reduced by the misguided US trade wars and protectionism, which have compelled Chinese policy authorities to stress the importance of self-sufficiency. Spillovers will be significant in those economies that participate in China’s huge Belt and Road Initiative (BRI), and the Regional Comprehensive Economic Partnership (RCEP), the vast new trade bloc.

Global growth engines, without voice

The US, the euro area and Japan are struggling with secular stagnation and exporting runaway inflation. By contrast, China’s growth is accelerating while inflation remains in check. Its reopening could lift global GDP up to a stunning 1 percent in 2023.

Large emerging and developing economies are today’s global growth engines. Currently, their share of global growth exceeds 80 percent. While cyclical recession will end in the major advanced economies, their secular stagnation has barely begun. In the coming decade, the growth gap between the rich and poor economies won’t go away. It is positioned to deepen.

With broadening secular stagnation, the long-run economic growth in the major advanced economies will approach zero. Perhaps that’s why they are now so eager to use geopolitics and military muscle.

 About the Author:

Dr. Dan Steinbock is an internationally recognized strategist of the multipolar world and the founder of Difference Group. He has served at the India, China and America Institute (USA), Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see https://www.differencegroup.net

The original commentary was released by China-US Focus on March 1, 2023.