By Joseph E. Stiglitz
The price they come up with is what they claim it would be if the goods and services were being exchanged in a competitive market.
For obvious reasons, this system has never worked well. How does one value a car without an engine, or a dress shirt without buttons? There are no arm’s-length prices, no competitive markets, to which a firm can refer.
And matters are even more problematic in the expanding services sector: how does one value a production process without the managerial services provided by headquarters?
Exploiting the system
The ability of multinationals to benefit from the transfer price system has grown, as trade within companies has increased, as trade in services (rather than goods) has expanded, as intellectual property has grown in importance, and as firms have gotten better at exploiting the system.
The result: the large-scale shifting of profits across borders, leading to lower tax revenues.
It is telling that U.S. firms are not allowed to use transfer pricing to allocate profits within the U.S. That would entail pricing goods repeatedly as they cross and re-cross state borders.
Instead, U.S. corporate profits are allocated to different states on a formulaic basis, according to factors such as employment, sales, and assets within each state. And, as the Independent Commission for the Reform of International Corporate Taxation (of which I am a member) shows in its latest declaration , this approach is the only one that will work at the global level.
For its part, the OECD will soon issue a major proposal that could move the current framework a little in this direction. But, if reports of what it will look like are correct, it still would not go far enough.
If adopted, most of a corporation’s income would still be treated using the transfer price system, with only a “residual” allocated on a formulaic basis. The rationale for this division is unclear; the best that can be said is that the OECD is canonizing gradualism.
After all, the corporate profits reported in almost all jurisdictions already include deductions for the cost of capital and interest. These are “residuals” — pure profits — that arise from the joint operations of a multinational’s global activities.
For example, under the 2017 U.S. Tax Cuts and Jobs Act, the total cost of capital goods is deductible in addition to some of the interest, which allows for total reported profits to be substantially less than true economic profits.
Given the scale of the problem, it is clear that we need a global minimum tax to end the current race to the bottom (which benefits no one other than corporations).
Lower taxes don’t lead to higher growth
There is no evidence that lower taxation globally leads to more investment. (Of course, if a country lowers its tax relative to others, it might “steal” some investment; but this beggar-thy-neighbor approach doesn’t work globally.)
A global minimum tax rate should be set at a rate comparable to the current average effective corporate tax, which is around 25%. Otherwise, global corporate tax rates will converge on the minimum, and what was intended to be a reform to increase taxation on multinationals will turn out to have just the opposite effect.
The world is facing multiple crises — including climate change, inequality, slowing growth, and decaying infrastructure — none of which can be addressed without well-resourced governments. Unfortunately, the current proposals for reforming global taxation simply don’t go far enough. Multinationals must be compelled to do their part.