The most valuable listed companies in the world are Apple and Google. With huge revenues and profits, they should be paying vast sums in tax. In absolute terms they may be, but they notoriously engage in tax avoidance. An arrangement with Ireland enabled Apple to pay an effective tax rate of just 0.005 per cent.
Ordinary taxpayers sense that this is unfair. Companies are gaming the system in order legally to minimise their tax liability. Governments have not caught up. It is urgent, not least for the legitimacy of capitalism, that they devise tighter rules so that companies pay their fair share of tax without deterring enterprise and growth.
The problem of multinational tax avoidance arises because the capitalist economy in the 21st century is very different from what it was even a generation ago. Production and consumption in advanced economies have shifted from manu- facturing towards information and services. Hence the output of some of the biggest and most successful companies is weightless: things like software, financial services, rights to intellectual property, patents, telecoms, digital services and home entertainment. What is weightless is easily shifted around the globe and hence hard to tax. The system has become a ramshackle contraption with many loopholes.
The British government is committed to lowering corporation tax rates and corporate tax reform is high on the agenda of Donald Trump, who becomes president today. He has pledged to reduce the US corporate tax rate from 35 per cent to 15 per cent. Paul Ryan, speaker of the House of Representatives, is pushing a shift to a system known as a destination-based cash-flow tax. This would involve taxing companies where they sell their output rather than where they book profits.
Mr Ryan’s plan might offer a route to closing the loophole that Apple has exploited. The downside is that it would involve taxing imports but not exports of American companies. It would probably also fall foul of World Trade Organisation rules and would certainly create economic inefficiencies.
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For other countries, including Britain, there is limited scope and a danger of lost revenues in pursuing a race to ever-lower tax rates. Reform needs international co-operation. Companies’ activities are mobile. Governments should treat those companies as single entities, rather than a set of independent operators, and allocate the shares of the tax revenues to which they are entitled according to a formula that no one can misinterpret or tweak to national advantage.
It would not matter what the measure of corporate activity would be (say, revenues on assets) so long as governments stuck to it. Their sovereign tax-raising powers would be enhanced by co-operation. And companies would find their reputations improved in the eyes of consumers. Capitalism, which rests on laws of contract rather than coercion, would be the winner.