This contribution is published as part of the Think Piece Series The Road To Addis and Beyond, launched to coincide with the third and final drafting session of the outcome document of this summer's Third International Conference on Financing for Development. In this Series, global experts discuss a range of topics complementary to the UNRISD research project on the Politics of Domestic Resource Mobilization on how to fund social development and raise provocative or alternative perspectives that can generate further ideas and debates. Please share your thoughts on this article in the comments space below.
The Third International Conference on Financing for Development presents an historic opportunity to make the commitments necessary to eradicate extreme poverty and reset the development trajectory on a sustainable path. While financing for the post-2015 development agenda must come from many sources, increasing tax revenue will be critical. Although capacity building efforts in developing country tax administrations have been partially successful in the past decade, much more can be done to reform the outdated international tax rules. This think piece argues tax reform is essential to mobilizing the resources required to achieve the SDGs, and surveys current reform efforts.
Erika Dayle Siu
is a Tax and Development Consultant and has worked for the United Nations, the International Centre for Taxation and Development and numerous civil society organizations working for tax justice.
The Third International Conference on Financing for Development presents an historic opportunity to make the commitments necessary to eradicate extreme poverty and reset the development trajectory on a sustainable path. Toward this end, the Addis Outcome Document sets forth an Action Agenda which places the mobilization of domestic public resources at the top of the list. In order to leverage this source of finance, the Action Agenda acknowledges the need for reform, specifically in the areas of building capacity in national tax administrations and setting revenue collection targets; combatting illicit financial flows, including tax evasion, tax avoidance and corruption; addressing excessive tax incentives; improving transparency; exchanging tax information; and scaling up international tax cooperation.
Experience with the Millennium Development Goals (MDGs) has demonstrated that tax revenue is a central component of development finance. The MDGs are already being funded two-thirds by tax revenue, one-sixth by international public finance and one-sixth by private flows.1
In the past decade, efforts to increase tax revenues have increased tax collections as a percentage of gross domestic product (GDP) by an average of 8 per cent, but these gains have now largely plateaued, and an additional 10 per cent increase is needed to fund the sustainable development goals (SDGs). While financing must come from many sources, increasing tax revenue will be critical to funding the SDGs.
Although capacity building efforts in developing country tax administrations have been partially successful in the past decade, much more can be done to reform the outdated international tax rules and institutions. The current international tax system dates back to the early twentieth century in the days when Singer Manufacturing Company, Standard Oil, and General Electric were among the first American corporations to venture across national borders to expand distribution of their commodities and manufactured goods. Almost a century later, however, globalization has transformed the contemporary economic landscape: Developing countries produce nearly one-half of global GDP; almost half of global trade occurs within related corporate structures; and the services sector comprises 63 per cent of global GDP. Yet, the international tax system has not adapted to this reality, and base erosion and profit-shifting (BEPS) has become the tolerated result. Even the most herculean efforts to build capacity of national tax administrations cannot remedy the deficiencies of an outdated set of international tax rules.
This think piece argues that international corporate income tax reform is essential to mobilizing the additional domestic public resources required to achieve the SDGs, and surveys current reform efforts toward this end. The piece concludes with thoughts on the way forward in funding the future of international development.
Why should countries have a corporate income tax, especially developing countries?
Since the first wave of corporate income tax (CIT) adoption in the early twentieth century by the United States and Europe, and later in the second half of the twentieth century by developing countries, the CIT has had its opponents and defenders. Defenders of CIT have pointed to three primary justifications: benefit, cost and enforcement.2
The benefit justification holds that public expenditures, such as physical and legal infrastructure, enable the flow of commerce, encourage economies of scale and protect property rights. Therefore, corporations should contribute their fair share of revenues to fund such benefits. Equally, some corporate activities impose costs on society, such as pollution, dangerous working conditions, corporate frauds, or financial market disasters, and corporations should contribute their fair share to pay those costs. Moreover, because individual investors could easily shelter personal income from taxation by creating a tax-free corporation to hold their assets, CIT provides a backstop for personal income taxation.
Alternatively, opponents of CIT have argued that the burden of the tax actually falls on workers’ wages, and not shareholders. Recently, the International Monetary Fund (IMF) estimated that between 45-75% of CIT burden falls on workers’ wages. However, the Fund also found that, in the case of ‘rents’ or super-profits, especially common in the extractives sector, the burden of taxation falls primarily on the owners of capital. 3
Table 1: Tax Collections by percentage of GDP (2006-2010)
Source: Pierre Kohler, “Redistributive Policies for Sustainable Development: Looking at the Role of Assets and Equity,” United Nations, DESA Working Paper No. 139, ST/ESA/2015/DWP/139, January 2015, p. 20, table 2.
|Region||Total Tax Collections||CIT Tax Collections||Ratio of Direct to Indirect Tax Collections|
|East, South and South-East Asia|
As an alternative, opponents of CIT have advocated promotion of indirect taxes, such as the value added tax (VAT). However, it is broadly acknowledged that VAT and other indirect taxes are regressive, and if unaccompanied by offsetting social spending, exacerbate income inequality.4
Such regressive taxes are uniformly paid by all taxpayers, from small, medium and micro enterprises (SMEs and MSMEs) to large multinational corporations (MNEs). Unlike CIT, which has the capability to be progressive, indirect taxes require lower-income taxpayers to pay a larger share of their income than wealthier taxpayers. As illustrated in Table 1, indirect taxes comprise the bulk of tax collections in developing economies.
At the same time, developing countries rely more heavily than developed economies on CIT for revenues. A higher proportion of their gross domestic product (GDP) is generated through the difficult-to-tax informal economy, sometimes providing as much as 50 per cent of GDP as in the case of India. As a result, higher income countries collect 20-36 per cent of GDP in tax revenues, while lower income countries only collect up to 10-19 per cent of GDP in tax revenues.5
At the same time, lower income countries’ CIT collections comprise approximately 14-17 per cent of total tax revenue, while higher income countries’ CIT collections comprise only near 8-9 per cent of total tax revenue.6
Consequently, developing countries have much to gain from effective and equitable international corporate tax rules. However, recent reports by the IMF and the UN Conference on Trade and Development (UNCTAD) indicate that developing countries are harmed most by the current system. The IMF study of 173 countries over 33 years finds that CIT revenue losses due to base erosion and profit shifting activities of multinational corporations are three times larger in developing countries than in OECD countries.7
Moreover, UNCTAD estimates developing country CIT losses due to profit-shifting by multinational corporations at $100 billion annually, which is one-third of their total corporate income tax base.8
Against this backdrop, it may be reasonable to conclude that reform of the international corporate tax system, particularly from the development perspective, is long overdue. If we are to mobilize the necessary resources from corporate income tax revenue to finance the post-2015 development agenda, an enabling environment must be established at both the national and international levels. On the road to Addis then, the question becomes: How do we get there from here?
Principles for reform of the international corporate income tax system
Establishing guiding principles is a good starting point because they encourage coherence in tax frameworks. The principle of efficiency requires that investment decisions result from societal demand for goods and services and not the tax treatment of the income from those investments. Efficiency results when capital is allocated to uses that yield the highest pre-tax return, and in this regard, welfare is maximized. Tax rules that drive investment decisions, however, create distortions in the allocation of market resources (although this can at times be the objective of tax incentives, if they aim to lead to internalization of external costs, those related to social or environmental impacts of investments).
Taxation is not just about economic efficiency, though. On a fundamental level, taxation is a manifestation of the social contract between a government and its taxpayers. At its core, taxation reflects societal ‘give and take’ in the provision of public goods. Tax equity among taxpayers relates to the issue of fairness and non-discrimination in the distribution of the tax burden. Because taxation reflects the social contract between taxpayers and the government, a tax must be viewed as a legitimate compromise to provide public infrastructure and services for the common good in exchange for the transfer of private wealth in the form of tax payments. If a tax unfairly burdens one group of taxpayers over another (for example large versus small businesses), the tax will lead to inequities and lose legitimacy. At a broader level, tax equity among jurisdictions requires sharing of taxing rights in a way that reflects the respective contribution to total taxable profits. Because much of today’s production takes place through global value chains in developed and developing economies, an equitable sharing mechanism must take into account the competing entitlements to the tax base among jurisdictions.
In the past two years, official investigations by the governments of the United States and the United Kingdom, by the European Union9
as well as leaks by whistleblowers10
have revealed numerous instances of tax avoidance by multinational corporations. In response, proposals for international corporate tax reform have been made to address the dysfunction of the system.11
Several notable reform proposals are introduced below followed by suggestions of how they might be coordinated to achieve the necessary funding for sustainable development.
Base Erosion and Profit-Shifting
The G20 and the Organization for Economic Co-operation and Development (OECD) launched a colossal reform effort
planned to culminate in a multilateral treaty and designed to ensure that profits are taxed where economic activities occur and value is created. The BEPS proposals will include country-by-country reporting by multinational corporations of taxes paid, revenues, and employees in every country in which they have business activities. However, this information will not be made public and will only apply to multinationals with revenue over 750 million euros. The BEPS package will include other guidance on preventing tax avoidance through inconsistent national tax rules, offshore passive holding companies, outbound interest payments on loans between related companies; tax treaty shopping; and transfer pricing abuse.
High-level Panel on Illicit Financial Flows from Africa Report
, commissioned under the auspices of UN Economic Commission for Africa and the African Union, finds that Africa loses between $50-$60 billion a year through illicit financial flows and identifies transfer pricing abuse as a primary source of these flows. The report recommends establishment of transfer pricing units in African tax administrations; financial reporting by multinationals on a country-by-country, subsidiary-by-subsidiary basis (or project-by-project basis for extractives companies); automatic exchange of tax information; transparency of ownership and control of companies; review of current and prospective tax treaties; and enhanced regional tax cooperation.
Report of the UN Special Rapporteur on Extreme Poverty and Human Rights
by Ms. Maria Magdalena Sepúlveda Carmona on taxation and human rights,
focuses on the relationship between tax and the fulfilment of human rights and demands that the post-2015 development framework align fiscal policy with human rights obligations. The report recommends measures to increase transparency of tax payments; establish public oversight on tax incentives; build national tax administration capacity; place more reliance on progressive direct taxes; pursue international tax cooperation that includes developing countries; and create legal accountability for the corporate obligation to respect human rights, including in tax planning practices.
Unitary Taxation of Transnational Corporations with Special Reference to Developing Countries
This research programme
, conducted by the International Centre for Tax and Development, comprises eight projects, which analyze the feasibility of a global unitary approach to taxing multinational corporations. Unitary taxation treats a multinational enterprise as a single firm, rather than attempting to tax the profits of its various affiliates as if they were independent entities. A global unitary taxation system would combine the multinational firm’s aggregate worldwide profits (excluding internal transfers), and apportion those profits using a formula based on factors reflecting economic activities in each country, such as employees and sales.
World Investment Report 2015
UNCTAD states in this report
that multinational tax avoidance delivers a major blow to development financing, to the tune of $100 billion annually. The report goes on to emphasize the systemic role of offshore investment hubs in international investment and offers reform recommendations that take into account the potentially adverse effects that national legislation to counter tax avoidance could have on investment flows.
Independent Commission for the Reform of International Corporate Taxation (ICRICT)
ICRICT is an independent group of global public intellectuals convened to consider reforms to the international corporate tax system from the perspective of the public interest. The Commission issued a Declaration
which concludes that the separate entity principle of international corporate taxation is the root of international corporate tax abuse and a legal fiction that must be reformed. Therefore, the Declaration recommends that all countries tax multinationals as single firms and suggests more inclusive international tax cooperation to achieve this transition.
As illustrated above, calls for reform of the international corporate tax system have increased over recent years, and as we face the challenges of financing the post-2015 development agenda, these demands have reached fever pitch. Reform proposals have come from myriad perspectives: human rights advocates; investment experts; trade unions; civil society; and numerous multilateral organizations such as the UN, G8, G20, IMF, OECD and the African Union. Some proposals, such as the High-level Panel on Illicit Financial Flows report, have focused on capacity building and transparency aspects of reform. Others, such as the OECD BEPS initiative, have chosen to address deficiencies within the existing framework. More ambitious proposals, such as the ICRICT and ICTD’s unitary taxation research, seek to reform fundamental inadequacies of the system by changing the way multinational corporations are taxed—from a set of individual separate companies to a globally integrated firm. The latter approaches align best with the reality of today’s globalized economy, but require the greatest political will to scale up international cooperation.
Although the various prescriptions for reform have been nuanced by the diversity of stakeholders, one thing is clear. We are all affected by the dysfunction in developed and developing countries alike through increasing inequality and the lack of tax revenues to fund public services. Yet, more importantly, we will all play a role in the reform of this system. Thus, there is a critical need for coordination—and this is what brings us to Addis. Addis is an opportunity to strengthen the social contract of the global community. Even now, as belaboured negotiations on the Addis Action Agenda seek solutions for financing the post-2015 agenda, it is important to shore up dedication to the common global good, realize that this is a process of ‘give and take’ and face the reality that international cooperation on many issues, including tax, is the only road that will lead us to the future we all want .
Development Finance International & Oxfam. 2015. Government Spending Watch 2015
See Jack Mintz. 1996. “Corporation Tax: A Survey,” Fiscal Studies
. vol. 16, no. 4, pp. 23-68 for more detail.
IMF. 2014. “Fiscal Policy and Income Inequality.” IMF Policy Paper
, 22 January, para. 24.
IMF. 2014. “Spillovers in International Corporate Taxation.” IMF Policy Paper
, 9 May, para. 25.
World Bank Group. 2013. Financing for Development Post-2015,
IMF. 2014. “Spillovers in International Corporate Taxation.” IMF Policy Paper
, 9 May, p.7.
IMF. 2015. Base Erosion, Profit-Shifting and Developing Countries
. WP/15/118, p.20.
UNCTAD. 2015. World Investment Report 2015: Reforming International Investment Governance,
See for example:
- U.S. Senate Permanent Subcommittee on Investigations reports and hearings, “Offshore Profit Shifting and the U.S. Tax Code – Part 1 (Microsoft and Hewlett-Packard)
,” S. Hrg. 112-781 (9/20/2012);
- “Offshore Profit Shifting and the U.S. Tax Code - Part 2 (Apple Inc.),
” S. Hrg. 113-90 (5/13/2013);
- “Caterpillar’s Offshore Tax Strategy,”
S. Hrg. 113-408 (4/1/2014);
- UK Parliament. Tax Avoidance - Google. London: House of Commons, Committee of Public Accounts, 9th Report 2013-14
- European Commission. State aid: Commission investigates transfer pricing arrangements on corporate taxation
of Apple (Ireland) Starbucks (Netherlands) and Fiat Finance and Trade (Luxembourg). Press release, 11 June 2014.
See, for example International Consortium of Investigative Journalists, Luxembourg Leaks Database
In addition to those reform proposals mentioned in the text (listed again below for ease of reference), see also:
- Development Finance International & Oxfam. 2015. Government Spending Watch 2015
- Pierre Kohler. 2015. “Redistributive Policies for Sustainable Development: Looking at the Role of Assets and Equity
,” United Nations, DESA Working Paper No. 139, ST/ESA/2015/DWP/139;
- Joseph E. Stiglitz. 2014. "Reforming Taxation to Promote Growth and Equity,"
Roosevelt Institute White Paper;
- International Bar Association. 2013. Human Rights Institute Task Force on Illicit Financial Flows, Poverty and Human Rights
- G8. 2013. Lough Erne Declaration
, (June 18);
- G20. 2013. Tax Annex to the Saint Petersburg G20 Leaders Declaration
Reform proposals discussed in the text:
- OECD, Action Plan on Base Erosion and Profit-Shifting
- High-level Panel on Illicit Financial Flows from Africa
, January 31, 2015;
- Report of the United Nations Special Rapporteur on Extreme Poverty and Human Rights
Ms. Maria Magdalena Sepúlveda Carmona, on taxation and human rights (2014), A/HRC/26/28;
- International Centre for Tax and Development, Unitary Taxation Research Program
- UNCTAD, World Investment Report 2015: Reforming International Investment Governance
- Independent Commission for the Reform of International Corporate Taxation, Declaration
ABOUT THE AUTHOR
Erika Dayle Siu is a tax and development consultant and has worked for the United Nations, the International Centre for Taxation and Development and numerous civil society organizations working for tax justice. Her research with the UN Committee of Experts on International Cooperation in Tax Matters focused on proposing recommendations for the UN Model Convention on the taxation of profits from emissions trading. Most recently, Erika has supported the development and work of the Independent Commission for the Reform of International Corporate Taxation. Erika is a member of the New York and New Jersey Bar.