Yellen’s new alliance against leprechauns

Over the weekend, largely at the urging of Janet Yellen, the Treasury secretary, finance ministers from the Group of 7 — the major advanced economies — agreed to set a minimum 15% tax rate on the profits of foreign subsidiaries of multinational corporations. You may wonder what that’s about, or why you should care.

So let me tell you about Apple and the leprechauns.

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Apple Inc. has vast global reach. Its products are sold almost everywhere; it has subsidiaries in a number of countries. It is also, of course, immensely profitable.

But where are those profits earned? Apple does very little manufacturing, mainly contracting production out to other companies, mostly in China. Much of its profits comes from licensing fees, reflecting the company’s intangible assets — its patents, trademarks, brands and trade secrets. And where are those intangible assets located? From an economic point of view, that’s not even a meaningful question.

For tax purposes, however, Apple needs to report its profits somewhere. Right now that means that it’s basically up to Apple to declare where it makes its money — and what it does, naturally, is claim that its profits accrue to subsidiaries in countries with low tax rates on those profits, Ireland in particular.

In fact, until 2014 it went even further than that: A large share of its global profits was assigned to Apple Sales International, which was registered in Ireland but for tax purposes was located nowhere at all. In 2015, however, some combination of pressure from the European Commission and changes in Irish tax laws induced Apple to reassign many of its intangible assets to its regular Irish subsidiary.

How big a deal was this? On paper, Ireland’s gross domestic product suddenly jumped 25%, even though nothing real had changed — a phenomenon I dubbed “leprechaun economics,” a term that has stuck. (Fortunately, the Irish have a sense of humor.)

The thing is, Apple is far from unique in exploiting its multinational status to avoid taxes, and Ireland is far from being the most egregious tax haven, even in Europe.

According to International Monetary Fund numbers, Luxembourg — which has about the same population as Vermont — has attracted more than $3 trillion in foreign corporate investment, roughly comparable to the total for the U.S. as a whole. What’s that about? Almost no real investment is involved; instead, the tiny duchy has offered many companies deals under which they can report their profits there while paying almost nothing in taxes.

So what do we learn from these stories? First, that the current international tax system offers huge scope for corporate tax avoidance.

Second, we learn that when nations try to compete with one another by cutting corporate tax rates — the so-called race to the bottom — they aren’t really fighting about who will get jobs and productivity-enhancing investments. There’s very little evidence that cutting profit taxes actually induces corporations to build factories and expand employment.

No, they’re really just fighting about where profits will be reported and hence taxed. And with tax rates falling and tax avoidance flourishing, the result is that tax revenue keeps dropping.

Back in the 1960s, federal taxes on corporate profits were, on average, about 3.5% of GDP; now they average around 1%. That’s a revenue loss of more than $500 billion a year, enough to pay for a lot of infrastructure, child care, and more.

Which brings us to that G7 deal. How would the 15% minimum rate work? Here’s how Gabriel Zucman — who has arguably done more than anyone else to highlight the importance of international tax avoidance — summarizes it: “Take a German multinational that books income in Ireland, taxed at an effective rate of 5%. Germany will now collect an extra 10% tax to arrive at a rate of 15% — same for profits booked by German multinationals in Bermuda, Singapore, etc.”

Obviously this would immediately slash the amount of tax corporations could avoid by shifting reported profits to tax havens. And it would also greatly reduce the incentive for countries to serve as tax havens in the first place. Oh, and if you think corporations can avoid all this just by moving their parent companies to, say, Bermuda, major economies can make that difficult.

To put this in a broader context, what we’re looking at here is the beginning of an attempt to fix a system that is rigged against workers in favor of capital. Workers have few ways to avoid income taxes, payroll taxes and sales taxes besides actually moving to another country. Multinational corporations, which are ultimately owned in large part by a small wealthy minority, can shop for low-tax jurisdictions without doing anything real besides hiring some skilled accountants. The G7 plan would curb that practice.

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So far, to be sure, all that we have is an agreement among finance ministers, with some important details still to be worked out. Turning it into legislation won’t be easy: Corporations can hire lobbyists as well as accountants.

But this is still a big deal — an important step toward a fairer world.