No country ever tax dodged its way to prosperity
Address to the McKell Institute, Sydney
Tuesday 27 January 2015
Thank you for that very kind introduction. It’s an absolute delight to have the McKell Institute as host tonight.
There’s been a lot of talk over the years about the need for more investment in progressive think tanks, and a lot less action. You are an exception. In just four years, McKell has established itself as perhaps the leading voice for practical public policy in this city and state.
Taking Bill McKell as your inspiration is a particularly, well a particularly inspired choice. My mum’s dad was a boilermaker, so I almost feel like I’m among family here. And McKell’s name is a constant reminder that Australian Labor’s practical, progressive, pro-growth tradition dates back a lot further than thirty years.
Your team’s efforts are quite remarkable and the evidence of that is right here in this terrific group of people gathered for an important discussion – so once again, thanks.
As Shadow Assistant Treasurer in the Shorten Opposition, I’ve got a lot of fascinating responsibilities.
CGT, DGR, FBT.
I get to dabble in EMTRs and the IGOT, and if all the work is done for the week by Friday lunchtime, then we break out MTAWE and MAWTO – five letter acronyms we reserve for a very special tax nerd afternoon.
But the four-letter word I’m spouting the most at the moment is ‘BEPS’.
That’s right, ‘base erosion and profit shifting’.
That’s a catch-all term for harmful tax competition between governments and aggressive tax practices by firms. Because of BEPS, many global companies pay a lot less tax than they should, and countries like Australia are at risk of missing out on real revenue.
It’s difficult to put a figure on the tax dollars lost to BEPS — after all, it’s hard to count something that isn’t there. But we do know that when Labor, in our last term of government, closed just a few of the loopholes that facilitated BEPS, the budget was over $4 billion better off.
It is often said that tax is the price of civilisation. If that’s so, there’s also a strong argument that requiring companies to contribute their fair share wherever they make profits around the world civilises the forces of globalisation.
That’s why this four-letter acronym really may be among the most important global economic debates of our time.
The starting point for understanding what is going on with base erosion and profit shifting in the global economy is just that – to acknowledge this as a necessarily global issue, and a direct consequence of globalisation.
The ‘runaway world’ that Anthony Giddens foresaw fifteen years ago has long stopped being a prophecy. Today, alongside the global spread of many fundamentally positive trends such as democracy and development, our domestic vices have become global ones as well.
Vices like tax dodging.
In the 1970s, Australian conservative governments notoriously lost between $3 and $6 billion in today’s dollars – a huge share of revenue at the time – to domestic tax avoidance schemes involving thousands of Australian companies.
This revenue streamed away through loopholes which were eventually closed only by two separate major tax act changes, the second following the Fraser-Howard Government’s public shaming by the Costigan Royal Commission. The bottom-of-the-harbour schemes were one of the historic peaks of rent-seeking behaviour in the Australian economy, and one of the historic troughs of effective administration in the public good.
When Paul Keating famously said that the economic opening of the 1980s “despivved the economy”, it was exactly those tax dodgers and rentiers who flourished under conservative economic policy through the 1950s, 60s and 70s that he had in mind.
And he was right.
But ‘despivving’ a global economy will prove a whole other challenge.
Meanwhile, imagine the revenue Fraser and Howard’s successors are capable of losing today.
Globalisation creates many opportunities for economic good. An open world is one where there is always somewhere to work. Firms that do business all over the globe are creating jobs and prosperity for all the world’s people and lifting growth in countries that desperately need this.
This has undoubtedly been a boon for humanity, with the rate of people living in extreme poverty declining from 52 to 21 per cent in the last thirty years.[i]
But there are others who see globalisation as an opportunity for a different kind of gain. A wider world is also one where this is always somewhere new to hide. We should not doubt that some firms are taking advantage of globalisation to avoid contributing to the public goods we all rely upon.
Even big firms themselves are concerned about this. In a recent interview with the Australian Financial Review, Rio Tinto chairman Jan du Plessis was quoted as saying “too many multinationals are getting away with murder”. He also pointed out that: “tax regimes need to catch up with the consequences of globalisation”.
I couldn’t agree more.
A central principle of economics is that everyone responds to incentives. We can politely encourage corporations to be good global citizens and do the right thing, but ultimately it is the incentives that matter.
If the global tax system creates incentives for doing dodgy deals, then dodgy deals will get done. Likewise, if the financial framework supports honest dealing and a fair contribution by all, then big corporations will find less reason to stray from this path.
As politicians and policymakers, we are the architects of this incentive system. That means it is within our power to get those incentives flowing in the right direction.
It is within our power. But whether it is within the will of the current government is a whole other point, one to which I shall return shortly.
Incentives matter amongst governments, too. Open capital flows – what used to be called ‘footloose capital’ – create inevitable competitive pressures between countries, and incentives to lower taxes to attract new business at home. This can be a good thing, as broader based corporate taxes with lower rates promote investment and growth.
But when governments excise whole sections of their tax base, not to attract flows of capital to their economy, but to reroute flows of capital through their economy – then that’s not productive competition, or even picking winners.
That’s just ‘clipping the ticket’ on a grand, international scale.
The opportunities for free flows of information in an economy which is not just global but globally digital are just as remarkable. But one of the effects of globalisation going digital is the huge increase in the economic importance of intangibles and intellectual property goods.
Today, three of the five biggest companies in the world are intellectual property companies. The most surprising thing about this fact is that nobody here probably finds it all that surprising – but it only became true for the first time in history in 2014.[ii]
This has greatly complicated the task for traditional tax regimes. These assume a firm has a ‘permanent establishment’ in a real place where its ‘product’ is ‘made’. None of that applies in a digital business, and this has greatly increased the scope for firms to shift profits to low-tax or no-tax regimes, regardless of where their profit is really produced. The intangible nature of digital goods also raises difficulties in correctly pricing transactions within companies. Multinationals have taken easy advantage of the transfer pricing opportunities that these ephemeral goods present.
I often describe transfer pricing using the simple example of a paperclip, sold between two arms of the same company for $1 million, in order to shift profits from high tax to low tax jurisdictions.[iii] But it’s relatively easy to combat this kind of blunt transfer pricing using so-called ‘arms-length’ tests. This kind of test asks how much an item would have cost if it were sold to a neutral third party. If you wouldn’t buy a paperclip from me for $1 million, then it’s clearly unreasonable for the Belgian subsidiary of Andrew Leigh Inc to do so.[iv]
But these judgements become a lot more difficult when it comes to the transfer pricing of intangible goods, such as data and intellectual property. This is particularly true if the intangibles could – and would – never be sold to a third party. How much is Facebook’s database worth? What about Apple’s intellectual property – its designs, manufacturing processes and marketing genius? Or indeed, Ikea’s famously hypnotic store layout? These are things that reasonable people may disagree about.
We have increasing evidence that major multinationals are forum-shopping. As Martin Lock, formerly a senior official in the tax office, recently told Fairfax journalist Michael West:
Almost effortlessly, a new subsidiary, partnership or trust can be established in any favourable tax jurisdiction, including in a tax-treaty country ('treaty shopping').
Lock suggests that the multinational can then convert equity into related-party loans, or sell its intellectual property to a related party and license it back.
He argues that "the multinational can even shift a parent company or subsidiary's tax residency by doing little more than flying the board members to a chosen tax-treaty country and holding a tax-deductible annual board meeting there."
Most governments around the world understand this and they are acting. It’s a global challenge, and there is a genuine effort underway for a global response.
This should be no surprise. Australia is not the only nation where revenue has been unseasonably low for some years now. Indeed, almost every developed economy has greater pressures on their budgets than we do.
At the same time, developing countries have deep and pressing needs to lift revenue and provide the public services and infrastructure which will deliver inclusive growth.[v] Many of you would be aware of the strong grassroots campaigns run by Oaktree, ONE, Micah Challenge and the C20 under Tim Costello’s leadership. Collectively, these campaigns have ensured that the conversation about multinational tax includes poorer countries.
So with budget pressures as they are, it is no wonder that almost every government is looking at tackling BEPS. This fact alone gives cause for optimism that we can get this done.
How? In 2012 the G20 leaders[vi] commissioned a detailed action plan from the OECD. Some of the world’s leading economic and legal researchers, in consultation with representatives of more than 110 tax jurisdictions, came together to tell us what would work. This package is a great start.
Then there’s domestic activities, like getting rid of the Double Irish Dutch Sandwich. No, not the karaoke joint in Byron – which would be a tragedy – but the tax dodge that launched a thousand op-eds.
Multinational companies have taken a big bite out of the Double Irish Dutch sandwich in the past, with one major technology firm alone reportedly using the loophole to avoid $3.4 billion in tax since 2007.
But back in October[vii] Irish Finance Minister Michael Noonan announced that his country would put a stop to these complex arrangements involving companies transferring money between subsidiaries registered in Ireland and European Union countries such as the Netherlands.
So global action, backed by national governments, is making progress. We need more of this from other nations – indeed we need to make sure Australia is actively negotiating with them to match and exceed what’s already happened.
This brings us back to the point about political will. Unfortunately, while the Irish government is closing tax loopholes (to the benefit of everyone, including Australian taxpayers), the Australian Government has re-opened significant ones which will cost us dearly.
Tony Abbott and Joe Hockey’s decision not to proceed with Labor’s proposals to tackle debt loading and improve the offshore banking unit regime has effectively handed $1.1 billion back to big global firms.
No strings attached.
And when the G20 finance ministers met in Cairns in September, and the OECD action plan was delivered, you’ll be amazed to discover that the Treasurer failed to raise any more revenue from multinationals. Not one dollar.
I argued at the time that he should use Australia’s position as G20 chair to push for a clear and specific timetable on OECD action item 15, creating a multilateral tax instrument. This is an innovative way to regularly and rapidly update bilateral tax treaties to ensure tax loopholes are closed over time – and stay closed.
Labor also called on the Treasurer to lock in country-by-country reporting requirements for companies operating in multiple jurisdictions – OECD action item 13. This would require big multinationals to report on their income, profits and the taxes paid in each country where they do business. It would leave them with fewer ways of hiding their true profits.
During the recent G20 leaders’ summit, Mr Hockey claimed that Australia had kicked off moves towards better financial transparency by committing to a 2017 start date for the so-called Common Reporting Standard on banking information.
In fact, this timetable puts Australia behind over 40 countries, including major G20 powers like the United Kingdom and Germany, and plenty of countries at a lower stage of development than Australia, such as Cyprus, Hungary and Poland. Indeed, Australia is lagging behind jurisdictions that have not always had the most progressive approach to tax collection such as Bermuda, the Cayman Islands and Jersey.[viii] These and other Early Adopter Group nations will start the process for automatic exchange of financial information a full year earlier than us, in 2016.
While the Common Reporting Standard is not strictly a BEPS issue, and is more focused on individuals hiding income, it demonstrates countries’ willingness to act against vested interests to increase the amount of tax collected.
No doubt this is why the Treasurer said the Finance Minister’s meeting during the G20 in Brisbane was like a “treadmill”.
Yes, there was a lot of puffing and blowing. But how much progress does a treadmill make?
So we await leadership from the incoming G20 Chair, Turkey, and the wider world. There’s precious little evidence of it here at home.
Joe Hockey's ‘announcement’ last month – and I use the term loosely – of ‘new' multinational tax measures shows just how out of his depth the Treasurer is when it comes to making companies pay their fair share.
The proposal Mr Hockey floated in the News Limited tabloids came with no details and no dollar figure attached. It appears he hadn’t even worked out whether new legislation would be needed to give effect to these measures, much less when they might commence.
The litmus test for whether something represents real action to tackle multinational profit shifting is revenue. Joe Hockey should be judged by the additional revenue his announcements deliver.
Results with a minus in front of them – as we saw announced by the Abbott Government in the months after coming to office – suggest a government that’s strong with the weak, but weak when it comes to taking on the strong.
That’s why the rules aren’t right and that’s why the revenue isn’t right either.
Zero new revenue equals zero new action.
Not that we ought to be surprised to find the Liberals doing so poorly on addressing multinational profit-shifting.
In Opposition, they voted against Labor’s Countering Tax Avoidance and Multinational Profit Shifting Bill 2013, which plugged loopholes in Australia’s transfer pricing rules and anti-avoidance provisions.
They also attempted to block our Cross-Border Transfer Pricing Bill 2012 – a measure championed by then Minister for Financial Services and Superannuation Bill Shorten – which cracked down on companies overvaluing assets in international transactions.
Since coming to office, as well as ditching those Labor reforms worth $1.1 billion, the government has also announced the sacking of 4,700 staff from the Australian Tax Office. That’s fully one quarter[ix] of the agency’s people, including as many as 1,000 auditors with specific expertise in complex international tax structures. Some of these gamekeepers will likely turn poacher.
The Liberals never change. Their inaction today is exactly the kind of blind-eye-turning that led to the bottom of the harbour scandals a generation ago.
Like many governments of all political colour around the world, Australian Labor believes there is a better way.
A smarter, more fiscally sustainable, more economically responsible way.
There should be immediate action on the measures we know can work now.
And long-term approaches where we should be actively bringing nations together to get progress over time.
First, we propose better tax transparency.
As Daniel Patrick Moynihan put it, you are welcome to your own opinion, but not your own facts.[x] Labor believes that a sensible tax debate must begin with the facts about how much tax our largest firms are paying. When in office, we changed the law to require companies with incomes over $100 million to report their total income, taxable income and tax paid. The information is currently scheduled to flow in late-2015.
This is going to shock you, but the Liberals are not wildly keen about tax transparency. A year ago, the Abbott Government even threatened to scrap it entirely, with former Assistant Treasurer Arthur Sinodinos telling the Australian Financial Review:
We don’t want to get into a situation where we’re putting more and more information out there.
Labor takes the opposite view. With the conversation about tax fairness roiling across the front pages and back bars of Australia, we believe tax reporting should happen sooner, not later.
Last November, I moved a Private Member’s Bill in the House to do just that. If passed, the effect of my bill would be to have information out in the public domain within months. But the Liberals have ruled out backing our changes.
Whenever tax estimates are published in the public domain, the Abbott Government and its backers claim that they don’t capture the whole picture.
So let get some hard numbers into the public debate!
It’ll lift the lid and lift the discourse at the same time.
Second: Labor will give strong consideration to re-introducing the measures scrapped by the Abbott Government when they came to office.
- Reforming the offshore banking unit to ensure that only genuine offshore banking activities may access a concessional rate
- Changes to multiple entry consolidated groups to ensure neutrality between foreign and domestic companies.
- The repeal of section 25-90 of the Income Tax Assessment Act
You might be interested to know that when the government said in 2013 that they wouldn’t proceed with Labor’s repeal of section 25-90, they promised instead to “introduce a targeted anti‑avoidance provision”.[xi] In last month’s budget update, the Abbott Government quietly broke that promise, announcing that they would not introduce an anti-avoidance provision.
When Labor was last in office, we believed that our multinational taxation measures could tackle key loopholes which created the risk of profit shifting. We still believe they are useful steps to take towards tightening Australia’s tax net.
For the long term, what’s needed is a combination of fresh thought and friendly advocacy between governments on the way ahead.
One of the real problems in this area has been corporate revenue that falls between the cracks. Clever corporate accountants are adept at exploiting differences in how countries’ tax laws treat debt and equity, how they value intellectual property, and how they classify complex corporate structures.
As an economist, I see nothing wrong with countries offering different company tax rates.
But it does worry me when Apple reveals to a US Senate Committee that one of its key income-generating entities was essentially stateless for tax purposes.
A bit like the Tom Hanks character in The Terminal – only very, very rich rather than very, very poor.
It is neither efficient nor equitable to let revenue fall into some dead zone between countries.[xii] One way to address this would be to establish an international consensus on our corporate tax base, and then allow countries to compete on the rate.
It’s so often said that the essence of tax reform is to broaden the base while lowering the rate.
Progressive tax reform does more – it broadens the base, lowers the rate, and delivers a fairer share for those who earn or own less.
In this respect, working with other countries to agree on these matters is a natural reform for a progressive party like mine to pursue.
I said earlier that BEPS is a four-letter acronym at the heart of global economic debate. As Vice President Biden might say, it’s a BFD.
In the time remaining, I want to expand on this point a little.
No question, this is about revenue adequacy.
When a handful of big businesses shift their profits off shore, it hits the federal budget’s bottom line.
And this is about fairly sharing the revenue burden.
When a small number of taxpayers do the wrong thing, it’s the great majority of big and small businesses, along with the self-employed and PAYG taxpayers, who pay more than we should.
But it’s also about our prospects for long-term growth.
That’s why BEPS really matters so much.
If we don't tackle multinational profit shifting, we're turning a blind eye to distortions in the market which will slow economic growth over time.
Dumb failings in the tax system, loopholes which reward the wrong kind of effort – these function unnervingly like old-fashioned subsidies. They privilege producers over consumers, distort the allocation of resources and give the biggest rewards to those who play the game by testing themselves against the rule book, not their real competition.
In the same way, harmful competition between jurisdictions and failing to coordinate tax regimes to protect our tax bases function unnervingly like old-fashioned trade wars. Each of us draws our knives, only to cut our own noses off to spite each other’s face.
Fixing this demands confidence in our national decision-making – understanding we can be successful as a globalised economy while maintaining an adequate tax base. Self-interested voices try to persuade us of the reverse. But we would be a very unwise nation to engage in a race with other countries to see who can get to zero corporate tax revenue first.
We still witness mercantilist arguments against reform. Often these arguments confuse what’s good for individual firms with what’s good for the economy as a whole. Sometimes they go so far as defying the whole idea that a general good exists.
What that loses sight of is that the crucial balance that must be restored through international tax reform is not the legal contest between taxpayers and tax collectors.
It is the economic contest between tax payers and tax dodgers.
Because the crucial question is not who do we want to pay more tax? It’s who do we want to win in our economy?
We need a tax system that rewards the productive, the innovative, the resilient, the clever and the competitive. Not a tax system that rewards shonks and shysters.
We need an economy that rewards hard work in business. Not an economy that delivers the biggest results to the biggest rentiers.
Australia is an importer of capital, and we have always needed investment from overseas.
So we need a plan to win investment from the world, yes, but one which works because big firms think it’s worth buying into Australia – not because Australian governments think they have to cut special deals that sell the rest of us out. One which leverages the ingenuity of the Australian workforce, the strength of Australia’s institutions and the quality of Australia’s infrastructure.
To have the right behaviours in our system for the future, we have to have the right incentives in our system for the future.
There is nothing rational, modern, outward looking or reformist about allowing the tax base to erode or encouraging profits to be shifted offshore.
Quite the contrary: we must apply our minds, update our policies, work with our international partners and press ahead with modernising change.
There is nothing anti-business in ensuring all businesses are able to play by the same rules. Quite the contrary.
This is a point easily lost in a debate which can tend toward belting up a handful of big firms who do the wrong thing, rather than backing in the vast majority of big and small firms who do the right thing.
As Shadow Treasurer Chris Bowen puts it, ‘It's not fair to other Australian businesses that do pay their fair share of tax if some companies are able to shift profits around to avoid tax.’
That is the centre of Labor’s critique – and in turn strengthening the tax law is the centre of Labor’s approach.
Unlike the other side of politics, our approach to tax reform will be grounded in equity, efficiency and simplicity.
It will reflect Australia’s egalitarian values.
It will recognise the way in which technology and globalisation are reshaping the economy.
This is the work of coming years in reforming international tax.
Australia’s economic future lies on the ‘far horizon’, not at the bottom of the harbour.
No nation in history has ever tax dodged its way to prosperity.
[ii] Annebritt Dullforce, ‘FT 500 2014’, Financial Times, 27 June 2014.
[iii] The paperclip example originates in James Hines, ‘Treasure islands’ Journal of Economic Perspectives (2010): 103-125.
[iv] A significant academic literature has estimated the magnitude and mechanisms of BEPS. See for example Dhammika Dharmapala, 2014, ‘What Do We Know About Base Erosion and Profit Shifting? A Review of the Empirical Literature’, CESifo Working Paper 4612; Gabriel Zucman, ‘Taxing across borders: Tracking personal wealth and corporate profits’, Journal of Economic Perspectives (2014): 121-148.
[v] For a recent account of the issues, see Clemens Fuest, Shafik Hebous and Nadine Riedel, ‘International Profit Shifting and Multinationals Firms in Developing Countries’ in Clemens Fuest and George Zodrow (eds), 2013, Critical Issues in Taxation and Development, MIT Press, Cambridge MA, pp. 145-166.
[vi] Angel Gurría, ‘OECD Secretary-General Report to G20 Finance Ministers’, September 2014.
[vii] Arthur Beesley, ‘Budget to end ‘Double Irish’ Tax Scheme’, The Irish Times, 14 October 2014.
[viii] Charles Savva, ‘OECD Early Adopters Group Commit to New Tax Info Exchange’, C. Savva & Associates Ltd, 14 April 2014.
[ix] Australian Public Service Commission, ‘APS Statistical Bulletin 2013-14’, June 2014 (ATO staff total of 20,622 as at 30 June 2014).
[x] Steven Weisman, ‘An American Original’, Vanity Fair, 6 October 2010.
[xi] Joe Hockey, ‘Restoring Integrity in the Australian Tax System’, Media Release, 6 November 2013.
[xii] For a good discussion of the issue of stateless income, see Kleinbard, Edward. ‘Stateless Income’, Florida Tax Review vol. 11 (2011): 699-773.