BrianGarst.com

At first glance the OECD’s Base Erosion and Profit Shifting (BEPS) project is difficult to understand.

There has been no decline in corporate tax revenues in recent years, and nations already possess a variety of tools to respond to erosion when needed. BEPS is thus drawing an inordinate  amount of global attention and resources for apparently low expected returns. The only way to thus explain the project is to recognize that it represents a new front in the OECD’s long running war on tax competition.

The BEPS project has proceeded swiftly following the initial 2012 communiqué from G20 leaders encouraging OECD action on BEPS. In just eight months the OECD returned a report declaring that, “Base erosion constitutes a serious risk to tax revenues, tax sovereignty and tax fairness for OECD member countries and non-members alike.” Only four months after that it followed up with an “Action Plan on Base Erosion and Profit Shifting” that identified the specific areas it intended to address.

Reports for about half of the items identified in the Action Plan were delivered in 2014, with the rest expected in fourth quarter 2015. What has already been released reveals an aggressive agenda clearly aimed at striking a blow against tax competition.

Why the rush?

Political processes typically move slowly, and it might be expected that a project as massive as BEPS with participation from across the globe would require a more deliberate pace. But BEPS has advanced with relative speed. The reason is that the OECD has learned from its past mistakes.

When the OECD released its infamous 1998 paper excoriating “Harmful Tax Competition,” the organization was caught by surprise at the backlash that developed. But it took time for that resistance to coalesce, and it was given a major boost when the United States presidency switched from a Democrat to a Republican in 2000.

A U.S. presidential election is again approaching in 2016, and with Barack Obama finishing his second term there is guaranteed to be a transition, with at least a fair chance of a similar party swap.

Such an outcome could turn the influential United States from a supporter of the OECD’s efforts to an opponent. The agency would rather advance the project beyond the presumptive point of no return before that can happen. Moving quickly likewise provides less time for the business community and other besieged parties to react with organized opposition.

It’s important to note that base erosion, if it really constitutes a problem, is fairly correctable through unilateral action. Transfer pricing rules offer governments considerable power to restrict corporate tax planning if desired, yet the OECD plan goes well beyond providing assistance in developing these rules. The most powerful tool, however, comes from the simple ability to set competitive tax rates.

Were the OECD merely providing tools and recommended practices to assist nations looking to address their own tax systems, they wouldn’t need to hurry the process. In that scenario individual governments could decide for themselves and without coercion whether to heed the BEPS recommendations whenever they happened to be ready. Because the OECD’s aims are much broader, they require not only for the recommendations to be successfully crafted, but eventually for them to be universally adopted as well. And that means getting to the finish line before the opposition even realizes what’s happening.

Homing in on tax competition

The OECD’s animosity toward tax competition by now has been well documented. To put it simply, politicians resent restrictions on the ability to tax and spend as they please.
As capital has grown increasingly mobile, the negative economic feedback from excessive taxation has simultaneously become sharper and more immediate.

Average corporate tax rates among OECD nations have been slashed by more than half since the 1980s, down from around 50 percent to almost 24 percent today. More nations have also switched to territorial systems. Of the 34 current members of the OECD, the number taxing corporations on a territorial basis has doubled since 2000, up to 28 of 34 in 2012.

Although these reforms have benefited the global economy, members of the ruling class tend to be firm believers in the power of government to direct economic growth. The more politicians have to spend, in this backwards view, the stronger will be the economy. The lack of decline in corporate tax revenues as a share of GDP despite major rate cuts, thanks to the dynamic growth effects of better tax policy, is met with denial. Revenues, they believe, would be even higher if rates had not been reduced.

On this understanding the OECD declared itself with the 1998 report to be the primary tool through which international tax collectors and bureaucrats would seek to mitigate tax competition’s impact on domestic policymaking. But because it initially faced political backlash, the OECD has waged the campaign against tax competition through various proxies – money laundering, tax evasion, and now base erosion and profit shifting.

OECD learns from past mistakes

Combating tax competition, unlike base erosion, requires governments working together in what amounts to a tax cartel. This is why it’s essential for the OECD to build a narrative of inevitability surrounding BEPS, and to conclude its work before opposition has time to puncture the narrative. It’s also why the eventual recommendations will be anything but suggestions.

Past efforts prove that when the OECD makes recommendations, they tend to be of the variety that cannot be refused. When developing policies to combat tax evasion, a previous but still popular stand-in for tax competition, the OECD has used a combination of blacklists, intimidation, and threats of sanctions to compel adoption of its preferred tax policies. Those policies naturally reflect the preferences of the OECD’s membership – primarily high-tax welfare states – and the G20 nations pulling its strings.

Although the OECD isn’t advertising the role of BEPS in restricting tax competition, they aren’t exactly hiding it either. The Action Plan lists the “Harmful Tax Competition” report as one of its only four references, alongside the G20 letter and the first BEPS report.

And shortly after the Action Plan notes without substantiation that “Globalisation means that domestic policies, including tax policy, cannot be designed in isolation,” its authors make the following stunning admission:

“While it may be difficult to determine which country has in fact lost tax revenue, because the laws of each country involved have been followed, there is a reduction of the overall tax paid by all parties involved as a whole, which harms competition, economic efficiency, transparency and fairness.”

That single passage includes two significant revelations. The first is that they don’t care whether or not there exists evidence of actual erosion. The second is that the OECD has staked out a normative position regarding nations’ domestic tax policies. Namely, that lower tax burdens reflected in “lost revenue” are presumptively harmful and even somehow unfair.

Conclusion

Corporate taxes are widely understood to be among the most economically destructive forms of taxation, providing just one of many reasons why rational policymakers might choose to find other sources of revenue. The BEPS project has as one of its core assumptions that they are wrong to do so because high corporate taxes are the ideal policy – a policy to which tax competition has become the primary obstacle.

Before the recent campaigns against tax competition, international cooperation on tax policy primarily focused on eliminating double taxation and ensuring that government greed didn’t choke the private sector and kill the goose that laid the golden egg. The OECD even assisted by helping facilitate these efforts.

Now, the OECD wants to turn back the clock and undo the tremendous gains brought about by tax competition.

At the same time as nations are negotiating historic new trade agreements to knock down barriers and further liberalize global commerce, the OECD is running in the opposite direction. BEPS threatens to erect substantial and costly new barriers to global commerce, and its proponents clearly hope that no one will notice until it’s too late.

BEPS OECD