Tax Analysts Blog

The Libertarian Case for BEPS

Posted on Aug 8, 2014

Milton Friedman described himself as a consequentialist libertarian. His preferred monetary policy was to abolish the Fed and mechanically increase money supply at a slow, steady rate. His fiscal prescription was to lower taxes at every opportunity—“for any excuse, for any reason, whenever it’s possible.”

At the turn of this century, Friedman was especially optimistic about the prospects of rolling back the Leviathan state—not because he believed his ideas of individual liberty, personal responsibility, and limited government would prevail over those championing an ever-expanding welfare state, but because he could foresee the impact on the fisc of the emerging Internet-enabled economy: “The Internet is going to make it harder and harder to collect taxes….Because you will be able to evade taxes. You will be able to do your deals in the Cayman Islands.”

Friedman was, of course, wrong about the size of the federal government shrinking between 1999 and 2009. In fact, it expanded significantly. Total outlays went up, way up—from $2.19 trillion in 1999 to $3.52 trillion in 2009, in constant 2009 dollars. As a percentage of GDP, outlays increased from 17.9 percent in 1999 to 24.4 percent in 2009.

What happened? Friedman himself never tired of warning us that governments will spend all they can collect plus whatever else they think they can get away with. It turns out that between the Afghanistan and Iraq wars and the largest stimulus in galactic history, the last two administrations figured out they could get away with a lot, as they worked hard to convert a surplus of $161.7 billion in 1999 to a deficit of $1.41 trillion in 2009, in constant 2009 dollars.

But were he alive today, Friedman would not have been totally disappointed. Receipts as a percentage of GDP have declined—from 19.2 percent in 1999 to 14.6 percent in 2009. Most of that decline was probably the result of the recession, which officially ended in June 2009. Receipts have climbed back up to 16.7 percent of GDP in 2013—still below the 1999 level.

More importantly, the anemic state of corporate tax receipts suggests that the erosion in the tax base that Friedman so confidently predicted and wholeheartedly welcomed in 1999 may be taking its toll. By 2009, corporate tax receipts had fallen to 1 percent of GDP, the lowest in 70 years. Those receipts have rebounded some—to 1.6 percent of GDP in 2013—but remain below the 40-year average of 1.9 percent.

The Internet is a great economic disruptor. By replacing mechanical widgets with electronic ones, it is fundamentally transforming how we do business—assets are becoming virtual, commerce is turning electronic, and the economy itself is increasingly acquiring a digital dimension. Many of the changes have the potential of significantly altering the relationship between governments and the governed—generally in a direction favorable to the libertarian cause.

For instance, the emergence of Bitcoin has been heralded as the beginning of the end of central bank monopoly on money creation. Interestingly, Bitcoin’s technical design comes close to, but does not quite coincide with, Friedman’s monetary supply ideal of constant automatic increases. The Bitcoin mechanism envisages an expanding supply, though at a declining rate.

In contrast with the as-yet-nascent world of cybercurrencies, the Internet’s fiscal disruptions have been much more evident. As foreseen by Friedman, a business’s ability to assign profits to almost any geographic location has allowed for the creation of both “stateless income” and “statefully taxless income.” The result has been a loosening of the state’s grip on returns to enterprise. Yet, almost no one, save perhaps the anarcho-capitalists, seems to have welcomed these developments. To the contrary, populist fervor has aligned itself alongside tax administrators in denouncing “base erosion and profit shifting.”

The reasons are not difficult to find. Most of the gains from BEPS are currently being reaped by large multinationals. And through most of modern history, multinational enterprises have usually been considered creatures of the state—from the British East India Company to Halliburton, many MNEs have marched abroad under the flags and protection of their national armies. It is no surprise, then, that as MNEs exploit the attributes of a digital economy to shield their income from taxation, by for example claiming virtual assets in tax havens, most individuals view the outcomes as unjust rather than liberating.

This may be a transient phenomenon. The Internet’s fiscal disruptions may eventually evolve to serve the libertarian ends that Friedman had contemplated. For that to happen, however, base erosion would have to be “commoditized.” In other words, it is not enough that Google can deduct royalty payments to an Irish subsidiary that supposedly holds valuable intellectual property; the bootstrapped start-up in San Jose, California, should also be able to set up such offshore intangible holding companies and claim deductions. Similarly, it is not enough that Medtronic can invert offshore to engage in earnings stripping; the family-run pharmacy in Peoria, Illinois, should also be able to do that. We could be headed in that direction, as the costs of professional services required for base-eroding arrangements come down, thanks in large part to the disruptive technologies of the Internet, which make available an ever-increasing pool of professionals worldwide at decreasing fees.

BEPS could indeed become an essential element of an entrepreneur’s business plan, along with marketing, financial, and personnel strategies. If an entrepreneur could choose BEPS as easily as he chooses a business name, a domain name, or a website, Friedman’s prophecy of an Internet-driven downsizing of the state would finally come to fruition.

Read Comments (1)

Lee JonesAug 8, 2014

You don't need BEPS to keep your income safe from the prying hands of the
state. What about all the businesses on eBay, Amazon, etc.? They operate under
cover of cyberspace. Once Bitcoin is more widely accepted, FATCA will be
meaningless. I can sell from a virtual storefront and be paid in virtual
money. How can the IRS keep track?

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