A colleague of mine, Tax Analysts’ Mindy Herzfeld, has written a spirited critique of the stateless income doctrine. Her observations help explain why the United States is getting cold feet about the OECD’s base erosion and profit-shifting project. You can read her full article here.
The term “stateless income” was coined a few years ago by Edward Kleinbard, a professor at the University of Southern California’s Gould School of Law and a fellow at the Century Foundation. Kleinbard has detailed the concept in the pages of Tax Notes here and here.
The gist of the theory is that modern corporate tax regimes have become overly permissive in allowing the earnings of multinational groups to be subject to tax in jurisdictions other than where the factors of production are located, or where customers are located, or where the group’s parent company is domiciled. The result has been a gradual disconnect between the accrual of corporate earnings and the receipt of corporate tax revenues.
Kleinbard’s ideas have drawn serious attention from academics and policymakers around the world. Although he is not officially affiliated with the OECD, his theory of stateless income is often perceived as the inspiration behind the BEPS project.
So why did the G-20 mandate BEPS?
Political leaders want their domestic firms to prosper – and hopefully employ a lot of people while doing so. But they’ve also realized that their constituents are unhappy about rampant profit shifting. In recent years, the media has been rife with tales of megafirms earning huge profits in Country X, but paying little if any tax there because most of the earnings have been siphoned off to Country Y, which is typically a tax haven.
Profit shifting is a brilliant contrivance. The talented tax advisers who perfect these schemes are masters of their trade, and the realized savings undeniably add to shareholder value. But it’s a contrivance nonetheless. The public has figured this out.
Herzfeld has a unique take on the prevalence of tax systems that enable stateless income. They endure for a very practical reason: They mask the political risks associated with subsidizing corporate multinationals.
It’s easier for countries to encourage direct investment by providing multinationals with opportunities for cross-border tax planning than to try to sell corporate tax breaks to a suspicious public. Developing policy proposals [e.g., BEPS] while ignoring these political realities bodes poorly for the success of the solutions.
You get the picture. The status quo (i.e., stateless income achieved through cross-border tax planning) is far more convenient for politicians than delivering equivalent subsidies through more direct means. If BEPS were to succeed, the conventional methods of providing those preferences would be largely cut off.
The U.S. check-the-box system is most often described – including by Kleinbard – as inappropriately perpetuating the use of foreign base eroding techniques and avoidance of subpart F inclusions by U.S. multinationals. Yet that description ignores the political reality that the check-the-box system permits the U.S. Congress to subsidize U.S. multinationals at little political cost. U.S. legislators have a vested interest in preserving a system that allows for base eroding by U.S. multinationals. … It is far easier politically to continue to allow U.S. multinationals to keep their effective tax rates lower by not overturning loose subpart F rules, rather than attempting a corporate tax rate cut.
For the sake of argument, let’s imagine that BEPS comes to fruition and is widely adopted. What would the new world order look like? Would source countries suddenly find themselves with expanded jurisdictional claims to tax commercial activity taking place within their borders? Perhaps. Would stateless income be eliminated? Perhaps, but I doubt that subsidies for multinationals would vanish from the tax code. (BEPS does not imply a global consensus on how vigorously nations should tax capital income.) New tax preferences would surely replace the old ones, though they might not be as cryptic in their design.
Reasonable minds can differ on whether stateless income was born out of historical accident or deliberate tinkering. Either way, the phenomenon is likely to have staying power. Therein lies the hurdle that BEPS has yet to overcome -- our tax systems are political constructs. Politics trumps policy every time.