The argument over taxing corporate profits may sound familiar, because claims that corporations aren’t paying their fair share of taxes have been going on for decades.
But the circumstances of large corporations have changed considerably in at least two ways: 1) they have become much more likely to cross national boundaries in their inputs, production, customers, and owners; and 2) they depend more on intellectual property, which means that profits are coming from something that isn’t physical in nature.
Alan Auerbach lays out the issues that arise, and runs through the solutions that have been tried, in “The Taxation of Business Income in the Global Economy,” delivered as the 2021 Martin S. Feldstein lecture at the National Bureau of Economic Research (NBER Reporter, September 2021). Here’s Auerbach on how the nature of the largest US corporations has changed (footnotes omitted):
Fifty years ago, the top five companies by market capitalization were IBM, General Motors, AT&T, Standard Oil of New Jersey (Esso, the predecessor of today’s ExxonMobil), and Eastman Kodak. … These were companies that “made things” in identifiable locations, to a large extent in the United States. If we shift to today, we see another five familiar names, all giant companies: Apple, Microsoft, Amazon, Alphabet (Google’s parent), and Facebook. These companies are worldwide multinationals, relying very heavily on the use of intellectual property in the goods and services they provide …
In the last half century, the share of intellectual property measured in US nonfinancial corporate assets more than doubled, according to the Fed’s Financial Accounts of the United States. That’s probably a conservative estimate, because the measurement of intellectual property is a fairly narrow one here. The share of before-tax US corporate profits coming from overseas operations nearly quintupled, according to data from the Bureau of Economic Analysis. US companies have become much more multinational in character, not just selling things abroad, but making them abroad as well. And the share of cross-border equity ownership has steadily increased, to the point that foreign individuals and companies account for a significant fraction of US companies’ share ownership.
When production, customers, and owners are distributed around the world, when the “product” can be a service supplied digitally, and when the ultimate source of profit is closely tied to intellectual property, taxing big global firms becomes complex. The idea of corporate profits itself is far from a crystal-clear idea in a world of high-powered accountants and finance, operating against a backdrop of differing national tax codes. Every country would prefer to draw up the rules so that it attracts companies that it can tax. Companies that are operating across national borders in multiple ways have the ability to shift between countries, and to claim that profits are actually being earned in one place rather than another. What might be done. Auerbach discussed the possibilities, which I summarize here.
The current international negotiations over global corporate taxation basically have two “pillars,” as they are often called. One “pillar” would take a certain share of the profits of big digital services companies and let other countries split up that tax revenue. Given that these big companies are mostly American firms, the rest of the world likes this idea, but it’s not clear that the US Senate will approve. The other “pillar” would be a minimum 15% tax rate on profits of large companies. The problem with this approach is that it essentially ignores the underlying issues. As Auerbach writes:
But beyond the immediate hurdles facing adoption, there is also a more fundamental, longer-term challenge arising from the attempt to preserve a tax system based on concepts that don’t really work anymore, that are ill-defined and endogenous: corporate residence and the location of production and profits (something that tax authorities have taken to referring to as the location of value creation). Because it relies on these ill-defined concepts, the two-pillar system is not going to be sustainable unless countries adopt and adhere to similar rules that lessen incentives for companies to shift production, profits, and residence.
Auerbach is a supporter of a destination-based tax approach, and thinks that economic and political forces will tend to push in that direction over time. Maybe he’s right. But an alternative possibility is that the nature of corporations keeps evolving, the importance of intangibles like intellectual property keeps growing, and the long-term argument over what it means for corporations to pay their fair share keeps sounding much the same, even though the underlying conditions keep changing.
Timothy Taylor is an American economist. He is managing editor of the Journal of Economic Perspectives, a quarterly academic journal produced at Macalester College and published by the American Economic Association. Taylor received his Bachelor of Arts degree from Haverford College and a master's degree in economics from Stanford University. At Stanford, he was winner of the award for excellent teaching in a large class (more than 30 students) given by the Associated Students of Stanford University. At Minnesota, he was named a Distinguished Lecturer by the Department of Economics and voted Teacher of the Year by the master's degree students at the Hubert H. Humphrey Institute of Public Affairs. Taylor has been a guest speaker for groups of teachers of high school economics, visiting diplomats from eastern Europe, talk-radio shows, and community groups. From 1989 to 1997, Professor Taylor wrote an economics opinion column for the San Jose Mercury-News. He has published multiple lectures on economics through The Teaching Company. With Rudolph Penner and Isabel Sawhill, he is co-author of Updating America's Social Contract (2000), whose first chapter provided an early radical centrist perspective, "An Agenda for the Radical Middle". Taylor is also the author of The Instant Economist: Everything You Need to Know About How the Economy Works, published by the Penguin Group in 2012. The fourth edition of Taylor's Principles of Economics textbook was published by Textbook Media in 2017.