The OECD has just announced a program of “detailed work on about a dozen of the most contentious issues, including the treatment of digital businesses and the rules on transfer pricing” in furtherance of its proposed Action Plan on tackling base erosion and profit shifting caused by globalization. There is a much simpler way of achieving the objective of tackling base erosion and profit shifting by corporations seeking “tax efficiency” than that being pursued by the OECD, which appears to have signed on to the idea of country-by-country reporting as the main modification of the current system. This is the idea usually described as unitary taxation, meaning common worldwide taxation of corporate profits.
Unitary taxation is usually criticized as diminishing national sovereignty. This is of course correct; the rate of unitary taxation would be set on a worldwide basis rather than by individual nation states. The question is how much this costs nations when the forces of tax competition oblige them to impose much the same levy for fear of losing revenue. There are those who believe that their particular nations gain by tax competition and would therefore oppose anything that would curtail it, but their attitude can be criticized as myopic; any short-run gain comes at the expense of other countries and lasts only as long as those other countries do not reduce their tax rates. The only logical basis for opposing unitary taxation is that it would help maintain the rate of corporate taxation, which will be judged undesirable by those who wish to see the abolition of all corporate taxation (for which there is some economic logic, though the likely cost would be further concentration of income).
Unitary taxation would demand a formula for sharing out the profits of a multinational company between the countries where it operates. There is no ambiguity about the distribution of sales, apart from those introduced by the variability of exchange rates, which could easily be resolved by adoption of a convention (e.g. to use the rates officially announced monthly by the IMF). There is a further important addition to ambiguity in the case of costs, since these include the costs of capital, and of research and development. These may, or may not, be amortized over several years. My inclination would be to leave this decision up to the individual firm, providing only that it sticks with the same rule each year. In addition, there would need to be a value-judgment regarding the rule for combining costs and sales. I cannot see that one needs to vary this by industry, although doubtless this case will be argued by some. A simple rule of 50:50 would seem as good as any.
Under these conventions, country A would be entitled to receive from firm X a payment equal to
t[½α(A) + ½β(A)]π
where t is the rate of corporate taxation, α(A) is the share of firm X’s revenues derived from A, β(A) is the share of firm X’s costs in A, and π is the firm’s worldwide profit (= ΣiRi – ΣiCi = R – C, where R is the firm’s total revenue and C is its total costs).
The great advantage of this approach is that it would dispense with the need for rules on transfer pricing, at the cost of a sacrifice of national sovereignty that is largely mythical. It seems a modest price to pay.