To those working on tax in a development context, none of this will be news. However, the significance of this paper is that the IMF is able to put numbers to the overall effects which have previously been illustrated only by anecdotal examples.
The IMF uses econometric analysis to find that "a one point reduction in the statutory [corporate income tax] rate in all other countries reduces the typical country's corporate tax base by 3.7 percent". The paper suggests that the effects of companies shifting paper profits are just as harmful as shifts in real economic activity, and that the effects on developing countries are "two to three times larger, and statistically more significant" than for OECD countries.
The IMF staff have direct experience of the tax avoidance that multinational companies engage in in developing countries, and they refer to striking examples they have encountered in the extractive sector and telecommunications - which are some of the most profitable enterprises in Africa. They make the important point that "the amounts at stake in a single tax planning case now quite routinely run into tens or hundreds of millions of dollars. These sums may be small relative to total tax revenue in sizable advanced economies, but are large for the developing countries that are increasingly involved in such cases".
As the IMF points out, tax competition is an example of the prisoner's dilemma: all countries have an interest in tax rates staying at reasonable levels, but any one country stands to gain by significantly undercutting average rates elsewhere and attracting a greater share of the tax base. The paper says that "in relation to profit shifting the collective revenue of the countries affected must fall. But revenue in the low tax country can only increase". They note that the persistence of tax incentives in developing countries, which the IMF has long emphasised as undermining tax revenues, are likely responding to the downward pressure of tax rates in other countries.
OECD BEPS project
The OECD's Base Erosion and Profit Shifting (BEPS) project, kicked off in 2013 by the G20 countries, is meant to ensure that national and international tax rules do not encourage profit-shifting. But the IMF implies that the OECD isn't going far enough: in its press release accompanying the staff paper, it says that "the case for an inclusive and less piecemeal approach to international cooperation grows".
The IMF notes that low-income countries are essentially source countries, whose taxing rights are significantly constrained by the network of bilateral double tax treaties based on the OECD model.
Developing countries have signed many treaties where they relinquish their right to tax corporate income streams, yet the evidence for increased investment in response to these treaties is limited at best. The paper ultimately warns developing countries that "considerable caution is needed in entering into any bilateral double tax treaties (BTT)".
The paper is bound to stir debate in international tax circles and implies a particular challenge to developed countries such as the UK, which has called for developing countries to obtain a fair share of the multinational corporate tax base while simultaneously adopting a policy of tax competition, based on low tax rates and special reliefs such as the Patent Box, which tax specialists freely describe as "aggressive". The implication of the IMF paper is that if the UK is going to stand by its commitments to help developing countries raise more tax, it will need to take a closer look at the effects of recent changes to its own tax rules.
Rachel Sharpe (rachel.sharpe@actionaid.org) is a policy researcher with ActionAid.
