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Monday, November 17, 2014

Tax haven benefits are not investment incentives

Tim Worstall at Forbes takes issue with my last post, claiming that we actually don't know that U.S. state and local governments give more in location incentives than EU Member States do. He then says that while it is true that EU states give less in cash grants and other kinds of subsidies defined as "state aid" in EU law, these same states give more than the U.S. in other types of tax benefits. His argument then moves quickly through Ireland's 12.5% corporate income tax (though he gives no examples) to Amazon's European sales all being channeled through Luxembourg subsidiaries. Worstall claims that the tax advantages created by this financial gimmickry comprise a location incentive just like providing Tesla $1.3 billion to build a factory in Nevada is.

I've been researching U.S. and EU incentives for 20 years, and I certainly don't expect Worstall to have read everything I've written on the subject, including two books. So this makes as good a time as any to clarify the terms I use and the analysis I've made.

My default term for my object of study is "investment incentives," as in the title of my last book. But you can't say that phrase multiple times on every page of the book, so I use a specific set of synonyms when I write: Investment incentive = location incentive = investment subsidy = location subsidy = development incentive and sometimes, as in the headline of the last post, simply "incentive," though I also use that term in its more generic sense. Note that the term Worstall uses in his headline, "tax incentive," is not a synonym, because investment incentives and subsidies more generally can take forms other than tax breaks, i.e. cash grants, low-interest loans, free infrastructure, etc.

What, then, is an investment incentive? I define it as a subsidy ( = "state aid" in the EU context) to affect the location of an investment. To get this kind of subsidy from a government, it is necessary to make an investment. An investment incentive can be contrasted with an operating subsidy ("operating aid" in the EU), which is a subsidy for ongoing operations and is, critically, not contingent on making an investment. The distinction between investment incentives and operating subsidies is crucial to what follows.

So an investment incentive requires a subsidy and an investment. Let's now consider Worstall's examples on these criteria. As some readers may know, Ireland for many years had a 10% corporate income tax rate on profits from manufacturing, a rate explicitly provided for in Ireland's EU accession negotiations, and which the European Commission long accepted as being part of the country's general macroeconomic framework rather than a subsidy (see my book Competing for Capital, pp. 94-95, for an extended discussion). Contra Worstall, I am certainly well aware that Ireland's tax policy is a method of competing for investment; in 2000, I called it "a clear and unregulated element in the country's competition for investment" (p. 95; italics in original).

 Despite that, when the Commission ruled in July 1998 that manufacturing was specific enough for the tax rate to be considered a state aid, it ruled that it constituted an operating aid. A manufacturing company was entitled to the 10% tax rate forever, whether it made new investment or not, or even if it disinvested, as Intel has done from Ireland. Since there was no link between the subsidy and investment, it did not constitute an investment incentive. In the end, Ireland and the Commission agreed that a 12.5% tax rate that applied to all corporations would not be considered state aid. Now we no longer have a subsidy, but tax competition. (This of course doesn't talk about the boutique deals that the EU is now investigating as possible state aid.)

One ironic takeaway is that despite the intentions and nearly unanimous views of Irish policy-makers (many of whom I have interviewed over the years), the evidence doesn't actually suggest that the country's low-tax policy contributed to its growth. For the policy's first 30 years, 1958-87, Ireland grew, but no more rapidly than the rest of the EU. For almost the entire period, it had no tax on foreign multinational corporations. The famed Celtic Tiger came together when the tax rate MNCs faced was 10 percentage points higher, 10%.

What about Amazon and Luxembourg? Amazon has real operations in Luxembourg, employing about 1000 people overall. But the turbocharged financial benefits Amazon receives come not from normal operations using the lower VAT (again, tax competition, not an investment incentive), but from its use of tax haven subsidiaries. As the linked article points out, where Amazon makes its money in Luxembourg is from Amazon Europe Holding Technologies SCS, a partnership with no employees or office, which had completely tax-free profits of €156.7 million in 2013, according to the Wall Street Journal article linked above.

Moreover, according to the huge dump of leaked documents from the International Consortium of Investigative Journalists, in 2009 Amazon Europe Holding Technologies SCS paid Amazon Technologies Inc. (located in the tax haven of Nevada) €105 million in order to license Amazon's intellectual property. By some miracle, this no-employee company managed to re-license the IP to Amazon EU for €519 million. Given Worstall's claim in July that transfers of technology to a tax haven subsidiary have to be made at "full market value," how does he explain the way that "no one," if you will, raised the value of this IP by €414 million, which just coincidentally was untaxed in Luxembourg? Could it be that Amazon Europe Holding Technologies SCS didn't actually pay "full market value"?

Worstall also makes the odd claim: "And we do regard different corporation tax rates within the US dependent upon location as being location based incentives and we don’t regard them as such in the EU." Aside from wondering who his "we" is, I know I'm not part of it: My estimates of U.S. state and local subsidies and investment incentives most definitely do not count differences in corporate income tax rates among states as a "location incentive." My posts on Tesla take no account of the fact that Nevada has no corporate income tax, while its home state of California levies 8.84%. Yes, it's tax competition, as in Ireland, but if you were to call it a subsidy, it would be an operating subsidy, not an investment subsidy. I also don't include the federal government's many subsidies in these numbers. (Note: Writing this prompted me to go back and look at the data ICA Incentives provided me last year, wherein I found that it did include some federal subsidies. I removed them from the totals from the ASDEQ paper I cited in my last post, leaving U.S. state and local investment incentives 3 1/2 times, not 5 1/2 times, as large as EU investment incentives. See corrected post here.)

Worstall, then, is trying to mix apples and oranges. For a tax provision to be a subsidy, it needs to be a derogation from a country's normal tax rules. Yet Amazon tells us it is "subject to the same tax laws as other companies operating" in Luxembourg. Of course, Amazon may be stretching the truth here. But if Worstall thinks that creating arcane tax haven arrangements (as in his examples of Apple, Google, Facebook and Microsoft sales flowing through Ireland for tax purposes) is the same thing as, you know, actually building things, I'm here to tell him he is mistaken. Using the same term, "location incentive," to try to cover two completely different types of economic activity, is certain to detract from our understanding of the policy issues, not increase it.

Cross-posted at Angry Bear.