Weekly SSRN Tax Article Review And Roundup: Elkins Reviews The Global Battle to Capture MNE Profits By Bankman, Kane & Sykes

This week, David Elkins (Netanya) reviews a new paper by Joseph Bankman (Stanford), Mitchell Kane (NYU) & Alan Sykes (Stanford), Collecting the Rent: The Global Battle to Capture MNE Profits, 72 Tax L. Rev. __ (2019): 

This article focuses on the concept of economic rent within the context of the taxation and regulation of multinational enterprises (MNEs). Rent is the income above and beyond what is necessary in order to induce an individual or firm to engage in any particular economic activity. For marginal producers, the rent will be zero. Infra-marginal producers will recognize varying degrees of rent. One consequence of the concept of economic rent is that a tax or regulatory scheme that extracts some or even all of that rent will not likely affect a firm’s behavior. In contrast, a tax or regulatory scheme that extracts more than rent will likely induce a change in behavior.

In describing rent, the authors distinguish between true economic rent and quasi-rent. Assume that there is a firm that has already incurred a large economic outlay in order to establish a production line, develop intellectual property and so forth. The difference between its income and its current costs is quasi-rent. However, to determine its true economic rent, we would also need to factor in its initial economic outlay. The difference is significant because a tax or regulatory scheme that extracts quasi-rents may not change the firm’s immediate behavior, but will affect future investment. Therefore, taxing quasi-rents is not sustainable on a long-time basis.

 

The authors argue that taxing foreigners on their quasi-rents or imposing taxes that drive out infra-marginal firms may impose costs on the rest of the world by reducing global welfare. When many countries engage in this behavior, the problem is compounded. Cooperation is required in order to reduce inefficiencies caused by extracting quasi-rents and infra-marginal rents.

The article then goes on to examine what the authors describe as “tax approaches” and “other approaches” to capturing MNE rent (this designation is not entirely accurate as “other approaches” include import duties and excise taxes). Tax approaches include source-based income tax with separate entity accounting and an arm’s length standard for policing intracompany pricing, expanding the reach of source taxation, unitary taxation with formulary apportionment, and destination-based taxation. Non-tax approaches include government purchasing and state trading enterprises, price regulation, anti-trust policy, import duties, and excise tax. 

This article makes an important contribution to the discourse of international taxation. Not all income is created equal. Attempting to impose a tax burden that extracts more than economic rent is an exercise in futility: by definition, once the after-tax income is less that what is required to induce economic activity, the firm (or individual) concerned will not undertake or will cease that activity with a resulting dead-weight loss. The authors do well to explain the difference between the short-term view (quasi-rents) and the long-term view (real economic rents) and to caution against the short-term expediency of imposing taxation that is less than quasi-rents but greater than real rents. Their suggestion that countries consider a variety of approaches, tax and non-tax, to extract a share of MNEs is well taken.

I believe that further explanation of a number of points that the authors make would be useful. As one example, they claim that taxing quasi-rents could benefit the taxing state but impose efficiency cost on the global scale by contracting a certain industry (and that cooperation is necessary to prevent those negative externalities). However, it would seem that imposing tax that exceeds true economic rent would first and foremost harm the taxing jurisdiction itself and only indirectly harm global welfare. It would be helpful if the authors would explain a tax could benefit the host country and at the same time curtail economic activity to the detriment of global welfare. As a second example, they claim that without market power, countries could not succeed in capturing rents because firms would pull out of those countries. However, if what the taxing jurisdiction is extracting is part of the true economic rent, then apparently firms would have no incentive to pull out, as their after-tax income would be greater than what is necessary to encourage the activity (if it is not then by definition the tax exceeds the economic rent). As a final example, they claim that the imposition of some forms of tax could fail for extract rent from the MNE if the tax causes the country’s currency to adjust enough to offset the effect of the tax. They suggest that if Germany were to impose a 10% import tax, the currency might appreciate by 10%, so that the €360 that the MNE receives following the imposition of the tax would equal the €400 that it would have received in the absence of the tax. In such a case, the authors claim, the MNE will end up in the same position in which it started and the tax will have failed to extract any of the rent. However – aside for the fact that Germany does not have an independent currency so that the analysis is seemingly inapplicable unless all countries using the Euro were to adopt the same rule – the claim that such a tax does not extract MNE rent raises the fundamental the question of the purpose of extracting the rent: is it to enhance the welfare of residents of the taxing country or simply to deny the MNE that rent? If it is the latter, then I believe some normative justification is in order. If it is the former, then an explanation, perhaps, of how the appreciation of their currency would have a negative impact on the welfare of German residents and a demonstration that the negative impact of the appreciation would outweigh the positive impact of the tax collected are necessary to avoid the conclusion that an import duty could produce benefit without any corresponding cost.

Here’s the rest of this week’s SSRN Tax Roundup:

• Chalie Beller (Freshfields Bruckhaus Deringer LLP), GILTI – “Made in America” for European Tax: Unilateral Measures, Excess Profits & the International Tax Competition Game, __ Va. Tax Rev. __ (2019)
• Craig Elliffe (Auckland), Interpreting International Tax Agreements: Alsatia in New Zealand, 28 New Zealand U. L. R. 1 (2018)
• John Gallemore (Chicago) & Martin Jacob (WHU), Corporate Tax Enforcement Externalities of the Banking Sector (2018)
• Ann Kayis-Kumar (UNSW), Implementing Corporate Tax Cuts at the Expense of Neutrality? A Legal and Optimisation Analysis of Fundamental Reform in Practice, 16 ejournal of Tax Research 201 (2018)
• Susan C. Morse (Texas), International Cooperation and the 2017 Tax Act, 128 Yale L. J. Forum 362 (2018)
• Michal Radvan (Masaryk), Petr Mrkyvka (Masaryk) & Johan Schweigl (Masaryk), Challenges of the Implementation of the European Charter of Local Self-Government in Czech Legislation, 16 Lex Localis – J. of Self-Government __ (2018)
• Reid K. Weisbord (Rutgers), The Governmental Stake is Private Wealth Transfer, 98 B.U. L. Rev. __ (2018)