1.2. Economic evidence of profit shifting and base erosion 5
Company taxation has come under scrutiny by tax authorities, tax experts and the general public in recent years. More and more evidence suggests that considerable amounts of corporate income can avoid taxation through the use of cross-border structures. The business models of multinational companies have become more complex, intra-group transactions have multiplied and multinationals' integrated value chains make it difficult to determine where profits are created. Governments struggle to determine, within the current set of international tax rules, which country should be allowed to tax which part of a multinational's income.
Shifting income across borders can lead to a loss of corporate income tax revenues. Many companies can adjust their internal prices whereby they have a possibility to shift profits to low tax jurisdictions. Digitalisation has made it easier for companies to organise their activities through offshore financial centres, and to create sophisticated structures for tax planning purposes. While differences in the statutory corporate income rates are one important driver of profit shifting, also the effective tax rates companies face play a crucial role since these rates also reflect preferential regimes and loopholes in national tax bases.
The existence of profit shifting and base eroding practises is demonstrated in many academic studies. Although the extent of these practices and its impact on total tax revenues is hard to measure, it might be considerable. The OECD/G20 BEPS report on Action 11 estimates the revenue loss at the global level at 4 to 10 per cent of CIT revenue, i.e. USD 100 to 240 billion annually at 2014 levels. 6 In a study comprising 51 countries, the IMF concludes that "the (unweighted) average revenue loss is about 5 % of current CIT revenue – but almost 13 per cent in non-OECD countries" 7 . Additionally, a recent study commissioned by the European Parliamentary Research Service finds that the revenue loss from profit shifting within the EU amounts to about EUR 50-70 billion, equivalent to 17-23 per cent of corporate income tax (CIT) revenue in 2013 8 . Based on a measure of total corporate profits in a given country and average collection rates across countries, the study estimates how much revenue should have been collected in the absence of any profit shifting. 9 It is important to note that the method only captures profit shifting within the EU 10 , and it therefore does not take into account profit shifting from and to other countries.
Other studies have not attempted to measure the total revenue loss, but are nonetheless indicative of the potential size of the problem. For instance, Lee et al. 11 find that 22 per cent of companies in their sample have a large tax gap, meaning that the gap between the taxes they would theoretically owe according to where they generate their revenues and the total tax they actually pay amounts to at least 10 per cent. Egger et al. 12 compare the tax liabilities of multinationals with those of domestic firms and find that foreign-owned affiliates in high-tax European countries pay 32 per cent less tax than domestically owned companies. A similar study by Finke 13 for Germany finds a gap of 27 per cent. Further, there is evidence on the sensitivity of affiliates' pre-tax profits to corporate income tax rates. Sullivan 14 and Clausing 15 show that pre-tax profits are higher in low-tax jurisdictions than in high-tax jurisdictions; a meta-analysis conducted by Heckemeyer and Overesch 16 finds that an increase in the corporate income tax rate by 1 percentage point leads to a lowering of affiliates' pre-tax profits by 0.8 per cent.
These observations have led to a more general debate on fairness and efficiency in taxation in the light of fiscal adjustment needs. 17 Addressing base erosion and profit shifting has become even more relevant in the context of rising concerns on fiscal sustainability following the economic and financial crisis: public debt levels have increased substantially in the EU from around 58% of GDP in 2007 to a forecasted value of 88% of GDP in 2015 18 . As a result of the crisis, many governments cut expenditures and increased taxes, notably on consumption, to consolidate public budgets 19 . The use of tax planning strategies by multinational corporations has created a debate about their fair contribution to government budgets. Another relevant consideration includes the more indirect effect that tax avoidance of some companies could have on the tax morale of all taxpayers. 20
While corporate income taxation and capital taxation more generally have a growing international dimension due to the mobility of the tax base, tax policy and administration remain primarily a national responsibility. All decisions on taxation in the EU are taken unanimously by the Council. This has in practice limited the degree of co-ordination and harmonization in this policy field in the EU as a whole as well as in the Euro area. In a Union of 28 Member States, unanimity has effectively reduced the chances of progress in legislation to safeguard national tax bases while ensuring a smooth functioning of the Single Market.
