To save the planet, focus on corporate-tax free riders

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For those of us who are keen to save the planet from global warming, there is only one international negotiation we should follow this year. It is not November’s UN climate change conference, COP26, in Glasgow. The one to watch is the discussion over the tax challenges arising from multinationals and digitalisation at the OECD in Paris.

Before concluding that the statements above are ridiculous, consider this. The fundamental economic problem is the same for both global warming and taxing multinationals: free riders. Both have the same emerging solution, based on principled and muscular unilateralism. It is clearer and easier in the case of taxation than the climate. For this reason, an agreement in Paris along the lines the US is now proposing could point the way towards the kind of environmental solutions that have so far proved elusive.

Free riders matter in combating rising temperatures, because global emissions of greenhouse gases are the core problem. Countries and their populations know that if they make a special effort to be green, others will free ride or cheat in any deal, so there is no incentive to make the required effort. You can see the outcome clearly in the data. The concentration of carbon dioxide in the atmosphere has not deviated from its steady upward march after 30 years of UN climate conferences.

For international corporate taxation, small countries free ride on the systems of their larger neighbours. By setting a lower rate, they can attract profits and some associated business, because the revenue loss from domestic companies is small compared with the gains from the profits they can attract. This calculation does not apply to big countries, so profits are shifted towards smaller jurisdictions, undermining the ability of all countries to levy corporate taxes.

One part of the solution the US now proposes to end the race to the bottom on corporate tax rates is an approach based on tough unilateralism. If small countries choose not to collect much tax from multinationals operating in their jurisdictions, the host of the group holding company — in the case of the tech giants, the US — will simply give itself the right to tax those profits instead.

Tax havens do not have to agree to the deal, or be part of it, so long as most countries make it impossible for firms to change the location of their holding companies. If enough countries agree, low-tax jurisdictions will respond by charging the minimum rate instead of free riding.

The climate solution is similar. The UK, for example, boasts that it has cut greenhouse gas emissions almost 50 per cent since 1990, which is true on the basis of territorial emissions produced on UK soil. But British people now consume many more imported goods and services containing carbon emissions than in 1990. Including embedded carbon in imports, the UK’s footprint is 50 per cent higher than its territorial emissions, and reductions have been far smaller. Official figures show a drop of only 9 per cent since these statistics were first collected in 1997.

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If the UK and other large advanced economies want to price carbon higher, which is necessary to cut greenhouse gases, they will need to ensure that domestic efforts do not simply end up generating emissions abroad. That will require carbon border taxes on embedded emissions in imports to stop consumers or companies simply shifting carbon dioxide to the equivalent of low carbon-tax jurisdictions, just as they shift profits today to countries with low corporate taxes.

Free riding will prevent a global treaty being agreed, let alone working. But principled and muscular unilateralism by big players can work. The test this year is in international taxation. If domestic or international politics prevents a deal on tax at the OECD, we should also wave goodbye to the prospect of a solution to global warming.

chris.giles@ft.com

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