Apple tax and the Prisoners’ Dilemma

22 / 05 / 2013
Category: Blog

Corporate governance tells us that the management of a company has a primary responsibility of maximising shareholder value. In a pure sense, this includes minimising the company’s tax bill using whatever legal means are available to it. Of course there are external ramifications of abusing other stakeholders (think garment industry and Bangladeshi workers), but this still usually boils down to shareholder wealth and value added.

Let’s turn our attention to national governments.

In CFA Level I Economics the concept of the Prisoners’ Dilemma is discussed in terms of describing an oligopoly: consider a duopoly in which the two companies can compete or price fix. If both price fix, they make $10m each. If both compete, they make nothing. If one price fixes and one competes, the competing firm makes $20m and the price fixer loses $10m. Each firm is now incentivised to compete, as they will be better off than price fixing, regardless of the other firm’s choice. Hence the only stable equilibrium is when both firms make nothing, clearly a suboptimal solution.

Now apply this to nation states. You are running a finance ministry and are negotiating with a (non-local) multinational corporation over the tax domicile of a subsidiary. If you permit the profits of this entity to be taxed at a lower rate than other countries would require, then your government generates revenue that it would not otherwise have had. Clearly a positive outcome. However if other governments compete by offering lower rates still, then your own government will only generate the tax on these profits if you “win” this race to the bottom – for instance by charging just 0.05 per cent.

Hence the prisoners’ dilemma: if countries refused to negotiate (price fixing in the previous example) then many of these tax battles will be lost by those governments – but the prizes, the tax receipts, would more than likely outweigh the losses.

With apologies to tax minimising shareholders.

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