On 30 August 2016, the European Competition Commissioner, Margrethe Vestager, announced that ‘Ireland granted undue tax benefits up to EUR 13 billion to Apple.’ Those benefits distort competition within the European marketplace and so the Commission instructed Ireland to recover the unpaid taxes. This announcement ignited a storm of protest from Apple and from the Irish government. It also sparked a wider debate about how multinational companies are taxed and about whether some form of tax harmonization is essential to the functioning of Europe’s internal market. Although some general principles have emerged from the conversation, the deeper implications of the controversy remain unclear. The debate here is less about the treatment of a single company than about the way European governments have tried to promote regional development and how the United States has relied on multinational corporations to exert influence in the wider world.

The complexity is evident in the phrase ‘up to EUR 13 billion’. The reason for the qualification emerges only toward the end of the Commission’s announcement. The Commission’s investigators can show that Irish tax authorities allowed Apple to allocate a large share of the company’s profits to a virtual ‘headquarters’ with no staff, facilities, or tax residence. If those profits were taxed, the bill (plus interest) would amount to roughly EUR 13 billion. The problem is that the Commission’s investigators cannot determine where those profits were generated and therefore to whom those tax revenues belong. The amount recovered by Ireland could be reduced if other governments could show that the profits resulted from activities that took place in other jurisdictions either elsewhere in Europe or even in the United States.

The complexity does not end with the Commission’s qualifications. The provisions written into bilateral tax agreements also raise concerns. If the Irish government were to collect the tax requested by the European Commission, Apple could use that payment as a credit to offset its obligations in the United States. As U.S. fiscal authorities were quick to point out, the result would be a net transfer from the United States to Europe rather than a charge on Apple itself.

The U.S. complaint raises a further question about whether and how much tax Apple is paying U.S. fiscal authorities out of its profits. The answer is complicated by provisions in the U.S. tax code that allow Apple to avoid paying tax on profits held abroad. These provisions are not limited to Apple. They apply to all U.S. based multinationals and they explain why such firms currently hold more than $1.4 trillion outside the United States. Those companies will have to pay tax on these profits, but only once they repatriate them into the United States.

Working backward through this list of qualifications, it is possible to argue that the real source of market distortions originates in the tax treatment of U.S.-based multinationals by the government of the United States. Such a policy may have made sense during the Cold War, when the U.S. government relied on multinational corporations to bind other parts of the world into the West. It is more a source of friction today. So long as U.S. fiscal authorities create incentives for firms to transfer and stockpile their profits abroad, they will also create incentives for firms to look for jurisdictions where they can shelter those profits. Whether those foreign jurisdictions shelter U.S. firms in general or whether they give preferential treatment to specific multinationals is unimportant. What matters is that the U.S. government is providing a subsidy for American multinationals to use retained earnings to invest abroad.

The election of Donald Trump as president may bring an end to that distortion. As candidate, Trump not only criticized U.S. firms for their overseas investments but also promised to create incentives for multinationals to repatriate their profits to the United States. It is not clear that Europe will be better off if Trump succeeds in that agenda. Europe’s situation will be even more complicated if Trump manages to lower the corporate tax rate in cooperation with the Republican-controlled Congress. The result will be an increase in competition across the Atlantic for multinational investment.

European governments would be unwilling to surrender their sovereign control over tax policy in such a context. On the contrary, they will be looking for ways to create incentives to hold onto multinational activity. Such competition will not vitiate the Commission’s ruling against Ireland and Apple but it will qualify support for subsequent European Commission proposals to promote a common consolidated corporate tax base. Competition across the Atlantic will reduce incentives to harmonize corporate tax rates even more.

The question is whether tax policy is a legitimate instrument for governments to use in competing for economic activity. The immediate presumption attached to the Apple case is that the Irish government has done something illegitimate in providing tax advantages to a large multinational corporation at the expense of the Irish people. There is some logic to that position but it is not all encompassing. Such a complaint leaves out consideration of what other instruments the Irish government could use to attract investment. It also leaves out what the economics profession tells us is the alternative.

The economics literature paints a bleak picture. Left to market forces, economic activity tends to accumulate in those places that are already active (and prosperous). Recognition of this insight – called ‘agglomeration effects’ – is part of what justified Paul Krugman’s Nobel prize. The implication for peripheral countries like Ireland is that they start at a disadvantage. As late developers, they will never be natural targets for foreign direct investment. From that perspective, selective use of fiscal incentives helps to level the scales. That is why Ireland has such a low corporate tax rate; it is also why the Irish government was eager to provide reassurance to multinationals in the form of tax rulings that they would not switch regimes once the firm has accepted the bait.

What goes for Ireland goes for other countries as well. Even highly developed countries like Germany have pockets of regional underdevelopment. The federal government may not openly engage in using tax instruments to attract foreign direct investment but the regional or Land governments have a long tradition of doing so. As in the case of Ireland, the Land governments also suffer from a lack of alternatives. Moreover, this is as true in the aging industrial heartlands in the north and west of Germany as it is in those regions still struggling to reemerge from the collapse of communism more than a quarter century ago.

What the Apple case reveals is that this particular model for the development and integration of the West is no longer desired by many Europeans. What Trump’s election suggests is that it is unwanted by the Americans as well. This does not mean that the state must surrender its authority to the market; it means rather that the postwar formula for using tax codes to influence where multinationals do business is nearing obsolescence. How the Apple case is resolved will tell us much about what instruments governments plan to use in shaping regional development policy in the future.

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This piece was drafted in early November and published in the 1 January 2017 issue of the EastWest Magazine. For the edited version, go here.