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The rich nations are currently responding to the increasing prevalence of tax avoidance by multinational corporations by attempting to rewrite the entire international corporate tax rule book. But instead of embarking on what is likely to be a very arduous and uncertain journey, wouldn't it be better for countries to simply do away with corporate tax altogether? This special feature looks at the arguments for and against abolishing corporate tax.
The Decline Of Corporate Tax
Whichever way you look at it, the reality is that multinational corporations generally pay less on corporate tax now than they did say 20 or 30 years ago. However, there is no one single reason for this, but many. For a start, 30 years ago, corporate tax rates in the industrialized world exceeded 40 percent in many countries. However, since then there has been a steady reduction in corporate tax in most developed countries, a trend which has accelerated over the last 10 to 15 years, so that now the global average is about 23-24 percent.
Another reason is that most Governments like to offer large companies, which are often major employers, incentives to operate in their countries, and they often do this by providing tax incentives. These tax breaks, when combined across many jurisdictions, have effect of reducing a multinational company's effective tax rate quite considerably. For example, the effective corporate tax rate paid by companies listed in the UK's FTSE100 Index has fallen from 30 percent five years ago to 22.6 percent last year, according to research by accountancy group UHY Hacker Young.
UHY concluded that the fall in the effective rate was caused by a combination of cuts to the statutory corporate tax rate and changes to tax reliefs. "Rampant tax avoidance," had less to do with it, the firm said, although we'll come back to this particularly raw nerve of a subject later.
Another reason is that corporate tax revenues tend to fluctuate along with the economic cycle. Therefore, it comes as no surprise that corporate tax revenues fell along with corporate profits in the aftermath of the global financial crisis. And given that most countries allow losses to be offset against future income, it is not surprising either that corporate tax revenues have remained subdued during the recovery phase. Indeed, it is estimated that only about 30 percent of companies in Japan pay corporate tax, with the remainder either unprofitable, or still absorbing previous losses.
Then, or course, as mentioned above, many multinationals go to some lengths reduce exposure to corporate tax in the main markets in which they operate. Typically, they achieve this by establishing complex group structures with subsidiaries strategically located in jurisdictions with low rates of corporate tax, or no corporate tax at all. Put very simply, these companies then shift income from the high tax jurisdictions in which they make most of the sales, to low-tax regimes through various forms intra-group financing arrangements. And in the vast majority of cases, this is all perfectly legal. Indeed, for the most part, multinationals have been exploiting the very tax deductions and incentives put in place by governments to attract investment.
Governments Vs. Multiantionals
The issue of corporate tax avoidance has, however, become hugely controversial. The companies themselves argue that they are under a legal and fiduciary obligation to shareholders to minimize costs, and, in the technical world of international finance, tax is just another cost. However, an increasing number of politicians, with increasing support from the voting public, have begun to see corporate tax avoidance as immoral. Individuals rarely get the opportunity to mitigate tax. And what's more, how can it be right, they argue, increasingly vociferously, that a multi-billion-dollar company can get away with paying little or no tax in a country like the United States, the UK or France, when the low-paid and middle classes have suffered a squeeze on their living standards thanks to austerity-driven public spending cuts and tax hikes?
That debate, it seems, has already been settled in those countries which have subscribed to the OECD's base erosion and profit shifting (BEPS) project, which aims to close the loopholes that allow companies to whittle away at their corporate tax liability. But how will this be achieved at global level? According to the OECD, only through a "comprehensive, coherent, and coordinated reform of international tax rules," will gaps in the international corporate tax framework be closed that allow about USD240bn in corporate tax revenue to "disappear" each year.
Naturally, member nations of the OECD are fully in support of BEPS, as is the G20, with which the OECD has worked closely throughout the project. Representatives of multinational businesses have also spoken positively about the OECD's work, and a lot of investors are in principle in favor of changes that bring further clarity to the international tax system. What the business and investment community is increasingly nervous about however, is the disruption to long-standing and long-understood norms in taxation before the intended changes are brought to bear, at some indeterminate point in the future. This, some fear, will only make a bad situation worse, and will be exacerbated if countries act on the BEPS recommendations unilaterally, which has already happened.
And this is where we start to enter very controversial territory. Given the upheaval that is in store for companies navigating the world of international taxation, and the energy expended by governments and tax authorities trying to make multinationals pay up, even when, ostensibly, they have played by the country's tax rules, wouldn't it be better to simply do away with corporate tax altogether? After all, the importance of corporate tax revenues, at least in the developed world, appears to be diminishing as governments transfer the tax burden from incomes to consumption and other forms of taxation.
Down With Corporate Tax?
Surprisingly, given the consensus view is that corporations, especially of the large multinational variety, ought to be paying more corporate tax rather than less or none at all, a growing number of authors, experts and commentators in the field of tax policy, and even some former policy makers, are arguing for the abolition of corporate tax.
One is economic author John Steele Gordon, who caused something of a sensation in the academic community in late 2014, when the Wall Street Journal published his article entitled "Top Ten Reasons to Abolish the Corporate Tax." In essence, Steele Gordon argued in his piece that there are compelling economic reasons for the abolition of corporate tax in the US. Obviously, this would dramatically simplify the byzantine US tax code, but it would also allow corporations to repatriate profits without facing America's high corporate tax rate, thus encouraging these domestic and foreign companies to invest profits in the US.
According to Steele Gordon, there would be little to lose and much to gain from abolishing corporate tax, because incomes, investment and wealth would rise, and so would the Government's tax revenues. "America's corporate income tax rate, at 35 percent, is the highest in the world," he observed. "A rising chorus would like to bring it more in line with foreign rates, which average around 23 percent. I have a better idea—abolish the tax. The long-term benefits would greatly outweigh the short-term costs. And revenue from other sources, especially the personal income tax, would quickly make up for it and then some."
On the other side of the Atlantic, Lord Lawson, UK Chancellor of the Exchequer under Margaret Thatcher's premiership, suggested recently that corporate tax has "had its day," because it is problematic to collect and subjects small companies to profound inequities. It should be replaced, he said, by a revenue-based tax.
"I have long argued that in the modern world corporation tax has had its day as a major source of tax revenue," he opined in an interview with the Daily Telegraph. "It needs to be a much lesser tax, bolstered by a tax on corporate sales."
"While multinationals can artificially shift profits to whatever tax jurisdictions they choose, sales are where they are, and can't be shifted," he added.
As Adam Smith said in the Wealth of Nations, "There is no art which one government sooner learns of another than that of draining money from the pockets of the people." And it is therefore not that surprising that the Adam Smith Institute, the think tank established in the 1970s to expound the 18th century economist's free market economic theories, has also suggested that corporate tax is an unnecessary tax.
In a blog for the Institute posted in January 2014, Tim Worstall, a senior fellow of the ASI, argued that, in the UK at least, corporate tax has simply been an advance form of tax on dividends paid by shareholders, with the recipients of those dividends receiving a tax credit on what has been paid already. And according to Worstall, ultimately, it would have little impact on overall tax revenue if the Government abolished either income tax at the corporate level or tax at the shareholder level. "[W]hich means that if we were to abolish corporation tax and then tax dividends simply as the income they are then there wouldn't actually be much difference in revenues," he wrote.
(N.B. the dividend tax credit is being abolished on April 1, 2016 in favor of a dividend tax allowance).
A similar sort of idea has recently emerged among tax reformists in the United States, mainly on the Republican side of the political divide, with Orrin Hatch (R – Utah) advocating what he calls corporate tax "integration." By allowing corporations to deduct the dividends paid to shareholders, "an integrated tax system would impose a single level of tax on corporate earnings," he noted in his keynote address at the annual Bloomberg BNA tax policy event in February 2016. "Rather than taxing income at both the corporate and shareholder levels, the tax would occur only once."
According to the Tax Foundation, one of the benefits of corporate tax integration along the lines of Hatch's proposal is that it would equalize the treatment of debt- and equity-financed investment, and therefore "reduce the incentive to debt-finance or reorganize to avoid the second layer of taxation," and with it, presumably reduce a great deal of corporate tax planning and tax avoidance.
No To Corporate Welfare!
However, predictably, many are vehemently against the idea of abolishing corporate tax, or at least changing its form so that in effect it ceases to exist. And their arguments revolve around the idea that large corporations often making billions of dollars in profits should make a greater contribution to the system which allows them to operate in the country in the first place, a system which would otherwise be funded – unfairly – by ordinary taxpayers on low and middle incomes.
In an infographic published online in 2015, the Tax Justice Network, the non-partisan international tax research group, said that there has been a long-running "smear campaign" against corporate tax "creating a widespread belief that the corporate tax is a bad, inefficient tax."
According to the TJN, corporate tax "holds the whole tax system together."
"It curbs political and economic inequalities and helps rebalance distorted economies. It protects democracy. It boosts financial transparency and accountability and curbs criminal behavior. It stops large multinational corporations and their wealthy owners from extracting wealth from societies by free-riding off taxpayer-funded public goods such as roads, education systems, or courts. It protects developing countries in particular, boosting self-reliance and curbing their dependence on foreign aid. It underpins economic growth. And it raises trillions in revenue that is used as a basis to pay for essential public services."
Writing for Left Foot Forward, a leading UK blog site for supporters of progressive political ideals, Prem Sikka, Professor of Accounting at the University of Essex, also takes issue with the idea of abolishing corporate tax, and like the TJN, contends that the tax represents a "fair contribution" to the social infrastructure, by which he means education, healthcare, transport, security and the legal system, enabling companies to make profits in the first place.
What's more, Sikka believes that abolishing corporate tax in the UK would leave a huge hole in the public finances to the tune of around GBP42bn a year, money which would simply be used to "line the pockets of executives and shareholders."
"As a consequence normal people will have to forego hard-won social rights, or face higher taxes," Sikka wrote in February 2016. "Income tax yield will need to rise by 26 percent. Of course, companies will still want subsidies and taxpayer bail-outs to rescue them from their own follies, as in the case of banks."
Sikka also rejects Lord Lawson's idea that companies should pay tax on sales rather than income, which as we have seen can be shifted to all sorts of places, because, he says, companies will merely attempt to avoid this new tax to, as the EUR168bn European Union VAT "gap" shows.
In an article published four years ago by Bloomberg Business, the publication's economics editor Pete Coy also suggested that many of the arguments in favor of abolishing corporate tax are flawed. For example, he posits that defenders of the corporate tax axe have yet to answer how they would tackle the likelihood that wealthy individuals would attempt to avoid tax in income altogether by "stuffing it into their own personal corporations."
Interestingly, Coy also invokes one of the reasons used to defend the introduction of corporate tax in the US back in 1909, "that the tax is a brake on excessive corporate power."
To support his view, Coy cites a paper by Reuven Avi-Yonah a professor at the University of Michigan Law School, who observed that corporate income adds to the economic resources of a corporation, and the more resources the corporation has, the more economic, social and political power it has. "In that sense, imposing a corporate tax reduces the economic resources and therefore also the power of corporate management."
Will It Ever Happen?
Given the lengths that governments are going to to prevent multinationals from avoiding corporate tax, the short answer to that is "no." What's more, corporate tax now seems so ingrained in the tax regimes of most countries, and the psyches of taxpayers and voters, that it is going to take a huge leap of faith by governments and societies as whole to come round to the idea that corporate taxes are unnecessary and economically damaging. That is, of course, whether you believe that corporate tax is unnecessary and economically damaging in the first place. And while some arguments in favor of its abolition might have merit from the point of view of stimulating economic growth, it seems that the down-with-corporate-tax camp have yet to make a completely convincing case for their arguments.
Nevertheless, it is just over 100 years since the introduction of corporate tax in the US, and who knows how attitudes will change in the coming century.
Tags: tax | multinationals | tax avoidance | Tax | dividends | investment | BEPS | education | business | corporation tax | United States | individuals | France | Japan | economics | law | tax incentives | tax breaks | court | G20 | tax reform
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