3 Nov 2016 09:00am

Debate: should corporation tax be axed?

Diego Zuluaga, a financial services research fellow at the Institute of Economic Affairs and Alex Cobham, director of research at Tax Justice Network discuss whether corporation tax should be axed in this month's debate

YES Diego Zuluaga

Louis XIV’s finance minister Jean-Baptiste Colbert once quipped that the art of taxation consists in plucking the goose so as to obtain the largest number of feathers with the least amount of hissing. It is evident that corporation tax does not meet Colbert’s definition of a good tax.

Taxing corporate profits is an inefficient way to raise government revenue. It leads firms to reduce capital investment, which in turn makes workers less productive because output per hour worked increases the more capital there is per worker. Because rising wages necessitate rising productivity, corporation tax depresses employee remuneration.

It has been calculated that as much as 57% of the burden of corporation tax falls on workers, not rich capitalists as we are sometimes led to believe. Further, the prospect of taxation leads firms to seek ways to minimise their overall tax bill. They do this by locating assets in low-tax jurisdictions and by lobbying governments to give them special breaks and to introduce loopholes into the system.

On almost every dimension, corporation tax has been shown to be inefficient

Diego Zuluaga

Tax administrations then expend considerable resources auditing companies in a bid to raise their payable taxes. Recent controversies in the UK and Europe revolving around some large American multinationals illustrate this wasteful process.

Britain would be better off abolishing corporation tax and replacing it with a tax on distributed profits – dividends – levied at the shareholder level. Inheritance tax and capital gains tax should also be axed, as both tax income, which has previously been sifted through by the taxman.

NO Alex Cobham

Corporation tax raises essential revenue for public services and infrastructure, and for the institutions that guarantee the rule of law and effective political representation. It is relatively cheaply collected, relatively progressive in its incidence, and its efficient collection is relatively likely to support tax compliance more broadly.

There’s also a political reason to retain corporation tax. We’ve just seen the biggest collaborative process in this field for decades, as major economies revised the OECD’s rules for international tax. This process took place because of the powerful public pressure for corporation tax to be made more effective – not less so.

Does the prospect of Brexit somehow make this a good time for the UK to go against the evidence? Evidence which, incidentally, is clear for the UK.

The government and the independent Office for Budget Responsibility have forecast zero impact on the base – ie no rise in taxable profits – from the recent rate cuts. The government’s best guess is that this means they have simply given away public revenue, for no benefit. Perhaps there’s a view that Brexit means the UK will need less revenue?

The reverse is true. There is near-unanimity among economists and forecasting institutions that there will be non-trivial revenue losses due to the combination of prolonged uncertainty followed by loss of market access and/or productive labour. Such an extreme policy as abolishing corporation tax would not only suggest panic in the UK government. It would reduce revenues significantly and would do little or nothing to retain international business.

Diego Zuluaga

On almost every dimension, corporation tax has been shown to be inefficient. According to HMRC, it is one of the costlier taxes to levy, at 0.76 pence per pound collected. Research from PwC has shown that firms in the UK spend 37 hours each year complying with it, out of a total of 110 hours spent on compliance with all taxes. Britain’s compliance burden is greater than even red tape-heavy France.

Corporation tax is unfair to poor countries. That is because the complex rules of the global tax system are designed to benefit rich countries with more sophisticated tax bureaucracies. The OECD recommendations will worsen this problem by making the rules even more complex.

Taxes are, indeed, the price we pay for civilisation

Alex Cobham

In any accounting of the costs and benefits of tax rate cuts, it is essential to take account of their impact on private investment. Lowering corporate tax rates will attract more capital to the UK, making workers more productive and thus lifting wages. Prosperous economies tend to have low and falling rates of corporation tax – stagnant economies have high and rising ones. This is no coincidence.

Alex Cobham

Diegos opening statement includes two causal claims for which evidence is weak or absent. First, our research shows that lower effective tax rates have been accompanied by more rather than less profit-shifting. Cutting rates does not stop this behaviour; it has simply added to the tax losses.

Second, the incidence claims are at best questionable as one leading US economist puts it, there is simply no persuasive evidence of a link between corporate taxation and wages. Econometrics aside, would multinationals lobby so hard against effective international tax rules if senior executives and shareholders did not bear much of the incidence?

If tax systems were perfect and all wealth and income transparently owned, a simpler structure without corporation tax is imaginable. But to do so
in the real world would be to lock in revenue losses and higher inequality, with no expectation of higher investment or growth. For these reasons, it is no surprise that the UK government has just recently confirmed that it will not pursue further cuts to corporation tax.

Diego Zuluaga

There are dozens of studies showing significant incidence of corporation tax on employee wages. Indeed, the 57% figure I cited comes from a comprehensive amalgamation of research in various countries. Cross-country data also shows an adverse impact on economic growth, a finding corroborated by the OECD.

An interesting result from my own research is that declining tax rates have not meant declining revenues from corporation tax. In America, Germany and the UK, the share of corporate tax in all taxation remains at levels similar to 1980, while as a share of GDP corporation tax revenues have grown by a third in the last 35 years.

The new government has decided to maintain the current downward trajectory of the tax rate. This is an acknowledgement of the importance of creating a favourable investment climate post-Brexit, and of the damage that can be wrought by high marginal tax rates. It is a fallacy that companies pay corporation tax workers and investors do. We should therefore abolish it and put something more efficient in its place.

Alex Cobham

Typically, the argument has been made that taxing capital deters investment and growth. The implied trade-off is used to lobby for tax cuts. (And of course, the corporate goose can pay to hiss more loudly than taxpaying citizens.)

But the evidence on this point, such as it ever was, has now been overturned. For example, the claimed sensitivity of multinational profit location to the effective tax rate only applies, it turns out, for those like Luxembourg that are competing at a near-zero rate. As the OECDs head of tax put it last month in The Wall Street Journal, "this argument is dead".

The previous World Bank chief economist, Kaushik Basu, once remarked that to abolish tax on unearned, inherited income and assets was equivalent to the caste system because it ensures that major inequalities persist from one generation to the next.

More generally, direct taxes are the key component of efforts to curtail the inequalities that further undermine human social cohesion, development and economic growth. Taxes are, indeed, the price we pay for civilisation.


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