Tax and Fiscal Policy

EU/OECD plans to tackle ‘profit shifting’ will just increase complexity

The corporate tax system is currently under attack from the EU and the OECD. In principle, this is not a bad thing because the corporate tax system is flawed. However, the EU and the OECD do not wish to change the principles on which the current tax system operates: they want to make the current system better at tackling “profit shifting” and “basis erosion”. In the process, they will make the system even more complex. This policy is about as likely to succeed as attempts by a child to reach the end of a rainbow. The more complexity that is created, the more complex the methods of reducing tax bills will become. Legal certainty will be reduced, the public will be no more satisfied and life will become still more difficult for businesses.

Unjustified criticism

It is worth just noting that many of the cases cited by campaigners on tax issues are totally bogus. For example, Philip Green is accused of avoiding tax on companies that are owned by his wife who does not live in Britain. A relatively settled principle of the UK tax system is that husband and wife are taxed independently and the husband is not assumed to own the property of his wife. We cannot blame Philip Green for taking advantage of this principle.

Apple is well known to not repatriate profits to the US and, though I do not know in detail the corporate finances of Apple, this could often be regarded as a rather inefficient arrangement which leads to principal-agent problems. But, when the US government has a corporate tax rate about twice the UK level and an unreasonable treatment of foreign earnings, this is a very predictable result.

The BBC did a feature on Amazon that reported that, in 2011, Amazon had sales in the UK of £3.35bn and only paid tax of £1.8m. Companies do not pay corporation tax on turnover, they pay tax on profits. This piece demonstrated a shocking lack of rigour or was an attempt simply to attack the corporate sector – in effect it over-stated Amazon’s tax base by a factor 100.

Government hypocrisy

There is also a great deal of government hypocrisy which actually creates the uncertainly and anomalies that companies exploit. Loopholes are created as a deliberate part of government policy. On one news bulletin, I once heard David Cameron as the top item saying that the government was going to crack down on tax avoidance. What was the third item on the same bulletin? George Osborne saying “I am delighted that Star Wars is coming back to Britain. Today’s announcement that the next Star Wars film will be shot and produced in the UK is great news for fans and our creative industries, and it is clear evidence that our incentives are attracting the largest studios back to the UK. I am personally committed to seeing more great films and television made in Britain.” These tax incentives – deliberately created – are being exploited by many rich people in the UK. To provide another example, the government has said: “The Patent Box will encourage companies to locate the high-value jobs and activity associated with the development, manufacture and exploitation of patents in the UK. It will also enhance the competitiveness of the UK tax system for high-tech companies that obtain profits from patents.” In other words, the UK government is systematically encouraging tax avoidance as a matter of deliberate policy.

In fact, tax competition is healthy. Developed democracies try to tax their citizens at around 45 per cent to 55 per cent of national income. Tax competition is one force that counteracts against the tendency of interest groups to increase the size of government in democracies.

Fundamental reform

We need to begin by asking “what is corporate taxation system for?”. If we ask this question, the answers make uncomfortable reading for tax campaigners. You can argue that companies should be taxed in order to finance the provision of certain public goods that make their operations possible – defence, policing, courts systems and so on. Such taxes should be paid, by the company in the countries in which it is operating. They are not an international issue. The British tax, business rates, is an appropriate (though now probably outmoded) tax that could be levied for that purpose. An alternative would be a turnover tax. The solutions might be different in different countries, but there is a case for charging businesses some kind of tax based on their establishment and not on their profitability.

Then, how should we tax profits? My preferred method is to tax shareholders on the basis of earnings per share, regardless of whether those earnings are distributed – there would then be no capital gains tax. Alternatively, shareholders could be taxed on distributions and on capital gains. Of course, the tax authorities would not like that because they prefer to tax single large entities rather than dispersed owners. That is their problem. If we adopt such a system, there is then no need to calculate profits in different countries, get into arguments about transfer pricing and so on. The global profits would be the global profits and the owners of the company would be liable for tax on them (or on distributions). Those owners who are intended to be tax exempt (such as the beneficiaries of pension funds) would not be taxed. This would also end the discrimination against equity capital because it would bring the taxation of equity into line with the taxation of debt.

There are other ways of achieving a similar objective – such as the allowance for corporate equity, which might be more practical.

But we need to have a discussion from first principles in order that we can build a tax system on sound principles rather than amend an existing system in a way that will simply enrich accountants and lead large companies to find new ways of paying less in tax.

Prof Philip Booth is the IEA’s Editorial and Programme Director and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham.

Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

1 thought on “EU/OECD plans to tackle ‘profit shifting’ will just increase complexity”

  1. Posted 27/10/2015 at 14:43 | Permalink

    Taxing output is both immoral and inefficient as it penalises people for what they contribute in production. Firms and individuals only owe the Community compensation for burdens they cause. Like exclusive occupation/use of valuable Land and other negative externalities, like pollution for example.

    This way we align incentives instead to distorting them. Unfortunately, organisations like the Institute of Directors and the Chambers of Commerce campaign for the opposite because it affords their members protection from the market. They want to scrap property taxes in favour of VAT. This is pure protectionism against efficient, competitive markets. Not only does our preference for taxing output reduce GDP, but results in a bloated bureaucracy and reduced economic welfare. Not to mention excessive inequality. If reforms don’t address this, they are not “fundamental” and will not succeed in any meaningful way.

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