Let’s abolish corporation tax
31 March 2016
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Government and Institutions
Lifestyle Economics
Economic Theory
The lack of meaningful reform of business taxation is one of the great failures of recent governments. But with public pressure mounting, MPs will soon have to move beyond headline-grabbing at parliamentary grillings and consider the future of corporation tax.
We could of course muddle along and carry on taxing profits, perhaps gradually lowering the headline rate to align it with more competitive economies like Ireland. “An old tax is a good tax” goes a dictum among economists. Keeping things as they are enables people to plan confidently on the basis of current rules.
Yet it is likely that maintaining the existing system would have more costs than benefits. For one, corporation taxes discourage capital investment by lowering returns, which makes workers less productive, with long-term consequences for wage growth. Profits taxation encourages capital to move elsewhere, both because it makes the UK less attractive as a location for “real” economic activity and because it creates incentives for avoidance through complex business structures.
Half-hearted attempts to overcome these problems have played a key role in turning the UK tax system into the world’s most impenetrable. They have also poisoned the political debate, breeding contempt for business and undermining the public’s confidence that elected officials have their back. Given this resentment, it is likely that some change will be attempted – but what form might it take?
One option is to move in a more interventionist direction. Politicians could decide that it is more important to raise revenue than to encourage productive investment. To do that, they could radically change the way in which payable taxes are calculated, for instance by using a formula based on assets, staff and sales in each country where a company operates. Or they could use the location of customers as a proxy for determining where taxes should be paid – the so-called destination principle.
This would be a dramatic break with the past. It would end the long-standing principle that taxes are paid where value is created, rather than where sales are made or where the clerical staff work. But interventionist reforms could have damaging unintended consequences. A destination-based tax might well lead companies to stop selling in high-tax markets, to the detriment of consumers. And as far as the tax formula is concerned, can we really trust officials to come up with a calculation that is suitable for firms in many different sectors, with disparate cost and business structures?
It’s not even clear that these interventions would solve the avoidance problem. What would prevent firms from playing with intra-company sales to minimise payable taxes in high-tax countries? Would there really be no opportunities for arbitrage depending on how the tax formula was designed?
So, what could be done instead? We could move away from taxing profits at the company level, and towards taxing dividends. Note that this reform would still achieve the original purpose of corporation tax, namely to tax income from capital, but without the damaging side effects on investment and worker productivity.
Estonia, whose tax system has repeatedly been named the most competitive in the OECD by the Tax Foundation, already operates such a system. For practical purposes, taxes are withheld at the firm level, but only distributed profits – dividends – are taxable.
There’s no reason why the UK could not implement a similar reform. Importantly, while it would work best when coupled with a wider simplification and lowering of the tax burden, it could be designed to be revenue-neutral and may even raise additional revenue through higher personal income tax and VAT receipts, among others.
The controversy around corporation tax is a chance to move away from the complexity and opacity of the status quo. It should be seized. We need a more rational and honest way of taxing capital income based on the unavoidable fact that only people pay taxes.
Diego Zuluaga is the IEA’s Financial Services Research Fellow and Head of Resarch at EPICENTER. This article was first published by City AM.
We could of course muddle along and carry on taxing profits, perhaps gradually lowering the headline rate to align it with more competitive economies like Ireland. “An old tax is a good tax” goes a dictum among economists. Keeping things as they are enables people to plan confidently on the basis of current rules.
Yet it is likely that maintaining the existing system would have more costs than benefits. For one, corporation taxes discourage capital investment by lowering returns, which makes workers less productive, with long-term consequences for wage growth. Profits taxation encourages capital to move elsewhere, both because it makes the UK less attractive as a location for “real” economic activity and because it creates incentives for avoidance through complex business structures.
Half-hearted attempts to overcome these problems have played a key role in turning the UK tax system into the world’s most impenetrable. They have also poisoned the political debate, breeding contempt for business and undermining the public’s confidence that elected officials have their back. Given this resentment, it is likely that some change will be attempted – but what form might it take?
One option is to move in a more interventionist direction. Politicians could decide that it is more important to raise revenue than to encourage productive investment. To do that, they could radically change the way in which payable taxes are calculated, for instance by using a formula based on assets, staff and sales in each country where a company operates. Or they could use the location of customers as a proxy for determining where taxes should be paid – the so-called destination principle.
This would be a dramatic break with the past. It would end the long-standing principle that taxes are paid where value is created, rather than where sales are made or where the clerical staff work. But interventionist reforms could have damaging unintended consequences. A destination-based tax might well lead companies to stop selling in high-tax markets, to the detriment of consumers. And as far as the tax formula is concerned, can we really trust officials to come up with a calculation that is suitable for firms in many different sectors, with disparate cost and business structures?
It’s not even clear that these interventions would solve the avoidance problem. What would prevent firms from playing with intra-company sales to minimise payable taxes in high-tax countries? Would there really be no opportunities for arbitrage depending on how the tax formula was designed?
So, what could be done instead? We could move away from taxing profits at the company level, and towards taxing dividends. Note that this reform would still achieve the original purpose of corporation tax, namely to tax income from capital, but without the damaging side effects on investment and worker productivity.
Estonia, whose tax system has repeatedly been named the most competitive in the OECD by the Tax Foundation, already operates such a system. For practical purposes, taxes are withheld at the firm level, but only distributed profits – dividends – are taxable.
There’s no reason why the UK could not implement a similar reform. Importantly, while it would work best when coupled with a wider simplification and lowering of the tax burden, it could be designed to be revenue-neutral and may even raise additional revenue through higher personal income tax and VAT receipts, among others.
The controversy around corporation tax is a chance to move away from the complexity and opacity of the status quo. It should be seized. We need a more rational and honest way of taxing capital income based on the unavoidable fact that only people pay taxes.
Diego Zuluaga is the IEA’s Financial Services Research Fellow and Head of Resarch at EPICENTER. This article was first published by City AM.
15 thoughts on “Let’s abolish corporation tax”
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What is it with the IEA recently? There’s been a shift from Classical Liberalism to Keynesian.
Diego – “So, what could be done instead?”
Thomas Sowell “No matter how disastrously some policy has turned out, anyone who criticizes it can expect to hear: “But what would you replace it with?” When you put out a fire, what do you replace it with”
“Our empirical analysis suggests that 1 percentage point cut in the corporate tax rate is related to a 0.1-0.2 percentage point increase in the annual growth rate.”
– http://ntj.tax.org/wwtax/ntjrec.nsf/175d710dffc186a385256a31007cb40f/d2eeb9d5f1d7f7ea85257a6f00551c60/$FILE/A03_Ferede.pdf
“This paper finds that the corporate tax rate is significantly negatively correlated with economic growth in a cross-section data set of 70 countries during 1970-1997, controlling for many other determinants of economic growth.”
– http://www.washingtonpost.com/blogs/wonkblog/wp/2013/06/05/corporate-taxes-dont-cause-recessions-but-they-do-hurt-growth/
Kevin Hasset and Aparna Mathur of the American Enterprise Institute examined 72 countries over 22 years and found that on average, a 1% increase in the corporate-tax rate is associated with a 0.8% drop in wages over the next five years after controlling for other relevant macroeconomic factors.
– http://www.aei.org/papers/economics/fiscal-policy/taxes-and-wages-paper/
“Corporate income taxes can be expected to be the most harmful for growth as they discourage the activities of firms that are most important for growth: investment in capital and in productivity improvements.”
– https://www.kent.ac.uk/economics/documents/research/papers/2009/0925.pdf
Corporation tax should be abolished yes. Should it be replaced with another tax? Most definitely not, only someone who didn’t believe in free markets would say so.
The IEA is renowned as a free market think tank, can we please stop we the progressive socialist blogs? Otherwise you’re part of the problem.
It is difficult to have much confidence in the people responsible for the present British tax system or in their success in continually messing about with it. I remember many years ago, when the question of investment incentives for corporate capital investment was being considered, it turned out that most companies — in trying to evaluate the prospective profitability of capital investment projects, looked at BEFORE-tax profits (or cash flows), not after-tax. So all the rigmarole of fiddling about with rates of investment allowances, grants, or whatever, was largely futile. It’s now more than half a century since Jim Callaghan introduced the new Corporation Tax and Capital Gains Tax. How time flies when you’re wasting so much of it trying to keep up with all the incomprehensible alterations to the tax what-for-want-of-a-better-word I’ll call ‘system’.
anonymous – you might be an anarchist and believe in no taxes whatsoever. If so, then your comment is fair. If not, then there is a reasonable debate to be had about where you might levy taxes to raise the 5-20% of GDP most classical liberals might believe is necessary for the government to perform certain function. Within that debate, it is perfectly reasonable to argue that returns to capital should not be taxed at all (for various reasons) or that there should only be a poll tax (for efficiency and even fairness reasons). However, it is also not unreasonable to argue -as Diego has – that all forms of income (from labour, land and capital) should be taxed in the same way and that corporation tax should be replaced by a tax on distributed income.
A Corporation is merely a legal entity setup for operational and financial efficiency. The fact that some legal entity should have to pay tax at all is absurd. After all, this entity doesn’t claim healthcare or pensions and isn’t (or shouldn’t be) entitled to state funds either so why should it have to pay tax at all?
Besides, a corporation usually hires thousands of people, all of whom pay tax. Also, let’s consider what a corporation does with its profits?
– It ploughs back part of its profit to grow its business, creating productive jobs in the process.
– The remainder is paid out as dividends to its shareholders, majority of who are basically pension funds starved for yield in a zero interest rate world.
Lastly, the price of products sold is set usually reflecting some sort of profitability ratio on a post-tax basis. Hence any increases in corporation tax in simply passed on to the consumer of those products who is already using his or her post-tax income to purchase those products in the first place. Although a part of the cost is borne by the company’s shareholders as well. Add to this the VAT collected on almost everything, another massive cost to consumers. Add to this the massive amounts paid in business rates to local councils. There is also the hidden cost of compliance and regulation that is also borne by consumers but that’s another story.
From a logical standpoint, if corporation tax is abolished, I can see the case for treating all dividends as regular income. However, from a practical standpoint, how long will it be before they bring back corporation tax because these companies need to pay their ‘fair share’? Needless to say that at that point, dividends will be taxed as income.
Call me cynical but when I hear the words ‘tax reform’, I see it as a way for the state to raise effective tax rates for everyone while further complicating the tax system.
What implications does this have for revenue raising when we think of companies like Google, Facebook and Amazon. There are no UK dividends to be taxed. Of course they do their best to avoid Corporation Tax, but at least that is something you can act on.
It always annoys me when others do not pay enough taxes. So unfair….
Yes, let’s abolish corporation tax by all means!
But no, let’s not replace it at all.
Simply discontinue all the pointless state activities that it finances.
Corporation Tax is a farce anyway, because in the end all tax is paid by individuals.
This tax just allows the state to pretend that individual taxation is less than it really is (“National Insurance” is part of the same con trick).
@ Metatone –
These companies do not claim pensions, healthcare or welfare from the state so why should they have to pay taxes in the first place. Add to this the large amounts in business rates paid to local governments and VAT collected on sales. Besides, they are even paying to use the infrastructure in proportion to their usage.
Companies like Google, FB and Amazon hire a lot of people within the UK and each of these individuals pay personal income tax. These are people who are financially independent and not living on public funds as a result of these companies. The British public should be more grateful to them for creating net tax payers into the system.
There are UK pension funds that do own a stake in these corporations but the percentage is small relative to those held by American investors. However, these companies were formed in the US and have grown their businesses from the profits generated within the US. These companies have provided value to their customers out there and are now simply looking for a higher return on their capital and are setting up offices around the world to satisfy the needs of other markets. No one is stopping local companies from doing the same.
The government goes into debt in the name of creating jobs. Why not let these companies keep more of their own money so that they can grow their businesses and create more productive jobs?
@anonymous- we can’t just ignore the fact that it is necessary to maintain the social state. Abolishing the corp tax would divert resources away from health, education and other re distributive schemes; leading to a reduction in the effective demand needed for firms to justify job creation and capital investment you talk about. So, abolishing corp tax would simply mean a greater share of retained profit paid out as dividends and compensation. Without the tax, corps would become an engine for driving greater inequalities within our society, not just a means of financial efficiency.
@ TJ – The private sector is very capable of satisfying the needs of all individuals. After all, health and education are basic needs and there will always be demand for these services at the right price. How does the state know how much needs to be allocated to these sectors anyway.
As for healthcare, why can’t there be a health insurance based system in the UK, the way they do in parts of Europe. That way everyone gets some basic cover and then is free to top-up if they want to.
As for schools, people have major stake in the future of their children and would always want to get the best possible education for their children but not necessarily at £6,000/term. Most of the developing world have plenty of low cost private schools that provide a decent enough service to millions of students. Even a school voucher system would be a big step up over the current system.
I would say that food is far more important to people than schooling yet I hope no one wants the state to nationalize all the farmland in the country cause if they combined nationalization with restrictions on outside food entering the UK, there would probably be a famine in the UK.
The point is that the government is simply a group of people who control the use of force over an area. They certainly don’t know how scares resources should be allocated and what products are needed in what quantity, of what quality, and at what price. Price is the FAIREST way to allocate a scare resource and all the government does is stifle the pricing mechanism of the free markets, leading to a misallocation of resources.
@anonymous – all fine in theory, but the common theme among UK public services is actually very simple: we need more. We need more resources to meet a growing need; for purposes that are essential but not necessarily profitable. Once these services become normal goods they exclude huge swathes of society. So privatising them won’t solve the problem of excess demand they will simply worsen it. Again, taxes such as corp tax are needed to maintain the social state, otherwise we risk damaging these sectors essential to our economy.
@ TJ
Pubic services should reflect the tax payer’s ability to pay for those services. The public needs to know that they do not have a RIGHT to tax-payers money or services and that there is a cost associated with those goods/services that have to be paid for by taxpayers. The problem is also that the state has used deficit financing to fund a lot of projects and has used accounting gimmicks to hide the real cost of unfunded liabilities and implicit guarantees. It’s also a problem with the way democracy is practiced in large parts of the world today. It’s based on this idea that individuals have no rights and that a large group of voters can use the state to take from others justly obtained private property as though they have no rights at all. We need to move towards John Loch’s interpretation of the social contract rather than Thomas Hobbes’.
If the goal is to simply ensure almost everyone has access to certain public services, then there should be some basic level of service for everyone in line with what the taxpayer can afford (funded through honest taxation, not debt) and then people can choose to top-up those services if they wish. This could be funded through VAT alone. The health insurance solution to healthcare is already in place in many countries and is the inevitable future of the NHS. There isn’t enough money in the world to fund the NHS as it currently stands. Taxing corporations isn’t going to change anything. The NHS is currently run as a jobs program, especially for middle and back office staff, and it’s much cheaper to have these people claim welfare than have them think they have a real job.
As mentioned earlier, the whole point of a price based system is to ration scarce resources efficiently and higher prices actually signal entrepreneurs to increase supply of those particular goods/services. Without a price system, you can only have chaos.
@ anonymous – sorry to say this but there is a sincere lack of understanding here. Let’s talk about the price mechanism; it is problematic to describe prices as some pervasive welfare maximising market force because plain and simple, prices are set by firms themselves. They react to higher demand normally by increasing price and quantity supplied. Those who can’t afford the new prices are left to wallow and die from preventable diseases, as in the case of an private, insurance based health service. Importantly, when a crisis hits these innovative, dynamic firms are left with their ***** in their hands as suddenly no one can afford healthcare and the business becomes unprofitable as prices plummett. This is where we have ‘total market failure’; there ceases to be a market for healthcare. With a government service these pro cyclical aspects are eliminated, everyone has healthcare all of the time. Aside from this, you mentioned the public dont have the RIGHT to taxpayers money; the taxpayers are the public so of course they have the right to their own money. You said the problem with many democracies is the lack of individual rights to private property, but it is fair to say sacrificing this in the absolute sense in order that we all have equal opportunities to pursue a full and healthy life through access to education, health and security (full access not present if left to the free market), is a fairly good idea. In terms of the fact that our NHS is funded through deficit spending, this is largely as a consequence of the strength of the economy at any point in time, so there is a similar pattern even in the united states which is largely an insurance based system. And don’t say ‘justly obtained private property’, I don’t think I need to go there.
I love the use of the whole – Taxpayer is the public and hence has a RIGHT to their own money. That line really made me smile :). If I may pay 10K in taxes over my lifetime but if I receive 100K in benefits then I have actually consumed 90K worth of taxes. I am in fact a net tax recipient and haven’t paid any taxes at all. Hence I may have a right to 10K worth of benefits but NOT to 100K worth of benefits. That’s the difference. Unfortunately, a very large percentage of the population are net tax recipients over their lifetime. Hence they don’t have a RIGHT to other people’s money even though they think they do.
Your statement reminded me of the whole Keynesian line about how debt doesn’t matter because we owe it to ourselves. Well…if we owe it to ourselves then why don’t we repudiate it to ourselves as well??
Also, I noticed that you’re a fan of John Rawls and the whole concept of equality of opportunity. For starters, if you truly wanted to achieve this then you are basically advocating destroying the entire family unit because some parents will always give their kid an advantage over others, even with a 100% inheritance tax. Really hope that’s not what you’re advocating. Besides, genetic differences will always lead to some people becoming much more successful than others.
Maybe you need to spend a bit more time educating yourself on how the economy works and the role that the price system plays in allocating scarce resources. While you’re at it, you can also read a non-statist version of how property rights come about. I recommend the Mises Institute and Murray Rothbard’s For a New Liberty in particular. It’s a fantastic site with loads of books/videos covering most of these topics we are discussing and best of all, it’s absolutely free.
Lastly just want to point out that even now on the NHS, certain treatments are rationed either by postcode or by panels that decide whether you are eligible for certain types of care. So you cannot get ALL the treatment you need and a lot of people are left to die so don’t make it out like the system is perfect right now. The system I’m proposing costs would work better and cost a whole lot less though I do admit it’s not perfect either.
I’m done.
Please don’t attack a different argument to the one I was making, of course I don’t believe debt doesn’t matter and of course some are more naturally gifted. Acting as though there are only two extremes of this debate excludes the more sensible options as i proposed. And i thought it was needless to say the whole economic consensus is behind me. The price mechanism does not always lead to the efficient allocation of resources, especially in the case of public services. It is far too easy to fetishise the phrase because essentially it is the same as maximising social welfare, which cannot be accomplished through the free market in itself, exemplified by the economic experiments during the reign of Pinochet in Chile. Social welfare will never be achieved by letting wealth become ever more concentrated, those who accumulate more and more will simply gain less and less in terms of the benifits derived, that those who have accumulated nothing.