Scrap archaic corporation tax now to avoid another fiasco over payments
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Politicians continually conflate and misunderstand the nature of corporation tax; it is not paid by corporations, but by shareholders, workers and customers, nor is it a tax on revenues. The shortcomings of the current framework include damaging unintended consequences for growth, investment and worker productivity; high related cost of administration and compliance, and incentives for tax avoidance by multinational firms. At the same time, globalisation and the growing importance of intangible assets further debase its reasoning, as this week’s EU ruling against Apple proves.
A new briefing from the Institute of Economic Affairs reveals the irrevocable problems with the current system and the flaws of the OECD’s latest BEPS proposals, going on to outline a clear and straightforward case for abolishing corporation tax in the UK.
The paper calls for the introduction of a tax on distributed income. This would improve the status quo without introducing new distortions – lessening the incentives for avoidance and raising revenue in a growth friendly way. Such a system exists in Estonia, which is recognised as the most tax-competitive country in the OECD.
Problems with corporation tax
- Corporations are legally liable to pay the tax but the economic burden is to a large extent borne by workers in the form of lower wages – a consequence of lower productivity as a result of lower capital investment in response to the tax.
- Whilst the evidence shows that workers bear a significant share of the burden of corporation tax, it is unclear whether this burden is shared proportionately among workers. It could well be that the less productive – and thus poorer – workers bear a greater burden, which would make the tax regressive.
- It is a hugely inefficient tax system that results in high administrative and compliance costs both for public authorities and the companies themselves.
- It discourages saving, impacts investment and therefore undermines long-term economic growth.
- It increases the scope and incentive for tax avoidance particularly for multinationals.
Why current proposals for reform won’t work
- The OECD package to tackle Base Erosion & Profit Shifting: Country-by-country reporting will increase compliance costs on multinationals. Moreover, the proposal only adds to the climate of regulatory uncertainty, which discourages investment and would make firms less likely to expand to new markets. Added complexity would hinder effective implementation.
- A turnover tax would mean that loss-making firms would face the same burden as profitable ones.
- A destination-based corporation tax could result in companies pulling out of operations in jurisdictions where their sales are large compared to their profit margins, harming consumer welfare.
- Formulary apportionment is a one-size-fits-all formula which does not account for the diversity between different firms and would penalise some firms and benefit others.
An alternative solution
For corporation tax to be beneficial it’s crucial that the principal distortion in the existing system, namely the use of corporate profits as the tax base, is overhauled. Replacing corporation tax with a tax on earnings distributed to shareholders would:
- Eliminate distortions in firm behaviour caused by corporate income taxation.
- Shift the tax base from a relatively mobile entity (corporations) to a less mobile one (individuals) therefore reducing avoidance opportunities.
- While there would still be some burden on workers, undistributed profits would remain untaxed.
- Together with this replacement for corporation tax, simplification of the tax code is necessary to avoid contradiction between tax policy and other objectives like economic growth.
- This system is in operation in Estonia, recognised as the most competitive tax system in the OECD.
Commenting on the report, author Diego Zuluaga, Financial Services Research Fellow at the Institute of Economic Affairs, said:
“Economic theory and evidence have increasingly shown corporation tax to be one of the most inefficient ways of raising government revenue. Yet, partly due to the fiction that it is companies rather than people – workers, shareholders, consumers – who bear the tax, meaningful reform has proven elusive.
“At a time of great change for the British economy, bringing our tax code into the 21st century is more important than ever. A competitive and growth-prompting tax system will enable the UK to fully reap the benefits of globalisation and technological innovation.”
Notes to editors:
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The full report, Why corporation tax should be scrapped, by Diego Zuluaga, can be downloaded here.
The mission of the Institute of Economic Affairs is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems.
The IEA is a registered educational charity and independent of all political parties.