Don't Lower Corporate Taxes. Abolish Them.
Lowering the corporate tax rate appears to be all the rage. Donald Trump has promised a cut to 15 percent from 35 percent in the U.S., and British Prime Minister Theresa May has pledged to make the U.K.'s corporate tax the lowest in the G-20, which would mean taking it lower than Trump intends to.
On the surface, it looks as though international tax competition is heating up. Trump's move can potentially change the business logic of U.S. multinationals, which now prefer to stash international profits -- more than $2.5 trillion of them -- overseas. May's pledge appears to be aimed at making it more attractive to invest those profits in the U.K. It's difficult to calculate the exact effect of lowering the top-line rates, though, because hardly anyone pays them. Now that business-friendly governments appear to have some leeway, they should go back to the old idea of eliminating corporate levies and just taxing personal income and consumption.
In the U.S., according to the Treasury Department, the average rate paid by profitable companies with more than $10 million in assets is 22 percent, not 35. The U.K. doesn't calculate the average effective corporate tax rate for its companies. Early this year, however, an investigation by the Sunday Times turned up a stunning fact: six out of the country's 10 biggest multinationals, including Lloyds, British American Tobacco and Shell, didn't pay any corporate tax at all in 2014.
In the U.S., the U.K. and elsewhere corporate taxation is a crazy quilt of deliberate exemptions, accidental loopholes and, in some cases, special sweetheart deals (just ask Europe's competition commissioner, Margrethe Vestager, about Apple and Ireland). Because of everything companies do to game it, the tax distorts financial reporting and creates a lot of needless work for lawyers, accountants and tax agents, imposing a high transaction cost on business and society. It also leads to ugly, unfathomable corporate structures that abuse globalization. International bickering because of what is perceived as unfair competition is by now white noise at G20 meetings, where a lot of time is spent on international corporate tax harmonization.
At the same time, in part because of the widespread gaming and the plethora of exemptions, corporate taxes don't contribute much to national budgets. According to the Organization for Economic Cooperation and Development, the average contribution in developed nations is just 2.8 percent of gross domestic product. In both the U.K. and the U.S. it's even lower, 2.45 percent and 2.6 percent, respectively. In 1968, corporate taxes accounted about a quarter of all federal tax revenues in the U.S. today, that share has shrunk to less than 10 percent.
Perhaps because of corporate taxation's diminished importance, big changes to the headline rate are so popular: They look impressive in newspaper stories and election platforms, but they don't have a huge effect on the budget deficit. For example, the change Trump proposes -- from the effective rate of 22 percent to 15 percent -- would shave off just 0.8 percent of GDP in revenue.
The argument has often been made -- including by U.S. Treasury Secretary Paul O'Neill in the early 2000s and, more recently, by Libertarian presidential candidate Gary Johnson -- for abolishing the tax altogether. There aren't many arguments in its favor, and the strongest ones that exist are of a philosophical nature. "The corporate tax is justified as a means to control the excessive accumulation of power in the hands o corporate management, which is inconsistent with a properly functioning liberal democratic polity," Reuven Avi-Yonah of the University of Michigan Law School wrote in a 2004 paper defending the tax. "People understand that corporations are powerful and that the corporate tax is one way in which the state, as representative of the people, can limit their power."
Since Avi-Yonah wrote that, however, the growing offshore industry has made a travesty of that government function. It could be argued that the existence of a tax that countries cannot properly enforce is one of the factors undermining trust in governments and feeding populist movements.
There are other ways governments can keep corporations in check -- for example, through environmental, safety and labor regulations, which U.S. Republicans and Brexiters dislike but which ultimately benefit consumers in a way the corporate tax doesn't. There are also other ways governments can get the revenue -- for example, by paying more attention to private income from corporate dividends and pass-through entities, or the European way -- by placing an additional burden on consumption through a value-added tax. In the U.K., VAT contributes 10.7 percent of GDP to the budget. To compensate for the absence of a corporate tax, it would need to go up from 20 percent to 25 percent -- the level that currently exists in Sweden and Croatia, for example.
It may look unfair to tax consumers to compensate for a major business tax holiday -- but then such a move would give businesses a strong incentive to keep prices lower to avoid a drop in demand. Besides, liberated from corporate taxes, they'd have more freedom to increase wages. And the same time, there is a degree of fairness in imposing taxes where goods and services are consumed, and not where a company that sells them is domiciled.
The populist governments coming to power in today's political cataclysm need to deliver economic growth and benefits to the disenchanted workers who have brought them to power. One way to do it in a way everyone would understand would be to abolish the corporate tax. Once a major power does that, other countries would quickly follow.
As for the proposed cuts, they are hollow promises that sell the right-wing revolution short.
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