The US and
OECD countries should realize that high corporate taxes are not a painless way
to raise money: they creates an arms race in which companies either lobby
politicians for exemptions, or find a way of not paying it.
During the reign of
King Louis XIV of France(1638-1715), his then finance minister once said that “the art of taxation consists in so
plucking the goose as to obtain the largest possible amount of feathers with
the smallest possible amount of hissing”(Rothbard, 2010). When it comes to
taxing U.S. corporations, this should mean getting the largest possible amount
of tax revenue without discouraging
business investment and entrepreneurship. Unfortunately, available
published evidence has revealed that among the countries that made up the
Organization for Economic Corporation and Development(OECD), the United States
has the highest income tax rate. At 39.1percent, the U.S. corporate income tax
rate, which is a combination of the 35 per cent federal rate and the average
rate levied by the individual states, put its corporations at a competitive dis
advantage(Pomerleau & Lundeen, 2014).
Broadly speaking, those
countries that try to squeeze their firms too hard with high corporate tax
often have larger black market(or
informal market), which, in turn cause significant amount of economic and
political damage to their economies. Simply put, given that different
governments offer a choice of rates and ways of taxing businesses, high taxes
may lead companies to move to places that
offer more tax breaks, especially for activities such as prospecting for natural
resources, research and development. At a time when America is struggling to
generate economic growth, the politicians at Washington and state legislatures
too often behave as though the business sector is the enemy. Instead of
competing with other OECD members to
attract good companies and stimulate them to create jobs, innovative products
and revenues, they have tended to sought
their scapegoats more widely to include the finance sector, energy
companies and technology giants. These companies were often blamed for tax
avoidance and for being the begetters of inequality.
The American high
corporate tax regime seemed to have inspired copycats in Europe: In late 2012,
the executives from Amazon, Google and Starbucks were brought before a
parliamentary committee and berated for paying little in the way of profit tax.
Starbucks was so embarrassed that it promised to pay an additional amount of
tax that the committee deemed to be legally required in that country –
specifically an additional $32 million voluntary payment to the British tax
authorities(Bullough, 2012; Economist, 2014).
How Much is
Enough?
The unhappy truth is
that, even though companies in U.S. and
in other OECD countries, on average, pay more tax on labor(such as employers’
social security contributions) than on profits, it is still widely but wrongly
believed that the only tax they pay is corporate tax, which is the one levied
on their profits. According to the available published evidence, the average
global company, in addition to paying property taxes, sales taxes,
environmental taxes, and so on, also pays as much as 43.1 percent of its
commercial profits in tax, of which 16.1 percentage points is profit-related,
16.3 is labor-related and 10.7 are others(Economist,
2014).
Today, the tax revenue
from corporate profits of the OECD
countries, including the United States,
has declined since the economic crises. According to OECD figures, the average member country now raises about 2.7 per cent of the GDP in the
form of profit taxes. This is less than the pre-crises value of 3.5 percent
raised in 2007(Economist, 2014). Across the political and financial spectrum,
officials and experts agrees that the current value is probably just a
reflection of the lower profits being reported
by corporation since the crises, and not a structural shift. The upshot
is that this value seems to have held fairly steady.
A growing body of
evidence suggests that the current tax regimes in OECD countries including U.S.
were developed when global trade has a smaller share of the GDP: At the time when companies were more national in character and the local economies were
largely concerned with the exchange of physical products made and sold in
physical locations. But today, the trade arena has changed a great deal. From
an entirely practical standpoint, individual American states and most OECD countries are finding it difficult to impose
sales taxes in this modern economy that is increasingly and heavily
dependent on services and intangible
goods traded over the internet. This do
partly explains the decline in corporate tax revenue since the economic crises.
It should be observed
here that the three main approaches to taxing corporate profits include
residence(where the company’s owner lives), source(where the goods and services
are produced) and destination(where the goods and services are consumed). So, if an American company, for instance,
produces computers in a Chinese subsidiary which are sold in Britain, China is
the source, United States is the residence and Britain is the destination. The bottom
line is that all the three countries – America, China and Britain – can claim a
share of the tax revenues in this example. In this case, a sales tax or
value-added tax system would obviously focus on the destination which, in this
case, is Britain. In contrast, a tax regime that is based on personal income
tax that is charged when the shareholders receive dividends or make capital
gains, would raise money in the residence which, in this case, is America.
Finally, a profit based tax regime will concentrate on China, which is the
source. In a practical sense, the elements of all the three systems are being
used among the advanced nations of the world.
Given that the
subsidiaries of multinational companies trade with each other all the time, the
biggest challenge arise when it comes to deciding where profit is generated.
The main concern here is that, in order to maximize the profits generated in
low tax jurisdiction, subsidiaries in these jurisdictions may start
getting involved in activities that
would distort the market such as
overcharging subsidiaries in high tax countries – a practice known as
transfer pricing. To get around this problem thereby ensure that the prices are
similar to those a company might pay if dealing with an unrelated business, tax
authorities in America and other OECD countries
often ask for intra-company transactions to be made on an “arm’s-length”
basis. With standardized goods such as commodities, this principle is easy to
apply. However, it becomes much harder to apply when it comes to more
specialized products, such as a multinational retailer who uses a franchise system in which the
parent’s brand is considered to be an intellectual property. In this case, all
the individual franchises of the parent company – wherever they may be – are
obviously dependent on the parent’s brand and hence must pay a fee to the
latter for that privilege. Note that the
intellectual property of the parent company can also be held in a subsidiary
that is located in low-tax country – a perfectly legal way of reducing
the company’s tax burden.
Another legal way for
reducing the tax burden is to load up subsidiaries in high-tax countries with
lots of debts, with most of the loans borrowed from subsidiaries located in low
tax regimes. This approach will lower the affected company’s overall tax bill
because interest payments are tax-deductible.
The availability of the
above strategies, and the fact that many U.S. and OECD corporations are using them, has led to a
series of cat-and-mouse games as
governments try to crack down on such strategies and companies devise ever new
approaches to exploit tax rules to the full. Hence it is a self-evident truth
that the current corporate tax system in both U.S. and OECD countries have
resulted in both high compliance costs for multinational corporations as well
as a very high administrative costs for the tax authorities. In the U.S in
particular, the corporate tax system leaves a bad taste since it hobbles the country in global competition. In
addition, it does little or nothing to promote equality, which is considered to
be its original and still recited justification. Besides, it is rife with distortions
that erode efficiency – distortions that promises to get much worse in the
future(Institute for International Economics, n.d.; Economist, 2014). It would
be logical, therefore, to suggest that, the corporate tax system in these
countries is in urgent need of reform.
It should be
acknowledged that U.S.’s companies have not been sitting on their hands waiting
to be fleeced. One of the approaches
which many of them are adopting is to form business structures such as partnerships that act as ‘pass-through’
vehicles. A rise in these form of structures has become one of the biggest
change in U.S.’s corporate governance in 21st century. And such
structures generally avoid corporate income taxes provided that all profits are
remitted to investors each year. But, across the political spectrum,
politicians and experts agrees that this leads to a three-tier tax system:
First, the partnerships escape the tax on profits. Second, the multinational
corporations cut down their tax bills by shifting both production and profits to countries with low tax regimes. Third, the
smaller companies – the losers, since they have less room for maneuver – will be
left ‘carrying the baby alone.’
The Way Forward
These simple
explanations are easy to square with the fact that five of the ten biggest
worries of the small businesses are tax-related. From a practical perspective, the
tax code is bound to be more and more complex as governments try crack down on the multinationals’ strategies. There is a slight possibility that
time may help reduce the problem. With some governments lowering their tax rates
to attract multinational corporations, and with many businesses already
escaping the profit tax, the world may
very slowly be moving away from
corporate profit tax. Many scholars believe that it would be a sensible reform if corporate profit tax
is allowed to disappear altogether in, say, 50 or 100 years’ time.
The trickiest issue is
that countries may end up creating a new form of tax avoidance
if they abandon the profit tax in isolation. In every country, there’s
always people and corporations who are willing to take advantage of any
government policy, provided that they will gain from it. Thus, abolishing
corporate tax will give people the incentive to shelter their money in companies – an option that would, in the
long run, might undermine income tax. Because a profit levy acts like a withholding
tax, the loss of revenue might be
substantial if it becomes abolished.
Added to this problem of revenue loss is the fact that many shareholders,
including pension funds, might make no contributions at all to the revenue pool
since they are either based overseas(often in low-tax centers) or have a
tax-exempt status.
Both the United States
and OECD countries don’t find it funny
to be stuck in this spiral. Many of them do realize that, the corporate geese
that are plucked too much won’t just hiss: they will either fly away or they
will find a way of not paying it by lobbying for the best deals. For the United
States, the solution to the problem is simple: lower tax rates, few
exemptions, and a tax system that
focuses on individuals not companies.
References
Bullough
O. (2012): Coffee Break. Latitude.
Retrieved April 29, 2014 from http://latitude.blogs.nytimes.com/2012/12/12/after-avoiding-taxes-for-years-starbucks-has-become-a-target-for-london-protesters/?_php=true&_type=blogs&_r=0
Economist(2014):
Special Report – Companies and the State.
Retrieved April 29, 2014 from http://www.economist.com/news/special-report/21596667-relationship-between-business-and-government-becoming-increasingly-antagonistic
Institute
for International Economics(n.d.): Replacing
the Corporate Income Tax. Retrieved April 29, 2014 from http://www.iie.com/publications/chapters_preview/3845/5iie3845.pdf
Pomerleau
K., Lundeen A.(2014): The U.S. Has the Highest Corporate Income Tax Rate in the
OECD. Tax Foundation. Retrieved April
29, 2014 from http://taxfoundation.org/blog/us-has-highest-corporate-income-tax-rate-oecd
Rothbard
M.N.(2010): Jean-Baptiste Colbert and Louis XIV. Ludwig von Mises Institute. Retrieved April 29, 2014 from http://mises.org/daily/4540
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