Tag Archives: Corporation tax

Taxing multinationals – after the sound and fury we need solutions that work

Multinationals like Starbucks, Amazon and Google has been on the wrong end of publicity in recent weeks here in the UK.  They don’t seem to be paying very much corporate tax, in spite of well established and successful commercial operations here.  But there is something missing from the debate: nobody seems to be offering much of a solution to the problem of taxing multinationals.  There’s a lot of sound and fury, but it all ends in a bit of a whimper.  We can do better than that – but only by adopting policies the government’s Conservative members will be deeply uncomfortable with.

The problem is easy to see.  If a multinational makes something in one place and sells it in another (to take the simplest possible description of a multinational supply chain), then it has the opportunity to apportion profits to more then one place…and to manipulate this to where tax rates are lowest.  This has always been so, but with an increasing proportion of costs being attributable to soft things like intellectual property, this is getting much easier to do.  The traditional way of fairly attributing profit is through establishing a fair “transfer price” for goods or services as they move between countries along the chain – based on open market value.  The idea of open market value has always existed more in theory than practice, and the process often ends up in endless bickering between the company and the tax authorities of the various countries it operates in.  And in the end the results are often hard to justify.  What are the alternatives?  There are two main approaches.

The first approach is to reduce corporate tax rates to make the issue irrelevant, and along the way to make your own jurisdiction very attractive to investors.  This is not as crazy as it sounds, and has quite a respectable intellectual pedigree.  Companies aren’t people, and ultimately taxation is about people.  Taxes are charged whenever people try to extract money from a company, through salaries, dividends and what have you.  Money that is left in companies is reinvested, and taxing it merely reduces the amount available for reinvestment.  This is an example of the idea that tax should be based on expenditure rather than income and capital.  It encourages saving and investment, and most of the time economists think that economies would be healthier if more resources were invested rather than consumed.

This line of reasoning was very popular in the late 20th century, but has since lost much of its appeal, except amongst the very rich.  Something has gone wrong with the savings and investment cycle.  The amount of constructive, worthwhile investment that comes out of savings is not what economists used to think.  A lot disappears into various forms of financial engineering that fatten up an overpaid finance industry and not much else, inflating selected asset values into unsustainable bubbles along the way.  Overall savings, especially by the very rich, seem to be a drag on an economy – often requiring “negative savings” from government deficits to keep the economy on track.  This process was described by Maynard Keynes in the 1930s and it is still true today.

Low capital taxes, including company taxes, simply seem to exacerbate a growing gap between the very wealthy and everybody else, without generating the needed investment. Profit taxes have a particular attraction: they are economically efficient and do no distort ordinary business decisions, outside the allocation of capital.

So what’s the alternative approach to taxing multinational businesses?  This is what we should be talking about a lot more: the top down apportionment of profits.  Under this system you establish a business’s worldwide profits, and then apportion it to national jurisdictions by a formula which measures activity: a combination of sales, employees, pay or suchlike.  Those jurisdictions can then decide what rate they want to charge.

The idea of top-down apportionment has been developed for some time by US states for allocating profits between the states of that country.  In the 1980s California tried to extend the idea to global operations, but was forced to back down, mainly after furious international lobbying from our own British government.  There is a nice irony if American companies are now runiing rings rounds us British.

But that example shows the idea’s main weakness: it needs international cooperation to get going.  It helps if all countries are doing it, and using the same formula.  There is an obvious first step for the British government though: to agree and apply such a system to the European Union.  I don’t think there would be much difficulty in mobilising the other EU countries; Ireland, a traditional advocate of tax sovereignty, is not in a particularly strong bargaining position these days, and we can let them keep their low rates.  Once the EU has an agreed system for recognising and apportioning profits, we would then need a treaty with the US.  Since that country is already a wide practitioner, there is good reason to hope for progress there too.  With the EU and US on board, a global critical mass starts to build.

But Britian’s coalition government does not seem to be thinking along these lines.  For its Conservative members, no doubt doing deals on tax with the EU is anathema.  Instead they are happy to quietly go down the first route and cutting business taxes, in spite of little evidence that this is stimulating investment.  Of the Liberal Democrats, however, I had expected better.

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The budget – the coalition at its best

George Osborne is gradually cementing a reputation as an effective Chancellor of the Exchequer and skilful politician.  He certainly understands coalition politics and how to play for the longer term.  Yesterday’s was a very interesting budget.

There a two schools of thought about coalition governments.  One may be characterised as “lowest common denominator”: all the bold ideas are knocked out and we are left with a few messy compromises that lack any kind of coherence.  The second is the “natural selection of ideas”  in which the ideas of the various parties have to compete on their merits and the weak ones don’t survive, the sum being better than any party would produce individually.  Britain’s first post-War coalition, formed by politicians unfamiliar with how coalitions work, has seen both types of policy formation at work.

The coalition started well.  The initial policy programme was full of bold ideas, while dotty ones (cutting inheritance tax for example) did not make the grade.  But things soon degenerated, as activists on both sides sensed betrayal.  This was especially evident on the NHS, where we are left with a messy compromise that is almost certainly worse than either party would have produced on its own.  But the 2012 budget shows a reversion to the “natural selection” model, for which credit must go to both George Osborne and the Lib Dem leader Nick Clegg.

One of the interesting features of the budget has been the disappearance of budget “purdah” – the absolute secrecy surrounding budget proposals.  Mr Clegg made the early running in the media game with his bid for an acceleration of increases to personal allowances.  But Mr Osborne clearly understood this to be an opportunity rather than a threat – in this case to reverse the top rate of income tax of 50%, which until a month or so ago looked to be entirely off the agenda.  A few years ago the Lib Dems had a big conference battle over this top rate (before Labour introduced it, as it happens) and rejected the 50% – so there was evidently some Lib Dem ambiguity over the tax, which Mr Osborne was able to exploit.  And indeed world thinking has long since turned against such high marginal rates, even for the very rich.

Meanwhile, weaker Lib Dem ideas about how to tax the rich more efficiently did not make the cut.  This applied to the Mansion Tax on high valued property.  Such an idea (though based on land rather than total property value) appeals to theoretical economists, but has two major practical problems.  First is that property is not the same as cash, and that owners of such valuable properties may struggle to pay, and hence create a fuss.  The wider the scope of tax, the more of a problem this is.  The second problem is that it has to be based on a theoretical valuation rather than hard and fast fact.  This is one of those things that becomes more of a problem the more that you think about it.  Property (or anything else) is worth what you persuade somebody else to pay for it, which depends on many factors unique to the individuals taking part in the transaction and the time they make it.  A host of practical issues follow.  The eventual compromise of an increase in stamp duty for properties over £2 million, combined with a clampdown on stamp duty avoidance, looks like a much better idea to me.

The idea of limiting allowances to higher income people so that effective tax is no less than 25%, the “Tycoon Tax” – attributed to Mr Clegg in the proposal process, though not coming out of any Lib Dem official policy – also looks like a very sensible proposal – and this made the cut.

Mr Osborne was also able to push through further cuts to the main Corporation Tax rate.  I have some reservations about this: companies are sitting on too much cash – if they don’t invest it, then the best way of getting this wealth back into the economy is to tax it.  But there is logic to it to help retain footloose international capital, something that the country has been quite good at, but needs to stay in the game.  And it’s not as generous as it looks, since allowances have been kept in check.  In fact the big thing UK companies have been asking for is more generous capital allowances – but the footloose companies aren’t so bothered about this, and the Chancellor did not budge.  I’m not sure that capital allowances have been set at the most efficient level – but I do know that business leaders always ask for too much, and the game is often more about tax avoidance than real investment.

One idea was not leaked in advance.  This was the phasing out of the age-related personal allowances.  This “granny tax” has attracted most of the press attention this morning, with howls of protest that the Labour opposition are seeking to exploit.  Yet the reasoning behind this change is solid enough.  Pensioners have done pretty well under the reforms already implemented by the government, and this is a nasty, complicated piece of work.  Although it is true that many pensioners have been punished by the general reduction in the value of savings since the crisis began, this allowance is a bad way to deal with the problem.  What is actually needed is for the economy to return to health, so that we can get back to a real interest rate of about 2% or so from its current negative value.  It was brave to take on the pensioner lobbies like this, and Messrs Osborne and Clegg (to say nothing of the PM David Cameron) deserve credit.  Critics suggest it may go down as a fiasco like Gordon Brown’s cut of the 10% tax band, or the negligible increase to state pensions the last government implemented when inflation appeared to be very low.  Both were politically very damaging, to Mr Brown and to Tony Blair respectively.  But this policy does not create cash losers (denying benefits to those who haven’t got them yet – rather than taking them away from those that have).  It may even mark a turning point in the battle of the generations, as younger voters start to appreciate just how generous the state is to pensioners, and shift their ire away from the much less costly immigrants and benefit claimants.

The budget does nothing for macro-economists.  There is no bold, imperial stimulus to “get the economy moving”.  But nobody was expecting that.  Overall this budget is a credit to the Coalition government.

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Is cutting Corporation Tax good for growth?

Everybody agrees that the UK economy needs more growth, like pretty much every other developed economy.  On the right it seems to be taken for granted that cutting corporate taxes will help.  This view deserves to be challenged.

An example of the argument for lower tax rates is this one from Tim Knox on the LSE website, promoted by the conservative think tank CPS.  Mr Knox suggests cutting the main rate from 28% to 20%, while simplifying a lot of the deductions.  The logic is simple.  The economy needs businesses to invest and expand.  A high corporate rate of tax is a disincentive to do so; a cut in rates would give businesses a shot of confidence that would get them moving.

This line of reasoning is not nonsense – and his ideas for simplifying the system on capital allowances and capital gains may make sense, though would be fiercely contested by lobbyists.  There is a lot nonsense talked about corporate taxes.  Companies aren’t people, and the payments companies make to people are taxed as employment or investment income.  There is quite a cogent argument (a classic essay topic for undergraduate economics students) that companies shouldn’t be taxed at all – though this would certainly open up opportunities for tax avoidance.

But a different way of looking at the predicament of the UK economy comes from Martin Wolf in the FT (paywall, I’m afraid).  He points out that one of the macroeconomic problems with the UK economy is the large value of the corporate surplus – in other words businesses are making too much profit and not spending enough.  He agrees with Andrew Smithers of Smithers and Co who published  a report entitled “UK: Narrower Profit Margins and Weaker Sterling Needed”.  Mr Wolf does not advocate raising corporate taxes, but he nevertheless poses an awkward question for those who advocate a cut.  The basic macroeconomic problem for the UK is that the government deficit is too high and its mirror image is a corporate surplus that is also too high.  Going back to Year 1 Economics, you can’t cut one without cutting the other (not entirely true, but the alternatives involve private individuals getting even more indebted, or an unrealistic export surplus).  How on earth does cutting corporate taxes help, without using voodoo concepts like the Laffer Curve?

In fact economically corporate tax is one of the more efficient ones in microeconomic terms – it does not distort incentives as much most other taxes, because it is based on profits, not inputs or outputs.  It amounts to a tax on capital – but capital is already having it very easy in the world economy, one of the drivers of increased inequality within nations (as opposed to between them…).

Strategically we should be thinking of more ways of taxing companies, on the basis of “use it or lose it” – it isn’t healthy for companies to sit on surplus profits.  A logical way would be to raise the tax rate but make dividends deductible – but this is probably a nightmare in practice.  Another idea is to cut the tax relief for debt interest – which would help restore the balance between debt and equity funding.  In the long term this would no doubt be very healthy and discourage companies from becoming over-indebted; in the short run it would be a bit like bayoneting the wounded after the battle, so implementation would need a great deal of care.

But even if either of these ideas look impractical, the argument for cutting the tax rate looks distinctly weak.

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