The US Republican company tax reform might be a good idea

I like to see the bright side. With the accession of Donald Trump as US President, alongside the Republicans controlling both houses of Congress, that is hard. Mostly, I simply hope that the process of challenge will make liberals stronger and harder. There is too much complacency in liberal thinking. And there is more cosying up to vested interests than we might like to think.

And among the flood of bad ideas coming out ot the new administration, there may be the odd good one. Reforming company tax might be one of them.

What I am thinking of are the plans proposed by Paul Ryan, the Speaker of the House of Representatives.  Liberals should support it, though alas many won’t because of who is proposing it, rather than its merits.  One part of the plan is to cut the rate of company tax to 20%, but reduce the number of deductions. This is an old debate. I am sympathetic to lower marginal rates and fewer deductions, though 20% is aggressive. I do not share the view that company profits should not be taxed, and that the burden of taxation should entirely be on distribution of profit instead.

There’s another old idea in the mix too: 100% write off of capital investments in the year the money is spent. Older British accountants like me will remember that we had that system here in the 1980s – called 100% capital allowances. It was the basis of many a tax avoidance scheme, and perhaps tilted the balance too much in favour of investing in plant rather than people. But there is some merit to it.

But the really interesting idea is the so-called “border adjustment”. This exempts from tax sales outside the US, and disallows as deductions spending on imports. This can be painted in different ways. To nativists this sounds like encouraging exports and discouraging imports. Alternatively it can be presented as a sort of value-added tax, which is well-established here in Europe. Neither presentation does it justice. It is not VAT, not least because the costs paying people is within its scope. And its effect on corporate incentives can be beneficial to the world economy rather than detrimental. It amounts to a constructive proposal to deal with a major problem: the taxation of transnational businesses.

At the moment companies are taxed by the location of profits, apportioned “fairly” using general accounting principles. This falls foul of manipulation through transfer pricing – what country-level subsidiaries within a transnational business charge each other. Thus when a multinational sells you something in Britain, it may treat as part of its costs the use of intellectual property based in a low tax regime, such as the Netherlands or Luxembourg. National tax authorities have been fighting a losing battle against abuse. The G20 recently adopted some new rules to reduce abuse, but this is sticking plaster to repair a fracture. It is best seen as an attempt by corporate lobbyists to stave off more radical approaches.

One such radical approach to reform corporate tax is unitary taxation. This method means that tax authorities assess a business’s global profit, and then allocate it to country based on the location of some combination of sales, employment or property. This is how US states tax the profits of US businesses, mostly allocating them using the Massachusetts formula. I have been advocating this for years internationally, but I have unable to persuade even the Liberal Democrats to pursue the idea.

Mr Ryan’s border adjustments are an alternative idea, and look simpler. In essence corporate taxes would be based on the location of revenues – something that would not be easy to distort. So, applied in the UK, Amazon or Starbucks would not be able to use spurious intellectual property charges to relocate profits to tax havens. Overall the scheme favours countries that have trade deficits (like the UK or US) rather than surpluses (like Germany or China), but that is no bad thing.

And probably unilateral action by the US is the only way much is going to happen. Multinational forums like the G20, and even the European Union, have completely failed to deal with this problem. Only the US has the power for unilateral implementation. Where it leads, others will be forced to follow. And post-Brexit Britain should be able to follow quickly.

Alas the power of corporate lobbyists in our democracies remains massive. They are masters of quietly undermining radical ideas and promoting “compromises” that have only superficial effects. Mr Trump is a sceptic, and that’s a very bad start. The hope must be that Mr Ryan will get his way in the inevitable horse-trading between the presidency and congress. Mr Trump may be sceptical, but he is not strongly against it either.

But even if this reform attempt fails, I hope that liberals everywhere will take on the challenge of corporate tax evasion with a radical approach, such as border adjustment or unitary tax. Alas I am not optimistic.

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4 thoughts on “The US Republican company tax reform might be a good idea”

  1. The ease of transfer pricing in the modern era means that the traditional model of corporation tax as we’ve known it is effectively unworkable. For most multinationals it’s a voluntary tax.

    So how to get by without it? We need to start by appreciating that government’s don’t need taxation revenue to spend. Government’s tax to give a value to their currency and prevent inflation. One of the big tax avoiders is Apple. If we buy a phone in, say, Australia, it will be made in China and shipped to Sydney. But the paper invoicing will take us via Apple in Ireland where corporation tax is much lower than it is in Australia.

    So Apple (Australia) may just about break even whereas Apple (Ireland) makes the profits. So how should the Australian govt respond? Effectively Australian dollars which could have been collected by the Aussie taxman are ending up in Ireland. In the short term it doesn’t make that much difference to Australia. If those dollars aren’t being spent by Apple they can be spent by the Aussie government without causing inflation.

    In the longer term, though, people tend to worry that the government’s debt is growing. Apple have a cash pile of some US$200 million. It won’t really be in cash. It will be held by the banks who will have bought government bonds denominated in different world currencies.

    So there needs to be a switch from taxing profits to taxing spending and wealth. If we are just interested in tacking inflation then we can forget about wealth. Taxing wealth only comes into it when we want to reduce inequality.

    So going back to our example it could make sense for the Australian government to have a zero rate of corporation tax. That would then mean it would make no sense for Apple to use transfer pricing via Ireland. But on the other hand there would need to be an increased tax on each phone sold. The end price to the user wouldn’t necessarily be any different.

    1. PS That should be £200 billion. Not million.

      PPS A very simple and effective wealth tax is inflation. 5% inflation seems too high now but in the post war period when capitalism was working reasonably well for everyone, inflation was relatively higher too.

      It introduces an element of use-it-or-lose-it to the cash hoarders. We need to find a way of tackling wealth inequality as proposed by Piketty . But that’s a lot harder than it sounds. Nothing works better than inflation!

      1. Spoken like a classical economist! Most Anglo-Saxon economists are more than relaxed about inflation. Some even want to raise the central bank targets, as if that would make much difference. A child of the 1970s, I am sceptical. I think inflation “taxes” the wrong people. The rich have plenty of strategies with which to thwart it and avoid consuming when they don’t want to (using other currencies or equities or real estate, etc.), so it’s the same old people in the middle that have their wishes to save up for later or for big purchases thwarted by the fat cat elites who run the government and central bank.

        I exaggerate for effect, but I do feel that the government’s huge powers over the currency, which you celebrate, are part of a social contract, which includes preserving the currency’s value. Inflation can produce a powerful political backlash, perhaps bigger even that unemployment, and we theoretical economists ignore that at our peril. And so it should.

    2. PPPS I hate unnecessary apostrophes in plurals but I’ve just noticed that I’m guilty myself with “government’s” 🙁

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