Shaxson's ten reasons for corporation tax, part deux

Posted by Christie Malry on March 15, 2011 at 11:32 pm

OK, back in front of a real computer, so I can spend a bit of time doling out a proper beating to Nick Shaxson's article 10 reasons we should tax corporations.

So, here we go, here's an in-depth analysis of why I think each of his ten points are stupid:

1) Corporate profits depend on tax-financed public goods: healthy and educated workforces; good infrastructure; publicly enforced respect for contracts and property rights, and so on. When corporations avoid or evade tax, legally or illegally, they free ride on the backs of the rest of us. Stop taxing them, and you savagely undermine political community.

Ordinarily when you prepare lists of this sort, you would try to put your strongest point first. So Shaxson has thrown us a curveball by starting with this one. It's designed to tweak the heartstrings of even the most cold hearted of capitalists. But it's nonsense. Corporations can no more "free ride on the backs of the rest of us" than bananas can. Corporations aren't people.

Now, there's a case to be made that we should aim, as far as is humanly possible, to tax every form of economic activity. But that's not what he's said. He thinks people free-riding can 'savagely undermine' community, which is a curiously right-wing notion.

2) Corporation taxes are an essential backstop to personal income tax. Cut them to zero, and wealthy individuals will increasingly reclassify their earnings as corporate income, typically using offshore corporate structures, and escape tax. Gauke's arguments about employees footing the corporate tax bill are irrelevant.

The UK rules on residence and domicile are a bit of a mess. This is partly deliberate, because politicians like to entice rich people to come live here and bring their wealth with them. The price to be paid is an acceptance that they'll maybe pay a lower rate of tax, but because they're richer they'll still end up paying more tax overall.

Hence the rules that someone who is not domiciled in the UK could, until quite recently, pay UK income tax on their UK-sourced income only but pay UK income tax on their other earnings only when remitted to the UK. The government is continuing a plan introduced by Labour to make this remittance route more costly.

Anyone who is resident in the UK and is domiciled in the UK must pay UK tax on their worldwide earnings. If they don't, it's evasion.

So, with that bit of groundwork done, what's Shaxson saying here? He's worried that, without a corporation tax, people will squirrel money away into companies and get that money untaxed. But for UK residents/domiciles this doesn't work. They would still get taxed on the money when they sought to extract it from their company. If they don't declare income they're receiving from overseas sources then that's evasion. The UK government is doing all sorts of deals with other countries to get information about accounts held by UK citizens, in order to ensure that they're being taxed properly.

If they're not UK domiciled then there's possibly more of a problem, but it's a problem that can be solved with enough resolve. A withholding tax on dividends, as would disallowing interest on loans to companies in 'unfriendly' overseas countries.

3) Gauke's claim of a "consensus among economists" that the burden of corporation taxes falls on employees and not on capital owners, is false. The US Congressional Budget Office said last week that it was "unclear" how much of the corporation tax burden fell on employees; earlier, it said that capital bore most or all of the corporate tax burden. The Institute for Taxation and Economic Policy (ITEP) in Washington said this month that the incidence of corporate tax fell mostly on capital owners, not employees. It added that corporate income tax was among the most progressive taxes, because stock ownership was heavily concentrated among the wealthiest taxpayers. This is an especially precious tax.

Gauke's basing his claim on the excellent work of Professor Michael Devereux at the Oxford University Centre for Business Taxation. Instead of reeling off a list of people who don't disagree, it would be better if Shaxson could deal with the flaws in Devereux's method.

4) When Gauke talks about "employees", who does he mean? Goldman Sachs employees earned $430,700 on average last year. To the extent that the burden falls on them, taxing such firms makes the tax system more progressive. It would also cut into excessive bank remuneration, which has been a big factor in the recent financial crisis. Taxing financial corporations also curbs the "too big to fail" problem where large banks can hold governments hostage and shift losses on to taxpayers.

So, having argued in (3) that he doesn't believe Devereux's conclusions, he then decides that he does, but that he likes the symptoms anyway. Arguments (3) and (4) are mutually inconsistent.

Taxing financial institutions quite clearly does not curb the 'too big to fail' problem. Government pockets the juicy tax revenues then blames the banks when they screw up.

5) If corporation taxes didn't fall on the owners of capital, as Gauke claims, then corporations, responding to shareholders' wishes, shouldn't mind being taxed. So why do they spend so much time and money designing tax avoidance strategies?

Because managers, which run companies on behalf of shareholders, do bear some of the burden of taxation because they're employees of those companies. Keep up at the back, Shaxson!

6) Limited liability companies are separate legal persons, greater than the sum of their parts. So they should be taxed separately: this is not "double taxation". Limited liability lets shareholders dump costs on to society when things go wrong. Corporations must pay for this privilege.

This is a distortion of history. Limited liability developed as a way to incentivise entrepreneurs to undertake risky prospective projects. Without entrepreneurs, a great deal of economic output would simply never happen because some of them would be terrified that they might lose their assets, their houses, their livelihoods. Limited liability allows them to partition their business and personal lives. An unfortunate downside is that it can allow directors to ditch a failing company and leave creditors or society in the lurch. That's why we have lots of laws around how directors should behave when their companies might be in trouble.

7) Many corporations earn what economists call rents. These – like oil money that flows effortlessly into Saudi or Kuwaiti coffers – are earnings that arise not from hard work and real innovation but from accidents of nature or good fortune. Adair Turner recently explained how banks in the City of London are particularly adept at earning rents, such as from exploiting insider knowledge and expertise; from natural oligopolies in market-making and other activities; and from "valueless" trading activity. Economists since Adam Smith – including Turner – have advocated taxing rents especially hard.

This point isn't made very convincingly. Sure, rents are bad, m'kay? But enormous amounts of value from oil accrues to, well, Saudi or Kuwaiti sheiks. They're the rent seekers. The oil companies which help them pump the stuff out of the ground in increasingly difficult conditions also make a good return, but they have to do a lot of hard work for it.

8 ) Corporate tax avoidance, despite hiding behind weasel words such as "tax efficiency", is unproductive and inefficient. When corporate managers pursue tax avoidance they take their eye off what they do best – producing better or cheaper goods or services – and focus instead on engineering transfers of wealth from taxpayers to corporations. Clamp down on it, hard, to make markets more efficient.

This point is batty.  Big companies employ a diverse range of professionals. They employ marketing professionals to do marketing, supply chain specialists to manage procurement, manufacturing experts to run their factories and finance experts to prepare their accounts. And they employ tax specialists to ensure that they're not unnecessarily structuring a transaction in a way that leads to a high tax liability when there's an alternative, equivalent transaction that leads to a lower one.

9) It matters where company owners and business activities are. Take a US mining company digging gold in Zambia. If Zambia raises corporation taxes, wealth will flow from wealthy US stockholders to ordinary African taxpayers. The investor will stay, because that's where the gold is – and even if it goes, another will take its place. That basic formula works for profitable opportunities in general. Tax corporations, within reason, and they may bluff and bluster – but they will stay.

But what the local tax authorities are trying to tax is economic activity. They could just as easily tax the wages of local workers. Oh, they do.

If you want to tax flows out of the company, then you can do this (withholding tax, disallowing interest to some countries, etc.) without having to tax it in the hands of the company.

10) The "Laffer argument" that corporation tax cuts pay for themselves has been thoroughly debunked. Even Greg Mankiw, formerly chairman of George W Bush's Council of Economic Advisers, calls Laffer's adherents "charlatans and cranks".

Well the discussion over at CiF makes it clear that this is a gross misquote of what Mankiw said. Of course it is. The Laffer curve is self evidently true - you raise no revenue at 0% and 100% and you raise something in-between. At some point, with higher tax rates, the yield curve must face downwards.

In his haste to find ten reasons to support a corporation tax, Shaxson has overlooked the most obvious and best reason to tax companies - because they're full of money. It's nothing to do with fairness, or Laffer curves, or tax incidence, or non doms. It's just that they make money and governments like to tax where the money is.

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