Corporate tax avoidance is once again prominent in the news. When Jean-Claude Juncker, the new European Commission president, was prime minister of Luxembourg, the country seems to have operated as a vast tax shelter. Leaked documents have revealed that special tax arrangements were agreed by his country with over 300 multi-national companies.
Getting a handle on the scale of corporate tax avoidance across the world is tricky. A detailed study has just come out in the latest issue of the top ranked Journal of Economic Perspectives, by Gabriel Zucman of the London School of Economics. His focus is on American companies. Zucman’s thorough analysis of balance of payments statistics and corporate filings shows that US companies are moving profits to Bermuda, Luxembourg, and similar countries on a large and growing scale. About 20 percent of all US corporate profits are now booked in such havens, a tenfold increase since the 1980s. Over the most recent 15 years, the effective rate of tax on the profits of US firms has fallen by one-third, from around 30 per cent down to 20 per cent. And about two-thirds of this can be attributed to an increase in shifting profits to low-tax jurisdictions. In money terms, the loss in revenue is some $175 billion, over 1 per cent of the total size of the American economy.
It is of course the most dramatic examples which hit the headlines. But if the effective rate is some 20 per cent, and a few massive companies are paying very little tax at all, many American companies must in fact paying tax rates on profits which are close to the nominal rate of 35 per cent. Although Zucman does not repeat his detailed exercise for the UK and Europe, a clear implication of the paper is that a qualitatively similar outcome obtains here. In other words, most firms operate in a way which most people would regard as being fair and reasonable. Blanket condemnations on the lines of Ed Miliband’s ‘zero-zero’ speech are wholly at odds with reality.
That said, there are undoubtedly serious problems with corporate tax regimes across the developed world. The increasing complexity of the legislation offers many opportunities for ingenious but perfectly legitimate avoidance schemes, such as Google’s “double Irish Dutch sandwich” described by Zucman. We can go down the route of trying to get greater international consensus on the treatment of tax, and steps have certainly been made in this direction. But it is a long and arduous process with no guarantee of success.
The simplest solution is to abolish corporate taxes on profits and to tax consumption instead. Ultimately, the tax burden can only fall on individuals. Taxing profits creates the illusion amongst the electorate that there is a free lunch. But someone, somewhere, pays. Higher corporate taxes might lead, for example, to lower dividends or lower wage increases. Companies might squeeze suppliers harder or cut back on investment. Tax needs to be transparent, so people can really decide what value they get out of it.
As published in City AM on Tuesday 18th November