Relationship between business tax and revenue

  • Two opposing views:
    • Conservative/right: lower corporate tax rates will lead to more business investment and thus faster economic growth. Hence the stock market enthusiasm after President Trump was elected on platform of tax cuts
    • Left: belief that business not paying appropriate amounts of tax and should be charged more to pay for spending commitments. Hence promise from the Labour Party in recent British election to push corporate tax rate up to 26% (from 19%)
  • Economist review: took corporate tax rates in OECD countries and divided them into quartiles from highest to lowest. They then calculated the five-year average in each quartile for gross fixed capital formation as a share of GDP.
  • Results: Countries with the highest tax rates generate less investment than the lowest – but there is minimal difference, probably due to that the decision to invest is based more than pure tax rates, such as underlying growth rate and regulatory climate. Includes such South Korean and Turkish companies that invest immensely.
  • Lower tax rates may also work by stealing revenues from other countries: Ireland, with a tax rate of 12.5%, earns a higher proportion of GDP in revenues than France, at 34.4%.
  • Headline tax rates may not be decisive: countries like America tend to offset them with allowances and deductions that bring down the effective rate that companies pay
  • Idea of using tax levels to boost revenues is also unsupported: countries with lowest corporate tax rates receive a bit less in taxes- but the difference between the top and bottom quartiles is only 0.9% of GDP.
  • Countries with highest tax rates (over 4% of GDP) tend to be those with high quantities of natural resources (Norway and Australia). They can take advantage of captive business, but this is not an option for most developed nations – especially due to tax competition
  • Two other factors at play:
    • companies are not simply legal entities: to the extent they pay more taxes, they must get the money to do some from elsewhere. This may includes shareholders (representing the pension funds of citizens). Further, reducing profits paid out to shareholders may increase the chances of it becoming a takeover target. This may mean they move their operations to a lower tax regime, charging consumers more, or by paying workers less.
    • Countries do not want to attract businesses for the taxes they pat but for the workers they employ and for the extra revenues they create for local suppliers. The effective tax take firms generate (on wages, sales, and property taxes) is much higher than the tax on profits alone. Thus there are dangers in lowering corporate tax which deters business that brings a wealth of other advantages.
  • Argument: profits tax should be abolished and shareholders should be taxed directly. Problem: many shareholders, such as pension funds and charities, are tax-exempt, and many are based in low-tax regimes. It would also create the incentive for individuals to lower their tax bills- so such a move should only follow comprehensive tax reform.



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