corporation tax is paid on profits, not sales, for a start.
That KPMG’s Chris Morgan felt the need to clarify this point in Tax Journal got me thinking. It seems that, in the wake of the recent spate of corporate tax scandals, there’s a confluence of opinion between the general public and many tax scholars. The first group assume, intuitively, that a company that makes a lot of sales in the UK should have a corresponding tax liability here, and are shocked to find that it doesn’t. Many in the second group (see, for example, the Mirrlees review [pdf]), have long argued that, in Michael Devereux’s words [£], “a good case could also be made for a reform that allocates taxes on profit according to where sales are generated.”
There are two ways in which a move to sales-based taxation might work. One would be, as the Mirrlees review authors advocate, to stop using profit as the basis of taxation altogether, replacing it with a VAT-style sales tax. The other would be to keep using profits, but through a unitary approach, apportioning a firm’s global profits between countries in proportion to its sales. This specific proposal (to rely only on sales) was mooted by some speakers at a Tax Justice Network conference in Helsinki earlier this year (although I can’t find it in the presentations).
Here are some arguments for and against such reforms – some familiar, some my own invention. I’m going to exercise my academic’s right to make a few observations, but not to come down on one side or another. [Edit: I tweaked the list a little bit to make clear that I’m summarising viewpoints, not expressing my own opinion]
The arguments in favour
- Corporate income tax is economically the worst kind of tax. It distorts incentives, discourages economic growth, and has a deadweight loss. Tim Worstall made this case in the comments here on Tuesday. If this is true, the corporate income tax at present is one of those trade-offs between economic efficiency, administrative practicality and fairness…
- …but it’s not as fair as you might think. Companies are not natural people, so the incidence of corporate income tax ultimately falls on their workers, consumers and shareholders. By taxing profits, a government leaves the firm’s management (and ultimately the market) to decide how to allocate that incidence, rather than choosing itself, and some evidence suggests that the incidence falls more on workers and consumers than shareholders (although the evidence is mixed [pdf])…
- …and it’s not that practical either. Because of the complexity of multinational companies today, and the growing porosity of geographical borders to services and assets, corporate income tax on the basis of transfer pricing is too complex to enforce. It would be better to use something less mobile and more tangible to divide up the tax base between countries and make it harder to avoid. One basis to do this would be sales.
- Because of tax competition, corporate income tax rates are falling, and tax bases are shrinking, around the world (except perhaps in countries like India and China?). If that trend continues, then, like it or not, this tax’s days are numbered.
- How about this, based on China’s approach to transfer pricing? Profits aren’t allocated very well by the global economy, so they aren’t a good basis for distributing taxing rights. Currently, China takes into account ‘location specific advantages’ to correct for what it sees as an under-valuation of China’s contribution to a firm’s value-added.
The arguments against
- The public don’t really want a sales-based allocation of tax. Right now, there’s outrage because of the lack of correspondence between some companies’ sales and tax payments. That’s because consumer brands have the biggest consumer profile, so they make the best stories. But what of companies with a large manufacturing or product development base in the UK? Intuitively, public opinion would expect a lot of tax revenue from this too. To survive the ‘intuitive outcomes’ test, a tax on companies needs to reflect the contribution of different parts of the business, including sales, assets and workforce (that argument tends to support a three-factor formulary apportionment).
- Corporations are citizens, legal entities in their own right, not just clusters of individuals. As a result, they have certain rights and privileges, not least those resulting from limited liability. Conceptually, it’s important that they pay taxes on their income in the same way that other citizens do. I remember a letter in the Financial Times a couple of years ago, which argued that the share of a person’s income that is ‘taken’ as tax is better seen as a contribution to the state in return for its role in generating that income – a fee for the education, infrastructure, rule of law and suchlike without which companies and individuals would not be able to generate that income.
- Taxing on the basis of sales will hurt developing countries, because most multinational companies make most of their sales in developed countries, where the consumer market is biggest. Shifting to a sales-based approach would shift the balance of taxing rights away from developing countries, in which many companies have their factories, mines and plantations, but not their sales. (It might be possible to mitigate for this by using a ‘global Value-Added Tax’ levied on export sales from developing countries at the same rate as domestic sales, but this would mean transfer pricing was still with us!)
- Even if corporation tax were eliminated, it would be politically unfeasible to raise other taxes on workers, consumers and shareholders enough to compensate. Similarly, if there were a shift to a sales-based allocation of taxing rights, developing countries would struggle to levy new taxes on businesses to make up for the revenue they lost.
What do you think? Any arguments I’ve missed or mischaracterised? Which do you find most persuasive?