The roots of the global corporate tax debate

by Enrico Colombatto

Developed countries on both sides of the Atlantic are trying to bully the world into harmonizing corporate taxation. Western policymakers have adopted an articulated strategy to make this proposal attractive to a wide audience. First, they have turned to international bodies like the International Monetary Fund to present it as a global proposal, rather than an initiative promoted by the “rich” part of the world (and the European Union in particular).

Second, this scheme follows a long campaign to depict the world of business as a set of scroungers and at the same time to persuade small businesses that “small” is different, and that large competitors can succeed only thanks to their unfair, superior skills in avoiding taxes. And finally, the pursuit of harmonized taxation has opened new horizons to tax authorities which until now hesitated to increase tax pressure, lest taxpayers be encouraged to leave for less greedy shores.

Ignorance and myopia have taken care of the rest. This scheme has been met with approval from those who believe that higher taxation would induce corporations to lower their pre-tax prices and generate resources to finance redistribution, sustainable growth, the war on climate change or whatever favorite initiative.

Bad deal

Some observers have raised several very reasonable objections that focus on three main issues. All taxes on corporate profits hit investments, encourage indebtedness, and deter risk-taking and entrepreneurship. If effective, therefore, such measures are a drain on growth and a burden on the financial health of a company.

Two long-run effects follow. Financial fragility will create opportunities to introduce more regulation (possibly justified by the need for more stable growth), more industrial policy (in fact subsidies to selected companies and industries) and more tampering with labor markets if unemployment arises. Furthermore, it has been pointed out that introducing a relatively low harmonized tax floor, at 15 percent, would serve the purpose of minimizing opposition to harmonization.

Once this is accepted and becomes a standard component of international meetings, however, raising the floor will be easier: future discussions will focus on the level, not the principle. In fact, if harmonized corporate taxation is a success, it can more easily be extended to other domains.

The upshot is that replacing tax competition with tax harmonization is a recipe for more public expenditure in the short run, and corporate financial fragility and slower growth in the future. It will also weigh on new competitors who dare challenge the incumbent producers, and need relatively greater amounts of resources to reward shareholders who rationally expect relatively higher pre-tax profits. Indeed, this last effect might explain why the large corporations have kept relatively quiet during the past months.

Tax logic

But beyond the specifics of the proposals lie even more fundamental and overlooked issues – ones that involve the very essence of taxation, and should take the center stage in any tax reform. Inattention could lead to momentous consequences.

Corporate taxation should be considered absurd even by those outside the free market, small-government camp. There are generally two kinds of taxes: those levied as if they were the price paid by individuals for a service provided by the government, and those that finance redistribution in favor of the have-nots. Taxes that finance public health and education belong in the first category, while unemployment subsidies and poverty relief programs are examples of the second.

Any tax system that claims to pursue the common good should be transparent, and treat the taxpayer with respect. Put differently, taxpayers should know where their money goes, and how much they pay for what they are forced to buy.

Regarding the first category of taxes – payments for services – companies already pay a price for what they consume (or are forced to consume), and the amounts involved factor into their production costs. For example, taxes on fuel include (or should correspond to) the price of the clean air consumed by vehicles and heating devices. The same applies to the use of infrastructure; most bridges and roads are funded by car taxes. (The only significant exception is perhaps security, i.e., police services.)

Precisely because these “taxes” are all prices a company pays (or should pay) for resources consumed, it is absurd to claim that the value of such resources is a fixed share of profits, or that the difference between the value of what a firm consumes and the price it pays should be at least 15 percent of its profits.

When it comes to redistribution, the second kind of taxes, advocates of social fairness argue that the relatively rich should help the relatively poor, thus reducing inequality. Putting aside whether and to what extent income inequality should be reduced for its own sake, few could dispute that the notion of rich and poor applies to individuals or households, not to purposeful organizations like companies.

A successful company is a source of wealth for its shareholders and for many people involved in its activity, but has no wealth of its own. A company runs not because the firm itself has made choices and taken decisions, but because its shareholders and managers have done so.

A machine or organization is neither benevolent nor coldhearted; individuals are. Profits remunerate entrepreneurship, insights and risk-taking, which originate from the talents, luck and propensities of individuals. Is a billionaire who owns stocks of an unprofitable company poorer than a low-income worker with 30,000 euros invested in a highly profitable business?

Deeper motivations

Taxing a company and its profits is absurd, regardless of one’s opinions about the purpose and the extent of taxation. One may then wonder why policymakers love corporate taxation and would like to have more of it. There are two possible answers, not mutually exclusive, that can shed light on what to expect from their efforts.

First, the authorities badly need more tax revenues to maintain the high level of public expenditure seen during the Covid-19 period, serve higher public indebtedness (especially if interest rates move higher), and possibly reduce the debt levels by reimbursing some capital. Income taxes have already hit disposable incomes hard, while wealth taxes are highly unpopular.

Yet although heavier tax burdens on corporations would end up targeting both income and wealth, the general public hardly perceives it, and is somehow induced to believe that an abstract entity – a bundle of contracts designed to produce goods and services – will eventually foot the bill. Of course, this is an illusion. But it will take time before voters realize the details of the transmission mechanism. Even then, they will likely react by seeking more government intervention to subsidize ailing enterprises and low-income earners, and perhaps to create jobs through active labor-market policies and partial nationalization programs. In other words, corporate taxation is attractive because it is not transparent. Its consequences generate demand for more government intervention, and it can be raised significantly once harmonization prevents companies from relocating to more favorable fiscal environments.

The second explanation tells us that the evolving principle according to which entities other than individuals can be taxed does not bode well for the future. Previous reports have mentioned the possibility of taxing robots, especially if equipped with artificial intelligence. The next step will be to extend current taxation from certain immaterial entities (companies and entrepreneurship) to other categories of immaterial items, such as contracts, information and knowledge (including patents).

Regrettably, these new efforts would hardly be conspicuous. Few ordinary people will realize that by hitting immaterial capital, these partially new forms of taxation would impair the engine that has made global growth possible during the past two centuries.

Enrico Colombatto is a professor of economics at the University of Turin, Italy. He is also director of research at the Institut de Recherches Economiques et Fiscales (IREF) in Paris.

Source: GIS Reports


The views expressed on austriancenter.com are not necessarily those of the Austrian Economics Center.

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