Category Archives: Corporate taxation

The Great Rise of Corporate Tax Avoidance?

“Perception is reality”. A simple and yet powerful idea.

It came to mind this week after I had conducted a complete unscientific yet exceptionally telling Twitter poll on the evolution of corporate tax avoidance over the past decade. Thanks to those who voted and retweeted.

89%(!) – a crushing majority – of around 1400 voters believe that, in terms of the tax lost to nation-states, corporate tax avoidance has become worse since 2007. Caveats abound – as noted, this is not a scientific poll: it is based on a convenience sample of followers of myself and my followers (in particular barrister Jolyon Maugham, who was the most prominent retweeter of the poll), who I’d wager are, on average, more critical towards corporate tax avoidance than the general population – but I believe nonetheless that it is a useful result for starting a reflection.

One reason why this is a good starting point is that it is backed up by other (and more scientific) work. Corporate tax avoidance has, if nothing else, seemed to get worse to many. For instance, while in 2011 corporate tax avoidance did not feature as a key concern around UK business ethics (per lists published by the Institute of Business Ethics), it has been the top issue every year since 2013. Another recent study has also shown that the public salience of corporate tax avoidance exploded in the wake of the global financial crisis, around the same time as investigative media reports began regularly scathing the tax planning of major multinational corporates like Amazon and Starbucks.

Okay, so attention by the public and by the media to corporate tax avoidance has risen in the past years. That doesn’t mean that corporate tax avoidance actually has risen. Bingo! This is one element that fascinates me about this – there is very little, if any, discernible, tangible, hard evidence to suggest corporate tax avoidance has in fact “gotten worse” in terms of tax lost to nation-states. To the best of my knowledge, there exists no longitudinal academic research that sheds light on the evolution of corporate tax avoidance, in terms of tax lost, over the past decades. (If you are reading this and know of some, please let me know!)

A number of tax administrations publish annual estimates of tax gaps – the difference between the amount of tax that should, in theory, be collected, and what is actually collected – on corporation taxes (thanks to Heather Self for nudging me to include this point). The British HMRC is one such example, with its “Measuring Tax Gaps“. Although I generally believe that most tax administration’s tax gap estimates on corporate tax avoidance are woefully cautious and inadequate (they are generally based on limited random samples or simple models based on immediately available information, and they have strong political motivation to underestimate the problem), at least they are usually consistent over time. In the case of HMRC, their most recent estimates (2016) find that the CT (corporation tax) gap has been slowly declining over the past decades.

Udklip

More broadly, we have a vast range number of point estimates on corporate tax avoidance, with the OECD’s estimate of an annual global $100-240bn gap probably the most well-known. But in terms of longitudinal academic research, the only even remotely relevant hard indicators we have (that I know of) are studies by Niels Johannessen and Gabriel Zucman and Lukas Hakelberg and Max Schaub, respectively, which both use data from the Bank of International Settlements to investigate the evolution of offshore bank deposits. (I should note that I posted this blog just before Johannesen, Zucman and colleague Annette Alstadsæter published a new paper with more extensive and time series data in this vein.) The former conclude that the international crackdown on bank secrecy circa 2009 had no noticeable effect on offshore deposits; the latter conclude that the second crackdown a few years later had some effect, but only insofar as individuals shifted tax haven deposits to the USA. Importantly, these studies concern bank secrecy and individuals’ bank deposits, not really corporate tax avoidance. There are some arguments that the two might be correlated, but there are also arguments that they aren’t, and once again we have no systematic research to substantiate it either way. In short: we still don’t really know whether corporate tax avoidance has really gone up or down.

In the way of softer indicators, my own research has given some tentative answers. I spend a lot of time interviewing and observing tax professionals – corporate tax advisers, in-house counsel, policy-makers, bureaucrats and others. One sentiment that has been reoccurring is that recent developments, around the world, have effectively addressed many historical opportunities for avoidance – both in terms of purely legal innovations in shutting down loopholes and such, but also in terms of changing conventional understandings of what is and what is not acceptable corporate tax planning. This aligns with the indications given by HMRC above, whose staff of course fall into this category of professionals.

So what are we to make of these huge discrepancies? The general public seems to perceive corporate tax avoidance as a growing problem, media attention and political momentum is up, but research does not offer anything in way of substantiating this perception, and the perception is exactly the opposite among many professionals, who believe that corporate tax avoidance has been addressed effectively (although certainly not entirely).

Clearly, the varying sources of information play a key role. Rising media attention has correlated with political action and public concern, while increasing exposure to regulatory shake-up and criticism quite possibly shape practitioner views. Another factor is likely to be the post-crisis environment, which has been more open for political innovation, new ideas and new villains. But in general the massive divergence in perceptions is a very intriguing and somewhat perplexing state of affairs.

This polarisation of perceptions has a number of key implications. Most immediately, it draws attention to the monumental gap in the academic literature on the evolution of the scope and scale of corporate tax avoidance, where systematic longitudinal research is sorely lacking. More broadly, it has implications for the general debate on corporate tax and potentially for political progress. As I have written elsewhere with Maya Forstater (final paper coming soon), this kind of polarisation of perceptions amongst people is not necessarily conducive towards effective, sustainable, long-term progress in terms of policy and practice. Reality is perceptions, indeed, but massively diverging perceptions (and thus massively diverging realities) can create an unstable, conflictual and potentially counterproductive environment. If we are to really address the current problems in the international corporate tax system, there is a need for fundamental change to perceptions and material realities, which must encompass all relevant stakeholders, both inside and outside practice – and it is doubtful that polarisation of perceptions will contribute positively towards that end.

Are large firms really successfully lobbying for low tax rates?

My last attempt at a review of recent academic literature on a corporate tax income topic was well-received, so here’s round two in the “Are firms really…?” series.

This time, I’ll take a look at another paper out of Oxford University in the context of an existing body of literature. Here, we are looking at the topic of whether large businesses are successfully lobbying politicians for low corporate tax rates.

Now, the political economy literature is torn on the matter. On the one hand, the “political power” literature holds that, indeed, large firms become politically influential due to advantageous positioning, political access, abundance of financial resources, etc. On the other hand, the “political cost” literature holds that firm size comes with increased public attention and thus relatively higher cost levels incl. taxation.

The former hypothesis is probably well-known to most readers, given the popularity of “business influence” or “regulatory capture” stories in academia and the media. A recent example is a story from Vice, titled “Bigger corporations are making you poorer” (https://www.vice.com/en_us/article/bigger-corporations-are-making-you-poorer), citing an interesting study by economist Simcha Barkai at the University of Chicago, which provides a link between industry concentration and firm profits, indicating a size effect on the ability of companies to extract value from the economy. And that’s just the latest in a long line of research on the firm size-influence connection. This the mechanism at play in the “political power” hypothesis.

The latter, however, is probably not as widely known, even though a noteworthy body of literature indicates that this is actually the theory more aligned with reality.

A study from February 2016 (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2697468) by a group of researchers at the University of Mannheim reviewed 46 papers dealing with the political cost/political power forces. Performing a meta-regression on the existing evidence, they conclude:

This analysis is interesting because the empirical results across primary studies are by no means clear-cut and no tendency can be observed towards either the political cost or political power. Generally, our findings confirm the political cost theory. (my emphasis)

In short, “it’s uncertain but we’re leaning towards the political cost hypothesis”.

Their overall findings conclude that, on average, a ten percent increase in firm size, leads to an increase in effective tax rate of between 0.5 and 1 percent.

However, just as I remarked in my previous post, the wide variety in methods, data and analyses across the literature make it difficult to conclude definitively on the superiority of the political cost theory. The authors specifically address this point, noting that key definitional variations of firm size, of effective tax rates and of the sample period significantly affect the estimation results. For instance, the size-cost connection is significantly larger when measuring size by total sales, compared to total assets.

There’s also the question of concluding “on the average”, which is what meta-regressions like this can tell us about, as opposed to “on the margins”. It may for instance be that an “on average” increase in ETR by firm size hides significant variations by firm size level, e.g. medium-sized firms paying relatively more than small-sized firms but mega firms paying relatively less than large firms.

We must also pay attention to the geographical coverage of the survey. Of the 46 papers in the Mannheim study, the vast majority sample only US firms, with only a handful focusing on Europe. Thus, there are questions of generalisability. (I note here that the studies that do sample European firms generally seem to have noticably lower correlations between size and ETR than US sample studies, perhaps indicating that ‘largeness’ in Europe is less likely to produce political costs than elsewhere – but definitive evidence remains elusive.)

That leads me to the recent Oxford paper (http://www.sbs.ox.ac.uk/faculty-research/tax/publications/working-papers-0/large-and-influential-firm-size-and-governments-corporate-tax-rate-choice), released in April 2016, which provides new and relevant evidence on the topic.

How so?

The Oxford study contributes to the geographical literature gap by utilising rich administrative micro-data for firm size and tax rates across German regions. The intra-national comparison provides an interesting and novel ground for study of these dynamics.

Moreover, the Oxford study looks at the relationships between firm concentration, a relative measure of largeness, as opposed to studies of absolute firm size. The underlying notion is that relative size advantage may be more important than absolute size in the political game, and/or that relative firm concentration within a community may foster collective benefits for businesses.

Finally, the paper studies the link with German local business tax rate choices, i.e. regional statutory rates, as opposed to effective rates, which most of the literature utilises. ETRs are notoriously subjective, difficult to measure, and a source of uncertainty in the literature (as noted above), so there is sense in using statutory rates. Of course, ETRs are an individual firm-level measure, whereas headline rates apply (at least in the first instance) to the community of local businesses as a whole. Each may be useful to study, but in the context of this paper, focus on statutory rates match the focus on firm concentration (also a community-level measure).

Based on the data, the Oxford crew carry out a number of econometric statistical regressions, arriving at the conclusion that:

 

(…) we find that higher levels of firm concentration in German communities are associated with lower local business tax choices. The effect turns out statistically significant and quantitatively relevant and prevails in various sensitivity checks. (…)

The results confirm prior descriptive and anecdotal evidence, e.g. suggesting that the German cities of Wolfsburg, Ingolstadt and Ludwigshafen, which host the head-quarters of leading car and chemical manufacturers Volkswagen, Audi and BASF, set considerably lower local business taxes than otherwise comparable jurisdictions with a more even firm size distribution.

The German evidence for the presence of a political power dynamic is a notable addition to the existing literature, which seems to have favoured the political cost dimension. Specifically, the Oxford authors find that a 0.1 point increase in the local Herfindahl index, a conventional measure of economic concentration (measured as the sum of squares of the market shares of firms in the defined community), reduces the local business tax rate by 1.7% on average. Again we must note all the caveats of above: definitions, “on average” vs “on the margins”, etc.

Although this seems contrasts with the Mannheim review, the Oxford study may actually align relatively well with this existing literature given its geographical emphasis (Germany). As noted above, European-focused studies seem to provide weaker evidence for the political cost hypothesis than US-sample studies. In any case, it is further evidence relevant to the sum of knowledge on the topic.

I don’t purposefully set out to end all of these blogs with the same conclusion: that there is competing evidence, all of which is valuable on its own, but provides no firm, universal takeaway. But that is where we seem to have arrived. The political cost theory does seem to have slightly favourable support, but only in the specific context of existing studies (e.g. US-centric.)

However, I do want to stress that we should take the particular context of each study into account when evaluating a coherent body of knowledge. Often, I think we do academic research a disservice by seeking easy generalisable answers from it, or falsely ascribing universal laws to it, when in reality it rarely, if ever, meets such lofty goals.

Are American firms really more tax aggressive?

Are multinational groups headquartered in the United States more aggressive in their tax planning compared to non-US competitors?

That is, at least, a very popular strapline in tax circles. Negative media stories about the tax affairs of major US firms such as Apple, Amazon and Starbucks are often described as contributing factors to the OECD/G20 BEPS project and the European Commission state aid investigations. Although of course, by critics these projects are described as undue crusades against American firms.

Given the notorious difficulty in measuring effective tax rates of multinational enterprises (MNEs), there remains little systematic cross-national comparative research on the topic. Studies have varied in approach and results. For instance, economists utilising the prominent Devereux/Griffith methodology have often found relatively high effective tax rates in the United States. However, the D/G approach is based on a hypothetical domestic investment example and is not attentive to international tax arbitrage. Using financial accounts data, legal scholars Reuven Avi-Yonah og Yaron Lahav concluded in a 2011 piece that US MNEs had systematically lower effective tax rates than European MNEs. Another 2011 report from PwC found relatively high book effective tax rates in the US.

However, recent years’ academic literature has provided indications on the stand-out role of American corporate actors in the world of tax avoidance. A 2015 study by Chris Jones and Yama Temouri from Aston University found that US MNEs were more likely to locate investments in tax havens compared to firms headquartered in continental Europe.

Drawing from existing economic literature, Jones and Temouri identify firm characteristics likely to relate to aggressive tax behaviour (in this case, measured as tax haven investments), including technology intensity (R&D and intangibles) and incorporation in Liberal Market Economies (LMEs), such as the US and the UK – as opposed to Coordinated Market Economies (CMEs), such as Germany or Japan. Both of these hypothesis are confirmed by the analysis. They conclude:

“We find that MNEs from the high technology manufacturing and services sectors with high levels of intangible assets are more likely to have tax haven presence. (…)

MNEs from LMEs are significantly more likely to undertake tax haven FDI compared with MNEs from CMEs.”

On the other hand, an interesting new paper by Katarzyna Habu from the Oxford University Centre for Business Taxation, draws these conclusions into question. While Jones and Temouri’s paper draws on financial accounts data, Habu utilises a fascinating new dataset of corporate tax returns, made available by the UK HMRC to researchers. This provides a more accurate gauge of corporate tax bases, although it comes with its own limitations, such as limited cross-country comparability.

In short, the paper compares the taxable profit levels of similar domestic and multinational companies operating in the UK (based on industry and level of total assets).

Buried at the far end of Habu’s paper, a compelling read, is the following table:

Udklip

Here we see the differential (ATT) between the taxable profits to total assets ratio of the two groups (domestic and multinational) for various ‘home countries’ of the MNEs.

The results indicate that, from the pool of MNEs with subsidiaries trading in the UK, MNEs headquartered in tax havens are most tax aggressive, followed by French, Asian, other European, US and German MNEs. Entirely contrary to Jones and Temouri’s findings, there is no evidence here that US firms are more aggressive than German or Japanese firms. In fact, it rather indicates that French and Asian headquartered MNEs are more aggressive than US MNEs.

There are various potential explanations for the discrepancies in the recent literature.  Tax haven FDI and UK taxable profits avoidance are not necessarily expressions of the same type of tax aggressiveness. American companies could indeed be more aggressive in locating investment in tax havens, while at the same time not being more aggressive in lowering taxable profits through tax avoidance in the UK. More broadly, the wide variety of empirical data sources, theoretical approaches, geographical scope and so forth do not allow for easy comparisons between the studies. 

And then there’s the question of the differential between effective tax rates of domestic and international economic activity – one that is substantial in particular for US technology firms due to the tax system design (thanks Heather Self for that point). Existing studies do not investigate this systematically.

We should also note, as Alex Cobham importantly pointed out to me, that the latter study expresses net numbers – the overall effect of tax aggressiveness, which may hide significant flows of profit shifting in or out of the UK. US firms could conceivably be shifting profits into the UK in a tax aggressive manner without it showing up here. However, the evidence can’t say.

Thus, we should be careful in drawing firm conclusions from this ascending literature, but we should take both studies as interesting results that shed light on our understandings of the dynamics of MNE tax planning. There may be continuing suspicions that US MNEs are generally more tax aggressive, but further research is needed in order for us to firmly confirm or deny such assumptions.

The fiscal coin and reasonable expectations: Taxes as business costs or intra-economy transfers?

Are taxes on corporations business costs or intra-economy transfers? This is a oft-discussed question in debates about corporation taxes – academic, political as well as layman debates. And it is one with significant implications for tax policy.

This blog is here to say: Both. Possibly. But mostly a transfer.

The fiscal coin and taxes as intra-economy transfers

Every so often, we’ll hear the argument that taxes are business costs. Simple as that. They reduce corporate profits by increasing expenditure. And the implications are straightforward: If taxes are merely costs, there is an imperative to minimise the cost, thus maximising profit, in order to generate value for shareholders and stakeholders, including society at large.

This view, however, neglects – deliberately or as an indirect consequence – the fiscal coin. A favourite concept of mine, which receives far too little attention, the fiscal coin is the equal and opposite mechanisms of taxing and spending. As a matter of economic reality, any tax must translate to an exactly equal expenditure or saving, and any spending must be based on an exactly equal tax (current or future). Taxes do not disappear into a black hole; they pays for something. We may not like how they are spent, but we cannot deny that they are indeed spent (or saved).

Thus, whether or not businesses perceive tax as merely a cost, it is, as a matter of economic substance, an intra-economy transfer. From corporate books to somewhere. And businesses act accordingly.

My old microeconomics textbook noted in its introductory chapter that, in the same way that pool players operate as if they were familiar with the basic laws of physics, economic agents act as if they are familiar with the basic laws of economics. I’m skeptical toward this as a universal assertion, but in this case I do believe it provides a helpful image.

Businesses do act as if they know that taxes are intra-economy transfers (at least to some extent). In making investment decisions based on the availability of local infrastructure, skilled workers, low political risk premiums, and so forth, there is a recognition that taxes, while they may be an initial cost, boost factors that ultimately contribute to profits. And indeed, there are many businesses that openly acknowledge this relationship, certainly in Denmark where tax norms are perhaps special.

Reasonable expectations and taxes as business costs

So, taxes are intra-economy transfers. But, there is an entirely plausible argument that taxes may in fact also be just business costs, although it is not the one often purported. It has to do with reasonable expectations.

If businesses have a reasonable expectation that corporation taxes, on average or on the margins, will not contribute to profits in any way, we can say there is a fair argument that corporation taxes are just business costs. If taxes do not contribute to local infrastructure, to skilled workers, to low risk premiums or to any such element, then there may be a point.

And while I am doubtful that assertion can be evidenced, the perception of such a situation may explain why the view of “tax as a pure cost” is prevalent.

Why might this perception emerge? I shall highlight two potential causes. First, businesses may reasonable expect that the overall tax burden and the associated level and content of public expenditure is not determined to any relevant extent by corporation tax payments. This view may in fact be reasonably substantiated given the structure and trend of overall tax revenues in developed countries over the past few decades. As corporation tax rates have steadily declined, many states have shifted tax burdens away from capital and towards individual income, consumption or property. In fact, this is the exact recommendation that the European Commission, along with the OECD, has been providing to member states over the past few years. So there may be a reasonable expectation from businesses that any reduction in corporation taxes, whether through avoidance/evasion or through tax incentives, rate cuts or base narrowing, would be countered by the state with a burden shift to other taxpayers, thus maintaining the overall level of public expenditure and thus profit-boosting institutions.

Second, businesses may reasonably expect that their marginal contribution to the overall tax burden has a non-existing or insignificant effect on any beneficial (for them) public spending. They may simply not perceive there to be a quid pro quo. This is the classic ‘tragedy of the commons’. Barriers to collective action will mean that businesses will seek to free ride. This goes for all taxpayers, but large, multinational companines in particular have a significantly greater ability to free ride, to selectively determine tax level and location, than the average taxpayer. In an age of declining societal tax morale due to increasing perceptions of injustices in the tax system, this may well be a phenomenon on the rise. Moreover, the general opacity of the tax-to-spend dynamic may worsen the dynamic. Politicians are largely skeptical towards earmarked public funding, and thus it is impossible to establish a specific link between the tax that businesses (or other taxpayers) pay and the associated spending. Finally, societal disinclination towards tax may also contribute: a general skepticism to taxation may mean taxpayers are less positive towards the fiscal coin.

Political implications

Thus, corporation taxes are, in substance, intra-economy transfers. But as a matter of perception and maybe reality, they may also be merely business costs. The political implications are crucial, I believe.

Whether or not corporation taxes – and indeed other taxes – are perceived as bearing effectively on taxpayers’ benefits deriving from public spending is essential to fiscal policy. If they are not, that is a major policy problem, both for the tax and for the spending system, and something that needs to be addressed by governments. Most definitively, we need to strengthen tax morale by ensuring tax compliance across the board. Perhaps we also need more transparency around the way in which average and marginal tax payments contribute to public spending and welfare benefits. More generally, perhaps we need a broader and more vocal discussion on the link between tax and spending. That is certainly a debate worth having…

 

Discussing discussions around the corporate income tax

The corporate income tax is under pressure. A host of factors have contributed to economic, normative and political discussions on the need for corporate income taxation and its role in the architecture of national and international tax systems.

Among the most persistent calls today is the lowering or scrapping of corporate income tax (CIT) altogether. And that’s not surprising, given that statutory CIT rates around the world have been in free fall for decades:

Untitled.png

Although arguments to support this call are in the media weekly, two recent posts brought them very clearly to my attention. First, Diego Zuluaga, of The Institute of Economic Affairs (a UK free-market think tank), wrote this post in City A.M., the City of London newspaper, arguing that the CIT should be abolished because it discourages investment and incentivises tax avoidance. Second, Scott A. Hodge of TaxFoundation (a US tax policy research organisation) re-iterated arguments that the CIT is harmful to economic growth.

These and other positions are heard often in the debate on corporate income taxation, so it’s fair to examine the arguments and the science behind, which is the aim of this post. I want to break down some of the most prevalent discussions:

Corporate income tax, investment and wages

One central discussion around the CIT concerns its impact on investment and wages. A particularly popular argument comes straight from the neoclassical econ textbook, and is well-established: The CIT discourages investments, harming wages. Capital and investments will flow where the costs are lowest and the returns are highest, relatively speaking. Thus, the higher the CIT, the lower the returns, and thus the less desirable investment climate. If your country has a high corporate tax burden, investors will find it less attractive to invest there. In turn, fewer investments lead to a greater labour to capital share (K/L), meaning workers have relatively less machinery, technology, etc. at their disposal, making them less productive. And since each production factor is rewarded according to their marginal productivity, labour’s wage compensation decreases as a result.

And it’s not just theory. A well-known empirical meta study on these behavioural effects (tax elasticities) tells us that in the average situation, a 1%-point decrease in the effective marginal corporate tax rate will increase the corporate tax base by 0.4% due to intensive investment decisions (e.g. increasing production), and a 1%-point decrease in the effective average corporate tax rate will increase the tax base by 0,65% due to extensive investment decisions (e.g. buying a new plant).

Udklip

On the other hand, there are a few criticisms of the argument. First, tax is only one side of the fiscal coin – expenditure is the other. Wherever there’s a tax, there’s a corresponding expenditure (or saving for future expenditure). So if the corporate income tax is raised, current or future government expenditure increases consequently, or the tax burden is shifted somewhere else, and vice-versa if the corporate income tax is lowered. The actual or potential government expenditure and the structure of the tax burden could raise the investment incentive by increasing returns or lowering risk, for instance via spending on education, infrastructure, technology – and thus if it is de-financed, the effect might be a net deterioration in the investment climate. But that would require detailed contextual analysis. Some studies confirm that CIT rates are relatively unimportant factors in business investment decisions – trumped by market size, human capital, infrastructure, etc. Some studies on the investment effect of CIT deal with the ‘fiscal coin’ issue by investigating long time series (usually 10-20 years) across many countries. Yet, even 20-year timelines may not necessarily be sufficient to reflect public spending or tax burden shift impacts, as it may take several decades for investment benefits, economic growth harms (e.g. from increase inequality) or structural tax shifts to kick in. Still, in the current research, the results are often, but not always, a negative semi-elasticity of investment to corporate income tax:

Capture

Second, even if investment is harmed by the CIT – what kind of investment is it? If it is real, productive investment that is discouraged, it is obviously harmful. If it is virtual ‘on paper’ investment is that is discouraged, it does not hurt the real economy. The latter could be profit shifting, round-tripping investment, or white-washing of black/grey investments. Evidence on the tax elasticity split of these two is naturally extremely sparse, given the difficult task of assessing the ‘real’ or ‘virtual’ nature of investments. Some studies have found that corporate tax incentives are poor at attracting real investments, whilst others argue that there is no relationship at all between low CIT rates and increased foreign investment. Well-known tax economist Kimberly Clausing has also argued that virtual investment re-allocations are far more tax sensitive than real economic activities.

The CIT and economic growth

A related argument, that CIT harms economic growth, is probably the most prevalent and well-analysed position against corporate income taxation. The intensely cited OECD ‘Tax and Economic Growth‘ piece from 2008, also referred to by Hodge, found corporate taxation to be the most harmful tax to economic growth. The conclusion was partly based on a statistical analysis of OECD firm investment levels and corporate taxes 1996-2004. In another study, the OECD compared tax levels with growth rates for 21 countries over 35 years and found that “corporate income taxes appear to have the most negative effect on GDP per capita”. Theoretically, the backdrop is familiar: the CIT causes behavioural distortions (fewer investments, more tax avoidance, etc.), which are harmful to overall output.

As noted above, there may be reasonable questions of the universal “CIT is harmful” thesis in relation to the timeline and the strength of conclusion. Are economic and statistical models sufficiently robust and sensitive to long-term structural evolutions caused by CIT changes, such as the impact of changed public spending levels, inequality (which may also harm growth), to provide clear evidence that the CIT is generally, or even in the average situation, harmful to economic growth? Much of the underlying economic science, based on statistical modelling and econometrics, is taken as evidence of universal laws or generalisable cause-effect relationships, but there are fair questions whether causality is really evidenced. Rather than asking or answering whether the CIT is generally harmful, you might say the more apt question concerns the specific circumstances under which a certain CIT raise or reduction might contribute to economic growth. We know, for instance, that because the CIT acts as a backstop for personal income taxation, at a certain low point, the CIT will facilitate significant tax avoidance as individuals disguise personal income as corporate income. In recent years, even the OECD itself has distanced its 2008 analysis with a more balanced view. Still, we must recognise that a sizable economic literature today holds that the CIT is, generally, harmful to economic growth.

Second, again parallel to above, even if the CIT harms economic growth – what kind of growth is it? If national output growth is based on proceeds from paper shifted assets, the real economy impact might be negligible. If it’s based on actual economic activity shifts, then the story is different. There are reasons to believe real economic activity is less sensitive to tax than virtual capital re-allocation, as noted above. And if that is the case, then lowering the CIT rate merely facilitates an international negative-sum tax competition game, based on virtual capital reallocation, harmful to overall world welfare.

Moreover, it is well-established that CIT rate cuts harm national inequality, as tax burdens are shifted from capital onto labour and consumption, which is usually less progressive, and as public spending (where less wealthy citizens are often the target) is cut. Thus, economic growth from CIT cuts might come at the cost of inequality, less social cohesion and democratic harm.

The question of incidence

A third common discussion on the corporate income tax is its incidence. Who bears the burden of the corporate income tax? Some might find that a strange question, but in economic theory, the corporation is merely an intermediate vehicle. In the end, all flows move through the corporation and end up elsewhere, as dividends to shareholders, as products and services to customers, as wages to employees, etc. When speaking of the CIT incidence, the debate is usually whether it is labour (in the form of lower wages) or the shareholders (in the form of lower dividends or retained earnings) that bear the brunt of the burden. The answer to that question is instrumental to both economic, normative and political assessments of the corporate income tax. If, for instance, it falls primarily on labour, a CIT reduction could well be quite progressive; if it falls mainly on capital (shareholders), it is more likely to be regressive (depending on who those shareholders are).

Hodge’s post and the WSJ essay cited both argue that “workers bear the true economic burden of the corporate income tax through reduced wages.” This is a popular sentiment, and is usually employed in arguments for reducing the CIT. And certainly, scientific support is abundantly available. Theoretically, the incidence depends on the elasticities (yes, that word again) and mobilities of the production factors. In a modern open economy, capital is said to be more able than labour to ‘escape’ the tax incidence, by shifting investments abroad, thus reducing the marginal productivity of labour and incidentally leaving them to bear the burden. Empirically, you can pick any of a long list of studies that find labour’s share of the burden in an open economy to be significant (e.g. 1, 2, 3)

Both the theory and the empirics here are simplified, of course. Corporate tax incidence is highly complex and context-dependent, with differences in the short-, medium, and long-term, but there is no doubt that a large literature supports the notion that labour bears the main burden of corporate taxation.

On the other hand, you can find an equally large literature to support the notion that capital bears the main burden of corporate taxation. Yes, that is correct. Again, there are variations in the way incidence is studied and theorised, but there is a similarly long list of studies available (e.g. 12, 3). In short, the argument here is that capital is not always more mobile and flexible than labour, partly because the ability of capital to ‘escape’ may have been decreased over time due to more sophisticated regulation.

In other words, there is a fundamental lack of consensus in the economics literature on the incidence of corporate taxation. There is no reasonable argument that the burden “clearly falls on labour”, nor that it “clearly falls on capital”. The only likely agreement is that there is some split, which is difficult to define and is context-dependent.

Corporate taxation and profit shifting

A final discussion, invoked by Zuluaga amongst others, is the extent to which the corporate tax burden incentivises tax avoidance. The argument that it does so significantly is, again, based in economic theory, as well as empirics. The CIT lowers the rate of return, and thus capital will flow elsewhere – a part of which will be virtual financial re-allocation (profit shifting). As De Mooij and Ederveen’s table 4 shows above, they empirically estimate that a 1% increase in the statutory CIT rate will decrease the corporate tax base by 1.2% due to profit shifting. The 1.2% estimate is based on a number of longitudinal and cross-sectional studies, mainly from the OECD countries or North America in the 1980s and 1990s. Whether one can generalise based on such evidence is, as discussed above, probably questionable. Still, there are many studies with similar findings. And the effect of profit shifting is obviously less corporate tax revenue, and thus public spending cuts or the shift of the tax burden to other areas.

On the other hand, and as noted elsewhere, over the past decades regulatory tightening of corporate profit shifting may have contributed to a notable reduction in the profit shifting elasticity. Subsequent international reforms have contributed to the lessened ‘virtual mobility of corporate profits. The OECD certainly seem to think so, at least. Furthermore, even if the elasticity is still substantial, ongoing reform attempts will likely squeeze the slipperiness more and more, so that in the future we might expect the effect on tax avoidance of corporate income taxation to become less and less important. So while lowering or abolishing the CIT might be advocated as one way to reduce tax avoidance, there are clearly regulatory alternatives, which may be more prudent.

To sum up: the impact of corporate income taxation on investments, wages, growth and profit shifting are hot, important and contested, and for each debate there are clear arguments for and against. Again and again, we see these arguments being used selectively by different discussants in debates. But it is important to maintain some balance. Ultimate claims on the “truth” about corporate income tax and the science behind it are simply untrue – there is no one answer. The state of our knowledge on these topics are not so that we can conclude decisively on cause and effect, unfortunately. Still, science can bring us far, and we should employ the best research available. But we should employ it with caution. I think we would all do well to keep that in mind.

September 2017 update: To all of the above, I think it is worth adding a recent discussion in economics on the nature of the contemporary economy, in particular economic concentration, and its impact on the investment, wages, growth and incidence. A number of economic researchers and commentators (1, 2, 3) have noted recently that the contemporary economy is marked by significant and increasing economic concentration and monopoly power. This has important implications for economic theory and reality on corporate taxation. In particular, monopoly power indicates that capital forces are able to extract significant rents from the economy. In turn, this might indicate that the incidence of corporate taxation falls more heavily on capital (shareholders), and less heavily on labour, which may also require a re-thinking of the economic effects on wages, investment and wages.