Category Archives: Tax economics

Why do people evade taxes?

A much talked-about recent paper by economists Annette Alstadsæter, Niels Johannesen and Gabriel Zucman has re-ignited popular attention to tax evasion and inequality.

While discussion of reliability and methodology have prevailed in some corners of social media, the broader questions raised by the fascinating new study should remain at the fore: Why do people evade taxes? Who evades taxes? How can they do so? And what are the effects – on our societies, institutions, political systems, and so forth?

In this post, I will look at what the existing academic literature has to offer on these questions related to tax evasion, in particular the former: Why do people evade taxes? And I’ll zoom in on how recent contributions, such as that by Alstadsæter et al. and others, adds to this scholarship.

What shapes tax compliance?

Existing work on tax compliance is abundant, in particular within behavioural economics, sociology and psychology (see reading list at the bottom of the post). This scholarship has highlighted five central factors that particularly shape tax compliance in the national context:

  1. Levels of wealth
  2. Tax rates
  3. Audit probability and penalty
  4. Tax morale
  5. Institutional environment

Firstly, wealth typically enhances the probability of tax evasion. Wealthy people simply have more ability to evade. They have more and more flexible sources of income, allowing for manipulating and escaping of national regulatory and administrative powers. Think of the Ultra-High Net Worth Individual (UHNWI), who can offshore his financial assets and the accruing gains or move artworks stealthily across the globe – as opposed to the carpenter or teacher, whose main income (salary) is typically taxed at source.

Second, relatively higher tax rates foster relatively more evasion. Because taxes are often perceived as an undue burden (rightly or wrongly), the willingness to evade rises with the tax burden. As I have written elsewhere, this is extensively discussed in the economic literature. Even though taxes also pay for public spending (the fiscal coin), there may be a reasonable expectation by wealthy taxpayers that any evasion on their part will not lead to a deterioration in public spending in relation to the public goods from which they benefit, or that the benefit received from corresponding taxes simply does not provide sufficient value.

However, it is worth noting that it is mostly large differences in tax rates, and at the margins, that foster tax evasion. As an indicator, a number of experimental studies have found that increasing tax rates e.g. from 30% to 50% had little or no effect on compliance, whereas raising from 5% to 25% or from 5% to 60% does have an effect. Related, recent economic modelling on optimal corporate tax rates also suggest that only very high tax rates inhibit growth.

Third, potential tax evaders assess the risk of getting caught through audit probability and penalties/punishment, adjusting their behaviour accordingly. If a taxpayer perceives a high risk of being audited (and thus caught) and/or a substantial penalty (economic or personal), they are simply less likely to engage in tax evasion. This is as much about the perception of audit risk and penalties (which can be fostered in various ways) as it is about the actual probability of audit and penalty.

Fourth, the individual taxpayer’s tax morale is a decisive factor in tax compliance. Tax morale encompasses the social and cultural norms, and individual allegiance hereto, shaping compliance motivation. Tax morale itself is a highly complex phenomenon, dependent on a host of factors. The ‘morale fibre’ of each individual – the dispositions one is ingrained with given a life history of events and perceptions – is obviously instrumental. The extent to which people perceive taxes as part of a valuable quid-pro-quo is also central. As noted above, when the cost of taxation is viewed as too high compared to the benefits received, people are more likely to engage in evasion. Finally, the social environment matters: where people trust each other and perceive high tax morale in each other, it will deter evasion.

Fifth, the institutional environment determines the taxpayers’ willingness and ability to comply. Formal (such as political organisations) and informal (cultural ‘rules of the game’) institutions associated with the tax system shape tax compliance. On the former, trust in public institutions is a well-known determinant of taxpayers’ willingness to pay; if we trust our democracy, if we perceive the tax system as fair, if we believe the political system is efficient, we are more likely to pay our taxes. This is why revelations of corruption or scandal are likely to negatively affect tax morale. For instance, in the Danish context, recent revelations of massive dividend withholding tax fraud have been found to harm societal tax morale. On the latter, socio-economic and psychological factors can help explain tax morale, such as interpersonal trust and belief in fiscal cost-benefits.

Recent contributions 1: Tax evasion and inequality

Now let’s circle back to the first paragraph of this post: the new Alstadsæter-Johannesen-Zucman paper. This is a contribution mainly to point 1 above, i.e. levels of wealth as a determinant of tax evasion. But it also raises questions more broadly about the structure of evasion and the effects on our societies. There have been plenty of media stories about the paper, so let me just highlight three particularly relevant contributions in the context here:

First, the AJZ paper illustrates the progressiveness of tax evasion by wealth more clearly than perhaps any paper before it. Using data from the HSBC SwissLeaks, Panama Papers, Swedish and Norwegian tax amnesties, as well as data from the Scandinavian tax administrations, they show a remarkably clear trend of increasing probability of hidden funds (which are likely to correlate with evasion, although this is an assumption up for challenge) with wealth. It indicates that it is the utmost wealthy, in particular the top 0.01% (owning more than $40m in assets), that evade taxes via offshore structures (which is likely to cover a similarly increasing proportion of evasion mechanisms by wealth due to fluidity of income and assets, as noted above).

Second, the paper indicates that tax amnesties may be a more effective tool to combat tax evasion than previously thought. While tax amnesties are typically criticised for merely offering a one-time free lunch to wealthy tax evaders, the study finds that tax amnesties in Sweden and Norway have had positive, lasting effect on tax payments, and reported wealth and income, by taxpayers using the amnesty. However, it is important to caution the interpretation with some key points. Firstly, the data utilised here relates largely to the mid-2000s, where we did not have FATCA, the CRS, or today’s levels of international tax administration cooperation. The presence of new modes of information exchange are likely to squeeze scope for tax evasion (and avoidance) by wealthy taxpayers, thus potentially eroding the benefits of tax amnesties. More broadly, while tax amnesties may have a positive effect on the tax compliance of individuals with a history of evasion, we know little about its societal effects. From the literature reviewed above, we might hypothesise that the presence of amnesties deteriorates trust in political institutions, belief in a fair tax system, and perceptions that others are compliant – all of which would decrease societal tax morale.

Third, AJZ touch upon the implications of their findings, in particular as it relates to inequality. Ever since Piketty, inequality has been at the top of national and global political agendas. This paper, alongside other work by the authors (and others), shows that unrecorded offshore wealth substantially skews national inequality and tax burdens, leaving national statistics incomplete. The paper estimates that the top 0.01% hide about 25% of their true wealth, and that counting hidden offshore wealth increases the wealth share of Norway’s top 0.1% from 8% to 10%. You can easily imagine what this does to national (and global) inequality statistics. Given that tax compliance is generally higher in Scandinavia than anywhere else, it is likely that the inequality skew shown from Scandinavian data provides a lower bound for the rest of the world.

Recent contributions 2: Comparative experiments in tax compliance

Another stream of scholarship that has contributed important recent insights is comparative experimental work on tax compliance. This scholarship provides insights mainly for points 4 and 5 above, i.e. tax morale and institutional contexts of tax compliance. Here I’ll highlight recent work by a group of mainly Italian-based scholars, with two recent pieces (1, 2), though I must also mention that my colleague at Copenhagen Business School, Alice Guerra, has embarked on a fascinating 2-year post-doc project to build on and strengthen this line of work. Using controlled experiments involving Italians, Swedes and Britons, the Italian-based scholars are able to gauge differences in tax compliance and its sources across national contexts. Here I’ll highlight two particularly relevant contributions for this context:

First, while Italians (and Southern Europeans more generally) are typically viewed as having low tax morale compared to Britain (Northern Europe) and in particular Sweden (Scandinavia), the studies in fact showed surprisingly little variation in the intrinsic motivation of subjects to comply, when facing similar circumstances. In fact, Italians were even showed to have higher propensity for tax compliance than Britons given identical institutional environments (simulated in the experiments). This is despite consistent measures of relatively lower trust and honesty (factors that we would think lead to higher evasion) in Italy, and a general perception of Italians as less moral. This indicates that it is not, as conventional wisdom holds, the lack of intrinsic motivation on the part of Italians that hinders tax compliance.

Second, the national “style” of evasion is important in determining tax compliance. While Swedes for instance are more likely to comply in full than Italians, they are also more likely to not comply at all. It seems that in Sweden, there is a “either or” dynamic to tax evasion. In Italy, in contrast, there is a much more significant propensity to fudge (i.e. “cheat by a small amount”). Although the overall effect is that Swedes and Italians’ tax morale is relatively similar, the structure of national tax morale varies significantly.

Policy implications

While these studies and all of their contributions are valuable in themselves, enhancing our understanding of tax compliance and evasion, we would be foolish not to look at potential policy implications. I would not recommend full regulatory overhauls based on individual studies, but taken in context of wider bodies of literature, we can sketch out some preliminary lessons.

From the tax evasion and inequality literature, it is clear that tax administrations and legislators must pay particularly close attention to evasion by wealthy people, designing and implementing targeted policies to combat offshore evasion. This realisation has not been lost; it is behind much of recent years’ surge for automatic exchange of information and tax transparency at the global levels. The emergence of FATCA and CRS, while shortcomings remain, are likely to make a substantial impact on offshore tax evasion by wealthy individuals, deterring some avenues of evasion whilst channelling illegal activity toward other vehicles (such as trusts), where new regulatory innovation must then focus accordingly.

It also points to tax amnesties as a potentially useful tool to instil lasting tax compliance in prior evaders. However, this must be balanced against any deterioration in wider societal tax morale due to perceptions of injustice. Perhaps a useful approach would be to utilise the revenue brought in from tax amnesties specifically to raise societal tax morale, such as via broad-based campaigns or strengthening the integrity of public institutions.

Finally, there is a need to recognise shortcomings in national wealth and inequality statistics. Putting offshore wealth in the spotlight provides an opportunity to gain a more real picture of inequality and wealth in national and international contexts, which should be to the benefit of polities and citizens alike – no one is better off with continuing concealment of actual wealth distributions, except for tax evaders.

Based on the experimental tax compliance literature, we would do well to start questioning prevalent narratives of a “moral North” and an “amoral South”, certainly as it relates to tax compliance. Italians are no less willing to pay taxes than Britons or Swedes.

Rather, recent studies tell us that we should focus on the institutional context in which tax compliance happens. There is no denying that tax evasion is more widespread in Southern Europe than in Northern Europe, but the literature indicates this is not due to varying individual intrinsic motivation. Instead, there is a need for policy-makers to focus on implementing policies that eliminate formal opportunities for evasion. As an example, 95.9% of Danish personal income taxes are levied based on third party reporting (from banks, employers, unions, etc.). This makes it difficult to evade taxes. Similarly, the development of expansive networks of automatic exchange of tax information is likely to contribute to this end.

Finally, we must recognise the differing national “styles” of tax evasion. For instance, given that tax evasion for Swedes is very much an “either or” question, there is a need to focus deterring efforts on the initial decision to evade or not, as compared to Italy where focus should rather be on the culture of “fudging” (‘cheating a little bit’). This may foster differing policy initiatives that emphasise intensive and extensive decisions to evade taxes, respectively.

As a very last note, I must also emphasise that, although tax evasion is certainly a serious problem in many countries, North and South, as evidenced by the literature reviewed here, all the studies discussed here found that most people are honest and want to pay their taxes correctly. While Alstadsæter, Johannesen and Zucman estimate that many of the wealthiest taxpayers hide substantial fortunes offshore, most taxpayers clearly did not. The cross-cultural experiments also found that the vast majority of people genuinely do not look to evade taxes, (almost) no matter the circumstances. This is a lesson not to be forgotten.


Reading list on tax compliance

Alm & McKee, 1998. Extending the Lessons of Laboratory Experiments on Tax Compliance to Managerial and Decision Economics. Managerial and Decision Economics, 19(4/5): 259-275. Link.

Cullis, Jones & Savoia, 2012. Social norms and tax compliance: Framing the decision to pay tax. The Journal of Socio-Economics, 41(2): 159-168. Link.

Cummings, Martinez-Vazquez, McKee & Torgler, 2009. Tax morale affects tax compliance: Evidence from surveys and an artefactual field experiment. Journal of Economic Behavior & Organization, 70(3): 447–457. Link.

Fonseca & Myles, 2012. A survey of experiments on tax compliance. HMRC Research Report 198. Link.

Hashimzade, Myles & Tran-Nam, 2013. Applications of behavioural economics to tax evasion. Journal of Economic Surveys, 27: 941–977. Link.

Onu & Oats, 2016. ‘Paying Tax Is Part of Life’: Social Norms and Social Influence in Tax Communications. Journal of Economic Behavior & Organization, 124: 29–42. Link.

Pickhardt & Prinz, 2014. Behavioral dynamics of tax evasion – A survey. Journal of Economic Psychology, 40: 1–19. Link.

Torgler, 2002. Speaking to Theorists and Searching for Facts: Tax Morale and Tax Compliance in Experiments. Journal of Economic Surveys, 16(5): 657-83. Link.

Torgler & Schneider, 2007. What Shapes Attitudes Toward Paying Taxes? Evidence from Multicultural European Countries. Social Science Quarterly, 88(2): 443–470. Link.

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…

 

Power in Numbers: How Data Shapes the Tax Policy Arena

Since the first number value systems were invented around 3400 BC, numbers have played a central role in human society. Arguably, though, they have never been more important than they are today. We fiend for data, quantities, statistics and numbers to an astounding degree. We live in an almost fetishised data-heavy society.

This applies to the tax world as well, of course. In fact, numbers and data are absolutely central to tax policy debates. We obsess over tax rates and the amount of tax lost to evasion and the percentage-growth effects of tax policy changes. We rank national tax regimes’ competitiveness and secrecy jurisdictions and tax avoiding companies. Etc. etc. etc.

Why? Because numbers allow us to quantify anything, communicate easily, analyse and conclude with simple outputs. And so, often times we absorb information and arguments construed as numbers over other types of inputs.

That’s why we play extra close attention when the hear that the European Union loses €1 trillion a year to tax dodging, that Estonia has the no. 1 competitive tax code in the world, that Apple is holding $215 million offshore. It’s also part of the explanation why mathematical models and econometrics is now the standard way to “do science” in modern economics (it wasn’t always like that, to be sure).

But numbers are not neutral. Numbers provide authority in a way that words or plain language sometimes does not. Numbers indicate “we did the math”, summoning ethos appeals that often provide instant credibility.

Thus, those able to produce, use and leverage numbers and data often hold greater sway, and they manage to be influential, impactful and effective in modern debates around tax. The point is similar to one I have made previously on technicisation of global tax policy processes and I think the two are related: This particular feature of the tax policy arena – an affinity for numbers – provides an environment where certain actors and arguments are often favoured.

How numbers rule

A recent paper by Hans Krause Hansen and Tony Porter in the journal International Political Sociology discusses the distinct features of numbers and how they affect transnational governance:

  • Mobility: As counting strips away meaning behind, numbers are mobile and travel easily across borders.
  • Stability: The meaning of numbers is less complex than words. 83 is less frequently interpreted in different ways than ‘democracy’ or even ‘house’.
  • Combinability: Numbers are easier to combine, also in different ways. 2+2 is always 4; five oranges and two bananas can be 7 or 5+2.
  • Order: Quantitative ranking is intuitive and comprehensible. 1 is higher than 2, etc.
  • Precision: Simple arithmetic allows for great precision in using numbers. One meter is exactly 100 cm, and so forth.

Hansen and Porter specifically analyse barcodes and radio frequency identification numbers in this light, but their insights are more broadly relevant, certainly in the tax world. A few real-world examples to illustrate this point:

Citizens of Tax Justice’s “Offshore Shell Games”

For the American tax think tank/advocacy organisation, Citizens of Tax Justice, the stated organisational focus is “federal, state and local tax policies and their impact upon our nation.” A wide span. And each year, they output hundreds of reports, blogs, analysis, etc. on these topics. Yet, since 2013, their most popular annual output has arguably been the “Offshore Shell Games” report, which surveys the deferred cash stock of US multinationals in tax haven subsidiaries. The vast amounts, up to $2.5 trillion per the 2016 report, and its “leaderboard” of offshore cash piles make for neat media stories.

The $2.5 trillion number is mobile, straight-to-the-point, easy to communicate, thus become widely cited, shared and discussed. The massive figure is also stable, eyecatching yet unmistakable, and leverages the combinability of numbers, being made up of similarly clear individual company numbers, plainly extracted from corporate accounts. Order is key: As we see the number go up each year, from $2 to $2.1 to $2.5 trillion, the simple narrative is one of growth, which CTJ firmly problematises. And finally, precision of the number provides strength: with the bottom-up data approach from corporate accounts readily accessible and the overall number down to a decimal point, the credence of the overall argument is enhanced. Together, these features make for a plain and intuitive case, allowing CTJ to successfully set out the argument that “big US multinationals are hoarding monumental cash piles offshore, avoiding billions in US taxes.”

Tax Foundation’s Tax and Growth predictions

Another American tax research organisation, the Tax Foundation, has been hitting the headlines recently. To be fair, it has been a lot since establishment in 1937. But arguably their current popularity has been driven primarily by data outputs. Of particular note is its “Tax and Growth Model” outputs, a macroeconomic dynamic scoring model used to evaluate economic effects of policy changes. The model is similar to macroeconomic models used by the US government (and other governments), though it allows for less conservative dynamic scoring, meaning behavioural and thus economic effects of policy changes are factored in to a much greater extent (a topic of much debate). (In Denmark, the centre-right/liberal think tank CEPOS works in similar ways, though they often rely on the independent DREAM model, and they work more broadly than tax issues). In short, the model allows you to input policy changes and receive a range of estimates about the consequent economic future. This is what allowed the Tax Foundation to ascertain during the American election campaign that Donald Trump’s tax plan would generate 10-year GDP growth of 8.2%, compared to Hillary Clinton’s -2.6%.

(The list of noteworthy data outputs also includes the Foundation’s US “State Business Tax Climate Index”, which compares and ranks each state’s business tax systems – garnering significant public and policy attention. Such rank comparisons are incredibly powerful, similar to PwC and the World Bank’s international “Paying Taxes” ranking – I’ll discuss why in the third example below.)

Again the numbers there are mobile and stable; they are ease to carry across debates and borders and simple for any recipient to comprehend. The order is central here, too: 8.2 is clearly superior to than -2.6. Combinality is a core component of the GDP estimates; they are made up of hundreds of assumptions and calculations on the effects of policy changes, possible only through such a massive scoring model. Finally, precision is paramount. We are provided with one single, definitive prediction of the GDP effects of a catalogue of tax policy changes, down to a decimal point, providing a true aura of conviction. Hundreds of assumptions, based on a vast economic theory and empirical research, boiled down. The final number provides the ultimate appearance of precision and certainty. In all, the number characteristics contribute to laying the ground for a simple conclusion: “Trump’s tax plan is better for the economy than Clinton’s”.

Tax Justice Network’s “Financial Secrecy Index”

The Tax Justice Network, another productive tax advocacy/research organisation, has been highly successful with its key number ranking output: the Financial Secrecy Index. The FSI compares jurisdictions around the world based on financial secrecy and size. The FSI, published first in 2009, then 2011, 2013 and 2015, surveys 15 key secrecy indicators (legal rules, administrative practice, etc.) and the overall national financial services market, which rolls up into a final global ranking of “secrecy jurisdictions”: 1, 2, 3, and so forth. The size feature was included in particular in order to challenge prevalent understandings of “tax havens” as small offshore island states. Instead, the USA, the UK, even Germany and Japan, have ended up high on the secrecy score, prompting headlines back in 2009 like, “Delaware – a black hole in the heart of America“.

Looking once more to the distinct characteristics of numbers, we can see the importance. The US being the number 1 (or number no. 3, in the 2016 report) most secrective jurisdiction in the world is a firm, easy-to-grasp statement, easy to transmit and hard to misunderstand. It provides a strong challenge to conventional wisdsom on tax havens. Combinability has also been central to one important FSI story. The anatomy of the FSI score is of course a combined number. Further, if you combine the scores for the UK, its overseas territories and crown dependencies, it would top the list – which has been one of the key media stories following the FSI launch. Order, of course, is the key ingredient to a ranking, and provides a powerful messaging tool. Number 1 is number 1, number 2 is behind, ahead of number 3, etc. The ability to say, based on an extensive data exercise, that “Switzerland is the top secrecy country in the world”, and “the US is (one of) the top secrecy jurisdictions in the world”, is highly impactful. Finally, the precise scoring on multiple indicators, allows for the appearance of a strong representation of reality: Switzerland’s 2016 FSI score is almost double that of Luxembourg – potentially a damning indictment.

Numbers affect tax policy, but not always

Numbers matter for tax policy. Much like the technicisation of international tax reform, the number-obsession creates participation barriers to policy debates and shapes politics and policies, with important democratic, economic and social implications. And much like the reliance of modern academic economists and indeed public and international economists on econometrics and mathematical modelling has become necessary and crucial in order to be taken seriously and impact economic policy debates, the ability of tax policy actors to draw upon quantitative support for tax policy arguments has become essential.

Indeed, numbers push arguments, emphasise issues and change perceptions. The $2.5 trillion dollar offshore cash pile guides attention towards US deferral reform and MNC tax behavioural norms. The 10%-point swing in GDP growth estimates tells us that one Presidential candidate’s proposals are significantly better for the economy. And the secrecy jurisdiction ranking persuade us that, despite conventional wisdom, the US and the UK are among the key enablers of ‘the offshore world’.

Policy actors able to produce, harness, manage and broker quantitative support for policy arguments thus stand at a potentially significant advantage in tax debates, with the possibility to effect real policy change.

However, it is important to recognise that not all numbers or data-based arguments are successful and influential. The datafication of policy debates is certainly just one part of the equation. Numbers are assessed and filtered through policy processes and debate arenas, and some are certainly less robust and authoritative than others. Maya Forstater, for instance, has done yeoman’s work to dispel the precision of certain ‘Wild Ass Guesses‘ within the tax policy area. When arguments with quantitative support are successful, it is often not entirely because of the quantitative element itself; often, it is because those proposing the data-backed arguments are also able to draw on strong expertise and key networks (as I have argued elsewhere). For instance, the ability of the Tax Justice Network to draw on credible expertise to build and push the Financial Secrecy Index as a global benchmark was a key success factor in changing the discourse around “offshore tax havens”.

Thus, the next time you observe a tax policy debate (or indeed other policy debates), pay attention to the use of numbers, data and quantitative support. And see how it is used, leveraged and combined with other factors, such as credible expertise and networks. Often, this is how policy arguments are won and lost.

 

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:

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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.

We’re changing the equation of tax competition and corporate profit shifting

Within tax economics, one of the central arguments for tax competition and low(er) taxes on capital, including corporate profits, is that it leads to increased investment and growth (at least in some countries, mostly small open economies).

Why? In short, we know that corporate tax rates and rate changes have behavioural effects. Capital income may change legal forms (between two corporate forms or between corporate and non-corporate forms), firms may change their debt/equity ratios, they may shift profits abroad or increase/reduce investments. It is the nature and size of these effects that determine the result of corporate tax increases or decreases. The ‘go to’ for empirical evidence on this is De Mooij & Ederveen’s 2008 “reader’s guide”. Their literature review finds that, in an average situation surveyed by the literature, the total semi-elasticity of the corporate tax base for these effects (i.e. the % change in the tax base from a 1% increase in the relevant tax, see below) is -3.1, with profit shifting (-1.2) the largest single effect:

Udklip

I.e. if the statutory corporate tax rate increases by 1%, the corporate tax base is predicted to shrink by 1.2% from increased profit shifting.

There are a myriad of potential arguments to question the certainty and applicability of these findings, but that is for another potential blog; suffice to note here that these figures represent the most accepted available evidence in economic literature on the behavioural effects of corporate taxation.

Based on this evidence, it is regularly argued that corporate tax rate reductions in isolation and tax competition more broadly positively support economic growth as facilitators of investment and eliminators of tax avoidance (again, in some countries at least).

Now, a key element in such assertions is that the status quo is taken for grantedCurrent behavioural effects (tax elasticities) are assumed as universally true. Rather than endogenous to economic tax competition models (i.e. “they can be changed”), behavioural effects are treated as exogenous (i.e. “this is how the world is”). As my review of Peter Dietsch’s recent book on tax competition notes:

One of the key points in Dietsch’s dismissal of tax cooperation as economically inefficient concerns optimal tax theory. Proponents of tax competition that leverage optimal tax theory hold that lowering taxes will result in increased labour supply and decrease tax evasion and avoidance. Analytically, the consequence is less need for tax cooperation to stem a race to the bottom of capital taxation. And this may be empirically true today. But these elasticies (the extent to which the labour supply and evasion/avoidance change with tax rate changes) are (partly) institutionally determined, and thus Dietsch argues there is no reason to assume today’s elasticities for tomorrow – they can be modified through policies and thus we can change the factors in the optimal tax calculation. For instance, by introducing stronger international cooperation on capital tax evasion, it is possible limit the tax evasion elasticity, and thus make tax systems more progressive by increasing the optimal levels of capital taxation, shifting the tax burden back on to mobile capital factors.”

The highlighted part is, in fact, exactly what is happening today and what has been happening for the past decade in particular. We’re changing the equation of tax competition and corporate profit shifting. Numerous and continuous reforms to combat tax evasion and avoidance are contributing to this evolution (even if some commentators questions their effectiveness). This includes regulatory initiatives (such as (automatic) exchange of information, FATCA and the CRS, the OECD MCAA, the revised EU Parent Subsidiary and Savings Tax Directives, the OECD Harmful Tax Campaign, Dodd-Frank, country-by-country reporting, the BEPS project, the EU ATAD and the EU tax state aid investigations) and voluntary standards (EITI, PWYP and the Fair Tax Mark), but also other significant developments (such as the Offshore Leaks, LuxLeaks and PanamaPaper).

Not just in their material effect but also in their normative impact do these reforms and events lessen the ability and willingness of corporations to shift profits as part of tax and regulatory arbitrage, thus decreasing the predicted elasticities (i.e. the positive corporate tax base effect from decreased corporate tax rates). This is not an unreasonable assumption, in any case. To my knowledge, there is still no systematic studies of the effects of these regulatory and normative changes on corporate tax elasticities.

This realization is what led Pascal Saint-Amans, Director of the OECD Centre for Tax Policy and Administration, to make the following comments in to the Wall Street Journal this week:

“For the past 30 years we’ve been saying don’t try to tax capital more because you’ll lose it, you’ll lose investment. Well this argument is dead, so it’s worth revisiting the whole story,” Pascal Saint-Amans, the OECD’s tax chief, said in an interview.

“In the past people, notably with international income, could use foreign bank accounts to receive and make payments and their home tax office would never know. That era will be over,” Mr. Saint-Amans said optimistically. “In the lead up to this new regime some countries have allowed their citizens to declare their foreign income without penalty, that alone has raised 50 billion euros in extra tax.”

Saint-Amans’ comments also come on the back of the OECD’s release of a new report entitled “Tax Design for Inclusive Growth“, which, as a lead up to this weekend’s G20 Finance Ministers meeting in China, breaks with the advice of prior decades, arguing that the case for low capital taxation and tax competition are “not as clear-cut as previously thought” (p. 40). Although this specific messaging was not included in the G20 meeting communique, the report’s section on capital income taxation is highly recommendable for those interested, and there is no understating the language used here and its policy implications.

The OECD is sending a message, which is likely to become increasingly prevalent: As reforms squeeze regulatory room for and normative consequences of tax competition, capital is less likely to flee national boundaries, and thus countries can, just perhaps, slowly start to ease the foot off the tax competition throttle.

* POST-SCRIPT JUNE 2018 *: A new paper by the IMF was released on this exact topic recently. I shared some thoughts on the paper on Twitter, which provides a relevant addendum to this blog post. To read, see below: