The problem is not that companies pay too little tax, but that they pay too much

Those attacking companies not paying corporation tax have opened up a new line of argument. Specifically, members of the House of Commons’ Public Accounts Committee have argued that because companies benefit from all the things on which governments spend money, they should pay more in taxes. This precisely replicates President Obama’s statement before the US election: “If you've got a business - you didn't build that. Somebody else made that happen.” He was referring to government-paid teachers, infrastructure and so on.

First of all, let us look at who it is that actually pays taxes and on what. It is as meaningless to complain about “companies” not paying taxes as it is to complain about “vehicles” not paying road taxes. Companies’ owners pay taxes. Taxes are paid by owners on the return on their capital and on the additional profits from entrepreneurship. It is also notable that some shareholders are not supposed to pay taxes – pension funds, charities, people on low incomes, and so on. Regrettably, Gordon Brown, in his 1997 Budget, ensured that such people do pay tax by preventing them from reclaiming corporation tax on dividends, and it is worth considering whether this is one of the reasons that companies are increasingly trying to escape tax. Non-taxpayers do not pay tax on returns to other forms of capital. If companies’ owners are at least partly made up of non-taxpayers then it is not surprising that companies try to preserve their owners’ non-taxpaying status by using tax havens.

But, what of the argument that companies should pay tax to finance the services that make it possible for them to operate and that, by avoiding tax, they are getting all the goods and services the government provides for free?

The most important government services as far as corporations are concerned are a functioning court system, a non-corrupt government, the absence of crime, and peace. This can all be achieved for about 5% of national income – roughly the amount of non-debt-interest government spending in the late nineteenth century, when perhaps the best business environment in history existed. It might be added that companies pay for many of these services themselves (for example, through private security firms and by using private forms of legal redress). Corporation tax alone stands at over 3% of national income and so would comfortably pay for many of these services for the whole country, never mind that part of defence, policing and so on from which companies benefit specifically. Furthermore, the providers of capital to companies also pay tax on dividends, interest and bank loans which is excluded from the corporation tax take figures.

Other services cited by members of the Public Accounts Committee for which companies should pay through corporate tax include the provision of roads, refuse collection, fire protection and an educated workforce. Road users – including companies – pay about £30bn in taxes more than the government spends on roads. This is certainly a bogus example. Companies pay for refuse collection directly. Most of the other services are financed through local government. Corporations directly finance the provision of these services through yet another tax – business rates. In fact, local business rates raise sufficient revenue to finance a police service around ten times the size of the British police forces or, alternatively, to finance the whole police service, fire service and all secondary education spending without any contribution from any other taxpayers (who are the main beneficiaries).

In fact, the main beneficiary of an educated workforce is the educated workforce. I have never seen any evidence that education raises returns on capital – but education certainly raises the wages that companies have to pay for workers. Indeed, companies do, of course, outsource to countries where labour is cheaper and less-well-educated because returns on capital in those countries are higher. Most of the gains from education accrue to the educated.

That is not to say that there is no gain to a company from its workforce being better educated (ignoring the debate about general and specific training). But, at the same time, the educated workforce (as well as the population at large) benefit from the opportunities that companies provide workers to enhance their productivity and earnings. This is just a specific example of the gains from exchange. The owners of Starbucks gain from its educated workforce (though trivially compared with the workforce itself) and the workers at Starbucks gain from the fact that people have provided the finance for the business. How do we maximise gains from exchange? By reducing taxation as far as possible.

Indeed, if the Public Accounts Committee had been looking down the right end of the telescope, instead of inquiring into Starbucks paying too little tax, they would have been inquiring into why Costa Coffee pays too much. Too much tax leads to too little economic exchange and entrepreneurship. When it comes to the empires that politicians create, it is amazing how much companies have built.

This article originally appeared on Conservative Home.

In a closed economy, the government could raise more in tax by scrapping corporation tax, simply because individuals owning shares typically pay income tax on marginal income at a higher rate than corporation tax. More complicated in an open economy, but still plausibly the case.
For more than forty years now I have advocated abolishing a separate corporation tax and simply taxing real company profits (after allowing for inflation) at the basic rate of income tax. This would be regarded as a payment on behalf of shareholders. I also advocate having only a single flat-rate of income tax, which would mean no further tax liability on dividends from shareholders. There would then be no tax consequences from companies paying dividends. One great advantage of such changes would be to enable the system of taxing incomes to be very much simpler than it is now. Governments occasionally pay lip service to this objective, but their actions speak a good deal louder than words. This year's Finance Act contained well over 600 pages, which is nothing short of disgraceful.

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