Should we get rid of corporation tax (part 2)

In the last post I talked about why so many people endorse the idea of completely scrapping corporation tax.  To briefly reiterate the main arguments:

  1. We don’t know who mostly bears the costs of corporation tax. So if what we really want to do is tax the rich beneficiaries of corporate profits, then we’d be better off raising capital gains and dividend taxes (or even the personal income tax at the high end).
  2. Corporation tax doesn’t work very well to discourage negative externalities like carbon emissions – a specific carbon tax would do this more effectively.

As I said last time, it seems to be economic gospel, even on the left, that the corporation tax is a ‘bad’ tax. However I did find one dissenting voice in the form of an old (1996) paper by Richard Bird, an economist at the University of Toronto.  He notes a number of interlocking reasons why eliminating corporation tax might be a bad idea. One their own, none of them are as persuasive as the straightforward anti-corporation-tax case (which is why they probably haven’t been covered as much). However, there is one fact stands in their favour – corporation tax is still around. That’s at least one indication that it can’t be as self-evidently idiotic as some would have you believe.

His case can broadly be broken down into ‘good’ economic arguments (i.e. sound economic reasons why the tax is beneficial) and ‘bad’ political ones (i.e. reasons why, regardless of whether corporation tax makes any economic sense, we probably can’t get rid of it).

The first ‘good’ argument is that corporation tax can work as a tax on profits deriving from economic rent. This is when companies can raise prices above what they would be in a perfectly competitive market, due to some natural or enforced scarcity. An example would be the profit drug companies make on patented vs. unpatented drugs. The patent enforces scarcity – only one company can make the drug so they can charge much higher prices than if they were competing with others. Taxes on these kind of profits are essentially ‘free money’ for the government because they don’t impose any real costs on the economy as a whole. The only problem is that, as it stands, corporation tax doesn’t distinguish between this kind of ‘pure’ profit, and any other kind.

The second argument is that corporate taxes can work as a sort of backup to personal taxes like those on dividends or capital gains. If taxes were only levied at the personal level, it might encourage investors to leave earnings to accrue at the corporate level, rather than taking them out as dividends (which would be taxable). 

These reasonable economic arguments aside, the continued survival of corporation tax probably has much more to do with how politically difficult it would be to get rid of. One big, obvious reason for this is that corporation tax brings in quite a lot of money (£39.5bn in the UK last year). To match this revenue, other taxes (capital gains etc.) would have to be increased by quite a bit. We’ve already established that one of the economic downsides of corporation tax is that we don’t really know who’s paying it. Politically however, this is a definite upside – nobody feels the pinch of corporation tax directly. Capital gains and dividend taxes, on the other hand, are felt keenly by rich people with loud voices. You see the problem.

If you’re a politician, another good reason to keep corporation tax around is that it gives you a lever by which to manipulate corporate behaviour. For example, if you want to encourage growth in certain industries, you can give tax breaks to companies working in those industries. Of course, this opens the door to all sorts of lobbying and dirty tricks by various industry groups as they battle for preferential tax treatment. But one more lobbyist lunch probably isn’t going to kill you…

The last, and probably most intractable problem for the anti-corporation tax movement is that it would be very difficult for any country to act alone. As Bird points out, one of the most important considerations when designing a tax system is how it interacts with everyone else’s. He lists a number of reasons why this is important when it comes to corporation tax, which basically all boil down to the fact that, if one country scrapped their tax, while everyone else kept theirs, that country might end up losing a lot of money.

The conclusion of all this, according to Bird, is that we’re probably not going to see the end of corporation tax anytime soon — but that’s not necessarily a bad thing. Instead of trying to scrap the tax completely, we should reconfigure it to better target the things it’s actually suited for – like taxing rent profit. This would hopefully leave us in a better position to tackle the things people think corporation tax is supposed to do — i.e. tax rich people.

About Robert de Vries

I'm an Early Career Research Fellow in the Sociology department at the University of Oxford. I'm mainly interested in how people are affected by concerns about their social status; how it colours the way they think, feel, and behave. I try and contribute here regularly, but my addiction to writing excessively long posts keeps getting in the way.
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2 Responses to Should we get rid of corporation tax (part 2)

  1. Bruce Bradbury says:

    In Australia we recently had an unsuccessful example of a tax designed to cream off the windfall economic rents accruing to mining firms (following large increases in commodity prices). The economic reasoning was sound – this would cream off the windfalls while providing a cushion for firms when prices were low. It would reduce the risk associated with mining investment and lead to substantial tax revenues in the long run while not discouraging investment.
    However, the politics didn’t work. The mining firms complained (with expensive advertising) and, more importantly, the tax didn’t initially raise much money (because commodity prices fell somewhat). The new conservative government will thus be able to abolish the tax.
    So, while in economic terms the public sector was better placed to absorb the risks associated with price fluctuations, politically it was not. Or at least selling the complicated long-run message was beyond the political skills of the Labor government.

  2. Hi Robert, coming late to this post, but you might be interested in this article from the US, which has further arguments for corporation tax: in particular, it points out that many corporates make their payouts to tax-exempt institutions … so if corporation tax were abolished, that revenue would never be taxed, at considerable cost to the government.

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