Corporate tax warning

Policy Research Officer, International Trade Union Confederation (ITUC)*

©David Rooney

Corporate tax is falling, both as a share of GDP and in the global tax take. Yet, just like other economic players, businesses rely on public investments too. To avoid a crisis, companies should assume a higher share of the overall tax burden.

“In this world nothing is certain but death and taxes”, Benjamin Franklin once famously said. But for corporations, paying taxes is anything but a certainty. Statutory corporate tax rates are plummeting in most countries, while business keeps finding ever more creative ways of getting around paying any taxes at all–leveraging debt in privately held corporations being the most recent trend of this. While the OECD has put itself in the driver’s seat of the international effort to combat tax evasion and avoidance in the form of transfer pricing and the use of tax havens, the detrimental tax competition that many of its own member economies are engaging in has so far been receiving scant attention. Yet if more attention isn’t given to this issue we could soon face a global tax crisis.Within the last 20 years, corporate tax rates have fallen from around 45% to less than 30% on average in OECD countries. And lately, with increased mobility of multinational corporations, tax competition has intensified. Thus from 2000 to 2005, 24 out of the 30 OECD countries lowered their corporate tax rates while no member economy raised its rates. The consequence is that average rates in all OECD countries dropped from 33.6% in 2000 to 28.6% in 2005.The conventional wisdom is that it is primarily small economies that feel compelled to cut corporate taxes in order to attract foreign investments–Ireland and a handful of the newest EU members are often put forward as examples of this–but it is actually some of the largest economies in the world that have lost most tax revenue from corporations over the last decades. Most notably, between 1970 and 2003, corporate taxation as a share of total taxation dropped by 51% in Japan and by 39% in the US and in Germany. And from 1995 only, the weight of corporate taxation to public finances dropped by around 20% in the US, Japan and Italy (see graph).Yet at the same time corporate profits are booming and wages are stagnating. After-tax profits in the US are, as a proportion of GDP, at their highest in 75 years, and in the euro area and Japan they are also close to 25-year highs. Wages, on the other hand, are making up an ever smaller part of national income, down from 68% in 1982 to 59% in 2005 in the 15 EU members. And at 56.9% in the US in 2005, they are, except for a brief period in 1997, at their lowest level since 1966. Hence, relying on the income and spending of wage earners to fund ever larger parts of public finances will either hollow out government budgets or lower workers’ incomes.Other developments emphasise the mistiming of the present corporate tax break. Business increasingly bases its success on institutional and societal competitiveness–in short the qualities of the societies they are part of, such as the skills of their workforce, publicly funded research and infrastructure, and well-developed legal systems and intellectual property regimes. As a result, more and more government spending is used to enhance such competitiveness. Yet surely corporations, as beneficiaries of these investments, should pay their share in taxation? Surely the burden should not fall on workers or on consumption? For the sake of both equity and efficiency, business tax cannot be allowed to go on falling.Click here for bigger graphAnd with ownership structures of private business becoming more international on a daily basis, corporate profits in the form of dividends increasingly escape national tax collection and thus contribute nothing to the spending and investments necessary to maintain and extend institutional and societal competitiveness. If tax on corporate dividends increasingly eludes national taxation, then taxing corporate profits should be the obvious place to find compensation.Corporate tax competition inevitably leads to declines in the amount of taxes paid by corporations, a loss of public revenue in many cases, particularly if economic activity is slack, and a greater burden on individuals. Since tax bases have been broadened while rates have been cut, globally the corporate tax crisis is still at bay. But there is a limit to how much corporate tax bases can be broadened. And in the OECD countries in particular, this limit is not far away. Even the broadest tax base will not matter if tax rates tend towards zero. And this might happen earlier than we think. If the linear trends in the OECD countries are extrapolated into the future, statutory corporate tax rates will hit zero by the middle of this century. The somewhat tragic irony is that the countries that have participated most actively in this downward tax competition haven’t even had the short-term gains in the form of increased foreign direct investment that motivated them to do so. The reason is simple: cutting tax to attract investment cannot work on its own and may be counterproductive. Take Ireland, often held up as a low tax success story. Yet Ireland’s inward investment and robust economic growth owe much to a strong public sector and smart use of tax spending in areas like education and infrastructure, not just to its tax cuts. It would be foolhardy to think that any country can emulate Ireland’s success by cutting taxes. In fact, given the need to build up their frameworks, they may end up damaging their prospects. Little wonder that research shows that the “new” member states of the European Union haven’t received more investments from the “old” member states in the years they have aggressively cut their corporate tax rates. Elsewhere, in G7 Canada a cut in the statutory corporate tax rate from 28% to 21% between 2000 and 2006 was followed by a decline in net inflows of FDI in the same period.Without action, we could be on the verge of a global tax crisis that could hurt economic activity. The tax burden cannot be carried by labour and consumption alone. The upshot of inaction would be a loss of revenue for governments and a downward spiral in economic activity. Governments must realise that “beggar-thy-neighbour” tax competition risks eroding their own economic and social foundations. And they must recognise that all countries have a common interest in cooperating to achieve fair levels of corporate taxation. This requires multilateral solutions.The message that tax systems enable growth and that corporations must pay their share surely makes sense to most governments. Is there any choice but to step up initiatives on harmful tax practices and discourage unfair tax rivalry? The EU has taken a first step by starting work on creating a common corporate tax base. Yet while positive in itself much further initiatives must be taken, both within and outside the EU, to address the fragility of current corporate tax practices. Political will and dedication is needed, but the public gains would be worth it. Surely that is what co-operation and development is all about.
*The views expressed in this article are those of the author and do not necessarily reflect the views of the OECD or its member countries. ITUC is a partner organisation of the Trade Union Advisory Committee to the OECD (TUAC).Visit www.ituc-csi.org and www.TUAC.org References
  • ICFTU (2006), “Having their cake and eating it too - The great corporate tax break”, ICFTU Online, 6 July 2006, Brussels. See www.icftu.org
  • OECD (2005), OECD in Figures, Paris.
  • OECD (2005), OECD Tax Database, www.oecd.org/ctp/statistics , Paris.
 ©OECD Observer No. 261 May 2007


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