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In 2007, as part of his last budget as Chancellor, Gordon Brown cut the main rate of corporation tax from 30 per cent to 28 per cent. In his own time as Chancellor, George Osborne has followed suit, using successive budgets to whittle the rate down to 21 per cent.

In a thought-provoking essay for Prospect, Charles Dumas argues for complete abolition. This isn’t because he’s a tax-cutting fundamentalist or wedded to an unquestioning pro-corporate agenda. Indeed, he’s highly critical of the tax-dodging and general irresponsibility demonstrated by various big businesses in recent years – especially the banks.

The nub of his argument is that corporation tax is founded on a grand bargain struck between business and government in the 19th century, in which a share in the profits made by the former was exchanged for limited liability laws enacted by the latter. In effect, limited liability is an insurance product and corporation tax is the premium paid for it.

In the 21st century, it is increasingly apparent that the old agreement is breaking down:

“Globalisation has helped erode this deal. The situation we have now unfairly benefits companies, and hurts taxpayers in the societies in which they operate, in at least three ways. The most obvious is that international firms pay less, often virtually no, tax… This means that they pay the societies in which they make their profits almost nothing for the privilege of limited liability.”

Of course, not every company dodges tax to the same extent – which distorts the level playing-field on which competition depends:

“…multinational firms gain a big advantage compared to smaller, domestic companies that have far fewer opportunities to shift income out of the tax collector’s reach. As smaller, domestic companies are likely to be the source of much invention—as well as providing the bulk of employment in most economies—this is damaging.” 

Dumas also argues that corporation tax creates an incentive for companies to shelter their surplus cash in tax havens, when they could be putting it to better use:

“…when they make profits, they keep them, rather than investing them internally, making acquisitions, paying dividends to shareholders and pension funds or paying them to employees in wages. They keep hold of cash that, if it made its way to households by one route or another, would lead to more spending.”

Governments can do more to tighten-up on avoidance, but Dumas doubts if this will ever be sufficient and that, therefore, we should admit that corporation tax is a “lost cause.” He may be right, but for a lost cause it still raises a lot of money – so how could this revenue be replaced?

“In its place, we could have a higher VAT, that is, a tax paid by consumers on the price of goods and services… in the long run, corporation tax does not affect companies’ return on capital after tax—that is, how much profit they make on their capital after they have settled their tax bills. Instead, it is eventually passed on to consumers in the price of goods and services…”

It’s much harder for corporations to hide sales than profits, therefore tax avoidance would be greatly reduced. This would help restore the level playing-field between international and domestic companies (and between online and high street retailers). The perverse incentive for companies to sit on their profits would also be dealt with.

Moreover, if it is the case that corporation tax is recovered through higher prices, then raising the same amount of money through VAT would make no difference to consumers.

Obviously, replacing one major tax with a big hike in another is a major undertaking. The transition would have to be phased in – which, given the changes made since 2010, could be what the Government’s up to anyway.

9 comments for: Heresy of the week: Why not get rid of corporation tax completely?

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