By Professor Philip Booth, Editorial and Programme Director, Institute of Economic Affairs
12 July 2013 - The aspect of the tax avoidance debate which most exercises organisations such as Christian Aid is the issue of the taxation of companies with subsidiaries in poor countries. Christian Aid links tax avoidance with worldwide hunger in a bizarre analysis which, for example, suggests that food distribution schemes could be hugely increased if Indian tax revenues from corporations were increased: this ignores the fact that half of the food in those schemes is stolen, rots or goes missing.
The 'If' campaign supported by campaign groups and churches, like many such campaigns, hits entirely the wrong target. When you start from a socialist disposition the solution to hunger is always going to be more government programmes funded by more taxation rather than an improvement in the conditions necessary for economic development or the elimination of corruption and inefficiency in existing schemes. If the hole in the bucket is big enough it really does not matter how much water you pour into it.
However, the Oxford academic Paul Collier is on the side of those who wish to reform corporate tax in order to improve the lot of the world's poorest. And, when he speaks, we should at least sit up and take notice. Whether you agree with him or not, he is one of the most intelligent and reasonable voices in the poverty debate. But, I do wonder whether Collier misses an important point.
There are four main ways in which it is claimed that poor countries lose tax revenue:
- Some countries – such as Mongolia – have signed taxation treaties with other countries (such as Holland) that allow foreign companies to repatriate profits without paying tax in the country in which the economic activity takes place. Presumably, when such treaties were signed, the government receiving the investment thought that the business that would be generated would be more important than the taxes forgone. And this is probably true. Of course, over time, the situation may change but it is a matter for the governments concerned to renegotiate the treaties at the appropriate time.
- Secondly, there is the problem of transfer pricing whereby economic activity takes place in one jurisdiction but the intellectual property that gives rise to the activity is owned in another. The key here is to ensure that the transfer prices reflect the economic reality. But, these are difficult issues. If SAB Miller produces beer in an African country and makes profits, it could not do so without the trademark for the beer; at the same time, it could not do so without the land, labour and capital in the African country. The allocation of costs is a legitimate matter for dispute on a case-by-case basis. The band of subjectivity is very wide.
- Companies take advantage of tax exemptions and loopholes in poor countries.
- Finally, there can be activity not dissimilar to the transfer pricing problem whereby companies sell commodities to Swiss subsidiaries which are then sold on at much higher prices so that the accounting profit appears to be made in Switzerland.
The problems raised by the campaign groups are grossly exaggerated. They argue that $160bn of tax goes missing in developing countries, but many of their solutions simply involve raising tax rates and creating new taxes – they do not relate to tax dodging at all. Yet it is corporations who attract the vilification of these groups for apparently tax dodging. Problems 1 and 3 require developing countries to have more coherent tax systems – corporations are not the guilty parties here. Problems 2 and 4, on the other hand, may require better enforcement of existing law.
However, there are other issues that transcend this debate which are wilfully ignored by campaign groups.
As noted above in the case of India, poor countries need a better environment for business. It will not be more corporation tax revenue that brings India out of poverty; its complex and easily avoided tax system is, quite simply, symptomatic of bad policy in India in general. India needs less corruption, a market economy and a tax system without loopholes and distortions. The most important effect of such reforms will not be the revenue they generate but the better business climate that results.
However, there is another twist to this debate. Imagine that we could build a really sound corporate tax system based on good economic principles. That corporate tax system would probably tax the owners of companies on their profits rather than taxing the company itself in the territory in which it is operating. In some countries, such as India, there may well be significant indigenous ownership but, in other countries, the companies who are on the receiving end of criticisms almost certainly have the bulk of their shareholders based in relatively well-off countries. A well-designed corporate tax system – along the same lines as the method by which we tax interest on corporate debt – would probably further reduce tax revenue in developing countries.
Indeed, we should not be looking at company profits as the appropriate tax base when it comes to poorer countries. A more appropriate tax base, which would be tied more closely to the benefits that a company receives from a country's legal system, the protection of its property rights, and so on, would be some kind of tax on business property rather like UK business rates.
UK business rates have existed in one form or another for well over 400 years whereas companies have only paid taxes on profits for a relatively short time – and for most of that time they were administered the same way as income tax. Taxes on companies' profits are, by and large, arbitrary, not necessarily just, easy to avoid and beyond the capability of many countries to administer. Other forms of tax on businesses that relate more closely to the (relatively small) cost of the benefits provided to businesses by governments would be easier to administer and lead to greater accountability of both governments and businesses. Such taxes, if genuinely related to the benefits that companies obtain from the basic functions of government, would be low. However, it would be a tax base that could work with the grain of good governance and development rather than promote avoidance, evasion and corruption. Instead of just jumping on the latest bandwagon, churches and campaign groups should more soberly consider both the rationale for taxation and the 450-year experience of British corporate taxation.
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