There is a lot being written about corporate tax optimisation/evasion these days both in Europe and in the US. This begs for a more general question, why do we tax corporate profits? I had the debate with a friend this summer and led me to research the topic.
There is a very interesting paper on this subject as well as an analysis of the distortion of corporate tax. Here is my summary.
Why (not) a corporate income tax
The main arguments - to me - in favor or against corporate income tax are summarized in the following paragraphs.
A corporation benefits from common infrastructures (highways, social security etc) and thus must pay its due to Society.
However a corporation is (in the end) always owned by individuals which themselves do pay taxes to finance common infrastructures. This is argued by some as leading to a double taxation.
A corporation can be owned by foreign investors: better tax these guys via corporate taxes rather than the folks that actually vote for us.
A corporate tax leads to some sort of pre-tax of the foreign investor by virtue of lesser dividends.
Individuals would feel it to be unfair if they were to pay for all taxes while corporations are making plenty. Of course, individuals do indeed pay it all in the end whether they see it or not but it looks like it’s a hard notion to grasp for most.
A corporation bringing the benefits from a foreign subsidiary can deduct from its dividend tax the actual income tax it paid in the subsidiary’s country. This essentially erase the foreign income tax assuming the rate is lower than the domestic dividend tax rate. These treaties are here to avoid double taxation and lessen the burden of an income tax.
Without corporate income tax, personal income tax diminishes as individuals find ways to “incorporate” their revenues to avoid taxation.
And of course the cynical view is that governments are addicted to spending and they need more fresh cash than a junkie needs dope (this argument is not in the paper for obvious reasons).
What distortions does it cause
Again this is a personal cherry picking from the paper. What is interesting is that this paper is based mostly on studies of the EU, not the US as it is often the case.
Small companies are often offered lower tax rates, to compensate for market failures. It would be better to use a separate explicit mechanism (e.g. direct aids) to compensate for them. As it is, different tax rate brackets create a disincentive to grow.
A European study shows that the more corporate income tax, the lesser wages are: for every additional euro of corporate income tax, wages are reduced by 0,92 in the long run. Income tax is not good for your salary apparently :)
As explained in the previous section, a corporate income tax lower than the personal income tax leads to a shift from personal to corporate taxes. People (e.g. entrepreneurs) optimise and “incorporate” their income. This is one of the few arguments that encourages a higher income tax.
Income tax influences where an international company opens foreign subsidiaries (a 1% point income tax increase, decreases the change of the subsidiary being opened by 3,96%). Ouch!
Same for foreign investment: a 1% point tax increase, decreases foreign investment by 2.9%.
And finally profit shifting. Profit shifting is what big international companies are accused of these days (Apple, Google, Starbucks, Ikea etc). One study estimates that due to this phenomenon, a 1% point increase in tax rate leads to a loss of 17,2% of the planned extra tax collection. I’m personally skeptical of the averages. We cannot consider this phenomenon by mean nor median: I imagine a company engaging in such activity would do it in an all or nothing fashion.
What’s the take away?
Tax is hard, you touch one button and unexpected things move all over the place. Be careful of tax that go to 11, you might become deaf… and sterile ;) More seriously, this paper has been hard to find but knowing about all this will make you a better citizen.
Read the paper, there is a lot more to it
I had to summarize, cherry pick and cut corners to keep this entry short. Go read the paper which is easy to read (except in some specific areas), goes in greater details and cite all of its sources. And above all it is very interesting !
I put a copy of this paper here since it disappeared from its original location. This paper is copyright the European Commission and written by the staff of the European Commission’s Directorate-General for Taxation and Customs Union (Gaëtan Nicodème in particular).