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Want to solve global tax problems? Stop taxing corporations

In the dock - Apple Chief Executive Tim Cook faces questions by a US Senate committee investigating tax avoidance. AAP

As governments across the globe have struggled with growing government debt, the pressures of austerity and stagnant economic systems, ire has been thrown at the corporate fat cats who - according to the court of political opinion - have avoided paying their fair share of taxes.

However, the battle over taxation is an old one. The political authority of the day — King, Church, Congress, Parliament, etc — invariably scrapes and pillages to fund noble and ignoble activities while rich and poor alike bury their silver in trenches, barns and corporate tax havens.

The modern variant of these dramas have been most recently played out in the British Parliament and US Congress. Chief executive officers of various multinationals have been brought into the dock to explain their nefarious attempts to keep corporate cash out of the hands of taxman.

The circus that has surrounded these discussions is mainly emotional and devoid of a real understanding of the complexity of taxing multinational corporations.

To the layperson the debate is simple: if they pay their share of taxes on the income they earn, why is it not fair that “rich” corporations do the same? However, such a viewpoint is a naive personification of the corporation. As too is the logic of those like Joseph Stiglitz, who argue that corporations should pay their fair share of taxes because they utilise societal infrastructure.

While Stiglitz acknowledges the complexity of figuring out how much to tax a corporation in a specific jurisdiction, he fails to understand that the point of a tax system is not to generate a pay-as-you-go system but to ensure that a society shares in the wealth created by economic activities generated within that society.

It is clear to nearly anyone following this debate that the current global tax system is dysfunctional. However, that dysfunctionality is not new, nor is it, like Stiglitz’s argument, fundamentally the result of private interests. Politicians ultimately decide on the tax system structure, and its failure to account for the activities of multinational corporations reflects: (a) the failure of politicians to understand the management of multinational corporate and economic networks (b) the naive attempt to develop quick-fix domestic tax solutions to global problems and (c) the lifeblood on which politicians trade off legislation and political favours for votes, money, influence and their legacy.

The result has been a hodgepodge of tax rules and rates in different jurisdictions, which are completely at odds with modern economic structures and increasingly incapable of funding societies’ basic needs.

For many the solution is yet more rules and regulations that will “force” corporations to pay more of their “fair share”. However, this is an impossible endeavour and one likely to do more harm than good - any one solution will, by definition, simply preference one jurisdiction over another.

If we decided to force corporations to pay income taxes based on where they sold their products, we effectively would dissuade demand and tax individuals/workers in the jurisdictions in which the product is produced. Similarly, if the producing nations decided they were going to tax corporate profits based on the level of production, they would dissuade production and it would amount to a partial tax grab from the consuming nations customers. In the end someone pays and it is not really the corporations.

Any such system would be both overly complex and lead to tax systems operating as little more than cash grabs, with countries attempting to figure out what they could tax that would keep tax revenues local. The only thing more regulation like this would ensure would be a boom in the tax advisory business, more government employment and the potential of a global tax war.

Doesn’t add up - it is clear to nearly anyone following this debate that the current global tax system is dysfunctional. Shutterstock

An alternative is to recognise that corporations are not people (in spite of the Citizens United ruling in the US Supreme Court) and that what needs to be taxed are the components of the process that lead to production of goods and services. This implies that the corporate tax rate would be reduced to zero and that any income generated by any component would be taxed equally (no capital gains taxes, just one simple tax rate structure). What would such a system look like? It would be quite simple.

Companies would bear no taxes and hence need to account for nothing from a tax point of view. Workers would be taxed on their income and all benefits. Executives would also be taxed at the relevant tax rate on all monetary and non-monetary compensation. Investors would be taxed based on the capital gains of any shares sold (again at the rate at which any income would be taxed without any preference) and all dividends would be taxed as income. If a company chose to pay fewer dividends and invest the money in new corporate ventures, it simply would not be taxed until it was released to the owners/shareholders as future dividends or employees as future pay and compensation.

Such a system has many benefits. First, it would not matter about the jurisdictional structure. If one country wanted to tax consumption via a VAT or ad valorem tax, this would be a separate decision. However, the taxes accruing to a country from any company would be driven by whether or not there were workers and owners/shareholders in the jurisdiction.

Second, the “infrastructure” usage argument would also be a separate decision. If political institutions wanted to charge companies for infrastructure, this would be a separate decision that would have nothing to do with “potential” real or actual economic gains. If there were actual gains, these would show up in revenue through the consumption taxes or the value generated via employment and dividends from the company directly or via the network of economic activities it generates.

Third, there would be no gaming of this system. All benefits and income would be taxed with a single set of tax formulas for money earned. Fourth, if the government was worried about power being concentrated in the hands of a corporate elite, a simple solution would be to require minimum dividend payouts, which would ensure that capital owners were always taxed and hence corporate profits taxed.

This idea is not new. Many others have outlined variations of this logic. However, the point I am emphasising is that a counter-intuitive solution may be the best solution. In many ways the politicians and various informed pundits are falling into the fallacy of expertise acknowledge by Sherlock Holmes in The Adventure of the Abbey Grange: “Perhaps, when a man has special knowledge and special powers like my own, it rather encourages him to seek a complex explanation when a simpler one is at hand.”

This solution may be politically impossible to implement, despite its simplicity, logic and value. It addresses the direct problem of where it is fair to impose taxes. However, it also removes, in one fell swoop, one of the most powerful and popular tools in the political toolkit — the ability to hand out economic goodies to politically supportive clienteles that are paid for by political opponents and those lacking in political power and influence.

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