Saturday, November 10, 2007

Is tax a cost?

Company directors love to argue that taxes are costs, costs should be minimised, so taxes should be cut. Not so fast.

Is tax a cost? In fact it is not, as any good economist or accountant should tell you. Bear with us, and you will see that this is obvious, really.

When companies look around the world, wondering where to invest, they need to consider many things. Each company is different, but a common mix of needs might include a well-educated workforce, good infrastructure, stable and accountable government, good laws and regulation, and so on. Tax is the basis on which all of these good things are built. Tax rates themselves are, of course, one of the other important things that companies consider. Many companies, and especially their accountants and lobbyists, love to argue that governments should cut taxes relentlessly to attract companies to their shores. (What company lobbyists especially love to pursuse is tax loopholes: that way, the companies still get the benefits of well-funded states, but someone else pays for them, with an end result of loophole-infested tax systems and the long-term erosion of the schools, hospitals and roads that underpin these countries' prosperity, and that of the companies that invest there.)

In fact, tax is typically the fourth or fifth most important factor that companies look at when deciding where to invest - many of these other factors tend to be more important. So, to attract investors, governments must strike a balance: if taxes are too low - roads don't get built, for example, or government isn't held accountable and can go rotten, and the companies won't come. If taxes are high in the extreme - then tax will rise up the list of companies' list of priorities until it overwhelms the other factors.

Let's see how an accountant, and an economist, would phrase this. First, TJN's Richard Murphy, writing in The Guardian newspaper, gives us an accountant's view. He explains:

UK-quoted companies reduced their effective tax rates from 26.6% in 2000 to 22.1% in 2004, compared with an expected 30% in both years. Tax avoidance is rampant, though companies insist they are cutting their costs to benefit their shareholders. This defence is disingenuous.

Tax is not a cost to a company. It is a distribution out of profits. That puts tax in the same category as a dividend - it is a return to the stakeholders in the enterprise. This reflects the fact that companies do not make profit merely by using investors' capital. They also use the societies in which they operate, whether that is the physical infrastructure provided by the state, the people the state has educated, or the legal infrastructure that allows companies to protect their property rights. Tax is the return due on this investment by society from which companies benefit.

Now let's see what an economist would say. Let's start with this article in the same newspaper, by TJN's John Christensen, which said this:

Tax havens warp the foundations of market capitalism. David Ricardo's theory of comparative advantage says that production should gravitate towards geographically relevant areas: cheap manufactures come from China and France or Chile produce fine wines. But now we have thousands of companies operating from one building in the Cayman Islands, and a former Thai prime minister avoids paying tax on a $1.9bn sale through a British Virgin Islands company called Ample Rich Investments. Small wonder that people lack confidence in the global economy.

Think about it like this. For an economist, costs are very specific things, which relate to production. One of the great strengths of market capitalism and market competition is that it puts pressure on directors to innovate and improve the efficiency of production, including by bringing down costs and improving the quality of the goods or services they produce. But tax is entirely different: it is about overall profitability, not about production costs. A company that uses a tax loophole may be able to use that to bring down its prices and steal a march on its competitors - but in the process it has done absolutely nothing to improve its efficiency or the quality of what it provides. The company has cut its tax bill, but the economy overall has seen no net gain in efficiency or productivity. The company has more profits, but that is offset by what the country loses in terms of fewer teachers or whatnot.

All of which starkly exposes the short-sightedness of the libertarian free-marketeers, who argue that tax is simply a cost to be minimised and that tax-cutting -- always -- is the route to a brighter future.


Anonymous Anonymous said...

Tax justice - a practical suggestion. Base the corporation tax assessment on the turnover in a particular country multiplied by the global profit rate declared by an organisation. If, say, Amazon revenue in the UK is £100m, and their global profit is 5% of global revenue, assume they have made a 5% profit in the UK jurisdiction, and assess corporation tax on this basis. Fair, transparent, and specific to each organisation.

9:14 am  

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