Monday, 17 March 2014

Economic Myths: Corporation tax is a tax on capital

More Faux Lib tomfoolery in City AM:

... what has not filtered through to the public debate is the question of who bears the economic burden of [corporation] tax – is it fat cats, or could it secretly come out of wages or turn up in higher prices?

If this is confusing, this is because, for economists, a tax’s burden is borne by who it makes worse off. For example, though shops hand over VAT to HMRC, it is generally accepted that consumers bear the burden through higher prices...


Basic logic as well as any sort of fact-based study show that suppliers bear the bulk of VAT; prices do rise slightly but output, and hence profits and employment, go down.

So what he is saying is: I will make up facts as I go along to support my preconceived notions.

And while employers hand over national insurance contributions, economists tend to think this money comes at the expense of lower wage offers than there would otherwise be.

Yes of course, you can't redeem yourself that easily though.

There then follows a load of drivel which you can dismember at your leisure. Here's my favourite bit:

First, higher corporation tax means less profit for firms and workers to bargain over.


The amount of pre-tax profit is exactly the same; workers and employers share this between them and then each pays tax on his own bit.

Second, higher corporation tax means less relative reason to tie up investment in capital as opposed to consuming it in general, and in particular less relative reason to tie up investment in capital in a given country.

Yes, all things being equal, businesses prefer countries with a lower tax rate, but that is way down the list of concerns. Nobody is going to relocate from Oxford to Afghanistan to save a few quid corporation tax (paper profits get shuffled around a lot, but not real profits).


1. "Investing" or "making profits" is not an alternative to consumption, it is the flip side of consumption, you can't have one without the other. So if you decide to 'consume' not 'invest' you are merely pushing up other people's profits and thus the amount other people will be prepared to invest to tap into those profits.

2. Corporation tax is not a tax on 'capital', however defined, in the first place.

It is a tax on profits accruing to businesses owned by limited companies/shareholders regardless of how much capital and of what type the company owns. Those profits arise if people are prepared to consume the business' output = turnover, and that turnover is in excess of costs incurred.

The profit element might stem from goodwill i.e. customer inertia/loyalty, dominant market position, low wages, monopoly rights (patents etc), owning the best sites (to trade from or rent out), simply doing everything a bit better than most of the competition, whatever.

Unbeknown to this idiot, corporation tax is anything but a tax on 'capital' as reinvested profits are not taxed and there is tax relief for capital investment (yes the capital allowances system is a bit shit, but broadly speaking it nets off). And if you set up a business with loads of capital assets but make no profit, you pay no corporation tax either.

Further, the amount of 'capital' owned by a business bears little or no relation to its profits. A well-run employment agency owns a few computers, telephones and desks, that's it; if it makes more profit than a capital intensive business like a steel works, then it pays more corporation tax.

Less capital per worker means lower productivity, and lower productivity means lower wages.

Workers/labour are capital and capital is workers/labour; capital is accumulated work/labour; if anything, taxes on wages are taxes on capital (because for a given £1 expense, the employer/investor gets less capital in return), not corporation tax.


Lola said...

So, what you could say is the factors of production are not land, labour and capital, but land, todays labour and yesterdays accummulated labour. In which case the factors of production are labour and 'rent', or rather, since rent isn't production, production is labour. Doesn't that push us rather towards the 'labour theory of value' or rather again why the LToV got adopted in the first place?

Mark Wadsworth said...

L, yes, but does the LToV help us explain or understand the world better than simply assuming things come into and go out of fashion?

a) Taxes aside, the price you can charge the customer is dicated by supply and demand; and

b) how the total revenue from the customer is split between rent, today's labour and yesterday's labour is simply down to relative bargaining power.

Derek said...

I think that the Labour Theory of Value is misnamed. It should be called the Labour Theory of Cost, since it really explains how much it costs to supply an item. But Value is related to Demand, not to Supply, so a Theory of Value should be based on the need/desire for an item, not on how much it costs to produce.

So for instance a Theory of Value should tell us why water is of more value to most people when it comes in bottles, even when a product of equal quality is available from the tap, particularly those of us living in Perth or Aberdeen.

Shiney said...

Yes but....

Surely its better to do away with the crap around CT (cap allowances, reliefs for certain favoured activities, R&D credits yada yada yada) and just tax dividends that accrue to UK tax payers.

Would take out a load of compliance issues - (like wtf is deferred corp tax? - try explaining that to a non-accountant).

Mark Wadsworth said...

D, yes, if you start dismantling the LToV it crumbles apart to nothing, it has no predictive value whatsoever.

SM, nope, CT could well do with being radically simplified, fewer silly disallowances and fewer silly tax breaks. In civilised countries you just take your accounts profit and times it by the tax rate, job done.

The idea of just taxing dividends is more Faux Lib nonsense, I'm afraid, it's administratively unworkable and would lead to so much evasion that the fiscally neutral tax rate on dividends would have to be very, very high.

With taxes like income tax or corporation tax, the least-bad thing to do is have the broadest base with the lowest rate.

AFAIC, there is no CT on reinvested profits because you get a deduction for investment/spending, so what's left is surplus cash.

Whether that cash sits in the company bank account gathering dust or is paid to shareholders makes little difference, and broadly speaking, it is better for companies to pay out surplus profits than to hoard them, seeing as that money belongs to the shareholders anyway.

So HK does the decent thing and has one flat income tax applying to corporate and individual income, there's no tax on dividends at all and that seems to work just fine.

Shiney said...


Sorry - you misunderstand me.... I wasn't advocating a distinct 'dividend tax'. That would be mad.

Just tax the cash received at the recipient's marginal rate - which as you say should be flat and low.

Anyway, under full-on LVT it all goes away... which would be better.

Mark Wadsworth said...

SM, perhaps I misunderstood you, I thought you meant zero % corp tax and then tax on dividends.

I don't like marginal rates, as I am a flat taxer. Everything taxed at the same rate (however high or low), and we sort out progressivity or redistribution through the welfare system.

And what does 'cash received' mean? Whether the money is in the company's bank account (on trust for shareholders) or in the shareholders' bank accounts, makes little difference.

And ultimately, corporation tax is inherently just a tax on that surplus cash (by its very nature and not because the UK's system is particularly good).

So the least-bad system is like HK, one flat rate for all corporates and individuals, no special dividend tax (as dividends have already been taxed).

Whether that flat rate is 16% like in HK, or 10% or 20% is a secondary issue. The lower the better, but 20% is sort of the cliff edge, below which stage the deadweight costs are barely measurable.