Economic Myths: Corporation tax is a tax on capital.

The Faux Liberatarians say little about the worst taxes of all (VAT and NIC) and usually refuse to countenance the least bad tax (LVT). Which leaves us with Milton Friedman's second least bad tax, a flat tax on income.

The Faux Libs, for reasons unknown to me, are putting the superficial legal form of a tax above substance and by some convoluted process of logic decide that corporate income is somehow special compared to employment or self-employment income, or indeed interest or dividend income.

Enter stage right The Institute of Economic Affairs…

Bringing capital taxation into the 21st century

Woah! Corporation tax is not and never was a tax on capital! Imagine Joe, our self-employed van diver who owns his own van, he drives around picking up and delivering parcels. Are his takings earned income? Yes of course. You could if you wished split it into a small part for return on capital and the rest as true labour income, but why? He claims the depreciation and running costs as an expense and only pays tax on the value of his labour. The small part that relates to depreciation and running costs is in turn earned income of the car factory and the repair workshop etc. You could then split the income of the factory and the workshop into 'return on capital' and 'labour', but ultimately it is all labour (until you get all the way back to raw materials in the ground).

If Joe decides to form Joe Limited and trade through that, does the nature of the income magically change from labour income to capital income? Of course not.

As a matter of fact, corporation tax is a tax on income, full stop. There is no particular reason why this should be taxed at higher rates or lower rates than any other kind of income. It is not a tax on 'capital'. A business with capital worth £1 million that makes £50,000 profit pays the same tax as a business with very little capital and a £50,000 profit. A bit of a clue. I would have thought?

Summary:

* Corporation tax is an inefficient way to raise government revenue. It has a negative impact on growth, investment and entrepreneurship. A 2014 review of the literature found that 57.6 per cent of the amount raised by corporation tax is borne by workers.

Corporation tax, like any tax on income, is an inefficient way to raise tax (but not as bad as VAT/NIC), as is anything but LVT. That's an argument against taxing earned income, not against corporation tax per se. That 57.6% is questionable indeed, but even if true, so what? Do they really believe that if employers get a tax cut, then they would pay their workers higher wages? And if you are a worker, would you rather have PAYE which you bear 100% or corporation tax which you only bear 57.6%?

And in a large, faceless corporation, managers are supposed to try and maximise profits and dividends for their shareholders as a vague collective body, and managers are paid according to results. Does it make any difference to the manager that in economic terms, the government is large but silent shareholder who automatically receives a certain % of profits?

* Since 1981, the average corporate tax rate in key OECD countries has dropped from 47 per cent to 29 per cent. However, corporate tax revenues as a share of all taxation have remained stable during this time. They have increased as a share of GDP, in line with growth in the tax burden.

The first bit is probably true, the last bit isn't - tax as a share of GDP of western economies has been surprisingly stable for decades (35% - 40% of GDP). Laffer effects ensure that it is nigh impossible to get over that 40% threshold.

And the reason why corp tax revenues have remained stable despite the (welcome) fall in rates is partly Laffer effects and more likely because corporate profits have increased as a share of GDP, which in itself is a bad sign because that extra corporate profit is largely monopoly income (patents, land income, monopolies, government contracts etc).

* Economic developments such as globalisation and the growing importance of intangible assets underscore the need for reform of the way in which capital income is taxed.

It's not capital income, see above. Intangible assets are a government protected monopoly right/source of income and so the government is perfectly entitled to collect more tax from those who benefit from the system. Which means that registering IP (which stifles the economy) would no longer be a one-way bet; people would have to choose between giving it a go in the free market at a lower tax rate or relying on government protection but paying the appropriate price.

* The OECD’s BEPS proposals are likely to entail new costs and uncertainty for multinational firms. Furthermore, their volume and complexity means that effective implementation will be difficult, especially for developing countries.

If multinationals played ball, it would not impose 'new costs'. Somehow the global profits of such businesses have to be allocated between the various countries in which they operate and each country taxes its own share at whatever rate it chooses. So each multi-national just submits one worldwide tax return and whatever info is needed to enable total profits to be apportioned between all the countries in which it operates. The various countries taking part in the scheme then chuck all these returns on a pile and agree on how to apportion profits.

* Radical proposals for reform include a tax on turnover, a sales-based corporation tax, and formulary apportionment of multination profits. While these reforms might curb opportunities for tax avoidance, they would have damaging side-effects of their own.

Boo to turnover and sales taxes, the worst taxes of all. All tax on income is arbitrary and so the formula will be arbitrary, so what? In theory at least, reducing avoidance means that a lower tax rate can be applied overall to a larger amount of taxable income (which must be a good thing).

* The only radical reform that would improve on the status quo without introducing new distortions would be to replace corporation tax with a tax on the income distributed to shareholders. Such a system would overcome the weaknesses of the current system, while also reducing incentives for avoidance, and raising revenue in a growth-friendly way.

Here we go again. These people do not live in the real world. That is exactly the position that Apple is in - it siphons off most of its surplus/rental income into tax havens and parks the money in government bonds. For psychological reasons, it does not want to use that to pay dividends, because transferring the money back to the USA triggers a high tax bill. So Apple shareholders never get their dividends and no government ever gets the tax (they have to borrow money from Apple's offshore companies instead!)

Or to use an analogy: wild animals are free gift of nature but a bit scarce. People like catching and eating them, so the government decides to levy a tax. Surely it makes sense to levy the tax on actually catching the animals to minimise the number of animals being caught. With a reduced number of animals being caught, we can be pretty sure all those caught will be eaten. What the Faux Libs propose is zero tax on catching animals, but then imposing a tax when they are eaten. The result if this will be that many more animals will be caught a lot of them will be wasted. Plus being even more difficult to police.

* This reform could be implemented in stages to ensure the UK’s international tax treaties are updated. Once fully implemented, the new system would see UK shareholders taxed on their worldwide capital income, while foreign shareholders in UK firms would be exempt.

That's a terrible idea. We can safely assume that people in rich countries own more shares in companies in poor countries than vice versa. So governments in poor countries would be getting less tax and governments in rich countries would be getting more tax.

The only way to do it would be to make companies pay tax when they pay dividends, which means that companies will end up sitting on vast piles of untaxed cash, like the Apple situation.

* It is important to recognise that this discussion is about tax structure, and not necessarily the overall level of taxation. Those who wish to maintain existing levels of taxation would be better served by the proposed reform than by the status quo.

They don''t understand the maths of it. Corporation tax in the UK is a nice low 20% and roughly half of profits are paid out as dividends. To remain fiscally neutral, the tax on dividends would have to be about 40%. This is such a high rate that companies will either not pay dividends (meaning cash is just parked in government bonds and not put to its best use) or they will find devious ways of dressing up dividends as capital payments (like share buy backs and so on) which are usually taxed at much lower rates. As a tax advisor, I say bring it on, but I don't see why anybody else would be in favour.