Sunday, 30 March 2014

Economic Myths: Capital is internationally mobile

This is half of a larger over-arching economic myth, i.e. "We can't have corporation tax because capital is internationally mobile".

I've already covered the fact that corporation tax is, by and large and if so only inadvertently, not a tax on capital, duh, it is a tax on profits however they arise*, so let's do the second half.

(* This does not make it a good tax - far better to have zero tax on normal business profits, earned income and return on real capital, of course, and a much higher tax on rental and monopoly income of course - but at a low flat rate of about 20% on everything, it is far from the worst tax).

From e.g. here:

The question of who bears the burden of the corporate income tax is important and controversial.

Proponents of higher taxes on business argue that these taxes mostly fall on firm owners and thus redistribute income from ‘rich to poor’.

Critics object that higher taxes on profits will not be borne by capital because capital is internationally mobile, with the burden of higher corporate taxes will be shifted to immobile factors of production, in particular labour.

If their bleeding heart, crocodile tear logic were true, then owners of "capital" have nothing to fear from corporation tax as they are passing it all on to somebody else, and if not they can evade it by moving their "capital" abroad.

I suspect that the real objection is because the burden of all nearly all taxes - be they corporate or personal - are shifted to the least mobile factor of all… the rental value of land.

Even if we take the extreme, simplistic view that all corporate profits are derived from "capital" then we can draw up a list of sources of/reasons for corporate profits, and consider how "internationally mobile" are. The seven broad and overlapping categories which immediately spring to mind are:

1. Reclassification of self-employment income as corporate profits.

Let's imagine a bloke who started out as a sole-trader plumber, painter and decorator who has built up a good reputation in his area, has got two dozen employees, a dozen vans and all the tools etc, if he ends up paying income tax/NIC at 42% and 47% of his profits but doesn't need to spend it all, he'd be well advised to transfer his business to a limited company so that he only pays 20% corporation tax on the profits which he doesn't need to take out as dividends or salary to fund his lifestyle.

Although he could move his vans and tools at the drop of a hat, he can't take his customer base and his employees with him, so his business is not mobile in the slightest, he can try and expand his catchment area to the nearest few towns, and that's about it.

2. Paper profit shuffling crap

Agreed, to some extent large corporates can deem their turnover and profits to arise anywhere they like, i.e. wherever they get away with paying least tax, by mucking about with transfer pricing, reclassifying dividends as interest, setting up letterbox companies, rewriting contracts so as to downgrade a taxable branch or subsidiary to a non-taxed "representative office". This changes nothing on the ground in the real world. The business is where it is, it is just the profits which magically appear somewhere else. That's a whole separate topic, which generates more heat than light.

And of course bank balances can be shifted from anywhere to anywhere in the world but that changes little or nothing on the ground either, we also observe that most people prefer having a bank account or a mortgage with a bank from their home country anyway. Many people will move savings or mortgage from one UK bank to another to get a bit more/pay a bit less interest, but few will use an overseas bank.

3. Rental income - access to markets - customers

Retailers especially need to have the best sites, i.e. where they get the most customers, i.e. where most people have the most access to the site, which could be in the middle of town if there is enough parking space/high enough population density and/or in out of town retail centres with good transport links and plenty of parking. A few hundred yards either way can make a huge difference.

The rental income element is a huge chunk of business profits. The total rental value of UK commercial land and buildings is £90 billion a year (£60 net rent and £30 Business Rates) against total corporate profits of about £160 billion. About half the the rental income is included in corporate profits (because a business is owner-occupied or because the landlord is himself a corporate), so the true split is non-land profits of £115 billion and land profits of £90 billion (albeit taxed at higher rates due to Business Rates).

4. Rental income - Access to market - labour and raw materials

An employer needs labour and raw materials.

With retailers, the pool of potential employees is directly proportional to the number of potential customers. Then there are highly specialised employers who are all fishing in a smaller pool of potential employees, which is why we see agglomeration or hubs - all the banks are in the City of London, the high tech businesses are at Silicon Roundabout or in the M4 corridor, car manufacturing is (or was) all in the Midlands etc.

Formula One is, along with golf and tennis, the most truly international sport, but half of all constructors have their main base in the UK, and all within a small arc across the south and east of England.

Even if a business breaks new ground and e.g. Honda sets up a brand new assembly site near Swindon, after a while, you will find that there are a lot of good, trained car workers and sub-suplier businesses in that area. So if another manufacturer wanted to set up a new plant in the UK, the obvious places to start would be in the Midlands or near Swindon so that he can poach workers and sub-suppliers rather than starting from scratch.

And if you want to make steel, the best place to make steel is somewhere near where the coal mines and iron ore mines are. If you make oil rigs, then Aberdeen was a good place to be for the last forty years, but if and when the oil runs out, those businesses will re-train as oil-rig dismantlers and then the whole industry will vanish.

5. Goodwill, brand name, customer loyalty etc

Some brand names are known all over the world (Rolls Royce, Coca Cola, Manchester United etc) but many businesses only have a brand name in one single country or even in a much smaller area.

So McDonalds is known world-wide, Greggs is UK-wide and while Percy Ingles has a baker's shop on most high streets in north-east London, but people anywhere else in the UK have never heard of them.

The advantage of this brand name depends on how internationally mobile their customers are. So if you like McDonalds (the world's best public toilet operator, if nothing else) and you are in a strange land, you are quite likely to visit one. If you like Greggs and are in a different town in the UK, you will visit a Greggs if there is one. And if you are from Leytonstone and like Percy Ingles and happen to be a few miles away in Walthamstow, you will visit the Percy Ingles in Walthamstow.

This is where UK retailers have often come a cropper. Marks & Spencers or Tesco means a lot in the UK, so a new M&S or Tesco branch anywhere in the UK will immediately attract business. Their management then get big headed and think they can apply their business model in other countries and so far have always fallen flat on their faces and lost huge amounts of money.

So this type of "capital" in its widest sense has to be slowly built up by trial and error, and is a kind of self-generated rental income.

6. Intellectual Property Rights

These are capital (the result of earlier investment in skilled labour) up to a point, and can be exploited anywhere in the world.

So a pharma company can sell its whizz-bang new drug anywhere in the world. But no pharma company is going to say "We will only sell our drugs in countries with a low corporation tax rate", they will simply sell as much of it in as many territories as possible (probably using price differentiation, i.e. selling at higher prices in rich countries and at lower prices in poor countries, which then requires enforceable contracts preventing reselling in the grey market).

So if they can sell the drug in the UK paying 20% corporation tax, this does not discourage them from selling it in the USA paying 40% tax, because the net profits in the USA are still incremental extra profits.

7. Real actual capital that arises as a result of real investment

Yes, physical plant and machinery can easily be moved around the globe, and even if not (too large), such capital constantly has to be replenished out of new income, so it might happen that a company allows its asset base in one country to be eroded and starts investing/creating new capital in another country.

But again, it is a constant process, a company can only create capital in the first place if he has access to skilled labour and raw materials. The Antarctic is the only territory which is not part of a nation-state and has no taxes of any kind whatsoever as there is no nation-state with the right to enforce them, but so far, very few businesses have decamped there because nobody lives there and nobody wants to live there.

8. Question

Having examined the evidence, how "internationally mobile" are all these things, even if we are prepared to accept that they are all capital in the first place?


Lola said...

Excellent analysis. But, the whole 'higher taxes on profits' meme is self evident nonsense even if you only devote two minuutes to thinking about it. And, 'capital' has always been mobile - I mean forever. From the very earliest civilisations people have been taking their wealth around the world with them, and all that has done is drive up the general wealth of all the places it goes to. TYhe really annoying bit is that that new wealth has mostly ended up in the hands of landowners.

Mark Wadsworth said...

L, ta. I'd been drafting this one in my mind for weeks and it took me an hour to type it up nicely.

"From the very earliest civilisations people have been taking their wealth around the world with them, and all that has done is drive up the general wealth of all the places it goes to."

Yup, because ultimately, people with skills = capital.

Applying Godwin's Law...

1. The Nazis drove away the top scientists who were Jewish - they went to New Mexico and built the atomic bomb.

2. See also Enrico Fermi, whose wife was Jewish.

3. Then having won that round, the Yanks absolved Von Braun of his crimes on condition that he built them Saturn rockets.

The Stigler said...

I mostly agree. It's not capital that's mobile - it's the owners of capital and skilled people that are. You raise income tax and Michael Caine gets on a plane to LA to live.

With regards to the sort of businesses that can leave (or maybe put part of their production elsewhere), if you want to keep the thing that the article scares against, jobs, the most important thing is making your country welcoming to the sort of jobs that can easily move.

As I've said before - one feature of highly mobile jobs is that they're generally in low LVT areas. If something can be produced that can be done somewhere else in the world, it is probably being done in a cheaper bit of the UK. Look at where beer and cars are made, there's very little within 60 miles of London.

Which is why LVT would be such a massive win for inward investment and rolling back offshore production. If the people in Rhondda paid near sod-all tax (and in fact, were quids-in because of CI), how much would it cost to hire people to work in the Burberry factory, and would it have been worth their while offshoring the work?

Mark Wadsworth said...

TS, but what about all the high paid, specialised jobs in very high rent areas (i.e. London)?

There's a place for everything. Rent is just the maximum that anybody is willing to pay to be somewhere, with the emphasis on "willing" (and so a tax on rent = rent = voluntary).

So every part of the UK would benefit equally, not just the large parts with low rental values = no tax areas, which of course would become the place to set up factories etc.

Kj said...

In conclusion, not very mobile. But #3 gives a slight advantage to larger companies where Corporation Tax is high (more resources to do shifting, hire lawyers and accountants etc.). #7: almost entirely depends on the wage levels. Investment in real capital isn't that much more expensive anywhere compared to anywhere, it all depends on the other factors that give a return on the investment.

Maybe a further differentiation could be: companies are not very mobile at all when it comes to where they *do* business, but can be very mobile where it wants to declare the income and hand it out to shareholders, as opposed to reinvest it, which will be done in the place where it's best to do business as above.

The Stigler said...


Sure, I was just thinking of the sort of businesses where we have a history of either closure or where we have paid subsidies for them to come (which would be unnecessary under LVT). I believe that LVT would stop a lot of offshoring of work.

And yes, there's lots of people with different specialisations with different values. I don't want jobs for quants going any more than jobs for people making Burberry coats.

Mark Wadsworth said...

Kj, you say #3 but don't you mean #2?

In the UK we still have quasi-LVT on business land, they can't evade that.

Agreed with the rest.

TS: "I want jobs for quants just as much as jobs for people making Burberry coats."

Exactly - jobs is jobs and jobs is good. Markets will tell us what kind of jobs.