Institute for Research in Economic and Fiscal issues

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Fiscal competition
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Textbook guru: “Scrap corporate taxation!”
Why is anyone against it?

A famous economist, author of even more famous economics textbooks, is calling for an end to corporate taxation. Not because he has been bought by the corporate world and multinational companies, but because it makes economic sense. Perhaps most surprisingly – it should make sense even to left-leaning thinkers.

Whole cities can be run on energy recovered from burning all textbooks on finance. Their main building block – that lending money to a Western government is riskless – is shattered. Many people have also called for burning economic textbooks, but that is premature.

The main worldwide university economics textbook is written by Harvard University professor Gregory Mankiw who is generally considered to occupy some quadrant within the post-neo-quasi-proto-Keynesian space. But he is a perceptive observer of the economic system, and when in the New York Times he calls for the United States corporate taxation to be scrapped, the world should listen.

Why is Mankiw against the US tax?

Early in the text, before calling for a complete end to corporate taxation, Mankiw wants at least the US rules standardized with the majority of developed countries. At issue is the principle of territoriality absent from the US tax code: Generally countries tax (corporate) income generated within their borders, while the US taxes world-wide income off US-domiciled companies.

No wonder, then, that such companies want to shake off the US domicile label through a process called “tax inversion”: A US company merges with a foreign one and then declares that “for synergy reasons” the company will henceforth only be run from the merged company’s foreign headquarters.

A simple trick, perhaps, but quite ordinary. In fact, because companies, unlike people, are so fungible and cannot be locked up behind bars, the whole system of rules on corporate taxation resemble an arms race. For every complication in the tax code the government introduces in its attempt to capture some more tax revenue, there appears another loophole which the companies’ tax lawyers start legally exploiting. It is all very costly, in terms of time and diverted production. The costs may not even cover the revenue the government gains – or rather postpones losing.

Mankiw argues that a company executive who would not avail herself of legal opportunities of tax optimization would in fact be failing his job that shareholders elected him to do: take proper care of their company’s economic health. We may add that contrary to popular opinion, the money that is thereby saved does not disappear from the system or even from the government’s hands. As profit it is either reinvested in the company to provide more (or better) jobs, or shows up as increased spending power of the shareholders. In fact, many large companies are co-owned by pension funds who share in the profits. Therefore tax-optimizing companies are also contributing towards social policy, a traditional domain that governments are doing their best to monopolise for themselves.

In this respect Mankiw recalls another way in which corporations get into the governments’ game: “corporations are more like tax collectors than taxpayers. The burden of the corporate tax is ultimately borne by people — some combination of the companies’ employees, customers and shareholders.” This realisation leads most economists to argue against corporate taxation on the grounds that it is effectively double-taxation of money which will end being taxed anyway through one of the channels.

If the corporate tax were to disappear, it would not necessarily mean that the government would necessarily have to do with less money. Even if standard taxes on money saved by corporations and earned and spent by its owners, managers and workers did not fully offset the “loss” of corporate tax revenue, Mankiw suggests that it can be “replaced with a broad-based tax on consumption”. For the US he proposes a European-style VAT; in the EU we can surmise he would equivalently suggest increasing the VAT.

Taxing spending, not earning?

Whatever the relative merits of European VAT vs. American sales tax may be (we have suggested recently that sales taxes can be more “salient” in many settings and thus more protected from arbitrary increases), a move towards taxing value consumption rather than value creation has a lot going for it.

Naturally, ideally both kinds of taxes should be decreased. But as a second-best, reducing taxes on income is more important. Any tax acts as a sort of “punishment” for engaging in the taxed activity. Do we really want to punish people for engaging in fruitful activity and earning money in the process? Here it does not really matter whether we are talking about natural persons (personal income tax) or legal entities (corporate tax); both of them create value.

Governments often use tax policy to prevent people from engaging excessively in what the government considers to be a harmful activity. Taxes on smoking, drinking, driving older cars, gambling, eating fatty or sugary food or voicing opposite opinions are ubiquitous. Does that also imply that working or providing people with what they want is also an evil activity and should be reduced? Of course not, but that’s pretty much the message the government is sending by taxing incomes, personal and corporate. No wonder that it took millennia before governments even dared to tax income (basically a 20th century phenomenon); since time immemorial they had to make do with taxing wealth, trade and consumption.

Why is anyone against ending income tax?

In fact it is surprising how little support there is among socialistically inclined people for transferring the tax burden from working to consuming. Most philosophers (and psychologists) see in meaningful work one of the most essential components of good life. Are we really OK with taxing such activity?

At the same time, many such people see modern capitalism as a gluttonous beast which overproduces, both in terms of quantity and range of goods. They claim that people are forced into consuming through the media, advertising and clever marketing, and end up with things they either do not need or do not want (depending on which commentator you read). Whole sub-branches of modern economics are devoted to the so-called “overchoice”. If some people see it as a problem, why aren’t they arguing for a rebalancing of the tax system towards “punishing” people for consuming instead of for creating?

Even many business-cycle economists would concur. Both the Great Depression and the Great Recession are sometimes said to have resulted from exuberant over-spending and associated bubbles. It is harder to be exuberant in a taxed activity. Many macroeconomists would also sound a few positive notes on how consumption tax encourages thrift (on the margin) which lowers the cost of investing in new technologies and economic progress.

Consumption taxes are sometimes seen as regressive, hitting the poor harder than the rich. Actual empirical evidence is mixed, but if you want to redistribute income from the rich to the poor, there are much more direct and therefore better ways of doing that - on the spending side, for example. You don’t have to rely on the tax system to cover all goals of your preferred fiscal policy.

Economists do not thrive in boxes

Whatever your ideas on appropriate social policy, one thing is clear from Mankiw’s article: those who constantly try to box economists and label them as either “right wing” or “Keynesian/left wing” must be on some heavily taxed (or even illegal) substance.
There are only three kinds of economics: good economics, bad economics, and ideology. When someone who is by some people considered to be in another “camp” agrees with you, the chances are you both are onto something.

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