Tax relationships that no longer hold true

Posted on

I recently noted Duncan Weldon's assessment of a new economic paradigm and economic relationships that no longer hold true. I have a strong suspicion that there may also be tax relationships that no longer hold  true in the new economic circumstance we now face. Let me suggest a few.

The first is that tax cuts work by making space for the private sector to invest. This is the old 'squeezing out' argument. With business now almost universally acknowledged to be sitting on a mountain of cash amounting to hundreds of millions of pounds and with a massive pile of resources just waiting to be used in the economy - most of them human - this suggestion is now ludicrous.

It's as ludicrous to suggest that cutting corporate taxes are necessary to boost corporate investment. Business already has more cash than it knows what to do with and profits as a share of GDP are rising. If business is not investing it's because it is bereft of ideas, not because it is in need of funding at enhanced rates of return. There is no economic excuse for corporate tax cuts.

And whilst still on corporation tax let's put to bed that age old (well, rather more recent, actually) myth that the cost of corporation tax is largely paid by labour. This myth is almost entirely the work of Prof Mike Devereux at Oxford who studied corporate tax increases (themselves a rare phenomenon) and suggested when they occur wages paid fall. He forgot two things. First he didn't notice countries did in the past only increase tax rates when they were in economic distress, of which falling wages are a sure sign. Second, Devereux forgot to check if the relationship he supposedly found worked in reverse i.e. did wages increase when corporation tax rates fell? Real wages have fallen steadily since 2008 and so have corporation tax rates. If Devereux had been right then falling tax rates should have boosted wages, but they very clearly have not. The evidence of any significant link between tax rates and corporate tax dates has been shattered for good. Devereux should have realised that correlation does not necessarily indicate causation.

Come to that so has any link between corporate tax rates and sales prices should be forgotten now. When the argument of those who say that labour bears the cost of corporation tax fails them they instead argue that corporate taxes are  paid by customers instead, to whom the price of the tax is, in their view, passed on. Now, that's true in the UK water industry where for some reason the competition regulator in this monopoly sector permits this to happen, but it is the exception that proves the norm. There is pretty good evidence that taxes on sales in the form of VAT impact on prices (unsurprisingly) but there is also ample business evidence - not least from the pronouncements of managers themselves - that they focus their business reporting on  earnings before interest, tax, depreciation ANC amortisation. In that case most managers having any pricing decision making powers are very unlikely to have any knowledge of corporate tax on activities they undertake, or even of where, when, how and why their company pays tax. So they will not take corporate tax into account when make pricing decisions. There is almost no chance that this argument is true for major companies.

Next, lets drop the argument that tax management is for shareholder benefit. Of course, it may be in the owner / director business where the interests of management and shareholders are consistent because they are one and the same but that still does not prove that the tax management that the company undertook was in the interests of the shareholder. It can be just as readily argued in that case that it is in the interest of the management and since by far the most common tax management scheme in such companies is to substitute dividends for pay to avoid national insurance and management have to be proactively involved in this sacrifice I think it entirely reasonable to argue that it is in fact the management viewpoint that prevails.

I happen to also think that the case in big business. When we have major companies like Apple borrowing to pay back members there is clear evidence of two things. First, the absurdity (admittedly) of the US tax system but second that shareholders have come second on this issue and earnings manipulation first. That, I have no doubt, is because of the wish to trigger bonus schemes. That is what most of this avoidance is about, I have no doubt.

But what all that means is that much of what is said about corporate tax is just mumbo jumbo that if it ever held true does not do so now.

We're in a new paradigm. It's time we realised it.