Original URL: http://www.theregister.co.uk/2012/11/25/tax_and_tech_biz/

Google, Apple, eBay shouldn't pay taxes - people should pay taxes

And we'll all be richer as a result

By Tim Worstall

Posted in Business, 25th November 2012 12:00 GMT

Opinion eBay is not paying enough tax in the UK because it sells everything through PayPal Luxembourg.

So the Sunday papers tell us, adding to the stream of stories about how Starbucks ain't payin' enough tax, Google ain't, Apple isn't and... well, we're being taken to the cleaners as a nation, aren't we? We provide this lovely country for them to do business in and we don't get a modest cut of the profits from the bastards.

The only problem with this narrative is that it's entirely false: indeed, we're being fed this nonsense by those who may have no clue at all about how taxation works - with, if I'm allowed my own little bit of prejudice, a decent assist from a pressure group.

I think we've all read enough of these newspaper pieces to know what the accusations are.

Various tech companies sell into the UK from outside the UK. They book their revenue outside the UK, make their profits outside the UK, and thus no money is levied to pay for essentials like diversity advisers and duck houses inside the UK. We are then told that this is tax avoidance and that they're all very naughty boys. Apple sells the iTunes stuff in from Luxembourg, eBay channels PayPal from there, Facebook and Google both sell in their adverts from Ireland and so on.

However, this is not tax avoidance (and it's most certainly not tax evasion, the illegal stuff). It is in fact tax compliance, this is exactly what the EU wants people to be doing. So here is your short guide to corporate taxation.

Firstly, companies do not pay tax. No, not ever

A tax requires that the wallet of some human being gets lighter; the study of exactly whose purse it will be is the study of tax incidence. Yes, corporations are legal people, this is true, but this is so that they can be sued and we like being able to sue companies.

With respect to the incidence of corporation tax, we have known since 1899 (when Seligman first pointed it out) that the company itself does not ultimately carry that burden. In theory it's some mixture of the customers (who end up with higher prices), the workers (who get lower wages) or the shareholders (who trouser lower returns). As it happens we now know that it's the workers and the shareholders who, in the end, take the hit.

This is not because the company or the shareholders are simply evil capitalists (although they may be of course).

It's actually due to something called the natural rate of return to capital, an idea that dates as far back as the age of Adam Smith in the 1700s. These days we would call it the average risk-adjusted rate.

All we mean is that, averaged over the economy, people who put in £100 of capital get, say, £10 a year return. So, when we introduce a tax on profits we cut that return. Say, a 50 per cent tax means that now you're only getting £5 a year on your £100. If everything just happened in one country then it would be the shareholders carrying that burden.

But with an international economy, with people able to move their money across tax boundaries, we've got to consider the international average return. People can take their capital out of the UK and get £10 elsewhere; people who can get £10 elsewhere won't invest in the UK to get £5.

Thus taxing the returns to capital leads, where capital is mobile, to less capital being employed. We also know what determines average wages in a country: average productivity of labour. And, to a large extent, the average productivity of labour is determined by how much capital (ie, how many machines multiply their effort) is added to that labour.

So, less capital, lower productivity, lower wages. Which is how the workers come to bear some portion of the burden of corporation tax: it's nowt to do with it being “passed on”, just the natural fleeing from the tax jurisdiction of the returns being taxed*. Empirical research seems to show that in the UK about 50 per cent, maybe a bit more, of the burden falls on wages.

So, companies don't pay taxes at all. Whining that they ought to pay more is a nonsense in itself

But it's worse than this: corporation tax is also one of the most damaging taxes we can impose. There's something called deadweight costs. Any tax stops some form of economic activity from happening. A reasonable guide is that we lose 20 per cent of revenue to deadweight costs. Raise £100 in tax revenue and the economy is £20 smaller than it would have been without the tax. The marginal loss is more like 35 to 40 per cent. Get another £100 on top of what we already get in revenue and we lose £35 to £40 in the size of the economy.

Of course we do need some tax revenue. Everyone except the anarchists agrees there. And certainly some of the things that the government does are worth £140 for each £100 actually spent. So we're fine.

However, these deadweight costs vary depending on what type of tax we use to raise revenue. A handy OECD chart is excerpted here. Repeated taxes on real property (land value taxers, this is you!) have the lowest deadweight costs per pound raised in revenue. Consumption taxes (VAT and sales taxes) have a bit more, incomes taxes certainly have more, and then capital and corporate taxes have the most deadweight costs.

So corporations don't pay taxes, and even trying to tax their profits makes us poorer than other methods of raising the same revenue.

Secondly, since when was obeying the law suddenly such a heinous act?

Now onto my final point: the difference between tax avoidance and tax compliance. We all know what tax evasion is, that's the breaking of the law that puts you in the clink.

Tax compliance is said, by some, to be doing exactly what the politicians wanted you to do when they passed the law. Tax avoidance is using the law to do what the politicians didn't want you to do.

Personally I reject that distinction: if our rulers are too stupid to write decent laws that can't be twisted then more fool them. But this is the distinction being used by pressure groups, such as the Tax Justice Network, that is fuelling this rash of stories about what Google and chums pay in tax.

Which brings us to the question of whether flogging stuff through Ireland is tax compliance or tax avoidance. And the thing is, even by the standards of the Tax Justice Network, this is tax compliance.

For the rules about corporate taxation across intra EU borders are set by the EU. And, amazing though it may seem, some in the EU know the aforementioned effects of corporate tax. Companies don't pay it, and it's also a very expensive way of collecting tax. Better, by far, to do it with some other mixture of taxes, such as VAT or land taxes.

But there's a great temptation for politicians to assume that everyone's too dumb to understand these points. Thus we end up taxing company profits because everyone thinks it's someone else getting stung for a change.

So, when the EU system was set up there were a number of things put in place. Any company can, indeed should, have only one corporate base in the EU and then sell to all 27 countries from those headquarters. Further, any company must be allowed to change or move that base without hindrance, just as any individual can bugger off out of a tax jurisdiction. And they will be taxed on their corporate profits from that one base: no one else gets a sniff at their tax. It doesn't matter where the sales are nor where the people are; where the brass plate is is all that matters.

Please do note, this isn't a failure of the designed system: this is what the system was designed to do. To allow, indeed tempt, corporations to shift stuff around so as to reduce their corporation tax bills. This, in turn, forces governments to keep their corporation tax rates low: for it's a very bad tax, d'ye see?

They're most certainly not doing tax evasion. Everyone agrees that they're not breaking the law. But they're also not doing tax avoidance. For they are doing exactly what the designers of the system, the people who set up the EU corporate tax system (largely Fritz Bolkestein, I believe) intended and desired that they should do. They are being entirely tax compliant by pressuring governments to keep corporation tax rates low for fear that the tax base will bugger off. Something that over the long term makes all of us rather richer. ®

Bootnotes

* The capital doesn't all flow out for the shortage will lead to returns rising until they are at the world average again. And it's not quite that simple either. For as Adam Smith pointed out in his only use of “invisible hand"** in Wealth of Nations, even if foreign profits are higher some will prefer to invest domestically, just 'coz, and will “thus be led as if by an invisible hand” to benefit their fellow countrymen.

** No, really, this is the only use. Nothing to do with the perfection of market systems or anything like that.