Corporate Taxation

The OECD has just announced a program of “detailed work on about a dozen of the most contentious issues, including the treatment of digital businesses and the rules on transfer pricing” in furtherance of its proposed Action Plan on tackling base erosion and profit shifting caused by globalization. There is a much simpler way of achieving the objective of tackling base erosion and profit shifting by corporations seeking “tax efficiency” than that being pursued by the OECD, which appears to have signed on to the idea of country-by-country reporting as the main modification of the current system. This is the idea usually described as unitary taxation, meaning common worldwide taxation of corporate profits.

Unitary taxation is usually criticized as diminishing national sovereignty. This is of course correct; the rate of unitary taxation would be set on a worldwide basis rather than by individual nation states. The question is how much this costs nations when the forces of tax competition oblige them to impose much the same levy for fear of losing revenue. There are those who believe that their particular nations gain by tax competition and would therefore oppose anything that would curtail it, but their attitude can be criticized as myopic; any short-run gain comes at the expense of other countries and lasts only as long as those other countries do not reduce their tax rates. The only logical basis for opposing unitary taxation is that it would help maintain the rate of corporate taxation, which will be judged undesirable by those who wish to see the abolition of all corporate taxation (for which there is some economic logic, though the likely cost would be further concentration of income).

Unitary taxation would demand a formula for sharing out the profits of a multinational company between the countries where it operates. There is no ambiguity about the distribution of sales, apart from those introduced by the variability of exchange rates, which could easily be resolved by adoption of a convention (e.g. to use the rates officially announced monthly by the IMF). There is a further important addition to ambiguity in the case of costs, since these include the costs of capital, and of research and development. These may, or may not, be amortized over several years. My inclination would be to leave this decision up to the individual firm, providing only that it sticks with the same rule each year. In addition, there would need to be a value-judgment regarding the rule for combining costs and sales. I cannot see that one needs to vary this by industry, although doubtless this case will be argued by some. A simple rule of 50:50 would seem as good as any.

Under these conventions, country A would be entitled to receive from firm X a payment equal to

t[½α(A) + ½β(A)]π

where t is the rate of corporate taxation, α(A) is the share of firm X’s revenues derived from A, β(A) is the share of firm X’s costs in A, and π is the firm’s worldwide profit (= ΣiRi – ΣiCi = R – C, where R is the firm’s total revenue and C is its total costs).

The great advantage of this approach is that it would dispense with the need for rules on transfer pricing, at the cost of a sacrifice of national sovereignty that is largely mythical. It seems a modest price to pay.

Aside | This entry was posted in OECD, Taxation. Bookmark the permalink.

2 Responses to Corporate Taxation

  1. Aynsley Kellow says:

    A uniform corporate tax rate would certainly go a long way towards addressing BEPS. The 15% Canadian rate vs the 35% US rate makes the Burger King-Tim Hortons merger and relocation to Canada possible. Whereas business often wants harmonised regulatory standards, this is a case of wanting ‘strategic inconsistencies.’
    But (as a political scientist) I wonder how such an approach might be legislated. Surely those interests that wish to continue the practice could readily persuade legislators to 1). maintain their control over taxation; 2). maintain higher rates (likely to be supported by the Left) or lower rates (likely to be supported by the Right).
    I guess the prospect of the US Senate ratifying an agreement is remote (needing a qualified majority), but it is perhaps possible it might legislate for a lower rate if Canada did a tit-for-tat and raised theirs, so that they converged on (say, 25%).
    I suspect such bilateral approach might then be built upon, leading eventually to reasonable multilateral coverage, assisted perhaps by something like the imputation of company tax in the hands of shareholders that operates here in Australia – dividends can be franked up to 100% of corporate tax paid. This might create an incentive for company tax to be paid – and demanded to be paid somewhere, by shareholders who would minimise their tax liability.
    Interested in your thoughts.

  2. admin says:

    Mr Kellow is surely correct in anticipating the source of resistance to the proposal for unitary corporate taxation. I did not elaborate on the political resistance to such action, but it is correct to say that this is likely to center on politicians’ desire to maintain national control of all sources of tax revenue, with a view to either increasing such tax rates if they are of a left-wing persuasion or to reduce such tax rates if they are right-wing.

    It is arguable that the exiting system creates pressures of tax competition that lead to a reduction of rates, so I can understand those of a right-wing persuasion being unimpressed by my arguments. What I cannot understand is that the left values the prospect of maintaining nominal national control of tax rates more highly than the prospect of being able to increase revenue.

    In short, it seems to me that unitary corporate taxation is inherently a left-wing cause, although one does not have to be very far to the left in order to embrace it. Just far enough to regard increased tax revenues as inherently a good thing, if they can be accomplished without imposing undesirable distortions.

    I am highly skeptical of the value of piecemeal moves of the sort he later advocates, since they leave open the possibility of evasion through good lawyering. I do not know sufficient about the Australian tax system to judge whether his (doubtful) objective could be furthered by the means he describes.

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