Over the past 30 years, corporate-tax rates have fallen across the developed world. Advanced economies have woken up to the fact that lower marginal rates encourage entrepreneurship and attract foreign direct investment. Political leaders have reasonably attempted to make their countries more attractive — a trend that has been described as a “race to the bottom.” In a recent speech, U.S. Treasury secretary Janet Yellen called for a rejection of this race. Rather than pursuing a competitive tax policy, Yellen is advocating a new global minimum corporate-tax rate to ensure all nations tax corporate profits fairly. But Yellen’s plan is misguided. In fact, it would hurt the citizens of all nations party to such an agreement.
In her speech, Yellen explained that the pressures of tax competition have prevented countries from enjoying full sovereignty over fiscal policy. If countries wish to spend more, and fund that spending with high corporate taxes, then they risk companies’ offshoring their profits and taking away any revenue that governments might gain. Countries such as Ireland, Moldova, and Paraguay have adopted extremely low rates to attract businesses to their shores. This has helped them compete with richer nations internationally, but has also resulted in a drop in American tax revenue, as companies move their profits toward these “havens.”
For Yellen, that simply won’t do.
But a global minimum tax isn’t the way to fix these problems. While countries’ abilities to raise corporate taxes is restricted by the fact that companies may offshore profits (and that may be problematic for governments in high-tax countries), that is a feature, not a bug. This economic phenomenon is well-known. It’s just called the Laffer Curve.
If governments tax beyond the optimal rate, then revenues will start to fall. All a global minimum would do is increase the point of receipt maximization: Beyond that minimum, countries would still compete on tax policy. Ireland may have to raise its rates, but so long as other countries maintain higher rates, they will still be at a disadvantage.
Sovereign nations are free to flex how they set their own fiscal policies based on their own needs. As the pandemic has shown, that’s a good thing: Evidence from the World Bank suggests that the developing world’s recovery from the pandemic will be more sluggish than much of the developed world. In response Ghana has opted to provide a 30 percent rebate for companies in sectors especially impacted by the pandemic. What good reason is there to prevent a poor country such as Ghana from providing tax relief to help kick-start its economy during a devastating recession? Indeed, what reason is there to prevent a richer country such as Ireland from adopting tax cuts that allow it to become an economic powerhouse?
These issues aside, there’s the plain truth that corporate taxes are a very bad way of taxing corporate income. Studies show 51 percent of corporate-tax costs are passed directly on to workers. Given that the marginal excess burden of the corporate tax is roughly 30 percent of the revenue raised, this would mean that for every single dollar generated for the government 65 cents would be lost from workers’ pockets.
Rather regressive, don’t you think?
There is a tax, however, that would help end the incentive for companies to offshore and would do so without needlessly restraining other countries. Yellen should consider a destination-based cash-flow tax, like the one proposed by the Republican Party in 2016. Rather than taxing companies based on where their profits are registered, this plan would instead work more like a value-added tax, levied on cash flows in a given country — something that cannot be avoided without withdrawing business from the country altogether.
The plan generates more income that could be used to reduce the overall tax burden and it would increase businesses’ incentive to invest in themselves and grow. Under the current system, firms cannot deduct the full value of their investments; instead they must deduct a fraction of the investment value each year over the lifespan of that investment. The cash-flow tax would allow companies to deduct investments entirely and in the same year they were made.
That’s a big deal. When this was adopted between 2002 and 2008 it increased investment by 17.5 percent and wages by 2.5 percent.
Policy-makers could respond to international competition with a hare-brained scheme that does nothing to improve welfare. Or they could pursue simple reforms that would rationalize the tax code and boost GDP. Let’s hope they choose the latter.