The Case for Abolishing Corporation Tax

Numbers And Finance

In recent years there has been much outrage at corporations who do not pay their “fair share” of tax. But since corporations are merely legal constructs, they technically don’t pay any share at all; instead the burden of tax is shared between shareholders, through lower profits, workers, through lower wages, or consumers, through higher prices.

If it turns out shareholders, the owners of capital, bear the burden of tax, this would provide the strongest economic rationale to oppose it. Capital flows to wherever it will earn the highest profit, so taxing capital provides a disincentive to invest. Capital investment is crucial for one simple reason: giving workers more machines to work with makes them more productive, which in turn is what leads to wage increases and rising living standards. What’s more, in an open economy like the UK, capital is free to leave to be invested in less heavily taxed parts of the world. Conversely, a relatively low corporation tax will make investing in the UK more attractive, boosting long term economic prospects.

However, there’s reason to believe that capital does not in fact pay the full share of corporation tax. In fact, empirical evidence points to workers paying 57.6%[1] of the total share via lower wages. Surely it would be both more efficient and transparent to tax that income directly?

But what of inequality? It’s certainly true that owners of capital tend to be the richest members of society, however there are more efficient means of income redistribution that are less detrimental to investment, wages and growth.

The UK tax code is…a huge waste of time, resources and talent

Another issue with corporation tax is that it skews companies’ incentives towards debt when they finance new investments. Because the interest paid on debt is [corporation] tax deductible, firms often prefer to raise capital via bond markets rather than equity markets. In fact, some companies will borrow despite having cash readily available to invest. The prime example of this is Apple who, in 2015, despite sitting on a hoard of cash worth $170bn, borrowed $6.5 billion through issuing bonds[2]. Now debt is not a bad thing ipso facto, but the bias towards debt, and the associated higher share of debt-financed corporate investment, increases financial risks within the economy. Do we really want to encourage more borrowing than necessary? Furthermore, recent research[3] has found that in advanced economies, an increase in credit is associated with slower growth, while stock market expansions are associated with higher growth. Perhaps rebalancing incentives away from debt and towards equity finance is desirable.

Additionally, because large companies are able to employ legions of corporate lawyers and tax advisors to help them whittle down their tax obligation to as low a level as possible, the burden of corporate tax falls disproportionately on small companies. Not only is this unfair, but it also creates a drag on investment in small firms, who employ about half of all workers in the UK economy[4]. This constraint on investment, as discussed earlier, hampers productivity and therefore limits wage growth.

Corporate tax evasion would cease to exist if there were no tax to dodge

But wouldn’t this significantly reduce government tax revenues? No, not really. Once tax breaks have been taken into account, corporation tax currently accounts for 6.2% of tax receipts, compared with 25.7% from personal income tax and 17.1% from VAT[5]. What’s more, there’s little reason to think abolishing corporate tax would actually reduce revenues by the entire 6.2% because tax revenues from dividends and wages would likely increase somewhat due to higher profits. And that’s ignoring the fact that a Britain with zero corporation tax would likely see a flood of companies arrive, boosting the stream of income and consumption taxes being paid to HMRC.

The UK tax code is over 17,000 pages long[6], meaning companies operating in Britain have little choice but to hire tax advisors to help them make sense of how much they need to pay (or reduce what they pay). It’s a huge waste of time, resources and talent. Corporate tax evasion would cease to exist if there were no tax to dodge. One final thought: if there were no corporate tax, maybe all those lawyers and tax accountants would have to go off and do something productive?


[1] http://www.adamsmith.org/wp-content/uploads/CorpTax8.pdf

[2] http://www.forbes.com/sites/timworstall/2015/02/03/why-apple-is-borrowing-6-5-billion-and-what-obamas-trying-to-do-about-it/#115dfcf94839

[3] http://www.oecd-ilibrary.org/economics/finance-and-inclusive-growth_5js06pbhf28s-en

[4] https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/402897/Lord_Young_s_enterprise_report-web_version_final.pdf

[5] http://www.ifs.org.uk/bns/bn09.pdf

[6] http://www.theguardian.com/commentisfree/2015/feb/13/britain-tax-code-17000-pages-long-dog-whistle-very-rich

65 Comments

Leave a Reply

Your email address will not be published.