George Osborne, the British chancellor, has announced that corporation tax will be reduced to 17% in 2020. But why stop there? There are very good reasons to think the unthinkable and get rid of corporation tax altogether.
On the one hand, corporation tax does not bring in huge tax revenues. Last year, the onshore component brought in 8% of all UK taxes. And it is a gross figure, which excludes the tax credits enjoyed by taxpayers on dividends (which will be replaced in April by a tax-free allowance). According to my calculations, the true contribution of corporation tax to tax revenue is more like 6%.
Corporate tax has generated less and less money around the world in recent years because governments have competed to reduce rates. After peaking at 13% of global GDP in 2006, it had fallen to 7% in 2014. There is every reason to assume that this trend will continue, especially as multinationals are better able to avoid tax obligations in n any country. Why fight this race to the bottom?
But there’s another big argument for why corporate tax is less important than you think: get rid of it and the money would still get to the government through other means. Suppose a company with 100 million shareholders decided to distribute all of its £50 million after-tax profit to its shareholders – a dividend of £0.50 per share would be paid. This means that a shareholder holding 10,000 shares would receive a dividend of £5,000. Assuming this was their only dividend income that year, they would pay no tax on it due to the £5,000 dividend deduction.
Now consider what would happen if there were no corporation tax and no dividend allowance. The person receiving the dividend would be taxed as if it were any other income. Instead of tax liability disappearing, it simply shifts from the business to the individual. Assuming they are a basic rate taxpayer taxed at 20%, this would mean the company would have to pay them a dividend of £6,250 for them to receive £5,000. This makes you realize that under the current system, corporation tax is actually prepaid income tax.
Yet, if you were to shift the tax liability to the person receiving the dividend in this way, you might have spotted a problem. Most companies do not distribute all of their profits to shareholders. British companies pay around 50% of their profits in the form of dividends. And some, like Ryanair, don’t pay any dividends. So would HMRC be the loser?
The answer is no. Get rid of corporation tax and the stock price of companies would rise to reflect their additional net worth. The lower the dividend, the higher the stock price. When shareholders sell their shares, it means they will realize a higher capital gain, which means higher tax revenue for HMRC.
You might be wondering if under such a system people would be more inclined to invest in something other than stocks and therefore tax revenue would be lost. I suspect the companies would still look like a good investment overall, especially because they would have gained in value and investors like the protection that limited liability provides.
There is always the problem that governments want their money as soon as possible since they have to fund public spending. It would potentially be slower to rely on tax revenue from dividend income/share sales than to obtain it from corporation tax. You could get around this problem by levying a withholding tax of, say, 20% on companies when they pay out dividends – meaning that dividend income would be paid net of withholding tax, whether the company would be responsible for paying HMRC – in a similar way to how VAT works. And levy a withholding tax, say 2%, when a shareholder sells shares.
You will then have to adjust the individual’s income tax payable to take these source deductions into account. This would encourage taxpayers to declare all their income and file tax returns, since they could be entitled to a tax refund. If you wanted to encourage them more, you could set the withholding tax at a higher rate, say 40% for dividends.
Yes, this system brings its own complexities, but they are not insurmountable. There is no perfect tax system. And shifting the corporate tax burden to the individual would have other benefits. HMRC would shift resources from corporation tax to income tax, which should bring in more tax revenue. Many, including Labor leader Jeremy Corbyn, say a better endowed tax administration would benefit.
Businesses would save money since they wouldn’t have to pay their accountants to take care of corporate taxes. Needless to say, it would create a more business-friendly environment, making the UK a more attractive place for businesses to invest in – and I say all of this as a supporter of public services and progressive taxation. Once you recognize that corporate tax abolition does not mean a loss of tax revenue, these benefits hopefully become more compelling.