The real corporate tax puzzle

Apple logo on building Apple's tax avoidance schemes have angered US senators

Big internet giants like Apple are going to extraordinary lengths to minimise their tax burden, and voters and politicians are understandably excited about it. But the puzzle for economists is not that big companies now pay so little tax - but why, in a global economy, they are still paying tax on their profits at all.

When I was first studying economics 25 years ago, my teachers were all expecting corporate taxes to disappear.

In a global economy in which capital and companies could go wherever they wanted, the assumption was that there would be an international "race to the bottom" when it came to corporate tax rates. Governments would either have to spend less or jack up personal income or consumption taxes instead.

Looking at the tax planning exploits of Amazon, Google and the rest, you might say the prediction had come true.

Except, corporate tax revenues overall have not fallen sharply as the world has become more globally integrated, or more digitally connected; rather the opposite.

IMF economists looked at this recently. They found that globalisation had pushed down corporate tax rates quite dramatically in the UK and around the developed world. (Especially in the 1980s - think of the successive corporate tax cuts under Nigel Lawson).

The median corporate tax rate in the largest 19 OECD countries fell from 50% in 1982 to 34% by 2003. But the researchers do not find this translating into lower corporate revenues: "...in fact, for the US and all regions save for Sub-Saharan Africa, revenues have risen over time."

Economists might not be surprised by that in itself. If corporate tax rates start out high, tax experts would say that cutting the marginal rate doesn't need to cost the government revenue, if the government broadens the tax base at the same time by cutting loopholes and deductions.

In large parts of the world, a lower rate might also encourage more black market companies to join the legitimate economy and pay tax for the first time. All of those things would tend to push up revenues, even if rates are going down.

But you can't usually raise revenues by cutting the tax on corporate profits to zero. With all the competition out there, economists might still wonder why corporate profit taxes are still with us at all, let alone be raising roughly the same amount as they were in the 1960s.

A chart (on p28 of the report) shows how corporate revenues have varied internationally since 1980 as a share of GDP. Predictably, the number jumps around a lot; corporate profits swing about wildly, depending on the economy, and you'd expect corporate tax revenues to do the same.

IMF graphic on corporate revenue

But, as I said, the prediction, 20-30 years ago would have been that in a global economy, revenues would be jumping around a fast-declining trend. That is not the picture you see on the chart. Before the financial crisis, OECD countries were raising significantly more from companies as a share of GDP than they were 30 years earlier. The average corporate tax take was 3.8% of GDP in 2007, up from 2.6% in 1990 and 2.1% in 1975.

Of course, you'd expect the financial crisis to have cut revenues. But corporate tax revenues, on average, were still 2.9% of GDP in 2010 (which is the most recent year available). In that year the chancellor raised 3.1% of GDP from UK companies - compared with 3.5% in 1990 and 2.2% in 1975. In the US, the figure was 2.7%, compared with 3.5% and 1990 and 2.9% in 1975.

None of this makes the tax exploits or Apple and the others any less disturbing, for voters or governments. Even Google's Eric Schmidt seems to agree that global tax rules have not kept pace with the development of the digital economy and they need to be reformed.

Individual countries care how much money they get from Google, relative to their sales. In economic terms, the interesting question is whether they are paying less than the average overall. It is quite possible that high-tech companies pay less tax, as a share of their global revenues, than the global average. I have not been able to find any research on this, either way, but you can't help feeling there ought to be some.

In the meantime, economists will continue to be puzzled that governments are still able to raise as much money from companies as they do. And governments, for their part, might be somewhat relieved that all the talk of scams and mounting avoidance has yet to seriously damage their capacity to tax companies overall. But companies that choose not to send their profits into the outer atmosphere - or any other offshore location - will not find that reassuring at all.

Stephanie Flanders, Economics editor Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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