Unfair international taxation undermines economic, political and social development progress

Oxfam’s report showing how developing countries have been marginalised in the process of reforming the rules for taxing multinational enterprises has been well received – unsurprisingly, perhaps, since the evidence of political marginalisation and of lost revenues is fairly clear.

Yet, here we are accused of such a lack of understanding that our suggestions “would actually reduce the wages of the workers in those poor countries.”

Tim Worstall of the Adam Smith Institute argues in his blog, ‘Apparently Oxfam Is Entirely Ignorant Of The Economics Of Taxation’, the following:

  1. Taxing corporate income (returns to capital) will discourage investment, so the optimal corporate tax rate is zero;
  2. Average wages in a country are determined by average productivity, which in turn depends on the level of capital; and therefore
  3. If the rules are changed to allow developing countries to tax corporate income more effectively, the effect will be to discourage investment and depress (average) wages.

On this basis, Mr. Worstall concludes that: “Oxfam is, quite literally, arguing that the wages of the poorest in the world must be reduced.” It should be clear that we are neither literally nor indeed metaphorically making such an argument. Here’s why. First, Mr. Worstall’s view – on its own, somewhat narrow economic terms – is unlikely to be realistic because it rests on a highly stylised model. The assumptions necessary are heroic, not least in relation to costless adjustment processes. As such, using this as the basis for understanding the likely effects of changes in corporate taxation globally may not give a terribly accurate picture. As leading conservative economist Greg Mankiw has written, “The theory of optimal taxation has yet to deliver clear guidance on a general system of history-dependent, coordinated labor and capital taxation for a realistically-calibrated economy.” Major issues include the difficulties of constructing effective alternatives that generate sufficient revenue and are not deeply regressive. Elsewhere, Mr Worstall has recognised at least some of these complexities of the real world approach to corporate tax – for example, here, where he considers a disagreement between Mankiw and Paul Krugman.  In addition, many studies including those from the IMF and McKinsey’s have shown that corporate tax rates have little bearing on investment location in developing countries.

Mr. Worstall’s second point, that productivity depends on capital, is also unrealistic. Tax revenues are vital to the kind of social spending and public infrastructure investments that will raise productivity over time, making countries more attractive for investors – and given relative scarcity, simple economics would suggest higher returns to public spending in lower-income, lower-revenue states (all else being equal). Neither of the foundational statements to support Mr. Worstall’s conclusion can therefore be supported. The more important errors in Mr. Worstall’s criticism, however, are political. The approach taken fails to recognise all of the central features of the current context:

  • that nearly all countries still tax corporate income (despite the long-standing theoretical result), suggesting that there may be good reasons to do so;
  • that the G8 and G20 have instigated a major action plan to combat the failure of the OECD’s rules to align profit with actual economic activity, suggesting that they want to tax corporate income more effectively; and
  • that lower-income countries, in general, suffer more this misalignment (that is, their share of total taxable profits declared is disproportionately small compared to their share of economic activity).

Mr. Worstall’s criticism is to argue that because simple economic theory suggests corporate taxation in general may distort, we should not be concerned with its effectiveness in developing countries. If the power to operate such taxation effectively has been made a priority for the richest countries, should we not be concerned if developing countries are marginalised from that process, or if the changes made do not reflect their challenges? If developing countries in fact suffer worse under-reporting of taxable profit, does it not make a case for rule changes that reflect this? There may one day come a time when the context allows countries to eliminate corporate taxation (in favour, presumably, of much more effective individual income, capital gains and wealth taxation). Until such time, however, poorer countries and their citizens should not be deprived of the power sought by OECD members to tax effectively the profits of multinational enterprises. Not only is this clearly unjust, but it is likely to undermine economic, political and social development progress.

To paraphrase Mr. Worstall’s rather aggressive headline: Oxfam could only support such a position if we were entirely ignorant of the reality of international taxation. 

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