Janet Yellen, then chair of the Federal Reserve, in Washington, DC, in 2017. (Jonathan Ernst/Reuters)
Yellen cannot end the international competition by fiat.
Osee Over the past 30 years, corporate tax rates have declined in the developed world. Advanced economies have realized that lower marginal rates encourage entrepreneurship and attract foreign direct investment. Political leaders reasonably tried to make their country more attractive – a trend that has been described as a “race down.” In a recent speech, US Treasury Secretary Janet Yellen called for the race to be rejected. Rather than pursuing a competitive tax policy, Yellen advocates a new global minimum corporate tax rate to ensure that all nations tax corporate profits fairly. But Yellen’s plan is misguided. In fact, it would harm the citizens of all nations party to such an agreement.
In his speech, Yellen explained that the pressures of tax competition has 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 shifting their profits offshore and taking away any revenue governments might earn. Countries like Ireland, Moldova and Paraguay have adopted extremely low rates to attract business to their shores. This has helped them compete with wealthier nations internationally, but has also resulted in a drop in US tax revenue, as companies shift their profits to these “havens”.
For Yellen, that just won’t be enough.
But a global minimum tax is not the way to solve these problems. Although countries’ ability to raise corporate taxes is limited by the fact that companies can offshore their profits (and this can be problematic for governments in high-tax countries), this 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, revenues will begin to fall. All a global minimum would do is increase the receipt point maximization: beyond that minimum, countries would still be in competition over tax policy. Ireland may have to raise rates, but as long as other countries maintain higher rates, they will always be at a disadvantage.
Sovereign nations are free to tailor the way they set their own fiscal policies to suit their own needs. As the pandemic has shown, this is a good thing: evidence from the World Bank suggests that the developing world’s recovery from the pandemic will be slower than most developed countries. In response, Ghana chose to provide a 30% discount for companies in sectors particularly affected by the pandemic. What good reason is there to prevent a poor country like Ghana from providing tax relief to help revive its economy during a devastating recession? Indeed, what reason is there to prevent a wealthier country like Ireland from enacting tax cuts that allow it to become an economic power?
These issues aside, it is clear that corporation tax is a very bad way to tax corporate income. Studies Pin up 51% of corporate tax costs are passed on directly to workers. Since the margin the excessive burden of corporation tax represents approximately 30% of the revenue collected, that would mean that for every dollar generated for the government, 65 cents would be lost to workers’ pockets.
Rather regressive, don’t you think?
There is, however, a tax that would help end the incentive for companies to relocate and would do so without unnecessarily restricting other countries. Yellen should consider a destination-based cash flow tax, such as that proposed by the Republican Party in 2016. Rather than taxing companies based on where their profits are recorded, this plan would work instead looks more like a value added tax, levied on cash flow in a given country – something that cannot be avoided without taking the business out of the country altogether.
The plan generates more revenue that could be used to reduce the overall tax burden and that would provide more incentive for businesses to invest in themselves and grow. Under the current system, companies cannot deduct the full value of their investments; rather, they must deduct a fraction of the value of the investment each year for the life of that investment. The cash flow tax would allow businesses to fully deduct investments and in the same year they were made.
It’s a big problem. When it was adopted between 2002 and 2008, it increased investment by 17.5% and wages by 2.5%.
Policy makers could respond to international competition with a foolish agenda that does nothing to improve welfare. Or they could pursue simple reforms that would streamline the tax code and boost GDP. Hopefully they choose the latter.
