Why we should not lower Corporate Tax

Keith Rankin, 30 June 1998

 

This morning on National Radio (Kim Hill, 9:15am), Treasurer Winston Peters said that he was considering a proposal to lower the rate of corporate tax. He claimed that New Zealand's corporate tax rate (ie 33%) was on the high side compared with other countries, and that a cut in the corporate tax rate would aid New Zealand's competitiveness.

This is a classic example of the kind of "beggar-thy-neighbour" policy that I have always argued against (eg see "What Policy is Best to Counter Global Depression?"). When all countries pursue policies such as lowering corporate tax to enable them to export more and import less, then the countries soon cancel out any advantage they may have gained, while the world economy as a whole becomes disadvantaged. In this case, world corporate tax rates would end up far below the optimal - ie efficient and sustainable - level.

The lowering of corporate tax worldwide would amount to a "negative-sum game" [1] in which the winners would be those corporations whose gains from less tax exceed any losses from reduced sales. Such companies are much more likely to be established companies, than new companies.

In the past, businesses in New Zealand (and other countries) have been very successful despite high corporate tax. Businesses seek to maximise profits within a set of constraints. One of those constraints is corporate tax.

Businesses do not require artificially low costs in order to attempt to maximise profits. The argument for the market system is that firms should be allowed to maximise profits within the constraints set by the political, social and physical environment. There is no argument that claims that the market system is enhanced by the removal of constraints, per se. (Certainly, there may be some constraints that could be usefully removed, but this is not a general proposition.)

One reason given by Peters for cutting corporate tax was the incentive it would give to new companies, especially companies with export capability. In fact, the rate of corporate tax is relatively unimportant to new companies. New companies are debtors, whereas established companies are often creditors. Thus new companies like low interest rates and are indifferent to corporate tax rates. Established companies' shareholders, however, like high interest rates and like low corporate tax.

There is a clash of interest between new companies and established companies. Cutting corporate tax gives a short-term unearned gain to established companies while doing nothing to help those who might challenge them.

The issue of corporate tax is particularly important to me, because of my stress on new concepts such as "production tax" and "social profit".

The corporate tax rate is a crucial parameter in defining the boundary between the public and private components of capitalist economies. Thus production tax equals GDP at factor cost times the corporate tax rate, and represents one part of a three way "factor division" of GDP (the other two ways are the profits of capital and the wages of labour. This revenue from production constitutes the major source of income to the sovereign; ie the major source of public income. In a democracy, the term "sovereign" means "the people treated equally as a collective or corporate entity". The aggregate of production tax can be called the "social profit", while the total income of the sovereign (including indirect taxes and the profits of publicly-owned enterprises) can be called the "social wage fund".

Thanks in part to the relative simplicity of the New Zealand tax scale, I tend to think that the corporate tax rate can be taken as equal to the upper personal rate. There is a key relationship between corporate and personal income tax, because people will have incentives to redefine themselves as companies if there is a tax advantage in doing so. If corporate tax was cut in New Zealand to 30% while the upper personal rate was left at 33%, then few would have the incentive.

To switch over from personal tax to company tax would save 3 cents in the dollar for each dollar over $38,000. But it would cost the person concerned an annual social dividend of $5,130 (the total amount of tax concessions available to any person grossing over $38,000 from July 1998). A person would have to be earning over $209,000 to benefit from a change of status. If corporate tax was cut to 25%, however, there would be a much bigger incentive to avoid personal tax.

How do we define the boundary between social profit and private income when the upper personal tax rate is not equal to the corporate tax rate? To some extent, the exact point of division is arbitrary (while the division itself remains conceptually important). For the sake of good analytical work, however, we need a consistent approach. I think that the historical context is important.

So long as we stick to a single tax rate - eg 33% - as defining the public-private share of national income, then we can interpret all other changes to income taxes, benefits and subsidies as a zero-sum redistribution of the public share. Thus, a cut in the corporate rate to 30% or 25% can be thought of as a straight out subsidy to companies that pay tax. The 3% or 8% giveback becomes just another allocation of social wage funds, of the sovereign's income. It becomes just another benefit.

In countries like Australia where the top tax rate is well over 40% but the corporate tax rate is below 30%, then it is probably more realistic to treat the corporate tax rate rather than the upper personal rate as the one to use when defining the division between public and private income. Thus in Australia, we can say that tax-paying corporations do not get cash givebacks, and we can say that high earning individuals pay a tax surcharge on the last dollars of their incomes.

If, in New Zealand, both corporate taxes and upper personal taxes were cut, then there would no longer be a zero-sum effect with respect to the distribution of the social wage. Rather there would be a wider zero-sum effect to the distribution of national income, with a larger share going into company profits and/or labour wages. The social wage would be then be cut as a share of national income, and persons reliant on income sourced from the social wage (ie beneficiaries) would be the losers of that zero-sum game.

It should be quite obvious to us that the calls to reduce corporate tax are no more than a zero sum game being played by the private corporations who stand to benefit. There is no national benefit, and the world economy will be much worse off if all nations simultaneously cut their corporate tax rates as a means of beggaring each other.

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[1] A zero-sum game is a situation in which a fixed quantity of goods (or whatever) are redistributed. The winnings of some equal the losses of others. Thus, it is a classic "win-lose" situation.

A negative sum game represents a redistribution in which the losses exceed the gains. There are two types of negative sum game. In the "Prisoners Dilemma" type, everyone loses, the classic "lose-lose" outcome. The more common type of game in, in particular, international political economy, is where the relatively powerful gain while everyone else loses. Because it is economic power that precipitates the redistribution - and not a drive for economic efficiency (although there may be a pretence of efficiency gains) - then the redistribution is likely to be to a position of lower overall efficiency, meaning net losses, meaning total pain exceeds total gain. This kind of negative sum game is summarised by the word "corruption".

Zero-sum and negative sum behaviour - attempts to win a "win-lose" game - are what is meant by selfish economic behaviour. On the other hand, "enlightened self-interest" is the promotion of "positive sum games" in which everyone becomes better off, either through a direct "win-win" outcome (where everyone wins), or through a "win-lose" outcome where the gains exceed the losses, and the losers are compensated by the winners. [back]

 


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