Tuesday 27 September 2016

EU's corporation tax plans may repeat euro mistake

Published 25/06/2015 | 02:30

NOT too many people have a curve named after them. Those who do are guaranteed a certain kind of immortality. Especially if the curve involves taxation. This is the case with the Laffer curve, named after the US economist Arthur Laffer. It portrays government revenues rising with higher taxation only up to a point. After that, revenues level off and eventually fall as taxation reaches very high rates.

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That this should be so accords with common sense. The big, hotly disputed question is at what point the curve begins to flatten, and at what speed.

Dr Laffer was in Dublin recently. His presentation to economists, civil servants and kindred souls left them open-mouthed. Not because they were unfamiliar with the concepts. Because they were Europeans.

He began by recalling how his move from California to Tennessee allowed him to buy a house with just one year's savings from his tax bill. Tennessee had no State income tax at the time and California had a lot.

This, of course, is in a federal country with free movement of goods, capital and labour. Even Dr Laffer admitted it is amazing how different US states have such different economic policies. "Everything that can be tried has been tried in some state at some time."

You see the reason for the Europeans' wonderment? Even with the barriers of language differences and the imperfect single market, imagine the consternation if Portugal, say, abolished income tax.

The odd fact is, that there is a far greater cultural consensus on the role of income tax among EU countries than among US states. Not, however, on corporation tax.

Last week, the Commission published its latest plan for an EU regime on corporate profits tax. It is the latest of many such plans, but things have changed enormously since previous efforts over the past decade or more.

Electorates have become aware of how services companies in particular can book their profits in quite different places from the ones in which they earn most of their revenues.

It is one thing when one can see where the product is made; another when an Apple or Microsoft shuffle the location of that most intangible product, intellectual property; and worse again when booksellers or coffee dispensers, like Amazon or Starbucks, do the same.

The commission plan though, is essentially as before. This is the creation of a common consolidated corporate tax base (CCCTB). Rates of tax would be set by each country but the system of calculating taxable profits would be harmonised.

Companies would pay tax to government based on sales in that particular country, rather than where they were tax resident.

Ireland would lose out under such a regime and much of the attraction of its low corporate tax rate would disappear. Some analysts suggest there could be more competition on tax rates, not less, but a country would have to be large enough to generate more business within its own borders to make this worthwhile.

Which raises the question of what exactly this is all about. Ostensibly it is about reducing tax avoidance - legally reducing tax bills - but it has got mixed up with illegal tax evasion, which is hiding taxable income in secretive places.

They both cost treasuries money but they raise quite different issues. That is why the investigation into Apple's tax arrangements in Ireland is so important. The alleged special treatment would not be tax evasion in the classic sense either.

But if it was a special deal, it breaks EU law. More importantly, it would shatter Ireland's main defence - reiterated by MEP Brian Hayes - that our corporate tax rate is low but straightforward, without the myriad breaks available in other places.

Irish governments' fondness for income tax breaks, which they enthusiastically create whenever the public finances show any signs of health, also undermines the defence of the corporate tax regime.

One does not have to go as far as Prof Laffer, who favours a "flat tax" where everyone pays the same rate, but on a very wide definition of income: but never forget that during the bubble Ireland created one of the steepest income tax systems on paper while in practice the highest earners could avoid paying tax altogether with various property offsets.

This leaves us short of clothes going into the negotiating chamber, where we will need all the cover we can get. There can be lots of arguments about what these plans would mean in practice, but one distinct possibility is that it would wreak havoc, not just on Irish economic statistics, but on the economy itself.

That is just the common tax base. The commission still hankers after "consolidation," as well as CCCTB. This would see all profits and losses from the subsidiaries of a group in different member states added together to reach a net figure for the group's entire EU activity, which would then decide its final tax base.

That would be close to being a single tax, albeit paid in different tranches to different states. One can see why Brussels would like that but, in the absence of an EU federal tax system, it raises a fundamentally troubling question for Europeans. Without tax freedom down the years, and even with a federal budget, how would Tennessee have fared?

The third thing this may be about is putting an end to "tax competition." There is widespread acceptance that this too is a bad thing. In fact, in the context of the EU, and even more the Eurozone, tax competition may be essential for smaller, poorer countries to prosper.

Lacking a central government, it is a natural tendency for Europe to harmonise arrangements instead. Natural but foolhardy. We have already seen the folly of a single currency meant to incorporate every member state, irrespective of income or productivity.

The big countries are already repenting at leisure their haste in preventing currency competition; if they get their way on tax competition the fruits may be just as bitter.

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