What Will the Corporate Income Tax Look Like When Claus Staringer Reaches His Sixtieth Birthday?

Die zukünftige Entwicklung der Körperschaftsteuer bis zum sechzigsten Geburtstag von Claus Staringer

I. Corporate Income Taxes as an Inspiration

I have known Claus Staringer for five of his fifties years, both as a friend and a colleague. Claus has been able to combine a professional and academic career, mainly focusing on corporate income taxes (CIT). Over his many years at the Institute, he has contributed numerous articles to academic journals, but of even more importance, he has fired the imagination of the next generation of tax experts. And not just at the technical level, but also showing them tax is a key to developing an accountable, open-market economy.

This article provides an overview of trends in the CIT, examining the pressure point on this tax, and how CIT are likely to be redesigned over the next decades.

II. Section A: Recent Trends on Corporate Income Taxes (CIT)

Before looking into some of these issues, it is helpful to examine the relative importance of corporate income taxes and how they have changed over the last two decades. Put another way, how have these taxes developed over Claus’s professional career?

Chart 1 shows the evolution of the OECD average yield of CIT in terms of their contribution to the overall revenues of governments since 2000.

On average, this percentage has fallen from 9.7 % to 8.5 % in 2015, the latest year for which comparable data are available. In some countries, particularly the Anglo-Saxon countries, this percentage has fallen quite dramatically. For example, it fell by almost one third in the UK. The gap in revenues has been filled by the increased importance of general consumption taxes (VAT) and taxes on payroll.

A similar picture emerges from Chart 2, which shows the development of corporate income taxes as a percentage of the gross domestic product (GDP). Here, the OECD average percentage has declined from 3.2 in 2000 to 2.9 in 2015. Again, this average conceals wide variations between countries such as the United States showing a remarkable stability, and others, such as UK, a fall.

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Chart 1: Corporate tax share of total tax across OECD

Chart 2: Corporate tax as a share of GDP

There are a number of qualifications to keep in mind when drawing conclusions from these tables:

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Chart 3: As countries compete for inward investment, corporate tax rates have declined

The decline in CIT reflects both policy and administrative decisions taken by governments. For example, most governments have followed the OECD’s advice of moving towards a low rate, broad base CIT, as can be seen from Chart 3. Since the 1980s, the average nominal tax rate in OECD countries has fallen from just over 45 % to just over 24 %. In the 1980s, most corporate tax (CT) rates were in the range of 35 % to 45 %; today, few countries have CIT which exceeds 30 %, although many economies in transitions and developing countries continue to have the higher rates that categorized the early period. Reducing nominal rates is expensive in term of loss of revenues, and the impact on the revenues has not been offset by the broadening base measures that have accompanied the reduction. In fact, over these two decades, especially in the last five years, there has been a spread of tax incentives both in the developed and developing countries. At the same time, countries have moved away from a worldwide to a territorial system of taxing corporations, which has depressed tax revenues.

At the level of tax administrations: the period between 1990 and 2010 was characterized by a benign approach to corporate compliance, with multinationals taking advantage of this attitude to shift profits into low tax jurisdictions, which in turn reduced revenue yields. Since the BEPS project was launched in 2013 and the gradual implementation of the 15 BEPS Action points, this trend is beginning to be reversed.

III. Section B: What Are the Current Pressures of the Corporate Income Tax?

There is a broad agreement among economists that, if we were starting again, nobody would design corporate income taxes in their current form, since they distort decisions on where to invest and which sectors to invest in; on how the investments are financed and particularly the choice between debt and equity financing; the form of carrying out the business (incorporated or unincorporated); how to engage in activities overseas: by exporting into a market; by creating a subsidiary in a country or a branch. These distortions were well documented in the OECD’s 2010 report on taxes and growth. At the same time, corporate income taxes are under political pressure, with a focus on whether multinationals are paying their fair share of taxes. This has shifted the debate on the design of corporate income taxes very much towards the question of how can governments protect the corporate tax base. These discussions have, in part, been stimulated by the S. 673 increased emphasis on tax transparency, whether in terms of country-by-country reporting, declaration of aggressive tax schemes, or the push for better information on the ultimate ownership of holding companies. There have also been structural pressures placed on corporate income taxes with the growth, as noted earlier, of unincorporated businesses, whether in the form of privately held enterprises, trusts, partnerships or other unincorporated forms. At the same time, we have seen an increasing number of small-medium enterprises (SMEs) “going global” and generally ignoring many of the international norms that have been established by tax treaties and transfer pricing which are primarily directed at MNEs.

The broader challenges to corporate income taxes which deserve particular attention are:

• Tax competition: Countries have always used their tax systems to gain a competitive edge, either by reducing the statutory tax rate, by providing low tax regimes for specific activities or sectors, or providing tax administrations which are business friendly. Both the OECD and the European Union have tried to get international agreements on what is fair and unfair tax competition. Despite these efforts, we have seen over the last decade a “race to the bottom” with nominal corporate income tax rates substantially being reduced (see chart 3), with countries offering low tax regimes, particularly for mobile activities and increasingly providing very favorable regimes for high net worth individuals (at the end of the day, it is individuals that take decisions as to where companies are located). The BEPS Action 5 sets out some guidelines on what is fair competition. Yet in practice, what BEPS has done is to produce a climate that can be characterized as fair but fierce competition. This can be seen from the fact that when BEPS was initiated there were only three countries that had IP boxes; today there are more than fifteen, and this is a trend that is likely to continue.

• Digitalization: The growth of the digital economy is changing business models and acting as a facilitator for cross-border trade and investment. At a click of a mouse, citizens can now use their computers to order goods and services from all over the world. Online platforms have disrupted existing business models and challenged traditional distinctions between goods and services and ways of being established in particular markets. The digitalization of the global economy is accelerating with almost a third of the growth in overall industrial output in Europe now being accounted for by digital technologies. In 2006, only one technology company was in the top 20 companies around the world: accounting for only 7 % of market capitalization. By 2017, nine of the top 20 companies by market capitalization were technology companies and these companies accounted for 54 % of the top total 20 market capitalization. The next wave of technology, which will focus on the internet of things, artificial intelligence, robotics and Blockchain, will open up new opportunities for citizens, business, investors and government. All of these developments will challenge our traditional concepts upon which the corporate income tax is based. For example, the underlying principle for corporate income tax is that profit should be taxed where the value is created. Yet in a digital economy, it is far from clear what that value is, how it should be measured or where it is created? The OECD BEPS Action 1 was intended to address these issues but failed to come up with any consensus recommendations, rather setting a set of options which will be further explored in the second BEPS report, which is expected in April 2018.

All of these developments have been accompanied by the change in structure of economic activities in developed economies with a shift away from traditional manufacturing S. 674 activities towards services, especially in the financial and high-tech areas, and the increasing importance of intangibles in the wealth of large corporations.

IV. Section C: How Has the International Community Responded to These Pressures?

The short answer is by commissioning report after report with few of the recommendations being implemented. But before talking about these recommendations it is helpful to ask why do governments wish to tax corporations? Traditionally the following arguments have been put forward:

• Collecting tax at the corporate level is easier than collecting tax at the level of shareholders.

• The corporate income tax is seen as a backstop for the personal income tax.

• Corporate income taxes enable governments to tax foreign shareholders on the income they earn in their jurisdictions.

• Corporate income tax is seen as a way by which corporations can contribute to the financing of the benefits that are provided by governments in the form of a legal and physical environment.

These arguments remain valid in today’s environment and explain why governments are unlikely to consider abolishing the corporate income tax. But redesigning these taxes may be an option, particularly if governments can do this collectively.

Figure 1: Characterizing corporate income tax systems

Figure 1 sets out a conceptual framework which characterizes the different ways of taxing corporations and was developed as part of the Mirrlees Review in the UK in 2010. It clarifies the different ways of taxing corporate income on the basis of the type of income subject to tax and the location of the tax base. The alternative ways to include income in the corporate income tax: the full return to corporate equity, the full return to all capital investment including debt, only including economic rent in corporate income. In terms of the location of the tax base tax, reformers have the choice of taxing only the income earned in the country where the activity takes place (the so-called source taxation S. 675 principle), income earned in the residence country (so-called resident taxation), or basing taxation on where the sale to final consumer takes place (destination-based taxation). All of these options have been suggested at one point or other over the last three decades, whether in the US Treasury Blueprint Reports or in the Mirrlees Review. Yet in practice, governments seem reluctant to implement fundamental reforms of the corporate income tax.

It is interesting to ask why this is the case? Part of the answer is that a fundamental redesign of corporate income taxes will involve significant transitional costs with winners and losers, and businesses are reluctant to incur short-term costs even if there are long-term gains from a major reform. Part of the reluctance is also due to the fact that any government may be reluctant to be a first mover. Fundamental reform is always easier if a large group of countries decides to move in a coordinated fashion (e.g. be the case with the CCCTB). The reluctance of government to engage in a serious redesign of a corporate income tax is also due to there being no international academic consensus on what is the right approach. This can be seen in the current debate on the benefits of a destination-based cash flow tax in the United States. Also, governments’ hesitancy may be in part explained by a reluctance to have to renegotiate their international obligations as embedded in tax treaties or WTO agreements.

So what will the corporate income tax look like as Claus approaches his 60^th birthday? My assessment is that, in one form or another, this tax will continue to exist but it will be significantly redesigned. Most likely, the following new characteristics will emerge:

• Low and nominal tax rates with most countries being in the range of 15 % to 20 %.

• The tax base will continue to be eroded by the spread of favorable low-tax regimes, particularly for intangibles and for unincorporated enterprises.

• Countries will continue to move away from worldwide territorial systems.

• A renewed interest may be expressed in integration regimes.

• Countries will put in increasing anti-abuse measures to curtail base erosion and profit shifting.

At the level of the administration of corporation income tax, we are likely to see a more fundamental difference in approach:

Distributed ledger technology, artificial intelligence and robotics are likely to lead to corporate income tax moving into a real-time compliance model with tax administrations having direct access into the accounts of corporations and thereby reducing the need for annual tax returns.

Tax administrations will also use their new access to information, whether in the form of country-by-country reports, master or local files or exchange of information, to develop a global ranking of multinational enterprises in terms of their compliance behaviour.

We will see a move from bilateralism to multilateralism both in terms of the assessment and audit of large multinationals.

The assessment and collection of VAT and corporate income taxes will increasingly be integrated both in terms of compliance and administration and thereby reduce the deadwood costs of these taxes.

Most of the routine work of compliance, both in companies and tax administrations, will be undertaken by artificial intelligence, robotics and Blockchain, leading to a substantial reduction in the staffing of tax departments: welcome to the world of “IBM Watson”.

We will see a renewed interest in corporate compliance.

This is the world in which Claus will spend his next decade and the world in which his students will need to adapt their qualifications to succeed.