Moral Panic Overlooks Real Company Tax Problem

with Sinclair Davidson

The corporate tax profit shifting debate is a classic example of moral panic. First, it’s incredibly complicated. How many Australians could explain how company tax is calculated, let alone what business practices a “double Irish Dutch sandwich” refers to?

Second, it’s driven by hyperbolic and simplistic reports of companies paying little to no tax. These stories pivot on even more complicated scandals, such as “Lux Leaks”, and the technicalities of foreign tax systems.

And third, it’s wildly overstated. The best current estimates of how much corporate tax is shifted across borders is in the realm of 2 per cent to 4 per cent of total corporate tax.

It’s true that earlier estimates in the 1990s were much more than that. It was those high estimates that got the Organisation for Economic Co-operation and Development interested in the issue. But the firm- and affiliate-level evidence is better now. It’s pointless to scrutinise a moral panic for the clarity of its claims. But the corporate tax debate is missing the point.

As a society we don’t value firms for the money the government extracts from them. We value firms because they produce goods and offer services that make us richer, our lives easier, more convenient and more enjoyable, and our standards of living higher.

We ought to design our tax system to encourage foreign firms operating and doing business on Australian shores, bringing investment and jobs. Any attempt to tackle profit shifting that raises uncertainty or lowers Australia’s investment climate would be a disaster.

The corporate tax is not a good tax. As a recent Treasury paper pointed out, it is one of the most inefficient taxes levied by Australian governments. The burden of the corporate tax is scattered and obscure.

Greens leader Christine Milne has been running around this week accusing companies of not paying their “fair share”. But that fair share is always and inevitably passed on to someone else. The literature on the incidence of corporate taxation suggests the burden of corporate tax is worn in the short term by investors, and in the long run by a combination of investors and workers. Of course, under our superannuation system every worker is an investor as well.

Few of the standard justifications for the existence of corporate tax – particularly in a small, open economy – are compelling. One fear is that company owners might divert their personal income into the company. But they’d still have to pay capital gains tax on the way out again. Another argument is that corporate tax is an easy way to get money out of multinationals. Absurd, we know.

That’s why there are academic tax papers with titles such as “Why is there corporate taxation in a small open economy?” and “Can capital income taxes survive? And should they?”

For the political class, the corporate tax has one great advantage: it’s unclear who ultimately pays. It’s easy and comfortable to beat up on corporations, just as long as you stay mum about who actually ends up paying corporate tax. The whole system rests on this clever one-two trick. Who could sympathise with big bad business?

But even if the government wishes to keep the corporate tax fiscal illusion going, there’s hope. For all the handwringing about the double Irish Dutch sandwich, one point often missed is that Ireland has been very clever. That country’s low corporate tax rates have brought in multinationals, and with them jobs and investment.

It’s not obvious those low rates have come at a cost to the Irish budget. Corporate tax revenue as a percentage of total revenue in Ireland is almost exactly the OECD average. There’s no reason we couldn’t copy the Irish example – get in on the Irish-Dutch sandwich ourselves. The Irish make their own luck. So should we.

A Submission to the Senate Inquiry into Corporate Tax Avoidance

With Sinclair Davidson

Introduction: In October 2014 the Australian Senate agreed to an inquiry into corporate tax avoidance. This comes after a wave of media comment about apparent tax “minimisation” strategies practiced by large multinational firms, particularly firms operating in the technology space.

The debate over company tax avoidance at home and abroad is a highly politically charged one, but the evidence suggests it offers far more heat than light.

The debate has exposed that the mechanics of Australia’s company tax is poorly understood. Even basic aspects of the company tax – such as the distinction between accounting profit and taxable profit – have been misinterpreted and those misinterpretations repeated.

Such misunderstandings and confusions multiply when the debate turns to the interrelation between company tax in different countries and the international corporate tax regime. Further complications are the growing significance of intellectual property and “border-less” commerce in the digital age. This makes the existence of confusion about the company tax burden understandable. But that confusion is no basis on which to alter the structure of the tax system, nor impose new regulatory controls or privacy-limiting information sharing policies, which could undermine the value of Australia as a business friendly economy.

Furthermore, the overarching public policy goal for Parliament must be the ultimate health of the economy, and the prosperity of the Australian people. We value multinational activity in Australia not because they provide revenue for the government budget, but because they create economic activity: provide jobs, services, and enhance our wellbeing.

Parliament must avoid introducing policy settings which purport to protect the stability of public revenue but at the same time cool the investment climate and push multinational economic activity outside of Australia.

The debate over corporate tax avoidance resembles another controversial and complex tax debate in recent years – that surrounding the mining tax. As we argued in The Australian in in January 2015:

The government should tread carefully. This obsession with multinationals and corporate tax looks like the Rudd government’s mining tax debacle. In 2010, Wayne Swan said foreign-owned mining companies were paying only 13 per cent tax in Australia. Tax office data told a different story but the government ploughed ahead. As we learned, populism made for poor policy …

There’s another reason for [the government] to be careful. When all the dust had settled from Swan’s tax crusade, the mining tax raised almost no money anyway.

Available in PDF here.

Beware Google Tax Grabs

with Sinclair Davidson

Last month, Treasurer Joe Hockey ­announced the government had “embedded” auditors in 10 ­unnamed multinational corporations to ensure they pay tax on profits earned in Australia. And the government is “contemplating additional legislative action” to ensure multinationals pay their “fair share”.

The government should tread carefully. This obsession with multinationals and corporate tax looks like the Rudd government’s mining tax debacle. In 2010, Wayne Swan said foreign-owned mining companies were paying only 13 per cent tax in Australia. Tax office data told a different story but the government ploughed ahead. As we learned, populism made for poor policy.

Last month, the British government announced a “Google tax” to tax 25 per cent of the profits earned by multinational firms in Britain that are “profit-shifted” to other jurisdictions.

As the London-based Institute of Economic Affairs pointed out, the British proposal is a “retrospective and arbitrary tax change designed to attack a particular small set of well-identified businesses that are not popular with the public”.

This financial year, the Australian government is budgeting to collect $71.6 billion in company tax revenue. Hockey says just 10 targeted multinationals could contribute up to another $3bn in revenue. This doesn’t seem plausible. Indeed, the entire corporate tax debate is a cloud of confusions and misconceptions.

There is a big difference between tax minimisation, which is legal and tax evasion, which is not and properly so. Hockey has made no allegation of illegality. Perhaps they are not paying as much tax as the government would like but there is no evidence that multinationals are not paying their correct tax liabilities.

Australia has some of the strongest tax avoidance laws in the world. Every government ­announces a “tax crackdown”. The idea that the powers which successive governments have granted the tax office are insufficient to deal with any problem in the tax system is ludicrous.

Governments have defined their own domestic tax base and established rules to define the international tax base.

The British Google tax is a big change to the principles of taxation. Countries can either operate a residency-based tax system or a source-based tax system. Many high-income countries ­operate residency-based systems and then enter into double taxation agreements to avoid (or minimise) double taxation.

The Google tax looks like a shift to a source-based tax system – or worse, an arbitrary hybrid of the two, designed on the run to meet temporary political goals. The British general election will be held within six months.

Politics aside, the question is how big is the problem of profit-shifting? The evidence isn’t as clear as governments and tax ­bureaucracies would like it to be.

In the past, academic studies suggested the amount of forgone tax revenue from profit-shifting was substantial. Shocked by those estimates, the OECD launched a broad campaign against profitshifting and tax competition.

Yet in recent years, economists have gained access to far more ­detailed data sets that offer a better picture of what happens within multinational firms. Now the story looks very different.

In a recent survey paper, Dhammika Dharmapala of the University of Chicago concludes “the estimated magnitude of (profit-shifting) is typically much smaller than that found in earlier studies”. Estimates of the amount of shifted profits are now between 2 per cent and 4 per cent.

This is not enough to justify undermining Australia’s relatively effective and coherent corporate tax system. Or risk damage to our investment reputation.

There’s another reason for Hockey to be careful. When all the dust had settled from Swan’s tax crusade, the mining tax raised almost no money anyway.

Climategate: What we’ve learned so far

With Sinclair Davidson

The exposure of thousands of emails and documents from the Climatic Research Unit (CRU) at the University of East Anglia is one of the biggest developments in the climate change debate for the last ten years.

The emails-now dubbed ‘Climategate’-reveal a pattern of behaviour. These emails describe attempts to subvert the peer-review process, refusal to make data available to journals, attempts to manipulate the editorial stance of journals, attempts to avoid releasing data following freedom of information requests, rejoicing at the deaths of opponents, and manipulation of results.

But more than anything this illustrates how politicised, manipulated and ultimately uncertain much of the global warming science is.

Statements suggesting ‘the science is settled’ can no longer be sustained. In an email from Mick Kelly (a reader with the CRU) to Phil Jones (director of the CRU) dated October 26, 2008, we find this gem, ‘I’ll maybe cut the last few points off the filtered curve before I give the talk again as that’s trending down as a result of the end effects and the recent cold-ish years.’ While on July 5, 2005, Phil Jones wrote: ‘The scientific community would come down on me in no uncertain terms if I said the world had cooled from 1998. OK it has but it is only seven years of data and it isn’t statistically significant.’ Kevin Trenberth, head of climate analysis at the National Center for Atmospheric Research (and a lead author of the IPCC’s 2001 and 2007 Scientific Assessment of Climate Change), writes on 12 October 2009 that ‘we can’t account for the lack of warming at the moment and it is a travesty that we can’t.’ Trenberth went on to argue in a 2009 paper in Current Opinion in Environmental Sustainability that it is not enough to claim that natural variability accounts for the lack of warming in recent years – something specific must cause the decline.

Much has been made of an email by Jones where he says: ‘I’ve just completed Mike’s Nature trick of adding in the real temps to each series for the last 20 years (i.e. from 1981 onwards) and from 1961 for Keith’s to hide the decline.’ (emphasis added) The word ‘trick’ doesn’t suggest anything untoward, rather being somewhat clever about some technique. But ‘hide’ is a problem.

Similarly concerning is the apparent destruction of data. The CRU has argued that a lot of their early raw data was destroyed because they couldn’t store it. That explanation is, unfortunately, all too plausible. We live in a world where as recently as 20 years ago, data would have been thrown away for want of storage space. But why then find a 2005 email from Phil Jones, which states: ‘If they ever hear there is a Freedom of Information Act now in the UK, I think I’ll delete the file rather than send to anyone’?

The latest development is that the CRU have promised to make their data available-but we know that a lot of the historical raw data has been thrown away. This makes reconstruction and audit of the CRU research much more difficult. It is going to be impossible to reconstruct an unbiased temperature record based on instrumental observations.

There are numerous emails trying to alter the editorial line of peer-reviewed climate journals. This would be trivial, if it weren’t for the fact that peer-review is treated by the IPCC as the gold standard for academic neutrality. Attempts to subvert the peer-review process show the politicisation of the supposedly unbiased IPCC.

But the most concerning revelations aren’t contained in the emails. They’re in the files detailing the complexity and uncertainty of climate modelling. The contortions which CRU programmers have had to make to force their data into what appears to be a predetermined conclusion underlines just how little we actually know about past and present global climate.

Some of the comments made by programmers contained within the released files (see accompanying box) reveal how unstable the CRU model actually is. It is clear that the data underpinning the CRU’s model has been manipulated, manually altered and patched together. The data is incomplete, inconsistent, and-too often-contradicts observed temperatures.

This is not a trivial problem. It goes to the heart of the international debate about climate change. The CRU model is one of the foundations of the IPCC’s entire climate framework. If the IPCC is no longer able to rely on the CRU, it will be substantially less assured.

With what we have so far learnt from the CRU emails and documents, we can no longer be as confident in the IPCC-or, indeed, the popular view that there is a ‘consensus’ on climate change.

But these are just the early revelations from Climategate. What we will learn once the CRU releases its raw data-or at least, what data hasn’t already been destroyed-may completely reshape the global debate.

Climatologist (and target of many of the CRU’s most vociferous internal emails) Pat Michaels has said that ‘This is not a smoking gun, this is a mushroom cloud.’ We haven’t yet seen how far the fallout from that cloud will reach.

Thumping the Table: Key Questions for the Labor Party’s ‘Industry Policy’

With Sinclair Davidson

Introduction: Is industry, in particular manufacturing, characterised by market failure that demands government intervention? The recently appointed Shadow Minister for Industry, Innovation Science and Research, Kim Carr has argued it is:

Industry policy is about addressing market failure … Clearly the reliance on market fundamentalism is not working. In the last five years we’ve seen the loss of nearly 40,000 jobs in manufacturing.

The Leader of the Opposition has similarly argued that Australia risks being relegated to the positions of ‘China’s quarry’ and ‘Japan’s beach’. In other words, the majority of Australia’s prosperity may become dependent on as few as two industries, tourism and mining, with a single buyer for each. Such a situation, it is implied, will provide a poor base for Australia’s future economic prosperity. Australia therefore requires a ‘sustainable economy’ buttressed by a diverse range of industries (a ‘broad economic base.’)

The Shadow Minister has also targeted low-end service industries as an example of what ALP industry policy will avoid, arguing that Australian employment cannot be restricted to ‘burger flippers’ and ‘cappuccino makers’. This constitutes an extraordinary slight on those workers, and indeed on all low-skilled workers. This type of job-snobbery is entirely inappropriate for an elected representative. Such a view also ignores the fact that these jobs are typically entry-level positions, as employees go on to higher level, higher skilled and higher paid positions either internally or externally.

Reflecting on the claim that Australia’s extractive industries provide an unsustainable base for economic prosperity, the Opposition Leader and Shadow Minister for Industry have signalled their intention to rejuvenate Australia’s ability to ‘make things’. This call for ‘reindustrialisation’ is a return to leftist ideas of the 1980s.

The term ‘industry policy’ refers to any active assistance given to economic production by government. These forms of assistance can range from the relatively benign — for instance, the legal protection of intellectual property — to the strongly interventionist — for instance, the imposition of protectionist tariffs, subsidies, or direct government control.

Australia has a long and disgraceful history of protectionism; high tariffs, the ‘White Australia Policy’ and highly regulated labour markets were some of the tools employed as part of previous industry policies. The state socialism, which characterised Australia’s political economy for much of its history, drained the nation of much of its natural wealth.

Instead of these ‘old-fashioned’ measures of an industrial policy, the Federal Labor Party proposes a new brand of industry policy. The Shadow Treasurer Wayne Swan says ‘Industry policy means to me getting the basics right — skills, education, innovation, infrastructure and tax’. Senator Carr has indicated a more expansive program, including measures such as utilising government procurement policy to provide a ‘base level of demand’ for Australian products.

Available here.