January 2016 newsletter – RES Annual Public Lecture – Does Starbucks Pay Enough Tax?

Contrary to popular belief, there is relatively little evidence that the UK or US lose substantial amounts of tax revenue due to firms' avoidance activities. This is surprising because it seems that there are ample opportunities for them to do so.In the RES Annual Public Lecture Professor Griffith discussed why that might be the case, and some of challenges that governments face in effectively taxing firm profits.

The payment of a ‘fair’ rate of tax by multinational firms hit the headlines in 2016. Starbucks, Amazon and Facebook (and others) found themselves in the spotlight and the subject of unwelcome criticism from the general public as well as politicians in all major parties. Professor Rachel Griffith of the University of Manchester chose it as the subject for the Royal Economic Society’s annual public lecture at the Royal Institution on Tuesday 24 November (and again at the Whitworth in Manchester on Thursday 3 December). As always, this popular event was well-attended and a much-larger audience was able to participate through subscribing to a live feed. For most of the audience, the major revelation of Professor Griffiths’s presentation will have been just how difficult the question is to answer. Certainly, it is unlikely to be satisfactorily answered by simply quoting a target proportion of profits.

Consider some of the difficulties:

Firstly, there is the question of jurisdiction. Since multinational firms (by definition) operate in many countries which may have different corporate tax rates, there is an incentive for firms to declare most of their profits in a low-tax jurisdiction. One way round this might be to insist that firms pay the rate that applies in the country where their headquarters are located — but a ‘headquarters’ is as much a legal entity as an economic one. It doesn’t cost much to put a brass plate on a door and employ a small ‘headquarters’ staff on a remote island with a low corporate tax rate. Furthermore, adopting this criterion might easily encourage a ‘race to the bottom’ as countries competed to attract mutinational HQs by offering a low rate.

An alternative may be to charge the rate that applies in the country where the firm holds most of its assets. But here we have a relatively new problem — but one which is likely to become more pronounced with time, namely that assets are increasingly intangible. These are ideas and investments that do not have a physical presence. Intangible assets by their nature are not tied to a physical location — and unlike a piece of machinery, an idea can be used in many locations at the same time. In addition, the most valuable ideas are often those that can be combined with other ideas to create even greater value. Tying the value created in this way to a physical location — and thus to a tax jurisdiction — can be very difficult.

Furthermore, what constitutes a fair share of tax is itself difficult to pin down. For firms, the recent debate tends to see it as the payment of the headline corporation tax rate on most of a corporation’s declared profits. (To put it imply — since the firm writes the cheque, the firm ‘pays’ the tax). But it is not so simple. When economists talk about who pays a tax, they don’t mean who writes the cheque. They mean ‘who is made worse off by the imposition of the tax’.

This is called ‘tax incidence’. A firm cannot be made worse off (it cannot bear the incidence of a tax); only individuals can. Which individuals bear the burden of corporate income taxes? Estimates suggest that the burden is probably shared between the shareholders, the workers of the firm and the consumers of the products that the firm makes — with the amount that each bears depending on factors such as what options each has in terms of alternative investments, jobs or products to consume. This led Professor Griffith to stress the importance of seeing ‘fairness’ not as a property of a specific tax but of a tax (and benefit) system — since there are many ways in which firms make contributions to, and draw from the public exchequer.

Then there is the question of ‘fair relative to what’. Is it:

• relative to how much of publicly provided goods the firm uses?

• relative to what competitor firms pay in tax?

or are corporate income taxes a tax on the owners of the firm, i.e. (rich) shareholders? in which case do we want the tax to be fair relative to the income of the shareholders?

Professor Griffith concluded:

‘We currently try to tax corporate profits at the location where value is created, under international agreements formed in the 1980s. Implementation of this system is increasingly difficult in the presence of intangible and internationally mobile assets.

An alternative, and preferable, way to tax corporate income would be to tax profits (value added) at the destination of sales (similar to VAT). Such a measure has been suggested by many prominent economists. But this is politically unpopular, and current policy reforms seek to reinforce the current system. They do nothing to address the fundamental issues of what is a fair and efficient way to tax corporate income.’