Should legal fictions pay taxes?

Published in Insights, The New Zealand Initiative’s newsletter, 2 September 2016

Thirteen billion Euros ($20bn) is a lot of money, even if you are a giant multi-national like Apple. That is the sum the European Commission wants Apple to pay the Republic of Ireland.

For many years, Apple enjoyed not only Ireland’s low company tax rates. It also had a special deal with the Irish government which reduced its effective tax rate to 0.005 percent.

Now the European Union claims this treatment amounted to an illegal subsidy, which Apple ought to pay back.

Apple’s case is too complicated to discuss here in detail. But the story reminded me of a question I have been pondering for a long time: Why do companies have to pay taxes at all?
Before anyone hurls abuse at me, let me clarify where I am coming from.

Companies are not real persons but legal fictions. Companies do not enjoy the fruits of their operations: their shareholders do. And therefore companies never actually pay taxes, either.

Of course, companies have to make tax payments. In a technical sense, it is them writing cheques to Inland Revenue. But that does not mean that companies really shoulder the economic burden.

In reality, there is always some natural person that pays. That person can be a customer, a supplier, an employee or a shareholder.

In economics, we call this phenomenon ‘tax incidence’. Put simply, there is a difference between those nominally paying a tax and those effectively bearing the tax burden.

Most economists would agree that for this reason companies never really pay tax at all. So my question is why do we keep pretending that they do?

To apply this logic to Apple’s case, what if we got rid of corporate taxes altogether and only levied income tax on the dividends shareholders received?

Such a practice would make it harder to avoid taxes since shareholders would have to physically move to tax havens to escape income tax. It would also allow companies to reinvest profits not paid out as dividends, thus creating an incentive to grow.

I know the devil is in the detail. For a start, we would need to ensure that individuals do not avoid tax by channeling their incomes through company structures.

However, Apple’s case demonstrates why it might be desirable to move beyond corporate taxes as they exist today. This could well simplify tax compliance and lead to stronger investment.

It would also eliminate the need to use countries like Ireland for tax avoidance schemes. And it would leave some tax lawyers unemployed.

But would that be such a bad thing?

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