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Why tax corporate income? (And what can go wrong when we do?)

What’s on offer?

Each year early career economists at IFS deliver a day of public economics talks, aimed at A-level and undergraduate students who have an interest in economics or might want to pursue a career in public policy research. As part of this year’s Festival of Social Science, we will be live streaming a selection of lectures from the series to anyone who is interested in finding out more about economics. There will be time allowed for Q&A on each topic.

What’s it about?

Why do governments tax corporate profits? And what are the policy challenges associated with doing so? The lecture explores whether the burden of corporation tax falls on shareholders or workers and asks why so many large companies appear to pay so little tax.

Who’s leading the event?

Isaac Delestre, Research Economist at IFS

Open to

These webinars are primarily aimed at final year undergraduates studying economics, but should be useful to anyone interested in the subject.

Why tax corporate income? (And what can go wrong when we do?)

Video transcript

hello everyone i'm helen miller i'm a deputy director at the ifs welcome to our event on corporation tax i think corporation tax is an interesting tax because despite the fact that the vast majority of us will have absolutely no direct interaction with corporation tax it still generates a huge amount of interest in fact i think it's probably the tax it's covered most often in in the news media and you know to a large degree that's because there are big debates going on about whether how we raise corporation tax is fair and whether we should do things differently so lots of juicy things to discuss in relation to corporation tax today you're going to hear a talk that gives you some of the facts and background information you need to know about the tax so that hopefully you can productively engage with these important debates the format for today is very simple you'll first hear a talk for around 40 minutes from isaac d'alestra who's an economist at the ifs there are then there'll then be time for your questions so if you have a question please do put it into slido you can find the link for slider either where you're watching the video or if you go to slider you can just use the code ifs to pop your question in there and if you like a particular question or want to see the answer please do vote on the questions you prefer because i'll take the most popular ones first so that's the plan for today without further ado let me head over to isaac to crack on with the talk isaac floor is yours thanks very much helen uh yeah so as helen mentioned um i'm going to be talking to you today uh about corporation tax or is it sometimes known uh internationally the corporate income tax and specifically i'm going to be thinking a bit about the kinds of challenges that policymakers can face when they try and implement these kinds of taxes so um just give you like a broad road map of where we're going to be heading in the lecture um we're going to start off by talking to you a bit about what a corporation tax is on a very basic level and also think a little bit about why we actually might want to have a corporation tax and the kind of purpose that it might uh serve in terms of a policymaker's toolkit um secondly we're going to move on to think a bit about who bears the burden of corporation tax who actually ends up ultimately worse off when we impose these kinds of taxes and specifically i'm going to be thinking about whether it's shareholders or whether it's workers uh who who bear the burden of the tax and then in the final part of the lecture i'm going to talk a little bit about some of the very specific problems that can arise in trying to impose corporation taxes on multinational companies so companies based in many different countries um and i'll be talking a little bit about some of the headlines you might have seen in the press um about ostensibly very uh profitable countries that seem uh profitable companies sorry that seem to pay uh very little tax in some uh countries so let's start at the beginning uh what is a corporation tax uh and why do we have one so um on a very very simple level a corporation tax is a tax on the profits of incorporated businesses um and that's so most most businesses that you might have heard of you might see in the high street or whatever they're going to pay a corporation tax on their profits so just to give you a kind of a tangible example let's say we've got a company here it's got some revenue flowing in from the sale of its products it's going to have some costs flowing out maybe we have a steel widget maker in this instance and it has to buy the raw steel to make its widgets and another category of costs that are going to be flowing out from the company are going to be the wages of the company which are going to go to the company's workers and then pretty straightforwardly once we've taken away all these costs from revenue what remains will be our profit uh some of that profit is going to go to the owners of the company in the form of dividends usually and then some of those profits might be reinvested um in the company maybe to buy more up-to-date widget-making machinery in the future now just a a side note to uh to bear in mind here it's worth it it's worth understanding that the owners of companies aren't necessarily the super rich right these aren't necessarily the jeff bezos's and uh the bill gates of this world anyone that has a private pension in the uk that private pension is almost certainly invested in stocks and shares so the class of people who are actually shelves in the uk is quite a broad class of people um now back to corporation tax corporation tax what are we actually taxing we're taxing this stream of profits uh that that exists in companies after we've deducted uh costs from revenue so that's what we're actually taxing when we talk about corporation tax um now it's important to note that while here we're talking about where the tax is legally levied so we're taxing this stream of profits that's going to end up flowing to owners through dividends it's important to understand that that doesn't necessarily mean that it's owners who are going to be worse off as a result of this tax as we're going to see later on the ultimate economic implications of the tax are potentially quite different so all i'm giving you here is just the basic legal structure of how the tax is set up okay so that's what a corporation tax basically is um how much money uh does it raise well uh in 2020 21 the uk corporation tax raised about 45 billion pounds it's obviously uh quite a lot of money but it's worth noting it's quite a lot less than some of the biggest taxes in the uk so the income tax for example raises about four times as much money as the corporation tax does okay so how has the corporation tax changed over time so on the horizontal axis here i'm giving you roughly the last 50 years or so and on the vertical axis we're going to have the main rate of corporation tax so the amount of profits that is taken by the government when it imposes this tax now as you can see in the uk the main rate of corporation tax has fallen quite a lot over the last 50 years um in the mid 70s it was over 50 percent now it's under 20 so it's a really really large fall and that fall mainly occurred in two big flurries of corporation tax cutting the first uh in the 1980s under margaret thatcher's government and the second uh since around 2010 uh under the conservative liberal democrat coalition um although it is worth noting that we now have scheduled the first corporation tax rise in the uk in many decades which is due to happen in 2023 and that's partially in response to some of the fiscal pressures that have been applied to the uk economy as a result of the coven 19 pandemic now it isn't only in the uk that we've seen uh big falls in corporation tax rates over this period of time if we look at the us we can see a pretty similar trend emerging um and actually i can show you a whole range of different european countries i've got germany here where we've also seen seen a similar trend these secular declines in corporation tax rates are something we're seeing all over the world um over the last over the last few decades okay so uh we've got an idea of how rates have changed over time what i want to talk about now is how revenue has changed over time so again on the horizontal axis here we've got a similar period of time on the vertical axis this time though we're going to have corporation tax receipts as a percentage of uk gdp okay so two broad things i want you to notice about this chart the first is just that corporation tax receipts are really pretty noisy they bounce around all over the place um and the reason for that is that corporation tax is a pretty pro-cyclical tax so during downturns uh when company profits are low um you don't get a lot of revenue through a corporation tax uh conversely in the boom times when everyone's making a lot of profit in the economy you get a lot more revenue through these kinds of taxes so um as i'm putting up here you can see that the the troughs uh in revenue from the corporation tax are pretty closely correlated to recessions stock market busts uh these kinds of events um the second thing to notice is that while revenue from corporation tax is pretty noisy while it bounces around quite a lot we haven't seen any very clear trends in corporation tax revenue uh either up or down over this period and it's worth noting that even though as i showed you on the previous chart the rate of corporation tax has been coming down that isn't necessarily true for the revenue that's actually stayed quite stable as a potential gdp across this period okay so we know basically what a corporation tax is uh i've told you how much money it raises and i've told you how it's sort of evolved over the last 50 years or so what i want to do now is just take a bit of a step back and think about why we might actually want to tax profits in the first place why might we actually have a corporation tax well um the first thing i just want to impress upon you is that corporation taxes like all taxes um the burden of those taxes is going to ultimately fall on people now that might sound like quite an obvious thing to say but i think it's quite easy when we think about corporation tax in particular to fall into the trap of imagining that we're taxing some kind of um anonymous amorphous entity and no nobody is really going to end up paying the cost of this tax um in reality um as economists we don't really care about the welfare of a corporation right a corporation is just a legal entity we care about the welfare of the people associated with that corporation and ultimately some of those people are going to end up worse off as a result of this tax either it's going to be the firm's customers maybe the the the suppliers of this firm maybe its workers maybe its owners and the reason why this is potentially relevant to this question of why we might want to have a corporation tax taxes it's worth noting that a lot of the streams of income that are flowing out of companies so in this case we're seeing wages and uh profits distributed through dividends are already subject to the income tax in the uk so we already taxed these streams of income as they fly out of companies and the question that that raises the obvious question that raises is if we're already going to tax these things for the income tax why do we also want to have a corporation tax why why tax this stream of profits um twice um now the boring answer to that question is just that it can be administratively easier to tax companies than people there are just fewer companies out there than there are individuals but i think the more interesting and the more fundamental question here is why do we want to specifically tax profits at all what uh what's the motivation behind trying to tax profits in this way um now i think one of the key answers to this is that we want to try and tax excess uh profits so what do i mean by that well even in a perfectly competitive economy we'd expect firms to make uh some profits and that's because let's say i'm an investor and i put my money in a firm um well first off i can't use my money while it's invested in a company um and secondly my money might be at some risk if the company goes bust i'm going to lose my money and so in order to incentivize me to invest that company has to pay me a return the way that companies do that is through making profits now in a perfectly competitive economy uh we'd expect companies to make what are known as normal profits and that's the exact amount of profit that's required in order to compensate investors uh firstly for not being able to use their money while it's invested and secondly for any risks they're taking with their money now of course we don't live in a perfectly competitive economy we don't live in a in a microeconomics textbook um and in the real world there are actually going to be quite a lot of companies that make profits above and beyond these normal profits that are strictly required to make investment worthwhile and there's a whole range of reasons why that might be you can think of companies who might have control over scarce resources so things like oil diamonds land that kind of stuff or they might have positions of monopolistic or oligopolistic power um now it turns out that these excess profits that some companies may be making in the economy are a really really good tax base why is that well if we think about uh the reasons that economists often caution uh against tax some of some of some of the reasons that tax can have a negative impact on the economy or on economic efficiency is that when we impose attacks um it can lead to a behavioral response that can compromise the efficiency of the economy so if we think of a classic example if we impose a tax on income an individual might say well i'm not going to work a few extra shifts now because it's no longer worth my while to work those extra shifts if the government's going to take a big chunk of my pay packet and so we might reduce the amount of work in the economy now the nice thing about excess profits is there are reasons to believe that we won't get too much of a behavioral response by taxing these profits and so we shouldn't cause too much inefficiency and the reason for that is that let's say i'm a i'm in a car i'm a monopolist making big fat excess profits if the government comes along and it takes away some of those profits i'm not going to be happy about that obviously but i'm probably not going to change my activity and that's because by definition i'm still going to be making profits in excess of the minimum required to make my company a worthwhile investment um and so we're probably not going to we're probably not going to see too much too much of a behavioral response to that tax and that makes it an efficient thing to tax um now before you walk away with the impression that uh the corporation taxes this perfect vehicle for tech for taxing excess profits it is worth mentioning that the uk corporation tax is currently constituted actually this is the case for many corporation taxes around the world doesn't only target excess profits it actually targets some normal profits as well um and the result of that can be distortionary so these normal profits are what are required to compensate investors so if we tax them away um that's going to change people's investment decisions and it's going to change commercial decisions it's going to lead to inefficiencies um broadly speaking though um these profits are a potentially desirable tax base and we can see a reason uh why we might want to have a corporation tax and the corporation tax could be a good vehicle for targeting uh this desirable tax base of excess profits now what i'm going to be focusing on over the rest of this lecture um are the threats that can be posed to the corporation tax as a means of getting at these excess profits when we start thinking about it in an international context what we're going to see is that once we enter this international context there are going to be some serious challenges posed to the corporation tax and that's going to be because we live in a world where companies investors benefit from a large degree of international mobility what we're going to see is that that's going to allow them to respond on an international scale to corporation taxes imposed in a given country so that can result in companies or investors moving overseas in order to escape corporation taxes and it could also lead particularly to multinational companies um using the international legal system to move their profits abroad even if they aren't necessarily moving their real economic activity abroad and we're going to explore both those issues in turn okay so the first lens through which we're going to think about uh this question um of the way in which the international context can pose a challenge to corporation taxes um is by thinking about who ultimately uh bears the burden of a corporation tax um in an international setting okay so we already mentioned that uh this key point that all tax ultimately is going to be paid by people but one of the important questions that raises is which people and when we impose a corporation tax who's ultimately going to end up worse off um and so you know as with any tax when we impose a corporation tax it's going to lead to a ripple effect across the economy we're going to move from one equilibrium to another um and in that new equilibrium some groups are going to be worked worse off now there's a whole range of potential groups that could be made worse off by imposing a corporation tax we're going to be focusing particularly on workers and shareholders that's why a lot of the economic literature has focused on in terms of who's ultimately bearing the burden of corporation tax and that's going to be relevant for answering a whole range of different questions so you could think for instance about inequality wage earners on average do tend to be worse off or have lower incomes than shareholders even though as we've already mentioned we shouldn't think of shareholders as being just the super rich and so if corporation tax turns out to be a tax that falls mainly uh on shareholders it's going to look like a less progressive tax than uh then if it falls approximately on okay um so the way we're going to think about this is we're going to we're going to have a simple set up we've believed here i'm not going to be doing uh any algebra in today's lecture but we're just going to have a simple intuitive setup we're going to think about what effects we might expect to happen when we impose a corporation tax on a small open economy like the uk so we've got the uk here we're going to have some standard microeconomic assumptions and we're going to have a few little molecules of production that you can see here in the uk they're going to be made up of a little k's and l's those stand for capital and labor as i'm sure you guessed um and at the start of our model start of our example there's going to be a prevailing rate of return to capital of three percent uh in the uk so investors who put their money in companies are getting a three percent return okay so what's going to happen in this economy um if we impose um a corporation tax well in the first instance um capital is going to be fixed um investment in firms is going to have been spent on machinery and stuff that can't easily be moved around the world so um essentially investors are basically going to have to swallow a lower rate of return in the first instance because companies are now having to pay a corporation tax and they're having to pay out a return to investors and so they're not going to be able to afford such a high return to investors so in the first instance it's the owners of capital the owners of companies that bear the burden of the corporation tax through this lower rate of return um but now let's start thinking about the international context imagine that we have uh the united states say another big country you know just an example and let's say the prevailing rate of return to capital in the united states uh is three percent just like it was in the uk before we imposed the corporations well what's going to happen in this instance what's going to happen um is that investors in the uk are going to say well why am i settling for this measly two and a half percent when i could be earning a three percent return over in the united states and as a result investors are going to start responding to this tax by moving their investment from the uk to the us now basic supply and demand as the supply of capital uh in the uk diminishes its price is going to go up and so the reduced supply of capital is going to drive the rate of return to capital back up to three percent once it reaches three percent investors are no longer going to have an incentive to move their money from the uk to the us um and we're going to be back in equilibrium now what's happened here ultimately if we take stock what we've seen is that capitalists or people the owners of capital um are no worse off at the end of this process than they were at the beginning uh right at the beginning they were earning a three percent return uh on their capital uh at the end they're earning a three percent return on the capital so the owners of companies have basically taken no hit at all as a result of imposing the corporation tax what about labor well one thing that's changed is there's less capital in the uk than there was to begin with investment has moved out of the uk we could think of this in terms of now companies in the uk don't have as much investment as they had before maybe they don't have the most up-to-date machinery anymore the most up-to-date equipment and as a result each hour that a uk worker works they're not going to be as productive because they're not going to be working with the most up-to-date equipment and machinery and the result of that as we know from any core microeconomics course is that as the marginal productivity of labour falls at solitude is the wage so ultimately we're going to be in a situation where the owners of capital have taken no hit because they're still making the same returns they were before but workers have taken a hit because their wages are going to fall as a result of the reduced investment in the uk um and so in this kind of setup we've basically created a scenario where labour is bearing the entire burden of the corporation tax now in reality we wouldn't expect to see something quite that extreme in the real world uh right there are lots of reasons for instance why capital isn't going to be able to perfectly move internationally quite so easily as that there might be location location specific activities that are being invested in um so we definitely wouldn't expect to see labour bear a hundred percent of the burden of his tax um but if we look at the empirical evidence on this question of you know how much uh what portion of the burden of corporation tax is borne by uh workers and it's worth noting this is a pretty difficult exercise to do empirically um if we look at the empirical evidence what we find is that there does seem to be a lot of evidence that labour do bear at least some part of the burden of corporation tax so here's one paper recently that looked at variations in corporation taxes in different u.s states and used that to estimate that around a third of the burden of corporation tax um falls uh on labor in in that situation and another paper that used variations in business taxes in different german states to uh estimate that around 50 of the burden of corporation tax falls on labor in that instance now it's worth noting that there's no reason these numbers should necessarily be the same it may be that the burden of corporation tax falls more on labour in some countries than it does in others um and it's also worth noting that there are a broad range of these different estimates in the empirical literature there's a fair amount of uncertainty as to how much of the uh burden of the tax is borne by labor and particularly the uk we haven't got a huge number of uh of estimates of this um but i think it's just worth being aware that you know when policymakers pull the lever marked corporation tax there's a fair amount of uncertainty as to who's ultimately going to be made uh worse off by the tax and that's as a result of this high degree of international mobility that we have once we start thinking about uh corporation tax in the international context okay so um the final part of this lecture i want to talk a little bit about the particular issues that are involved with trying to impose corporation taxes not countries available and we've got a multinational corporation that's got operations in all three well this multinational corporation is going to have some total amount of profit that it makes in these three countries but what these three countries need to decide is what share of that total profit each country is going to get to tax now the way in which uh the international community sort of has agreed to do this is through something known as the 1920s compromise which was an agreement brokered as the name suggests right back in the 1920s by the league of nations which is the interwar predecessor of the united nations um and what this agreement sets up is the principle of taxation at source um what does that mean well it essentially means that profits um are taxed where value-added activity takes place um not whether the sales or the customers of a firm are located so let's have a little think about how that works in practice so um let's imagine that we have a french car manufacturer renault in this case and let's say that the french car manufacturer wants to sell its cars into the uk market and it wants to do that by selling its cars first to an independent uk car dealership that will then sell them to uk customers well how's this transaction going to work pretty simply the cars are going to be exported from france to the uk and the uk car dealership is going to pay for them now the value associated with those cars is their wholesale price that's being transferred from the uk to france where it can be taxed as part of renault's french profits um and you can see that taxation at source in this case is kind of working automatically uh the value of those cars has been transferred to the place where production took place um okay so let's go to a slightly more complicated example um now let's say that renault wants to sell its cars in the uk not through an independent car dealership um but through a subsidiary of renault through renault uk okay so what's going to happen in this instance well renault france is going to start off by exporting the cars to the uk just as it did in the last example but the difference here is there's now no obvious reason why renault uk should pay renault france for these cars right we're talking about the same company we'd just be shuffling around money within renault so what the uh the legal structures associated with taxation at source mandate is that uh in instances like this renault uk needs to make what's known as a transfer payment to renault france and that basically means that it needs to pay for these cars as if these were two separate companies um now crucially it has to pay for these cars in accordance with something called arms length principle now what is the arm's length principle the arms length principle basically means that renault uk in this instance is going to have to pay a fair market price for those cars so it's going to have to pay the same price that renault charges to uh separate companies to make sure that a fair amount of value is transferred from the uk to france for the purposes of corporation tax okay so taxation at soul seems to be working pretty well in those examples so why is it that we see headlines like this why is it that we see headlines suggesting that ostensibly very profitable companies seem to be paying very little tax in some countries the key issue here is that as we've moved into a far more globalized economy there have been some uh some aspects of the taxation of source regime have become less and less suitable to the kind of economy which we live in today and that's posing some pretty serious threats to the way in which the taxation at source system works so firstly taxation at source creates incentives uh for companies to move their profits to low tax cut to to lower tax countries so that's pretty obvious if you're going to tax a company um on the basis of where it undertakes its value-added activity it's got an incentive to move that value-added activity to a lower tax country now in the 1920s when this agreement was dropped up that maybe wasn't too much for a problem most a big multinational companies were doing things like manufacturing and it's not that easy to move all your factories and workers from one country to another uh so it's going to be pretty difficult for firms to uh shift their activity from one country to another in response to tax the problem is um over time we've moved to an economy where things like intangible assets things like brands and patents have become much much more important uh inputs to production um and the thing about intangible assets is it's very easy to move them um to different parts of the world and so it's become much much easier for companies to shift their profits from a high-tech country and to a low-tax country we're going to see the kinds of problems that's caused secondly what we're going to see is that the system of taxation at source by taxing uh value added where production is taking place rather than where customers are can in the modern economy lead to a situation where a company has many customers in the country but really pays no tax there and that's gonna be particularly a problem for things like digital companies okay so let's start with the first of these uh these two uh threats to taxation source and i want to think about uh in the context of a cup of starbucks coffee sold uh here in the uk so let's think about um how taxation sauce works in terms of working out where the value of this cup of starbucks coffee is created so let's imagine the cup of starbucks coffee begins life on a starbucks own coffee farm in rwanda um those coffee beans are then exported to a starbucks owned roasting and preparation facility in switzerland we can imagine here taxation at source is going to work pretty simply um starbucks switzerland is going to make a transfer payment to starbucks rwanda coffee beans are a readily traded international commodity it's going to be quite easy to work out what the what the price paid for those coffee beans should be um next the coffee beans prepared and roasted in switzerland they're going to be exported to the uk uh and again we're going to see that taxation at sauce should work pretty simply here the transfer payment from made from the uk to switzerland should be quite easy to work out uh roasted coffee beans are presumably sold by a whole number of different companies and if this was the end of the story stuff would be pretty simple um we'd work out the total uh amount of revenue that starbucks uk makes we deduct costs including these imported coffee beans and then we can work out how much profit should be taxed in the uk the problem is we're missing one key component of the value of this starbucks coffee and that's the starbucks brand now let's let's imagine that the starbucks brand the intellectual property for that brand is held in the netherlands what this means is starbucks uk has to make a payment to starbucks netherlands for the right to use the starbucks brand now i hope what you can see is that knowing the right price that starbucks uk should pay to starbucks netherlands that brand is going to be very very difficult and the reason for that is that the starbucks brand isn't like coffee beans it's not something that's internationally traded on commodity markets it's never bought and sold outside of starbucks and so it's going to be almost impossible to know what the correct price to pay for that brand should be and so the truth is that these questions are very important for working at taxation at source like where is value created are going to become increasingly ambiguous in this world where things like intellectual property are a very important input to production and that's going to make the whole system of taxation at source inherently ambiguous i don't think we should be surprised that uh when we ask companies these kinds of ambiguous questions they're going to give answers that minimize their tax burdens so how does that work in practice well starbucks uk in our example is going to have to make a payment for the use of this intellectual property to starbucks netherlands what we can quite clearly see here is that if the uk is a high tax country and the netherlands is a low-tax country starbucks has a really big incentive here to value that intellectual property as highly as it can make as big a payment as possible from the uk to the netherlands and so increase its profits in the netherlands reduce its profits uh in the uk and essentially shift its profits from one country to another through this kind of legal mechanism and the ease with which uh profits are being able to uh can move from one country to another in this way in certain circumstances um has led a lot of people to point to this this reduction in corporation tax rates that we've seen around the world which i showed you at the beginning of the lecture and to say that well the ease with which corporations can now move their profits around the world is basically leading to a race to the bottom where countries have big incentives to compete by offering lower and lower corporation tax rates in order to try and attract profits to their country okay so we've talked about this first issue which is becoming easier and easier for companies to move their profits from high tax countries to low-tax countries the second issue i want to talk about and the second threat that's posed to taxation at source in the modern economy and is this question of um having potentially lots of customers in the country but paying very little tax there so um we can imagine that this is going to be a problem particularly for digital businesses so uh the classic example of this kind of setup might be a company like amazon so amazon let's say amazon sets itself up in luxembourg it's going to be able to sell and deliver lots of products to its uk customers but as long as it doesn't have a big headquarters in the uk as long as it doesn't undertake any value-added production in the uk it's going to be able to have all its revenues flow from the uk back to luxembourg to be taxed there and you can think about a whole range of different digital businesses and how this could be a problem the facebooks the googles of this world potentially have a lot of users in the country but don't undertake any value-added activity there and so won't be subject to corporation tax there and again this is a way in which the economy has changed a great deal since the 1920s uh when this agreement uh when these these these international legal agreements were created you know if you wanted to sell products in the uk in 1920 you had to set up a whole load of shops there in a way that amazon doesn't need to now okay so what kind of international responses have we seen to these problems uh by by governments around the world well you guys might have seen headlines like these over the last few months about this great blockbuster agreement that's been signed by different countries around the world to try and tackle tax avoidance by uh international companies um what i want to do just in the very last bit this lecture is just go over the key elements of this agreement so um the agreement is part of something known as the base erosion and profit shifting uh initiative which for the acronym lovers of you uh uh out there that's uh beps for short um and um the uh the base erosion profit shifting uh initiative has uh what's known in the job as two different pillars that's basically just two different parts to the agreement um so this new agreement has been signed the first the first pillar the first part of the agreement um is basically trying to address this problem of digital companies in particular having lots of customers in the country and but not necessarily paying very much tax there um whereas the second pillar is trying to deal with this issue of companies finding it easier and easier to shift their profits from high-tech countries to low-tax countries and it's trying to deal with that by imposing a global minimum tax rate so let's go through those things uh one by one um so we've got pillar one which is uh addressing uh this question of uh tax not necessarily being based on where uh customers are found um and it's and this is particularly an issue when it comes to come to these kind of digital businesses the basic idea behind the agreement is to take some chunk of these businesses uh profits these digital businesses profits and redistribute them on the basis not of where a value-added activity is taking place but on the basis of where their users or customers are so facebook has tons of users in the country it's going to have to pay some tax in that country even if it doesn't necessarily have lots of software engineers based there or anything like that um now that's a broadly sensible thing to do but it is worth noting that the scope of the agreement is pretty limited so it's only going to apply to firms with revenues of over 20 billion pounds um details aren't too important the point is that this is only going to be a it's only going to apply to about 100 companies so it's not going to apply to very many companies at all um 20 billion pounds is a huge amount of revenue and it actually excludes lots of very well known companies that you've heard of these three companies twitter uber netflix none of those are big enough to uh to fall under uh the uh fallen of the jurisdiction disagreement so you know we probably shouldn't expect this to be a total game changer uh in terms of uh how much tax these digital companies are paying so the second element of the agreement is basically trying to impose a global minimum corporation tax rate so the basic logic here is that if firms are finding it increasingly easy to move their profits from high-tax countries to low-tax countries well if we have a global minimum corporation tax rate so that no countries can offer let's say a zero percent corporation tax rate anymore there's going to be less incentive for companies to shift their profits internationally in this way um again it's a potentially uh sensible idea but uh there are some pretty serious uh uh you know there are some pretty serious reservations and it might not be exactly uh what it says on the tin and the reason for that is that there are um some exemptions written into this agreement which mean that if you've got loads of employees or loads of buildings and loads of assets in the country you're not going to have to pay this minimum tax rate um and what that means is that we're potentially going to see a whole new set of incentives created for companies to shift their profits to countries where they have lots of employees or lots of buildings lots of physical assets and because that's going to allow them to pay potentially below 15 tax rates so again a potentially sensible idea potentially a good idea maybe a step in the right direction but unlikely to uh be the silver bullet that solves the problems we've seen the taxation of source okay so just want to come to a free a few brief conclusions um i told you right at the beginning of this lecture the excess profits are potentially quite a desirable tax base and that the aim of corporation tax should essentially be to try and tax those uh those excess profits um but i hope what you've also taken away from this lecture is that once we start thinking about corporation tax in an international context particularly particularly in the kind of international context that we have today where we have a very very highly globalized economy um there are going to be some very very big challenges that policymakers are going to face when trying to implement corporation taxes now firstly capital is going to have the opportunity to flee overseas um and as we saw in the middle part of this lecture uh the result of that can be that investment in your domestic economy reduces efficiency goes down and potentially wages are reduced as a result of your corporation tax and secondly we can see that when we try and tax our multinational corporations we can end up in a situation um where companies are able to shift their profits to low-tech countries and we end up uh without any any international coordination with a situation where countries are essentially competing to offer the lowest possible tax rates uh to attract the most profits uh to their country so that's gonna be all from me um i uh be very happy to take any questions wonderful thank you very much isaac so as i said we've got time for questions now so if you do have questions please pop them into slido and i will ask them for you um so a few questions already let's get started with um with those so um chris mccormack asks regarding the research that corporate tax burden is broadly shared between workers and owners does the same happen with tax reductions i.e are they shared equally um and perhaps it's an opportunity isaac to say a bit more about what we know about the burden and who it's shared between yeah absolutely so you know as i said that i think it's worth just caveating um all the research around the the burden of corporation tax that's borne by workers with the fact that there are a huge range of different estimates in the academic literature as to what that burden might be and i don't think we can say with a great deal of precision uh what percentage exactly of corporation tax would expect to be born by workers particularly um in the uk where there's relatively limited evidence um theoretically you might expect it to uh happen in a symmetrical way if you reduce corporation tax although you do see in other areas that sometimes that symmetry doesn't exist perfectly when you when you're increasingly decreasing taxes there can be a behavioral factors that mean that mean you don't get that perfect symmetry and another thing that's just worth raising is that it's not only workers and shareholders that can bear the burden of the corporation tax right so it's totally possible uh for instance under some setups to imagine that uh customers might bear the burden of corporation tax through higher prices or even uh other companies so if you're uh if you're a contractor with a company that's having to pay a corporation tax you might feel a knock-on effect as well so there's a whole range of different um different facts of production that can that can uh that can be impacted by corporation taxes and we've just been focusing there on on workers and uh workers and shareholders but but it can be really quite a complicated picture yeah and perhaps i can add on top of that that um the effect won't only depend on what a an individual country does but also on how that country's corporate tax system compares to other countries so if a country changes its tax and it goes up or down a little bit but it really doesn't change how attractive that country is rented for other countries then the burden may not change very much but if actually it suddenly cuts its tax and attracts a lot of uh capital you know isaac showed you the picture of the little atoms moving or it raises its tax it loses a lot of capital that'll have a bigger effect on the burden so there isn't really a linear relationship between the rate of a country it's also about how that country fits into the broader landscape um second question then isaac so is from david rickard he asks um would a sales tax be more effective than a corporation tax i guess i mean i don't know what david has in mind there are two different types of questions that i often get asked about this i think maybe you could address both of them so one is if you have a corporation tax with a corporation tax that does it more located on sales and so still a tax on profits based on the location of sales be better or an alternative that the question might mean is rather than a corporate tax at all why don't we not tax for profit but then tax sales instead so it's an alternative um i think there's two different varieties of that question there for you sure so i mean you know as i said the the system we currently have is to uh tax uh profits where production basically is taking place rather than where customers are um increasingly as we've basically seen it's quite easy uh either to actually or to legally move where it looks like that uh that production is taking place um around the world so there has been a lot there have been a lot of economists that have suggested um that we might be better off um moving corporation tax to a basis where we basically focus on the share of customers or the share revenue being made because those things are much less mobile potentially uh than uh than where the production is actually taking place much harder for you to move your customers halfway across the world than if you to move uh your your production halfway across the world so it's a it's a broadly sensible um it's a broadly sensible way to potentially go with it the big problem i would say is that uh as with any of these uh proposals to come up with a wholesale with a the new way of a new way of calculating corporation taxes you're going to need realistically a broad amount of international consensus in order to implement something like that um and the problem with doing that of course is that there are always going to be winners and losers when you implement a big change to how corporation tax uh is calculating so that you're always going to run up against some degree of international resistance to uh to making that kind of change great uh it's another question from um jm says is another reason for corporate taxes not to prevent wealthy individuals from investing their savings via a company to at least defer income tax question about the backstop role of corporation tax in in taxing personal income yeah absolutely that's that that is also another sense i mean that's not something we've managed to get into here but there are there there's definitely uh a role to play for corporation tax in terms of uh ensuring that we tax income that for whatever you know through whatever loopholes that exist in uh in the domestic tax system aren't being taxed uh through any other uh through any other tax and so that's so that's also a very sensible way in which to to to look at the corporation tax uh great so one other i guess i asked my own question um uh abused my position as chairman one thing people might have heard about um if they've been following the press is that recently we've had these pillar one pillar two discussions the big international agreements but before that we had lots of countries um operating their own digital services taxes in fact a lot of european countries still have digital services taxes um and the americans don't like that and they're trying to stop that um so how does that fit into this landscape and what should we expect from that going forward do you think sure yeah so i mean the way the digital services tax basically works is that it's a response to this problem that i was talking about that you can have these big digital companies the facebooks the googles the the amazons who have a lot of customers in a country but don't necessarily pay any tax there because they haven't got any uh they're not undertaking any production there um the way in which the uk and a number of other european countries responded to this was by basically unilaterally uh imposing their own digital service taxes on these companies basically the way they did that is they said okay we're gonna we're gonna do our own calculation to work out how much uh of that company's global revenue we think is attributable uh to customers here in the uk or users here in the uk um and we're going to tax their their that percentage of their revenue uh uh in the uk and it's worth noting the digital services tax is a revenue tax in the uk not a profits tax in the way the the corporation taxes um now as helen just said the us wasn't terribly happy about uh the uk and other european countries imposing these additional services taxes because they're because they're taxed on big digital companies they're effectively taxes on american companies because basically all these digital companies are american companies um and one one of the reasons why uh the us has a certain amount of motivation to take part in these big international agreements in terms of uh trying to come up with uh new ways of allocating corporation tax is because part of the quid pro quo is that it would like european countries to remove these these unilateral digital services taxes um and to move to this more this morning this more multilateral approach great so um you mentioned the minimum global tax proposal i mean how confident are you that that's going to have you know be a game changer should people would be expecting that a couple years time will no longer be hearing about big multinationals and avoidance or is that just going to uh patch up the system do you think yeah so i sort of touched on this while while i was well i was talking about but i don't think we should expect it to be an absolute game changer so this is this is definitely a step in the right direction having having a minimum corporation tax is not a crazy response to this problem that companies are finding it easier and easier to shift their profits from one country to another um but there are some major issues with the way in which it's currently been constructed and i think that's largely as a product of the fact that you're dealing with these big international agreements we have to get lots of countries to to come to a consensus um one of them is something that i i kind of raised a bit briefly but maybe i can go into a little bit more detail which is that um under the current agreement um you're going to be able to deduct from your taxable profits um a lot uh five percent in fact of your total payroll in the country and your total physical assets in the country and so what that basically means is that if you own loads of buildings in the country or you're in loads of physical assets in the country or if you have loads of workers in the country uh you're basically not gonna have to pay the minimum corporation tax rate and that's because uh you know in these international agreements lots of countries who have companies employing people in their countries they don't want those companies to uh move overseas in response to tax changes so they essentially giving them these these uh these tax breaks for the minimum corporation tax um as i sort of mentioned you could imagine a world in which uh that creates a whole new dynamic of profit shifting you can imagine a world where now companies basically uh how basically they they can shift all their profits to countries where they have lots of employees or lots of physical assets and benefit from a lower tax rate in that country so it might not reduce the amount of profit shifting it might just change where the profits are being shifted to um another thing just to bear in mind is that um while this is going to reduce potentially the lowest tax rates that a company can access so maybe it's not going to be able to get a zero percent tax rate um anymore by moving all its profits to some tax haven like you know bermuda or something um it may still be able to you know even if it can access a 15 corporation tax rate that's going to be lower than most countries have um and it may be the case that even if it's a bit lower than they can get in another country it's still going to be worth their while and if if for most companies it's still worthwhile to shift profits even if it only means they're reducing their corporation tax rate by you know five or ten percent um then it might be that you just don't see a big reduction in profit shift because it's still worth it's still worth companies while to shift profits to tax havens even if those tax havens having to charge a slightly higher rate of corporation tax i think you're muted helen schoolboy era thank you um so question from the audience your chart showed that corporation tax rates have been falling since 1970s um but revenues aren't falling uh so does that suggest this when it comes up in the press very commonly does that suggest that corporation tax cuts pay for themselves sure yeah so um i'm afraid it doesn't it doesn't necessarily mean that so uh i mean we would expect that uh you know as we reduce corporation tax as we said if we if we're taxing uh normal profits some extent then corporation taxes are going to lead to some inefficiency so cutting those taxes uh might grow the total size of the economy um a little bit but it's certainly not going to grow the total size of the economy enough to mean that actual corporation tax revenue increases you we don't live in a world uh certainly at the current current rates of corporation tax where cutting corporation tax is going to increase revenue and the big reason why we've seen corporation tax rates fall in the uk um while seeing revenues stay pretty constant is that successive governments have basically pursued a strategy um where they've not only reduced corporation tax rates but they've also actually broadened the base and so what what governments have basically done is they've made the deductions you can make from your taxable profits for things like investment less and less generous over time so that while companies are paying a lower rate of corporation tax they're actually paying it on a much wider definition of profits and so obviously if you're paying a lower rate but on a larger amount of money that doesn't necessarily mean you're paying less tax and that's the big pattern that's driven the fact that uh the revenue from corporation tax hasn't fallen even though the rates have oh great it's another question um from jm so scandinavian countries have higher taxes um at least overall they don't appear to have suffered capital outflows and workers are not paid less than in the uk what are they doing differently of course these questions are always hard to answer because there's tons of things different countries are doing differently lots of moving parts so perhaps you give us some indications of the kind of things we should be looking at in comparing countries yeah sure i mean uh you know i haven't actually got the figures uh in front of me as to what scandinavian scandinavian corporation tax rates are like but i don't think scandinavian corporation tax rates are necessarily that high whereas although scandinavian tax overall um is pretty high um so i'm not sure that actually corporation tax rates are super super high in uh in scandinavia um another point just to raise though of course is that you know as as we mentioned there are lots of reasons why uh we're not going to be in this this world where you whack on corporation tax and instantly all the capital flies out of your country and there it's good there are going to be lots of instances where companies want to operate in a particular country because they have certain attachments to that country or they can only do what they're doing in that country they might you know there are going to be a whole raft of reasons why you know apart from the tax system that it might be attractive to operate a particular country you have to also look at the regulatory environment um you have to look at the kind of other opportunities that are available in that country it might have a particularly attractive workforce um and so you obviously can't just consider these taxes um uh in isolation and they're you know there's a whole there's a whole raft of different um policy instruments you need to think about when you're trying to consider how you're going to impact investment uh in a particular jurisdiction actually just give you one example of that until very recently the us actually had a pretty high rate of corporation tax um obviously it's still home to these big global multinationals and part of the story there just to back up you know give you an example of what isaac was saying is that the americans have a very generous tax base so you can deduct lots of costs and they had a particular particularly generous treatment of foreign incomes so a lot of these multinationals the income they're earning abroad were sort of treated generously so often the headline result the headline rate only tells you relatively small part of the story about the kind of broader picture that isaac's painting about all the other bits and pieces that um that can that can matter so we're running up against our our time so i guess it's the last question i mean when we step back a little bit we've gone through tons of details here about corporation tax how it works what we're trying to do with it obviously it's an area that's contentious lots of debates are happening about what it should do what it could do what it is doing i mean maybe tell us give us your views on what's the best case tonight what we can hope for in in the coming years and what should we be looking out for what should people out there be looking out for what's going to really change and what should politicians be doing differently or what's the next thing they should be looking for in this policy space well i think you know i think it is it's it's definitely a good sign that even even if these international agreements are flawed it's a good sign that you know countries are around the table and are making tangible agreements on this stuff it might be that in the first instance these agreements don't go as far as they need to in terms of reducing the amount of profits that being shifted around the world but hopefully if those agreements are reached and you know it transpires that they haven't done enough to prevent the kind of behavior that they're aiming to prevent then hopefully at least this will provide a platform and a forum uh to make more progress in the future so i think we should be positive that you know we're at least moving in the right direction we seem to move in the right direction in a tangible way there's these kinds of talks around these issues have been going on for very many years and we haven't necessarily seen a lot of progress where we do actually now seem to have um countries coming to a tangible agreement and once you have an agreement sometimes it can be easier to make progress on off the back of that so i think there are lots of reasons to think that we're moving in the right direction with this stuff but i mean i think you also have to be realistic that we are talking about agreements being made you know between many many different governments and it's just going to take a bit of time to uh make the kind of progress that we'd like to see as a result particularly as i said because any kind of change you make is inevitably going to have losers as well as winners as always intact for price you need to have losers it's hard to do things but i guess that's a nice place to end optimistically that countries are around the table they are doing something about this so hopefully we have a better system in the in the pipeline and let me thank you all for uh let me thank isaac for giving us a great talk let me thank you all for uh listening um and i hope we'll see you again another ifs event