Do lower tax rates curb tax cheating? Really?

Median statutory corporate tax rates, by country income group, 1980-2010. (Source: IMF.)

It’s a good question. Now, an Australian story, via The Guardian:

“Treasurer Joe Hockey has said Australia is “losing control of our destiny from a taxation perspective” because of “holes” in the tax treatment of multinational corporations, as a parliamentary committee prepares to grill global companies about the tax they pay and former tax officials warn that the tax office has lost the expertise to tackle the problem.”

Fair dinkum. Free-riding off others, increasing inequality, eroding democracy, distorting markets: the charge sheet is a long one. And Australia isn’t the only country setting up parliamentary committees to get active on these pressing problems.  But then the article goes on to say something else:

“Hockey’s tax discussion paper proposes “a lower corporate tax rate” as one way to tackle the problem because it “would reduce the incentive for tax planning and profit shifting from Australia.”

“This would potentially reduce the revenue that is lost to tax planning and allow the resources devoted to tax planning and compliance activities to be used more productively in the economy,” the discussion paper says.”

Really? Really? At what point, exactly, are corporate bosses supposed to say “OK, that’s enough, lads: the rate is low enough, and we can stop cheating on our taxes”? Perhaps Mr. Hockey like to spell it out: where, exactly, is the evidence for this statement?

Well, the evidence seems to suggest that cutting corporate taxes may increase tax cheating. From our recent report Ten Reasons to Defend the Corporate Income Tax:

“Those arguing that corporate tax rates are ‘too high’ might also like to explain why tax avoidance and evasion, and the use of tax havens, has exploded around the world since the 1980s – amid tumbling tax rates.

Of course correlation isn’t causation, but this trend is very strongly suggestive that the conventional wisdom on tax cuts may have it the wrong way around. They kept saying this in the 1980s, when rates in many countries were up in the 50s, that this would solve the problems. They cut, and the problem got worse. Now the rates are in the 20s. What has changed? And bear in mind that, given that there is literally no limit to which corporate bosses would like to free-ride off the tax contributions of others, the effective rate — once tax cuts and other incentives and subsidies are taken into account — does not stop falling when it reaches zero. 

Why should it?

And there are other particular reasons why the conventional wisdom may be wrong:

Tax avoidance generally happens for reasons other than the tax rate: notably the ease of doing so, the rising availability of widespread tax ‘planning’ advice, the ‘shareholder value’ revolution making corporate bosses disregard other stakeholders, the pressures of ‘tax wars’ (see Section 3) – along with prevailing ideology, culture and attitudes towards the acceptability of tax avoidance. As tax cuts, loopholes and special tax incentives proliferate, the ease and frequency of tax avoidance grows, and it becomes more acceptable.”

Now here is something else, which it turns out that the Australian tax document agrees with. Our report again:

“if corporate tax rates fall far enough below personal income tax rates, wealthy folk start reclassifying their personal income as corporate income, to avoid the higher rate. The provision of special tax incentives to attract overseas money often generates substantial ‘round-tripping’ (see Section 3.4) that involves widespread tax evasion.

For all these reasons, corporate tax cuts and offering special tax incentives and loopholes may well lead to more avoidance activity overall, not less.”

  And the funny thing is, the Australian report actually says this, on page 2:

“The gap between the top marginal tax rate and the company tax rate results in tax planning and avoidance. Tax concessions need to be well justified to ensure the fairness of the tax system.”

And despite what they say in the report itself, they end up drawing the opposite conclusion about corporate tax rates.

Why ever would that be?