Corporate Tax vs. Sales Tax — Adam Smith Institute

I was on the Today show this morning at the ungodly hour of 6:15 p.m. arguing for the abolition of the corporate tax and its replacement with a sales tax. It came on the agenda because Lord Lawson, chancellor under Margaret Thatcher, and major consumer income tax shifter, suggested the idea. I also made a similar argument in AM City Last week.

Why might we want to abolish corporation tax? Companies are legal fictions; the burden of taxes they pay must come out of the pockets of their stakeholders. In fact, it comes from the salaries of their employees and the returns of their shareholders. That in itself is not a huge problem, but we have a huge weight of economic research telling us that we should not tax capital.

Why would we want to switch to a sales tax instead? Well, unsurprisingly given where I work, I would probably prefer no tax hike. But, assuming we were to increase revenue somewhere, then the goal is to minimize distortions in the system. Taxing corporate profits discourages profits – the most reliable guide to a business doing its job – and discourages business – the backbone of modern capitalism.

Sales taxes shift the burden a way from successful and desirable economic activity and towards less successful or unsuccessful ventures. And note that if companies have a future, investors will pour more and more money into them despite tiny profits or even losses. It doesn’t change that: start-ups can still spend years making losses before succeeding.

They also help resolve public discord over the corporate tax burden. Since it seems impossible to forget that it is Google’s pension funds and staff who lose if Google is in a hurry (Google might be a bad example because it seems that in this case it pays the required amount at a time by the letter and spirit of the law), perhaps this more transparent levy would satisfy popular demands.

True, taxing companies on their profits, but on the basis of their sales in a territory (rather than where they create value, as in the current system) would create horrible disincentives, driving many corporate subsidiaries out of the UK.

The main objection is the same as people give to VAT: sometimes it’s not clear whether a sale is made in the UK or not; small businesses find it costly to keep up. These are legitimate but overshadowed by the distorting costs of investments under the current system.

The real problem is that if a “sales tax” were to become a tax on income and hit intermediary transactions as well as final sales, it would discourage all outsourcing and push companies to become vertically integrated giants. But I am optimistic: with a little pressure, sometimes reform-minded officials and politicians will do the right thing.