Tuesday, 17 April 2007

Corporation Tax and Payroll Tax: the stealthiest taxes of them all

Imagine, if you will, a society made up of two types of citizen: the taxpayers and the voters. Taxpayers cannot vote, and voters do not pay tax. What will the result be? It seems fairly obvious that voters will vote for high taxes to pay for public services from which they will benefit at the expense of the taxpayers. Such a society would quickly fall apart, as the taxpayers agitated for more representation and refused to pay “taxation without representation

Such a society would seem anathema to us, nowadays. Which is surprising, because we live in such a society. In one respect, devolution has created such a situation: Scottish voters choose representatives that will implement policies – say, free care for the elderly – that will be paid for in part by non-Scottish British taxpayers who have no control over the decision. This is a dangerous situation that is undoubtedly contributing to the loss of faith in the Union among English voters.

However, there is an older and more fundamental form of this: the taxation of companies. Companies do not have a vote, and yet they are taxed on their income, and required to pay additional taxes when employing staff. This seems a rather clear example of “taxation without representation” – it is true that the owners have votes, but they only have as many votes (one each) as non-owners, and consequently are being taxed in a manner additional to that of their non-company-owning fellow voters. If there was a tax on people over 2m in height, we would consider this arbitrary and unfair. A tax on business-ownership is ignored.

To be clear, it is not as if the income that owners derive from their investments is not taxed. Share dividends are subject to income tax at the same rate as salaries. However, when companies turn a profit they have to pay Corporation Tax before paying dividends, which are then subject to Income Tax. This double taxation can only be justified by treating the company as a legal entity distinct from its owners – it is taxed in its own right. But this legal status does not stretch to being permitted to vote.

Socialist economists and policy makers would probably argue that it is only reasonable to tax businesses, as they are the products of capital and that to exempt capital from taxation when the other “factors of production” (land and labour)
are taxed would represent an unfair tax exemption for rich investors (and poor investors, but socialists tend to ignore them!). This is certainly true, and it is not my intention here to suggest that capital should not be taxed. However, there is no justification for taxing it twice: if capital or profits are taxed when earned, they should not be re-taxed when they are paid out. This “double taxation” (distinct from the double taxation that arises when people and capital operate in different jurisdictions) is unfair and ultimately should be ended.

Ironically, those who support business taxes (and here I add in payroll taxes, such as employers’ National Insurance contributions) are actually harming UK consumers more than UK business. After all, the inevitable consequence of business taxes is that they will drive up prices. If tomorrow a Chancellor of the Exchequer announced a 5 per cent rise in corporation taxes, it is not going to result in Tesco generating commensurately less profits next year. The board may take the decision to absorb part of the cost of the additional taxes as a public relations stunt, but ultimately they are going to hand the extra costs down to customers. The same is true of payroll taxes.

The real danger in this is that the tax is therefore invisible. Consumers are aware of the 17.5 per cent VAT they pay on most goods, and most receipts even explicitly state the amount of VAT paid – next time you are looking at you wage slip in despair and your eye flicks enviously over the part that says how much tax you’ve paid, remember also to get those old receipts out of your wallet and factor in the bit at the bottom. This is only (or rather, less than) half the story, however, as the 82.5 per cent of your bill that isn’t VAT includes other business taxes, without which your supplier would be able to (and due to competition would be obliged to) charge lower prices.

Thus Corporation and Payroll Taxes are the ultimate stealth tax: the Chancellor sells them to us on the grounds that they are levied on businesses, and so we are led to believe that they are free money – taken from “someone else”, a faceless organisation with no vote; in fact, they are taken from us every time we open our wallets and purses. Our Income Tax bill confronts us regularly; our VAT bill every time we spend; but taxes on business slip in under the radar, taking money for the state disguised as money for the supplier.

This is ultimately damaging, as visible taxes have more obvious impact and so teach us to exercise more fiscal discipline. If our receipts also told us how much Corporation Tax we were paying, and if we received larger gross salaries but paid higher National Insurance (i.e. the employer contribution was instead factored into our salaries and personal contribution) we would have a more honest view of how much tax we paid. While we were at it, it would be nice if there were a means of quantifying the number of jobs foregone because payroll taxes made marginal employment (i.e. jobs which are only barely going to generate more revenue than they cost – usually the lowest paid jobs) unviable, thus driving up unemployment for the poorest and least skilled. Only then would we have an honest idea of the costs and effects of the policies our leaders are perusing, and for which many of us have voted.

5 comments:

Joe Otten said...

Sorry Tom, but:

1. The whole double taxation argument is a crock. What I care about, as a worker, investor, and consumer, is not the number of times taxation is applied, but the total amount. By all means make a case for lower business taxes.

2. I don't see why the principle of no taxation without representation should apply to companies any more than to tracts of land. Should sods of earth get the vote? No. Companies are not granted human rights, but rather whatever legal rights are thought to facilitate general prosperity.

3. While higher taxes on Tesco would drive up prices, it would not work in the simple way you suggest. It is not as if Tesco is currently forgoing some margins, that they would suddenly start to take should taxes rise. As an investor I would be most annoyed if they were. No, such taxes put up prices by increasing the cost of capital.

4. Who, exactly, has led you to believe that corporation tax is free money?

Andy said...

If we should be told how much of our payments to corporations go in corporation tax, then should we also be told how much of the money we pay *real* people in exchange for goods or services goes on their income tax (if indeed they are declaring it!)? I don't think so. We should never lose sight of the fact that corporations are *not* people. Arguing that there is something inconsistent about treating them as people and taxing them but not giving them a vote is fine (although I think it's more than possible to argue that, representing as they sometimes do large concentrations of wealth and power, they exert quite enough influence over the political process in their own way).

But the solution is not to give corporations a vote - and I don't believe you seriously think it is. Surely the solution lies in dismantling what makes the concept of the corporate person so bizarre in the first place? The creation of legal entities, entitled to buy, sell, employ people, own land etc. whilst being both potentially immortal and more importantly immune from any form of punishment for damage to the environment, etc. other than a financial one is bizarre in the extreme, and allows the people who actually run them to take decisions which, in a free society where no such legal construct existed, they would not otherwise take. The corporate person needs, in my view, to be seriously diminished as a legal entity.

Besides, if we allowed corporations a vote, how many people do you think would all of a sudden discover the wonders of incorporating pretty damn quickly?

Tom Papworth said...

The idea of businesses voting isn't quite as outlandish as you might think - I think that there was a business vote in local elections in the C19th. But to be honest I'm not suggest that they should be given representation; I'm suggesting that they should not pay taxation.

So in answer to Joe's points:

1) Because all dividends are taxed as income in the same way as wages, ANY additional tax taken at the point that a company declares a profit is going to result in capital being taxed at a higher rate. So basically, Joe, I AM arguing for lower business taxes, but my suggestion is that they should be zero.

2) I agree, despite my point above.

3) I totally agree, but the point remains that Corporation Tax is passed onto the consumer, so in the end it is just another tax on us, which is why...

4) I have lost count of the number of times I have heard people say that we should tax poor people less and rich companies more. It totally misses the point, but it is a convenient misunderstanding that politicians are happy to play to as they continue to tax us through the prices we pay to businesses saddled with heavy tax burdens.


Andy,

I totally agree that businesses are not people; as I said above, I don't want businesses to have a vote.

However, companies DO know how much of their payroll goes in taxes (including the employees Income Tax) and this undoubtedly pushes up the price of labour, resulting in higher unemployment.

As for the corporation as a legal entity, it is an anomoly, but it is one that has worked very well, creating a lot of wealth and employment in society. I would be loath to mess with something so successful.

Joe Otten said...

Tom,

Income tax on dividends is at a lower rate. See

http://www.direct.gov.uk/en/MoneyTaxAndBenefits/Taxes/BeginnersGuideToTax/DG_4015566

Presumably this lower rate exists in recognition of the double taxation.

This is also a good explanation:

http://www.bbc.co.uk/blogs/thereporters/evandavis/2007/04/that_pensions_raid.html

Tom Papworth said...

A useful link, Joe. Thanks. Moving on a page to http://www.direct.gov.uk/en/MoneyTaxAndBenefits/Taxes/TaxOnSavingsAndInvestments/DG_4016453 I was impressed to find how byzantine it really was.

Nonetheless, if Corporation Tax is levied at 30%, then the capital of an investor whose income is less than £39,825 is already being taxed at a higher rate than income from labour. To then withold a further 10% seems punative.

Similarly, if one has an income over £39,825, one's investment having already paid 30%, it may make sense to tax the income by a further 10% (on the original sum) so that all marginal income is taxed at 40%. But to slap on an extra 32.5% leaves one with less than half the procedes of one's investment (i.e. paying a marginal rate of tax of 52.5% through a combination of Corporation and Income Tax).

Thus, capital is taxed at a higher rate than labour, which is both arbitrary (why pick on one factor of production and not another) and distortionary (discouraging investment).

I may not (yet!) be arguing for flat taxes across incomes, but flat taxes across sources of income seems perfectly fair and sensible.