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Harmful corporate tax competition calls for a new system

Anis Chowdhury | August 07, 2019 00:00:00

In a recent research paper, the International Monetary Fund (IMF) has highlighted the harmful impacts of falling corporate tax rates. In particular, this phenomenon since the early 1980s has been detrimental for developing countries which rely on direct taxation more than developed countries.

Admitting the unfairness of the current international corporate tax rules, shaped largely by developed countries with scant consideration of how they would affect low-income countries, the IMF's departing Managing Director, Christiane Lagarde, has called for a new system.

WHO TO BLAME? Interestingly, however, neither the IMF research, nor Ms. Lagarde says anything about why corporate tax rates have been falling across all country groups for over three decades. Worth noting, this began with the triumph of neo-liberalism, epitomised by the Washington consensus about so-called 'good policies' among the US Treasury and the Washington-based two Bretton Woods Institutions (BWIs) - the IMF and the World Bank (WB).

As part of conditions for receiving support from the BWIs, developing countries were required to undertake tax reforms which consisted of lowering direct tax rates and greater reliance on regressive indirect taxations, such as value added tax (VAT) or goods & services tax (GST). A review of the IMF's tax policy recommendations to Sub-Saharan countries during 1998-2008 reveals that in a "one-size-fits-all" fashion, they invariably included reductions in the rate of corporate and to a lesser extent, personal income taxation; reductions of both export and import taxation; and introduction or expansion of VAT.

Vitto Tanzi, who headed the IMF's Fiscal Affairs Department and Howell Zee, the Chief of the Tax Policy Division, recommended taxing labour instead of capital arguing that "small countries should not levy source-based taxes on capital income", because highly mobile capital compared to labour would leave.

Following the same argument, an IMF paper concluded: "The complete abolition of corporate income tax would be the most direct application of the theoretical result that small open economies should not tax capital income."

The WB propagates the same mantra with its controversial (allegedly politically motivated) Doing Business Report (DBR). For example, one of the 11 areas that the DBR 2017 included in ranking a country's business environment is paying taxes.

Thus, it is the advice of the BWIs, ostensibly to encourage investment, in particular foreign direct investment (FDI), that led to the harmful tax competition resulting in declines of corporate tax rates since the early 1980s disproportionately affecting developing countries.

NO EMPIRICAL BASIS: However, the BWIs' advice lacks robust empirical support. For example, research within the OECD (Organisation for Economic Cooperation and Development) finds that direct tax concessions have little effect in diverting international investment, let alone in attracting such flows. The WB's enterprise survey also reveals that tax incentives are not high on the list of critical factors affecting inflows of FDI. Business-friendly The Economist observes that the relationship between tax rates and growth or investment is not very strong.

Thus, one earlier IMF research paper found that competitive tax concessions or beggar-thy-neighbour policies led to unnecessary loss of revenue for many developing countries. A G20 report prepared by the IMF, WB, OECD and UN (United Nations) notes, "Tax incentives generally rank low in investment climate surveys in low-income countries, and there are many examples in which they are reported to be redundant - that is, investment would have been undertaken even without them. And their fiscal cost can be high, reducing opportunities for much-needed public spending on infrastructure, public services or social support, or requiring higher taxes on other activities."

REGRESSIVE TAX STRUCTURE: Not only have corporate tax rates declined over the past three decades, tax structure has also become more regressive as reductions in direct taxations accompanied increases in indirect taxes, such as VAT.

As mentioned earlier, support for a VAT is one of the most distinctive and prevalent features of international financial institutions' (IFIs) tax policy advice to developing countries. A study on IMF's advice on tax matters based on a sample of 54 IMF Article IV reports between 2005 and 2008 from a sample of 10 Low-Income Countries and 10 Middle-Income Countries found that, "VAT was recommended or endorsed by the IMF in 90 per cent of the overall sample and 80 per cent of the consultations advised a decrease in tax exemptions."

The entrenched view within the IFIs, as noted in an IMF paper, is that tax is distortionary and hence the tax system should be assigned a much narrower role in raising revenue and in a manner which is administratively and politically feasible while minimising the level of associated distortions.

Such a narrow focus does not recognise the legitimacy of the use of taxation in attaining some other objectives, particularly redistribution. Distributional concerns are typically relegated to footnotes.

Belatedly, IMF research now shows that the reduction in tax progressivity has contributed to growing inequality since the early 1980s.

WAY FORWARD: Better late than never - the old adage still holds. There is a ray of hope that this belated recognition of the importance of tax system in both mobilising resources for development and addressing inequality will bring about fundamental changes in the advice and technical assistance given by BWIs to developing countries. One can also hope for genuine inclusiveness and greater participation of developing countries in designing international tax rules to deal with tax avoidance and evasion by multinational corporations.

This can only happen when the dominance of the OECD ceases in international tax matters. The Platform for Collaboration on Tax (PCT), created in 2016, comprising the OECD, IMF, World Bank and UN, is a promising innovation in this regard.

Anis Chowdhury, Adjunct Professor at Western Sydney University and the University of New South Wales (Australia), held senior United Nations positions in New York and Bangkok.

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