Paul Ormerod: Corporation tax: fostering the illusions of the electorate that someone else will pay

Corporation tax is very much in the news. Starbucks is merely the latest to be in the spotlight, having paid no corporation tax on more than £1billion of sales in the past three years . This became noteworthy when the Prime Minister himself declared he was unhappy with the level of tax avoidance by big corporations working in Britain.

The plain fact is that if corporation tax did not exist, it would be madness to introduce it. The tax plays to the ignorance not only of the general public, but of almost all politicians. It encourages the fantasy that there is a free lunch, that someone else will pick up the bill for the welfare state and bloated state bureaucracy.

Mainstream economic theory has many faults, but it is by no means a completely empty box. A key insight is that, ultimately, the tax burden can only fall on individuals. Companies are simply legal entities. If a company pays more corporation tax, someone, somewhere, pays the bill.

There are untold nuances to corporate tax law, what can and cannot be offset and so on. To illustrate the basic economic principles, we need to set these aside. So, for example, one way for a company to respond to an increase in corporation tax is to reduce dividends. Obviously, the income of the shareholders suffers, and these include pension funds. Higher corporation tax might lead to lower pensions.

Another way to respond to an increase in the corporate tax levy is to offset it by holding down wage increases. This way, the company’s workforce gets less money. Or the overall wage bill might be reduced by simply not employing as many people. So, somewhere, some people pay the price of the tax by not being offered jobs.

Alternatively, the company could try and be tougher with its suppliers, screwing their prices down. In this case, the supplying companies in general and their work forces pay the cost of the tax. Or capital expenditure plans can be cut back, when the burden falls on the specific group of firms who supply such equipment.

In all these examples, the cost of the increase in corporation tax is eventually borne by individuals. The specific ways in which these actions might be implemented will depend upon the subtleties of the tax system. But there is no escape from the fundamental fact that only people can pay tax.

There is a further cost to the massive complications of current tax law. Highly skilled professionals are employed by HMRC, by big companies and by the major accounting firms solely to do battle over the interpretation of legislation. Abolishing corporation tax would free up these resources for productive uses rather than the complete waste which the current system demands.

Of course, it would be a bold, not to say foolhardy, politician who would make this promise in the current climate. But eventually Western electorates will have to face up to many realities, including the one that corporation tax does them no good.

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Paul Ormerod is an economist at Volterra Partners LLP, a director of the think-tank Synthesis and author of Positive Linking: How Networks Can Revolutionise the World