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Theo Vermaelen

Economics & Finance

Comment: How Should Multinationals Be Taxed?

Comment: How Should Multinationals Be Taxed?

The recent attack on the tax policies of corporations becomes close to ridiculous when politicians argue that companies that try to avoid taxes (legally) are “socially irresponsible” and “immoral."

The people interviewed in the recent INSEAD Knowledge piece How Should Multinationals Be Taxed are disproportionally representatives of the political left: two socialist politicians (Fleur Pellerin from France and Dirk van der Maelen from Belgium) and representatives of left-wing organisations (War on Want, Tax Justice Network).  As usual, the Left talks about taxation in terms of “fairness” and “justice” rather than economic efficiency. In other words, it’s always about dividing the pie more equally assuming that the size of the pie is unaffected. Fairness and justice are very subjective concepts. The French Left believes that taxing people at 75 percent when they make more than 1 million euros is “fair”, while I believe that this is an unfair confiscation of private property by the State.

The debate about fairness also ignores the fact that corporate income is taxed twice: once at the corporate level and then again at the personal level when investors pay taxes on capital gains and dividends. Since 2,000 U.S. taxpayers have paid more than $US1 trillion in capital gains taxes. So the capitalists have shared their gains with the rest of us. Presumably a significant part of this tax payment comes from Apple and Google shareholders, considering the meteoritic rise in their stock price during the last 10 years. So it is not true that the shareholders of Google and Apple don’t pay taxes on the profits generated by their companies. 

A question of morality

The recent attack on the tax policies of corporations becomes close to ridiculous when politicians argue that companies that try to avoid taxes (legally) are “socially irresponsible” and “immoral”[1].   Such a statement makes one immediately think of the famous quote from Judge Learned Hand[2]

“Anyone may arrange his affairs so that his taxes are as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands”

In other words, the CEO, has a fiduciary responsibility to minimise corporate taxes. If he wants to do good by financing the Belgian and French social model, he should do it not with shareholders money but with his own money (for example by voluntarily taking fewer deductions than legally permissible when filling out his personal tax form).  Paying more taxes than is legally required may also mean breaking the implicit contract with shareholders if they expect the CEO to do everything legally possible to minimise corporate taxes. In my view, breaking these implicit contracts is unethical.

Employment opportunities

Belgium and France are two countries governed by Socialist leaders and both have the highest unemployment in history. It seems that increasing taxes on corporations, and thereby discouraging investment and employment, should be the last thing politicians should be thinking about. They should be supportive of the fact that companies can separate the location where they pay taxes from the location of their operations. If Google was subject to French taxes it would do less business in France and French unemployment would be even higher than today.   So the slogan on the web page of the Tax Justice Network “Tax havens create poverty” is far too simplistic.

The action plan of the OECD to fight the “beggar-my–neighbour” tax policies to create a “level playing field” is similar to the behaviour of a cartel that wants to prevent price competition. Competition between governments keeps taxes low and forces politicians to stop their wasteful spending. It increases return on investment and stimulates private sector growth, rather than growth of non-value creating activities in the public sector. It seems to me that this is the true reason for the tax offensive: after a few virtuous austerity years, politicians want to go back to their traditional “tax and spend” addiction, which does not bode well for the economic future of the so-called “developed” world.

Theo Vermaelen is a Professor of Finance and The Schroders Chaired Professor of International Finance and Asset Management at INSEAD. He is also the director of the Advanced International Corporate Finance Programme, part of INSEAD's suite of executive education programmes. 

[1] EU tax commissioner Algirdas Semeta is quoted by the BBC on May 22 2013 that “a corporation cannot be treated as socially responsible if it aggressively plans its tax obligations” and such behaviour is “not morally right”.

[2] Judge Learned Hand (1872-1961), Judge U.S. Court of Appeals made this famous quote in the case of Gregory v Helvering (1934)


View Comments

Anonymous User

19/11/2014, 02.09 pm

thanks you Prof for this article, i hope this article can be useful for anyone.


Anonymous User

08/12/2013, 08.53 pm

On our view it is not a question of morality but corporate governance. Companies should try to maximize profits after taxes, so when a country raises taxes, companies's headquarters run away to other countries.


Anonymous User

10/09/2013, 07.14 pm

"The CEO, has a fiduciary responsibility to minimise corporate taxes."
Simply untrue. The professor has moved in one unexplained jump from one statement (directors MAY avoid tax) to the much stronger statement (they are OBLIGED) to avoid tax. But that's a jump too far. The Tax Justice Network just obtained a formal legal opinion from a top UK law firm to the effect that 'there is no such duty.' Though this strictly applies only to the UK, the accompanying press release provides pointers to scholarship that suggests strongly that exactly the same is true in the United States, and in many other countries. This 'fiduciary duty' argument is an old canard, routinely repeated. Time to kill it off.


Anonymous User

31/08/2013, 03.12 pm

Dear anoymous

It seems the crucial assumption in your analysis is the hypothesis that "The French government will have the same expenses to cover". Of course my argument for tax competition is to put pressure on governments to cut spending because government spending involves a lot of waste. This waste is a direct result of the poor "governance model" of the government.

Imagine a company where the CEO is elected not only by shareholders but also by customers and workers. Moreover the CEO has the power to force shareholders to put up more money to finance expenditures( no limited liability) and guarantee loans to finance these expenditures. Obviously such a company would have a huge incentive to make bad investments by giving away products for free, hire more workers than necessary and increase salaries, as long as voters consider themselves more as customers and workers than as shareholders. But this is exactly the governance model of the government where the shareholders are tax payers and the management are the politicians.
In other words, Government Inc. has massive agency problems, an issue largely ignored in economics textbooks. The way to reduce them is to turn off access to equity financing (tax revenue). In other words, the goal should be to "starve the beast".

You are also assuming that if we cut corporate taxes the government will increase personal tax and TVA. However, this is politically more difficult than increasing corporate taxes : corporations don't vote ( shareholders do but they represent a small fraction of the voting pool) but individuals do vote. They will revolt against politicians who increase TVA and personal taxes. In contrast, I have never have witnessed a massive public outcry against an increase in corporate taxes, especially when we are talking about multinationals So I can fully understand the desire of politicians to increase corporate taxes.

I agree that efforts to avoid paying taxes is wasteful because we have to employ lawyers and accountants. But collecting taxes with the main purpose of transferring money from rich John to poor Mary costly as well. Which cost is more important is ultimately an empirical question.

Today the EU has announced the largest unemployment in its history. I would have hoped that the EU in these circumstances would refrain from imposing a "minimum corporate tax" , which sounds a lot like a "minimum wage" . As the miniumum wage, the minimum corporate tax will reduce investment and worsen the EU employment statistics. Unless of course the goal is to put even more workers in the public sector.


Anonymous User

31/08/2013, 01.40 pm

"Belgium and France are two countries governed by Socialist leaders and both have the highest unemployment in history". That's correct, as it is also correct that, for example, the UK, Portugal and Spain all three have liberal/conservative leaders and the highest unemployment in history, and that is because there is a crisis going on, and therefore, regardless of being a left or a right wing government, this countries are being pressured in to employ austerity measures, remember?

There are a considerable amount of papers in the field of financial mathematics, which clearly prove that tax havens are not pareto-efficient at all, and whose conclusions lead as to assume that tax havens actually cause economic instabilities. While we keep the black and white world speech, while we keep arguing pro or against left or right wing politics instead of start changing our socio-economic paradigm, our society will keep sinking into a social-economical caos, where there won't be neither economical efficiency, nor fairness or any kind of respect for human rights.


Anonymous User

28/08/2013, 04.02 am

Professor Vermaelen’s point that government spending is often wasteful and value destroying is well taken. However, the discussion on tax harmonization is mostly about tax income, not about the way it is spent. And it’s a fact that corporate and personal tax income is being eroded in most EU member states because of EU directives that were originally meant to guarantee and stimulate the free flow of capital across national borders.
Let’s illustrate how this works with a simplified example. Suppose you are a wealthy French tax resident with various investments in France as well as abroad. In the old days, you would have kept those investments in your own name or through a French holding company, subjecting any returns to French corporate or personal income tax. Nowadays, EU directives allow you to replace the French holding company with, say, a Luxembourgish or Latvian one with zero practical consequences. In most cases your investment returns will now be subject to the Luxembourgish or Latvian tax regimes, where deductions and exceptions may help you push your tax bill close to zero. The French authorities will likely not be able to tax these returns until the moment you actually realize capital gains or repatriate dividends from your Luxembourg or Latvian investment – which you may well decide to postpone until after you’ve retired and moved to Monaco.
Now you may argue this is healthy competition between the Latvian, Luxembourgish and French tax authorities. The problem is, however, that assuming all three governments are equally efficient spenders of tax money, the process does not add any economic value at all because none of the economic parameters have changed. The individual still lives in France and the investments themselves have not changed. If anything, the new situation is value destroying because it involves a decent number of expensive lawyers and accountants to set up and maintain. The French government will still have the same expenses to cover and – given the decline in corporate income tax – will simply resort to other taxes such as VAT and other indirect sources of tax. It may also try to further complicate its tax code in an effort to close ‘loopholes’, thus making the whole process of taxation even more complex and inefficient.
In short, ‘tax competition’ on corporate income tax between member states is simply harmful because it creates inefficiencies and destroys economic value, which is enough reason to try to put an end to it. There are two ways to accomplish this. The first is for member states to accept the new reality and pro-actively lower corporate income tax rates whilst raising VAT and other taxes. This is the approach preferred by many northern member states, where corporate tax rates are at an all-time low and VAT and fuel tax rates at an all-time high. In my personal opinion, VAT is a much better base for taxation than income, because it is less based on arbitrary rules made up by politicians, lobbyists and accountants and more based on verifiable, actual cash flows.
The alternative second approach is to forcefully harmonize corporate tax laws all over the EU, whilst discouraging the flow of capital in and out of the union by high levels of withholding tax and restrictive tax arrangements with third countries. This is the approach preferred by the EU commission, which is working hard to push its CCCTB (common consolidated corporate tax base) despite strong opposition from member states and a total lack of popular support amongst the ordinary citizens.
Where we will go from here, only time will tell. One thing is well known though – taxation like death is one of the two certainties in life. So while we may not like it, let’s at least try to make the process as efficient and least value destructive as possible and thus work towards an elimination of corporate income tax ‘competition’ within the EU.

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