Ritchie on tax competition: you’ll like this one

Today’s blog output is really quite remarkable.

Here’s one blog:

More important is a new paper by Tidiane Kinda for the IMF, the abstract of which says:

Using manufacturing and services firm-level data for 30 sub-Saharan African (SSA) countries, this paper shows that taxation is not a significant driver for the location of foreign firms in SSA, while other investment climate factors, such as infrastructure, human capital, and institutions, are. By analyzing disaggregate FDI data, the paper establishes that, while there is considerable contrast in behavior between vertical FDI (foreign firms producing for export) and horizontal FDI (foreign firms producing for local markets), taxation is not a key determinant for either type of FDI. Horizontal FDI is attracted to areas with higher trade regulations, highlighting interest in protected markets. Furthermore, horizontal FDI is affected more by financing and human capital constraints, and less by infrastructure and institutional constraints, than is vertical FDI.

In other words, tax competition does not work.

OK, excellent. The bald statement that tax competition simply does not work. Firms do not locate for tax reasons.

A second blog. And recall, this is on exactly the same day, culled from the same day’s newspapers:

Reuters has reported that:

Fiat said on Wednesday it would register the holding of its newly created Fiat Chrysler Automobiles group in the Netherlands and set its tax domicile in Britain, cementing a politically sensitive shift away from its home base in Italy.

The combination of Fiat and Chrysler through a Dutch holding company tax resident in the UK has all the appearance of being a massive tax planning exercise. The UK is quite explicitly playing the role of a tax haven in this set up, combined with the use of the Netherlands in a similar capacity.
How is that? Firstly, the UK only charges UK resident companies to tax on their UK earned profits now and not on any profit earned anywhere else in the world or on profits remitted here. I have a strong suspicion Fiat makes very little money in the UK (barring on car distribution, which will already be taxable here anyway). This makes the UK a perfect headquarters location for a group that has absolutely no real ties with the UK and which wishes to avoid sending its profits back to its real centre of control – Italy, in this case. Combining this with the Netherlands generous tax haven treaty structure which allows income and gains to flow through Europe to an HQ location (like the UK) with little or no withholding tax on the way and the ultimate ‘no tax’ set up can now be created in london based on the argument ‘nothing happens here’ because it’s all been taxed ‘elsewhere’ whether that in fact is true or not.

That is, a complaint that a company has based its location decision purely upon tax motives.

It is really most wondrous that a man who has actually held a professional job at some time can manage such cognitive dissonance.

13 thoughts on “Ritchie on tax competition: you’ll like this one”

  1. Tax rates matter less than ability to make money. If ability to make money is equal, tax rates matter. Can you overcome crap infrastructure when infrastructure is mission critical with lower tax rates? No. Can you persuade a firm to locate a business in small country that suffers from high tariffs to export to a larger neighbour with lower taxes when you can build in the large neighbour? Not unless taxes are much higher in the big country.

    Does this mean tax doesn’t matter? No of course not. Next!

  2. “It is really most wondrous that a man who has actually held a professional job at some time can manage such cognitive dissonance.”

    In the world of economics, maybe. But your man writes narratives for those who understand the world through narratives.
    Robin Hood robs passing travelers despite the evil Sheriff’s attempts to thwart him. Peter Pan thwarts the evil pirates who rob passing seafarers.

  3. again, I think it is coherent to claim

    1. firms don’t pay attention to domestic taxes when deciding where to build local manufacturing plants because …

    2. they can always piss about with the location of holding companies etc. to avoid those domestic taxes

  4. Luis Enrique

    Yes,entirely coherent. Indeed it formed the basis of the exchange between Tim Worstall and Pr Clausing. It is therefore quite possible, albeit somewhat pyrrhic, for Ritchie to argue both that firms are tax dodging bastards AND that tax competition doesn’t impact on investment decisions.

    However, throw in his support for Sol Piciotto’s bonkers Unitary Tax (UT) idea and his claims break down. UT would charge consolidated profits to tax based upon a formula using the siting of employee, tangible fixed assets utilised and sales made. In other words, the tax cost once again becomes dependant on decisons on where real investments are made. The result: 1) tax IS number 1 or 2 in the rankings for importance and 2) tax competition increases as real investment becomes ever more dependant on low tax rates.

  5. I don’t see the pyrrhic angle – tax competition doesn’t work because firms are tax dodging bastards. Where’s the problem with that (from his point of view)?

  6. Ironman – I’ve been looking at UT in some depth, trying to produce a workable model for it.

    One thing coming out of studies of the US state tax system (whcih is the closest current parallel to UT, even though it’s not all that close) is that states have decided that taxing people based on the number of people they employ in the state and on how big their capital investment there is, tends to drive jobs and workplaces to states that don’t. So many states are moving over to only or mainly using sales, rather than assets or labour, in their formulas, to attract those jobs and workplaces.

  7. No, not really. Sales tax is (in theory) a tax on the amount the purchaser spends.

    This is saying that a company makes $100 profit, and 30% of their sales are in state X and 70% in state Y, so $30 of profit gets taxed in X and $70 in Y.

    The older version of the apportionment would say: state X has 30% of the sales, 40% of the payroll costs, and 50% of the fixed assets, so 40% (average of the three) of the profits get taxed there. That’s the basic formula that Picciotto uses in his discussions of UT, though he acknowledges that there may be some good reasons to go for a slightly different one.

    Given Sales:Labour:Assets percentages in a state of 30:40:50, some states would say your profit share is 30% (based only on Sales), some 40% (all three equally), some 37.5% (double-weighting Sales), and so on. The way that different states have different formulas results, apparently, in a bit of a mess 🙂

  8. Pellinor

    I did get it; I was being facetious.

    Taxing profits but not using profits as the measure is like winding up a gordian knot. Taking out 2 of the 3 contributors to the formula is better but still poor. In the international sphere it quite obviously works to the advantage of states with mature consumer markets. To be fair though, I guess this isn’t as big an issue when viewing internal inter-state competition in the U.S.

    The states can tax sales (or tax them more), tax profits, tax distributions instead, introduce an LVT. In short they can do whatever they want, but surely not the dog’s breakfast that UT or even UT-Light gives us.

  9. Sorry, busy day 🙂

    Yes, you have a good point: it’s taxing one person based on where someone else lives. I can see an argument why some of the seller’s profit relates to the market they’re doing business in, but to me at least as much should relate to where the seller is.

    But then the thought does occur that if you’re going to tax some profit because of where sales are, some because of where assets are, and some because of where employees are, then you might be better off increasing VAT, business rates and employer’s NI (or equivalent), and binning the corporation tax 🙂

  10. It does seem to follow doesn’t it!

    What a surprise Pr Picciotto and his friends haven’t appeared to have joined the dots they themselves have drawn.

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