Almost every country in the world levies some kind of tax on company profits. Yet companies are, in a sense, no more than the sum of their employees and shareholders, linked together with customers and suppliers by a web of contracts. Since most of these people will be paying tax themselves, the role of a separate tax on companies is not straightforward. The strongest justification for a separate corporate tax is as a withholding tax on investment income, in the absence of an adequate capital gains tax. Other possible arguments for a separate tax, based on the benefits of limited liability or on the value of public services to the company, are less persuasive.

The key features of any given corporate tax system are the base on which tax is levied, the rate, and the relationship with other parts of the tax system. The immediate effect of the corporate tax is to transfer funds from company to government. But the structure of the tax system can alter real decisions on how much, in what and in which country to invest. It can also alter financial decisions on how to fund investment, and on what proportion of profits to pay out as dividends, as companies try to minimize their tax liability. The actual impact on financial decisions will depend on the level of integration between corporate and personal taxes, and on the relative personal tax burdens on dividends, interest and capital gains. That said, tax is only one of many factors involved. Investment is driven mainly by the likely returns, and managers will always trade-off the benefits of a low-tax financial structure against the non-tax costs. Empirical studies indicate that non-tax factors dominate most important corporate decisions.

The growth of international capital and product markets puts new strains on domestic corporate tax systems: on the one hand, companies have more opportunity to arrange their affairs to reduce their overall tax burden but, on the other, they face new obstacles to seeking out the most profitable investments, as more than one government seeks to share in their profits. Fundamental questions are raised about whether corporate taxes are sustainable in a world capital market and how governments can best cooperate to raise revenue without limiting new investment opportunities.

Lucy Chennells