It has long been held as gospel that cutting corporate tax fuels investment and growth. However, without fundamental reform, business tax cuts may hinder rather than boost economic progress and investors can ill afford to ignore the consequences.
Governments, in their efforts to boost domestic economies, are offering tax cuts left, right and centre. Brexit-bound Britain, for example, saw its Prime Minister, Theresa May, promise to cut business tax to the lowest level in the G20. President-elect Donald Trump has also promised to cut corporate tax rates. The main reason for the ‘race to the bottom’ in corporate tax? That attracting companies to locate their operations in a country will mean growth and prosperity for those who live there (and vote there).
But does it really work?
Some of the biggest global brands – Facebook, Apple, Starbucks, Amazon, Vodafone to name but a few – have been vilified by the press and consumers alike not only for failing to pay their fair share of tax on what are staggeringly large profits, but also for their increasingly unfair employment practises. Last year Apple was handed a €13 billion fine by the EU after it was found to have benefited from illegal state aid because of a tax deal it cut with Ireland. Meanwhile, Amazon’s draconian employment conditions have repeatedly attracted strong criticism in the press.
The tax practices at these companies mean that many of them in fact pay little or no tax as they are able to shift their profits to jurisdictions with even more beneficial tax policies. In fact, corporate tax has become so flexible and altogether dodge-able, that only 6% of the UK budget, for example, is paid by companies, according to Jeroen Wilbrink, delegated CIO at NN Investment Partners in Holland. Workers pay 60% of that budget.
If these companies are already able to pay very little tax while squeezing their employees ever harder, who exactly is it that benefits from a government policy of cutting tax to attract big business (while failing to close the loopholes that allows companies to pay well below the headline rate)? They are hardly helping to bolster the public purses for the largely debt-laden governments offering them. It doesn’t do much to help the workers either – they are still left carrying the lion’s share of the burden for ballooning national debt, which has led to dramatic cuts to the services those workers are reliant on, such as the NHS. It seems to be a bit of a double-whammy for workers (aka voters).
Shareholders are the key beneficiaries. It is they who benefit through greater profits shared out in dividends and valuations propped up by hefty and growing balance sheets.
Or is it? Corporate tax risk presents a real and growing danger to investors.
Governments are beginning to crack down on overly-aggressive tax practises and, as Starbucks has found out, consumers are also capable of having a very negative effect on brand reputation.
This points to investment risk as there is a very real danger that companies will have to adjust their expected revenues downward (in some cases meaningfully) and/or cut dividends as pressure builds for them to pay their fair share into the public purse. The fact that many companies are failing to consider this risk makes it all the more of a concern for long-term investors.
But it’s also unreasonable to expect workers to accept the current status quo much longer without biting back. If a few shareholders are enjoying inflated profits while workers face low or zero wage growth, tougher employment conditions, less job security and cuts to their public services, the inequality that breeds can only hurt investors in the long-term.
After all, as we saw in 2016, the populist backlash caused by inequality leads to political uncertainty, financial market volatility and reduced corporate confidence. This continues to bear out into 2017 as Sterling bounces around on every word the Prime Minster utters and Trump’s Tweets continue to threaten some of the largest global businesses.
The long-term results of a more protectionist, anti-globalisation policy environment have yet to be fully understood, but are likely to mean lower economic growth. That translates into lower financial returns.
So what should governments be doing instead of cutting headline corporate tax rates? Fundamentally restructuring them in a manner that makes them much harder to avoid and rewards companies for taking a more responsible approach to their role in the global society.
We need a serious debate about what form such a tax regime might look like. The ‘Wilbrink tax plan’, for example, suggests a system that is more likely to deliver what May and Trump are both trying to achieve – more jobs, less inequality and less disenchantment among voters.
Fig 1: Outline of the Wilbrink tax plan
What should investors be doing? Taking a much closer look at the tax policies of their investee companies to ensure they have analysed and addressed tax risk in a meaningful way. Companies that do so are more likely to offer sustainable returns in the long-term.
MSCI, the index provider, has already recognised the growing risk corporate tax presents. From the start of this year, it began penalising companies that use aggressive tax avoidance policies through the governance ratings in its ESG indexes. Assets totalling $67 billion are reportedly already benchmarked against these sustainable investment indexes, but this is a drop in the ocean of total invested capital.
Hopefully, this move by one of the world’s leading index providers will spur others to sit up and take note: sustainable long-term investment returns are increasingly a matter of tax.
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A quick cuppa with Faith Ward, Chief Responsible Investment and Risk Officer, Environment Agency Pension Fund