This article first appeared in Forum, The Edge Malaysia Weekly on August 26, 2019 - September 1, 2019
The harmful effects of falling corporate tax rates have been acknowledged in a recent International Monetary Fund (IMF) research paper. This trend, since the early 1980s, has been especially detrimental for developing countries, which rely on direct taxation much more than developed economies.
Acknowledging that existing international corporate tax rules are unfair, set by developed country governments scantly considering their effects on poor countries, IMF managing director Christine Lagarde called for a new system earlier this year.
However, neither the IMF research nor Lagarde said anything about why corporate tax rates have been falling across all country groups for over three decades.
The neo-liberal “counter-revolution” against Keynesian and development economics saw the brief popularity of “supply side” economics in the early 1980s. The Washington Consensus of the US Treasury Department and the two Washington-based Bretton Woods institutions (BWIs) — the IMF and the World Bank — ensured its global impact.
All serious empirical research has discredited Chicago Professor Arthur Laffer’s claim that lowering corporate tax rates boosts investment and growth rates. Significantly, this included the work of former US president Ronald Reagan’s first Council of Economic Advisers chair, Martin Feldstein, and his Congressional Budget Office director, Doug Elmendorf.
Instead, most growth during the Reagan era was due to expansionary monetary policy as lower interest rates helped the economy rebound from the severe recession in 1982. Likewise, the 2001 and 2003 Bush tax cuts also failed to spur growth, according to Andrew Samwick, chief economist to his Council of Economic Advisers.
Despite their dubious premises, the Laffer curve and similar claims have re-emerged under the Trump presidency, which has already brought corporate tax rates to new lows.
To qualify for BWI support, developing country governments were expected to undertake tax reforms by lowering typically progressive direct tax rates in favour of regressive indirect taxation such as value-added taxation (VAT), often dubbed the goods and services tax.
A review of IMF’s tax policy recommendations to Sub-Saharan African countries from 1998 to 2008 confirmed that in a typical “one-size-fits-all” fashion, they invariably included reducing corporate and even, personal income tax rates as well as export and import taxation, besides introducing or expanding VAT.
As an IMF paper concluded about the ostensible justification for its advice, “The complete abolition of corporate income tax would be the most direct application of the theoretical result that small open economies should not tax capital income.”
Vito Tanzi and Howell Zee, of the IMF’s fiscal affairs department, even recommended taxing labour, instead of capital. They argued that “small countries should not levy source-based taxes on capital income” because, compared with labour, capital was highly mobile and could escape such taxes.
The World Bank’s controversial Doing Business Report (DBR) argues likewise; paying taxes was one of 11 criteria DBR 2017 used to rank a country’s business environment although the World Bank’s enterprise survey found tax incentives not critical among factors affecting foreign direct investment (FDI) inflows.
Policy advocacy despite evidence
Thus, BWI advice, ostensibly to encourage investment, particularly FDI, led to the harmful competition that has lowered corporate tax rates since the 1980s. Earlier IMF research found that such “beggar-thy-neighbour” tax competition has caused unnecessary loss of revenue for many developing countries.
OECD research found that direct tax concessions barely diverted, let alone attracted international investment flows. The Economist also found the relationship between tax rates and investment as well as growth rates to be weak.
A G20 report noted, “Tax incentives generally rank low in investment climate surveys in low-income countries, and there are many examples in which … investment would have been undertaken even without them. And their fiscal cost can be high, reducing opportunities for much-needed public spending … or requiring higher taxes on other activities.”
Corporate tax rate declines over recent decades have contributed to overall tax incidence becoming more regressive as direct taxes have declined, and indirect taxes such as VAT have risen. VAT adoption has been central to BWI tax policy advice to developing countries.
A study of IMF advice on tax matters in 54 IMF Article IV reports between 2005 and 2008, show that 10 low-income countries and 10 middle-income countries found that “VAT was recommended or endorsed by the IMF in 90 per cent of the overall sample”.
An IMF paper found that the BWIs presume that tax is distortionary and the tax system should focus on raising revenue while minimising associated distortions. This precluded using taxation for other purposes, for example, progressive redistribution. Recent IMF research shows that reduced tax progressivity has contributed to growing inequality since the 1980s.
Recognition of taxation’s potential for resource mobilisation and reducing inequality can still bring about fundamental changes in BWI conditionalities, advice and technical assistance for developing countries. However, greater developing country engagement in designing international reforms to reduce tax avoidance and evasion by transnational corporations will be crucial.
Jomo Kwame Sundaram, a former economics professor, was United Nations assistant secretary-general for economic development. He is the recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought, and a member of the Economic Action Council. Anis Chowdhury, a former professor of economics at the University of Western Sydney, held senior United Nations positions from 2008 to 2015 in New York and Bangkok.
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