The principles that underlie the tax system and which, in an optimal situation, would lead to a system that, taking into account the current social and economic circumstances, is perceived as fair and legitimate, must be reassessed regularly, see Avi-Yonah (2004). What principles should a green corporate tax be based on?
The underlying rationale for the corporate taxes that are currently in place is difficult to establish. There are several legal grounds, the hierarchy of which changes according to the perspective presented, see Bird (2002) and Boer and Elsweier (2019). If the relationship between corporate tax and income tax at the level of the shareholder is taken into account, the justification for levying corporate tax is what is called the support function in connection with the income tax, which is based on the ‘ability to pay’-principle. Without a corporate tax, levying income tax on business profits and income from capital becomes largely illusory. From that perspective, corporate tax is ‘backstopping the personal tax’ (Bird, 2002).
However, if the independence of the company is emphasized, and there is much to be said for this given the independent operation of large multinationals, then the corporate tax cannot be justified by relying on the maintenance of a properly functioning income tax (Brooks, 2003). The question then is what can be regarded as the guiding principles of corporate tax. Four arguments for the existence of a corporate tax can be derived from legal scholarship, to which I add a fifth one, the principle that also underpins environmental taxes.
The arguments are (i) the principle of privileged acquisition, (ii) the benefits principle, (iii) the prosperity principle, and (iv) the principle of balance of power. I add to these four principles a fifth one, (v) the polluter pays or damage principle. This is the principle that underpins environmental taxes, but in my view may also play a valuable role as a legal rationale for a ‘renewed’ corporate tax. I will briefly elaborate on these five principles below.
The Principle of Privileged Acquisition
According to the principle of privileged acquisition, the amount of tax due on income or capital, should be in proportion to the effort that is made to acquire that income or capital. A tax on income received without any significant activity being carried out is neutral in the sense that the tax will not cause the taxpayer to change his or her behavior, activities or investments.
Corporate tax is a tax on what is called pure economic profits (‘rent’ or ‘excess profits’). Pure economic profits are the earnings in excess of the earnings needed to cover all the firm’s costs (the costs on labor and on capital, including the opportunity costs on equity), see inter alia Brooks (2003) and De Langen (1954). Such profits would not have been achieved in a fully transparent and well-functioning free market but arise ‘whenever a firm has a degree of monopoly power in a market, is exploiting naturel resources, is operating in a regulated industry, or has some unique location or other business advantage’ (Brooks, 2003). Therefore, taxing such profits is justified under the principle of privileged acquisition.
The Benefits Principle
A company benefits from public expenditure. It makes advantage of the legal system from which it derives its legal personality and which makes it possible for the company to participate on the marketplace. Furthermore, companies benefit from a countries educational and healthcare system, infrastructure etc. Based on that fact, it is justified to levy corporate tax, see Gooijer (2019).
The Prosperity Principle
The third principle that is considered important in the design of corporate taxation is what it referred to as the prosperity principle (Brüll, 1964). The argument is that corporate taxation should be limited because it has a negative effect on the level of investments and future growth of companies, which has a negative effect on economic development, employment opportunities and, in general, on prosperity.
Obviously, this principle limits the scope of the principle of privileged acquisition: despite the fact that there is windfall profit (rent) and in theory a levy of 100% of these windfall profits is justified, the levy must be limited for the benefit of further economic development and investments in, for example, research and development. Therefore the prosperity principle mitigates the principle of privileged acquisition and ensures that ‘sufficient’ profit remains for (re)investment and economic growth.
The Principle of Balance of Power
A fourth rationale, particularly relied on to justify corporate taxation in the United States, is based on the economic power of corporate management, see Avi-Yonah (2004). I want to refer to the principle as the balance of power principle. Avi-Yonah argued that this rationale is of importance to today’s corporation taxes. In the context of the question of the role of corporate tax in the transformation to a circular economy for which a changed relationship between state and market seems necessary, it is interesting to discuss Avi-Yonah’s arguments in a bit more detail. The line of reasoning is as follows.
Because of their position and the financial resources companies often have at their disposal, corporate managers have power in the sense that they have the ability to influence the behavior of others. Avi-Yonah pointed to sociological literature from which it follows that this influence extends into three areas. First, political power, because corporate management can influence political decision-making. There is also economic power, which manifests itself mainly in relation to the employees and the communities in which companies are established (for example, the establishment of a factory and the location of the head office). Thirdly, especially if there is a monopoly or oligopoly, the corporate manager has power over customers. The dominance the American tech giants have, is a perfect example of this.
What is the problem of the (possible) dominant power of corporate managers? According to Avi-Yonah, there are ‘two principal arguments why a liberal democratic state should curb excessive accumulations of private power’. The first argument concerns democracy, the second the principle of equality. For a democracy to function optimally, it is necessary that there is no great accumulation of power among persons or organizations that do not have to render public account for the use of that power, Avi-Yonah argues. And private concentrations of power can affect equality within a society, equality in the sense that ‘every social “sphere” should have its own appropriate distributive principles and that possession of goods relevant to one sphere should not automatically translate into dominance in other spheres as well.’ Concentration of power in one sphere should not lead to disruption of relationships in other “spheres” of society, such as politics.
Corporate tax could play a role in countering excessive concentrations of power, resulting in the two aforementioned problems. After all, the levying of corporate tax reduces the financial possibilities of corporate managers, which has a direct effect on the position they occupy. Avi-Yonah: ‘Whatever the economic incidence of the corporate tax, from this perspective its most immediate burden falls on corporate management, and not surprisingly, they are the strongest supporters of corporate tax repeal.’
The Damage Principle
The economic rationale for environmental taxes such as CO2-taxes and waste taxes is that of repairing market failure, based on the theories of the economist Pigou, see Parry (2012) and Stancil (2010). For example, costs associated with CO2-emissions in a properly functioning market would be included in the cost price. Involvement of the state is necessary for the proper functioning of the market.
The legal foundation of environmental taxes - and of environmental law in general - is found in the ‘polluter pays’ principle, see Bervoets (2019). That principle, which is also laid down in Article 191, paragraph 2 of the Treaty on the Functioning of the European Union, expresses the notion that it is reasonable for polluters to bear the costs of pollution control and elimination, because they caused that pollution.
In my opinion, both principles are suitable for underpinning corporate taxation in a circular economy. Restoring a market failure can be seen as the economic equivalent of the legal principle of privileged acquisition (which in fact deals with the effect of, for example, monopoly positions). The polluter pays principle justifies the levy of corporate tax on profits from activities that causes damage to the environment. Following Grapperhaus (1995), I will use below the expression ‘damage principle’, because it better expresses the premise that in general the conduct of a business should not lead to damage to public goods and that, insofar as damage does occur, that damage should be compensated.
There is not one decisive legal rationale for corporate taxation. In my opinion, however, the above-mentioned principles together have sufficient persuasive strength for the existence of corporate tax systems, also in a circular economy. When looking for a - composite - legal rationale for corporate tax in a circular economy, these motives must therefore be considered in conjunction with one another.
It is particularly relevant that the operation of the principle of privileged acquisition is limited by the principle of prosperity and that the balance of power principle seems to supplement the principle of privileged acquisition. While the latter permits the levy of tax based on the mere fact that a beneficial position such as a monopoly has resulted in the pure economic profit, the former adds that corporate tax is justified to control the influence of corporate managers. Leaving pure economic profit unencumbered may lead to excessive concentrations of power with the possibility to exert undue influence in areas other than the economic realm.
On the basis of the damage principle, in particular those profits should be taxed that arise from activities that (potentially) cause damage to the environment. Under the damage principle, profits from activities that do not harm people and planet could be taxed less heavily. Furthermore, given the relationship between personal income tax and corporate tax and in accordance with the support function of the corporate tax, any measure introduced in corporate tax system should likewise apply to personal income taxes, as far as business profits are concerned.