LONDON (Reuters Breakingviews) - Societies work best if everyone helps out. Two new studies suggest that many big companies in developed economies are shirking. They are taking too much in profit and paying too little in tax.
Start with profit. International Monetary Fund economists Federico Diez, Daniel Leigh and Suchanan Tambunlertchai have waded through 631,000 corporate annual reports from around the world. They observed trends in what they call “corporate markups” – basically gross profit margins adjusted for capital intensity.
Markups are on the rise in advanced economies – a 39 percent increase in the sales-weighted average since 1980. The gain for companies based in the United States was 42 percent; for the rest it was 35 percent. Diez and his co-authors did not find a strong trend in developing economies.
More detailed analysis shows that most of the increase comes from the expansion of what the authors call superstar firms: industry leaders with very high profit margins. Technology, especially biotechnology, shows the greatest profit expansion, but the trend is widespread.
Questions may be raised about the study’s many assumptions and simplifications, but its results correspond with those of other academic research. It seems clear that profitability is on the rise in general, led by the development of winner-take-most industries. In short, shareholders are doing very well.
If the only standard of corporate success were the creation of shareholder value, this trend would be unequivocally welcome. The world is not so simple, though. Companies actually have many responsibilities.
One of them is to customers. As yet, the rise of superstar firms has mostly served users well. Unlike traditional monopolies, which often wallowed in inefficiency, today’s profit leaders – think Google or Apple – are mostly dedicated to innovation and efficiency.
Workers have much more to complain about. The increased share of income going to capital has translated into a steadily lower share for labour. Pressure on wages has been relentless, with people without many skills feeling it most.
Governments, another important constituency for corporations, have also lost out to shareholders. The other study, by Gabriel Zucman of University of California at Berkeley, along with Thomas R. Tørsløv and Ludvig S. Wier of the University of Copenhagen, makes that clear.
They calculate the effect of tax-shifting – multinational companies moving profit from high- to low-tax jurisdictions. The authors estimate that these perfectly legal techniques deprive the European Union of 18 percent of its corporate tax revenue. For the United States, the loss is 14 percent.
It would be interesting to know what portion of superstar companies’ profitability advantage comes from better tax management than peers which have to rely on less skilled advisers. Either way, the non-shareholder citizens of affected countries lose out.
In theory, the governments can make up for the taxes that slippery companies do not pay by increasing other levies. In practice, raising taxes can be difficult, in part because politically powerful businesses are often effective lobbyists against bigger government.
Beyond politics, there is ethics. There is something anti-social about the corporate dedication to pushing the tax law to the limit. It would be more appropriate to pay a fair share of extraordinarily high pre-tax profit to support the common good.
All in all, the gains for generally affluent shareholders come at the expense of poorer people – lower-paid workers and recipients of government benefits. In effect, winner-take-most corporate economies work like a Petri dish filled with the nutrients of populist economic resentment.
It could get worse. The evidence in the IMF study suggests that industry-leading companies tend to slow down on investment after they reach a certain level of dominance.
Change would be welcome, but it does not look likely. For one, the problems caused by higher mark-ups are truly difficult to solve, because there are no rapacious and lazy monopolists to break up or regulate. On the contrary, some likely causes of increased profitability – network effects, superior technology and better service – are socially beneficial.
For example, carving Alphabet into three mini-Googles would not necessarily be an improvement. Enforced price cuts at the internet giant might reduce shareholder wealth, but they would also make life harder for higher-cost competitors. Google’s market dominance would only be reinforced, along with the temptation to corporate sloth.
Still, more vigilant governments could certainly do more to curb abuses by superstar companies. Fairer corporate taxes would be a start. That requires new laws and, more important, political and economic pressure to follow them in spirit as well as by the letter.
Unfortunately, few politicians and even fewer business leaders seem very interested. The system works well enough for them. Even right-wing anti-establishment populists have not focused on high profit or low taxes.
The free-market economists who promoted the pursuit of shareholder value were not trying to subvert social justice. On the contrary, they believed that lively competition would limit corporate earnings while bringing high investment, lower prices and good wages. Their faith was misplaced. Single-minded profit-seeking is definitely good for investors, but not necessarily for the world.
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