Corporate tax reductions have often been proposed as a magic formula to drive business expansion and stimulate economic growth. In fact, they have become a recurrent feature of electoral manifestos among leading political parties. On the other hand, some economists and politicians have militated for higher corporate taxes as a tool to reduce deficits and fund public expenditure. Can we make a definitive statement about the outcome of changes in corporate tax rates?
First, a definition. Corporate taxation is a levy imposed on business profits, with rates varying based on jurisdiction and each company’s corporate earnings structure. In Malta, all tax-resident companies are subject to tax on their worldwide income and capital gains, irrespective of where their income or gains arise, and irrespective of remittance of such income or gains to Malta. The chargeable income of a company resident in Malta is subject to flat rate tax of 35%.
Under an imputation system inherited from the days when we were a colony and which was approved by the EU in 2006, the law prevents any double taxation of the same income in the hands of the company and again in the hands of the shareholders. As a result, following the distribution of dividends, shareholders are entitled to a refund of part, or of all, the tax paid by the company. The amount of the tax refund is set at 67% of the tax paid (5/7ths in the case of passive interest and royalties). Currently there are 8,012 companies actively registering for tax refunds under the refundable tax credit system.
Some business organisations have long had an issue with the fact that companies operating exclusively in the local market are subject to the 35% tax rate but do not get a refund. Conveniently, they forget that this scheme was introduced specifically to attract to Malta large corporations or companies that would otherwise have no purpose in setting up here. Recently, the Malta Chamber of SMEs pressed the government to fulfil its electoral promise of lowering corporate tax to 25% on the first €250,000 in profits.
The new Opposition Leader Dr Alex Borg waded in with a promise that a future PN government would “harmonise at 15%” corporate tax for local and foreign businesses within the hospitality, catering, and retail industries. He added that the current tax rates create “unfair competition as local businesses pay 35% while foreign businesses pay 5%” (a reference to what they allegedly pay after the refund). While it is rather doubtful that all foreign businesses pay what one might call an “effective” 5%, one must ask why it is not unfair that all industries, except the three concerned, would still pay 35% (or 5% according to Dr Borg) while the others pay a new rate of 15%.
Dr Borg appears to have partially endorsed a call by the Malta Developers Association last year that Malta’s corporate tax should be a flat 15% for all businesses. Finance Minister Clyde Caruana has already shot down this suggestion, saying it is in the country’s interest that the rates remain the same “for now.” The proviso appears to take into account the PL pledge, in its 2017 electoral manifesto, to reduce corporate tax for local companies to 25%.
It must be said that recent decades have been characterised by falling statutory corporate tax rates on the one hand, and a rise in corporate tax bases on the other, in many countries. Empirical studies have examined the growth effects of corporate taxation in different country groups and periods. The findings vary considerably:
The main argument for reduced corporate tax rates is that, lured by the prospect of keeping a larger share of their subsequent profits in after-tax income, companies would make new capital investments. This investment would then boost economic growth and create more jobs on the back of new technology and equipment.
Indeed (or so the argument goes), in this virtuous circle, competitive labour markets automatically generate higher wages to reward higher worker productivity, so that workers would benefit too. In fact, some advocates of this view have even argued that workers, not businesses, are the biggest beneficiaries of lower corporate tax rates. Bingo.
All governments support stronger business investment spending because of its many positive implications for macroeconomic performance, technological innovation, sectoral composition, export competitiveness, and wages. I wouldn’t say this is always reciprocated by private businesses, some of whom prefer distributing after-tax profits through dividends or share buybacks to putting money at risk in new investment projects.
What does economic theory say? It’s complicated because there are several economic models. Supply-Side Economics postulate that lower tax rates incentivize business expansion and investment, leading to broader economic growth. Meanwhile, Keynesian economic theory asserts that tax cuts alone are insufficient for sustained growth and should be complemented by government spending on infrastructure and social programmes. Additionally, Optimal Taxation Theory emphasizes the balance between economic efficiency and revenue generation, contending that overly aggressive tax cuts can lead to fiscal imbalances.
Researchers and policymakers have spent thousands of hours examining the cumulative quantitative evidence on the corporate tax and economic growth nexus, but it is still challenging to draw valid conclusions from their studies. Suffice to mention that a paper by Sebastian Gechert and Philipp Heimberger that analysed 441 estimates from 42 primary studies, using a toolbox of meta-analysis and meta-regression methods, found that a cut in the corporate tax rate by 10 percentage points would increase annual GDP growth rates by about 0.2 percentage points.
However, the authors found a bias in many of them in favour of reporting growth-enhancing effects of corporate tax cuts. Correcting for this bias, they rejected the hypothesis that the effect of corporate taxes on growth is zero. However, they noted that there may be cases with positive or negative growth effects within the average. They also note that more recent empirical studies tend to find less growth-enhancing effects of corporate tax cuts, in line with recent theoretical contributions.
Another study about the experience from Canada concludes that across-the-board cuts in corporate tax rates are a terribly ineffective way to foster more business capital spending. In fact, according to both Canadian and international data, it is hard to see that lower business taxes have any positive investment impact at all. In fact, the study found that the decline in business capital investment since the turn of the century has coincided almost perfectly with substantial tax reductions!
Yet another study by Patrick Kennedy on Trump’s Tax Cuts and Jobs Act established that, while economic growth from the tax cuts modestly offset their revenue cost to the government, the tax cuts did not pay for themselves. His model estimates imply that the corporate tax cuts increased annual GDP by a merey 0.18%, with around 80% of the income gains flowing to the top 10% of the income distribution.
The failure of across-the-board corporate tax cuts to stimulate robust capital spending is also strikingly visible at an international level. The countries that have achieved the strongest rates of capital investment since the global financial crisis (for example, Korea, Mexico, and Australia) typically have high tax rates. On the other hand, some countries with comparatively low tax rates have experienced very weak rates of investment. Across the OECD as a whole, no statistical correlation at all exists between CIT rates and business investment.
Naturally, nobody in Malta has published any serious study showing what is the relationship between corporate taxes and business investment in Malta and how any changes to the corporate tax rate would impact business investment, GDP growth, and income distribution. Notwithstanding, we have Tom, Dick and Harry parroting what they may have read on Facebook or YouTube to buttress their case for lower taxes.
My view is that there is no reason to believe that across-the-board tax cuts will have any measurable effect on productive investment. To the extent that taxes are a factor in investment at all, tax incentives focused on investment decisions are more effective than tax cuts. Incentives such as accelerated depreciation, investment tax credits, and public co-investments are more likely to get strategic or large projects off the ground. Other policies are more conducive than taxes to fostering strong investment – for example, sector-specific strategies to build innovation-intensive industries, more effective R&D incentives, and skills and training supports.
I would also add that businesses and their owners have a responsibility to contribute to the health of the communities and society in which they do business, and corporate taxes are one way that they should continue doing that. Current rates should be maintained, not cut, and the integrity of their enforcement should be strengthened. The share of corporate profits in GDP Malta has risen from 44.4% between 2008-2012 to 49.4% between 2013-2024. It is also an absolute disgrace that the Government is owed millions in taxes by companies.
Frans Camilleri is an economist. He studied at Oxford and University of East Anglia, is a former corporate head at Air Malta, and has served on various public and private boards.