Tax is good!

No-one much likes paying taxes but, like death, it is said, they are inevitable. There has been a lot of debate recently about corporation tax rates, and avoidance, and about tax havens. This was highlighted by the leak of the ‘Panama Papers’ that showed how some of the world’s leaders and many of the world’s wealthy, are finding ways not to pay what most of us would feel to be fair. Companies and individuals who have the most money seem to be able to use a little of it to set up complicated arrangements so that they pay as little as possible, while those with the least money feel they are paying amounts which hurt. If you need every penny to survive, even a low tax rate is a heavy burden, and the weight of that burden feels all the greater when you see rich people and big companies, who could easily afford to make a bigger contribution, going to great lengths to pay as little as they can. But the question is not just about fairness. It is also about delivering the vital services for which our taxes pay. Even ‘tax havens’ do collect taxes, but they usually have low or zero rates of income and corporation tax. Instead they may have very high import duties or purchase taxes to pay for their Government services. Countries have different rates for different taxes and compete against each other to attract investment through low tax rates. Some politicians, and economists, argue for low taxes to drive demand, and economic growth, by putting more money in people’s pockets and to attract foreign investment and create jobs. Others argue for higher taxes, especially on the rich, to ensure fairer distribution of wealth and good public services while driving demand and creating jobs through public expenditure. So let me try to make sense of it all and look for a way forward.

There are four main positive reasons why we have taxes.

  • First, of course, we need to find the money to pay for things we like or need. We can argue about what we should spend money on, and the choices are important (more for the NHS or a new nuclear missile system – anybody?) but few would argue that there are not many valuable services we need to pay for. There are choices about how big or small Government should be, and how far services should be paid for from tax or from individual incomes. In the UK, most people place huge value on the National Health Service. We don’t believe the market would be able to deliver fairness in access to healthcare. We believe in equal access to health regardless of wealth. That means a health service largely paid for from tax revenues. We’re proud of it and mostly happy to pay. The same could be said for education, and there is a broad consensus that we should pay to help those who are suffering from poverty and disadvantage (even if there are differences of opinion about the details). I’m proud too that we spend some of our tax receipts helping the poorest and most vulnerable people in the world through our aid programme. Government provision at its best provides equity and certainty in the provision of services that can’t be achieved just by relying on the market or through charity (though each has a part to play). Whenever someone avoids their taxes, someone else has to pay – either through higher tax rates for the non-avoiders, or through greater limitations on public services.
  • The second reason is redistribution of wealth. There is a general belief that taxes should be progressive – the rich pay more – while Government expenditure supports the incomes of the poorest. Income tax and the welfare state together have a Robin Hood function – to take from the rich and give to the poor. VAT and other indirect taxes are less popular because they are regressive – the poor tend to pay a higher percentage of their income in indirect taxes than the rich, though governments seek to mitigate this by exempting essentials like most food, and children’s clothes. It is generally accepted that the market alone would leave many in poverty while others get extremely rich, and that the state has a responsibility to even things out a bit. Tax policy is the most important way to do that. If the rich don’t have to pay, it rather defeats this object!
  • Thirdly, taxes are used to incentivise behaviour that society feels is desirable. Smoking is discouraged by high rates of duty on cigarettes, while saving for a pension is encouraged by tax relief on pension contributions. Charitable giving is incentivised by the Gift Aid scheme. Green taxes, or tax reliefs, are designed to encourage environmental responsibility.
  • And finally, taxation is one of the potential levers (alongside monetary policy, particularly interest rates) through which Governments manage and enhance economic performance, manage inflation and even out borrowing across economic cycles. This would mean reducing taxes during a downturn in order to increase personal spending and expand the economy. The Government would need to raise borrowing at the same time to maintain public services and even increase Government expenditure to stimulate demand further. During an upturn, they would increase taxes to limit demand and manage inflation, and use the revenues to reduce borrowing to compensate for the higher borrowing in the downturn. The big problem with cuts in Government spending (especially welfare spending) when the economy is in bad shape (“austerity”) is that they have the opposite effect. The poor spend all they receive so every pound taken from them reduces demand. Perhaps it would be better to increase welfare even at the cost of more borrowing. When the economy picks up, welfare spending decreases as employment and wages increase, and tax receipts go up for the same reason.

But there is a 5th factor that determines tax policy, and that is politics. Political parties believe that they won’t get elected if they promise tax rises, even for excellent reasons. Spending cuts are also unlikely to be a recipe for electoral success, though the latest UK election saw all parties promising to make cuts. Voters like to see lower taxes at the same time as more money being spent on the things they like, such as the NHS and schools. These days they are also interested in seeing reductions in the budget deficit. Of course it isn’t possible to achieve all these things at once, so we get ‘stealth taxes’ and big cuts described as ‘efficiencies’ that are not meant to impact on services, but do. There is pressure at election time to make commitments not to raise income tax or VAT, which seriously limits Governments’ options for fiscal policy. Balancing the books then requires spending cuts and the resulting austerity reduces demand and economic growth. We seem to have got ourselves into a vicious cycle by talking ourselves out of using some of the tools in our economic toolbox. We seem to be repeating in our own economy the mistakes made when the developing world was subjected to ‘structural adjustment’ in the 1980s. UNICEF’s ground-breaking report “Adjustment with a Human Face” (1987) highlighted the painful impacts on the poorest and most vulnerable, especially children, through cuts in vital social programmes. In the UK, the IFS estimates (pre Brexit) that child poverty will increase in coming years due in significant part to planned tax and benefit changes. It seems the human face has gone missing again, especially the face of a child living in poverty.

Relative Poverty rates

So, coming back to taxes, the simple fact is that we need them. They are there for good and valid reasons, but politics seems to get in the way of doing what may be economically wise.

But traditional policy approaches to tax are facing the challenges of globalisation and the new virtual economy. When the likes of Google deal in intangible products it is relatively easy to move money around the world to reduce tax liabilities (harder to move a car factory or an oil refinery). Even more, financial businesses like hedge funds can be based anywhere on the planet and often choose low tax territories. Corporate tax rates across the world have been coming down as countries compete for business investment.

G20 corporate tax rates

While much of the debate has focused on trying to crack down on avoidance, perhaps the real problem is that Governments have allowed tax competition to let companies off the taxes that the public would expect them to pay on their profits.

A similar thing has happened to income tax rates in the UK, especially the rate paid by those with the highest earnings. Yes, perhaps we have been allowing big companies and the wealthy to get away with tax avoidance, but the far more significant factor is that successive Governments have cut taxes for those very people and organisations.

Income tax rates 1974 to 2014

But there is a bigger and far more important global issue to consider.  At the end of last year the international community adopted the Sustainable Development Goals, a radical and ambitious set of targets to change our world into one which is fairer and more sustainable, in which poverty is consigned to history at last. There are many differing estimates of the cost of delivering on all the goals, but developing countries are expected to need some $3.9 trillion a year – and they are facing a gap of $2.5trillion. While aid will be critically important in some countries and sectors, especially for the poorest, it is generally agreed that the largest contribution to this funding gap will have to come from tax revenues generated in developing countries themselves. Yet, according to the European Network on Debt and Development (Eurodad) this funding is being “tragically undermined” by international tax evasion and avoidance, which cost developing countries hundreds of billions of dollars every year.

There is no doubt that the world needs a radical new approach to tax to ensure that we can achieve the goals of fairness, equity, sustainability and economic and social development which we have set ourselves at the global level, as well as to ensure that those progressive policies are reflected domestically. The SDGs are universal – the UK and other rich countries need to invest to achieve them as well as to support poorer countries in their own efforts.  This is a global endeavour to remake the world for the betterment of future generations. It simply cannot be achieved without reform of tax policy domestically and internationally.

So what is the policy prescription? Here are some ideas:

  • We need to see a rapid and deep change in business culture, which recognises that paying taxes is a necessary part of their corporate social responsibility agenda, not something to be minimised for the sake of shareholder profits. Companies need to accept and embrace their responsibility to a wider set of stakeholders as well as shareholders. Those stakeholders include the world’s poor who need the SDGs to be achieved. The best companies are already moving in that direction, but more need to be persuaded and incentivised to do so. Socially responsible investment vehicles should include tax behaviour as one of their core criteria and all of us as consumers or investors need to use our power to influence companies in the right direction.
  • A report by Development Finance International and Oxfam identifies the following international tax reform measures:
    • major changes in international tax rules and practices, to give fair treatment to developing countries, including in current G20/OECD tax initiatives. By allocating taxation rights primarily to source countries of raw materials, redesigning tax treaties and sharply reducing tax exemptions.
    • major reinforcement of developing country capacity to receive, analyse, audit and supply tax information, prosecute evaders, and renegotiate contracts and agreements with corporations.
    • agreement on inclusive global governance of cooperation in tax matters, via the Financing for Development (FfD) process and a reinforced UN Tax Committee, to give developing countries equal decision-making power.

In short, we need to manage tax at a global level instead of competing with ever falling corporate tax rates. Global harmonisation of corporation tax rates would be a great start. And perhaps we should shift the tax from profits to sales and supply chains to avoid profit-shifting as a means of avoidance.

  • There is broad agreement that transparency is a necessary precursor to tackling tax avoidance. This means extending the OECD and other initiatives towards universal public registers of beneficial ownership so that people and businesses can’t hide their money from the relevant authorities. Secrecy only helps the tax avoiders.
  • Governments like the UK need to simplify and clarify tax rules so that there are fewer loopholes for people and businesses to exploit.
  • In the UK, there is certainly room for higher rates of income and corporation tax for those who are making the most money in order to finance public services, stimulate the economy and avoid the vicious circle of austerity. We need to revert to fiscal policy that allows the use of progressive taxation rather than changing only (usually regressive) indirect tax rates or relying excessively on spending cuts, especially those targeting the poorest, to balance the books.
  • To achieve the SDGs we will also need new ‘innovative financing’ mechanisms such as the ‘Robin Hood Tax’ on financial transactions. The DFI/Oxfam report estimates a need for at least $500bn a year in innovative financing ‘including taxes on carbon, bunker fuels and air travel (US$250-300 billion), financial transactions and currency (US$100-150 billion), and issuance of IMF Special Drawing Rights (SDRs) (at least US$100 billion)’.
  • UK and international aid programmes need to invest in helping developing countries to strengthen their tax collection capacity and infrastructure and prevent leakage of taxable wealth and profits offshore.

Everyone, it seems, would be happy to see more taxes as long as they don’t have to pay them themselves. But a better world needs a better tax system, which is more transparent, more global, more innovative and more progressive. This is not just important for some time in the indefinite future. It is essential and we need to get going right now if we are going to meet the global goals by 2030.  It is challenging and difficult, as all the best things are, but we can’t afford to put it off.

As long as it is progressive and the funds raised are applied equitably, tax is good.

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