Multinational taxes: what do politicians know?

This election has ratcheted up the calls for Starbucks and other multinationals to pay more taxes on their British revenues.  Politicians give no indication of how they will achieve that; one suspects their silence is based on ignorance.

This blog is a brief explanation of why multinationals are fully entitled, under present laws, to push profits into lower tax regimes.  If the UK wants to change, it may need multinational legislation.

If a brand owner in one country sells to a distributor in another, they split the total profit between them.  If the companies are independent, the presumption is that the split is “arm’s length” and that is accepted by the tax authorities in both countries.  The game gets tricky when both companies are owned by the same group and the brand ownership is switched from one country to another.

The practice began with Bailey’s Irish Cream which was launched in 1972 to accept the Irish Finance Minister’s offer that any export profits for a new Irish agriculture-based brand would be free of tax for 10 years.  The brand became a huge global success and, come 1982, the ultimate brand owner, Grand Metropolitan, was about to be hit by a sharp jump in taxes.

By coincidence, the concept of “brand equity” as a marketing asset which could go on a balance sheet was also being developed in the 1980s.  Why not move the brand equity from Dublin to the Netherlands which was, then anyway, offering low taxes on Dutch earnings by foreign-owned assets? Why not indeed?

As you can imagine, the British and Irish tax authorities were less that thrilled with that and Grand Metropolitan had to justify that the Netherlands company really was marketing the brand globally.  In effect, the distributor company is renting the use of the brand equity asset from the brand owner and has to pay for that.  If the transfer price is “arm’s length” it is all perfectly legitimate so, for two companies both parts of the same group, what exactly is “arm’s length”?

The multinational can count on the support of the tax authorities in the brand owning country.  Their take decreases by the amount of profits switched to the distributor (or franchisee) country.  And if the brand owning company can show it sells, on the same terms, to (or franchises) companies which are not part of the same group, the case for “arm’s length” is strengthened.

HMRC has spent a huge amount of time and money on this issue.  Whilst it is possible they have not been tough enough, it is much more likely that the law is not on their side.  It is also likely that any unilateral action by the British government would lead to even more expensive legal costs on appeal.

With corporation tax down to 20% the UK is closing the low tax gap, but unless politicians can show they understand the game, and come up with a credible big stick, HMRC is going to have to settle for goodwill payments by the multinationals.

Some really bad ideas just keep staggering on, don’t they?

One of those really bad ideas being the financial transactions tax. Never mind that it’s a very bad tax, that transactions taxes themselves are a bad idea, and concentrate on the most important point of it all:

Think what Labour could do, if it chose, to revitalise public services. A 0.01% financial transaction tax would raise £25bn a year.

That’s George Monbiot missing that important point. And he’s quoting the IPPR who also miss that major point. That major point being that an FTT won’t in fact raise any tax revenue. In fact, it will decrease the amount of tax revenue raised. At which point there’s no point in thinking about all the lovely things you can go and spend the money on, it’s necessary to start thinking about what of current spending you’re going to cut. Which would rather temper peoples’ enthusiasm for this tax one would have thought.

The mechanism is that transactions taxes are really, really, bad taxes. Their deadweight costs soar above those of other methods of taxation: that is, for each unit of revenue raised they kill off more economic activity than other taxes. And an FTT could, in theory, be so bad in this manner that it would shrink the entire economy. Shrink it so much that total tax revenues would fall, despite our being able to see this new money coming in from the FTT.

That is of course an empirical question: would those deadweight costs be sufficiently large so as to reduce the total tax take? And fortunately someone has gone and done this work for us. It was the European Union itself, reporting on the idea of an FTT implementation. And the answer is yes. The economy would shrink so much purely from the effects of the FTT that overall tax revenues would fall.

This does, of course, still leave room to argue in favour of an FTT. Maybe you want to screw the banksters, perhaps you just hate everyone and want to make them poorer, possibly even you could make a tortured argument that this will shrink the state. But you can’t go around talking about all the lovely stuff you can do by spending the FTT revenues: for there won’t be any.

Which isn’t, when you come to think of it, all that much of a recommendation for a tax.

We think we’ll chalk this up as a win

We here at the ASI are of course politically partisan: you can’t work in the think tank world without meeting many politicians and making decisions about who is worthwhile and who isn’t. However, we here at the ASI are not politically partisan when we’re here at the ASI. Because, as Madsen has said, our job is to be the loons howling out in the wilderness over some policy that is seemingly ridiculous and to keep arguing for it until it becomes simply the accepted wisdom of the day. It is much easier to do this without being in the pocket, or being seen to be in the pocket, of one party or another.

At which point we think we’ll claim a victory over one such policy for it’s now in three of the four major manifestos for this coming election. That’s as close to being the received wisdom as anyone is likely to get. We refer to this:

Under a Conservative government the minimum wage will be linked to the personal allowance, which the Tories want to increase to £12,500 by the end of the next Parliament.

It means that if the minimum wage increases faster than expected, workers will always be exempt from paying income tax.

We know how this got into the UKIP manifesto for when away from the ASI one of us is so politically partisan. We also know how it got into the Lib Dem one, we can track the activist who read about it here and marched it through the party’s policy making process. And of course that’s also how it arrived in the Tory one. We can even identify it as absolutely coming from us because of the figure being used. £12,500 was the full year minimum wage in the year that we wrote about it: it’s a little bit higher now.

Our basic analysis has always been that we do not in fact have “low wage” poverty in the UK. Rather, the State makes depredations into the incomes of the lowly paid and thus causes them to fall into tax poverty. The solution to such poverty is thus to tax those lowly paid less: after all, if you want the poor to have more money then the answer is to stop taking bloody money from them.

We can also check this with the Living Wage. This is, by construction, the amount that one needs to be able to live not in poverty, that poverty level being calculated as in Adam Smith’s example of the linen shirt. The difference between that Living Wage once it is taxed and what an untaxed minimum wage would bring in is roughly zero, perhaps a few pence an hour. We thus don’t have low wage poverty, we have tax poverty. It is the tax taken from the lowly paid that puts them into poverty.

So, obviously, simply stop taxing those lowly paid and they won’t be poor. We thus welcome this move.

At which point there are three things to note. The first is that this needs to apply to national insurance as well, raise the allowance for that to the same as the income tax allowance (while, as with the very low paid already, crediting them with amounts deemed to have been paid so that pensions accrue). Secondly, those advocating this might want to point out that this does indeed produce the Living Wage for all minimum wage workers. And thirdly, of course, we need to find something else to go and howl about in the forests in time to make it the received wisdom for the next election.

The problem with inheritance tax

Now that inheritance tax is back in play in this election season perhaps time to think about the basic problem with it:

The Tories suffered a blow on Sunday when the Institute for Fiscal Studies warned that a pledge to raise the inheritance tax threshold on family homes to £1m would disproportionately benefit richer people.

As David Cameron tried to reset the faltering Tory campaign by declaring that he was championing the “Conservative dream”, the IFS described the inheritance tax pledge as “rather odd” special treatment for homeowners.

Leave aside the specific details of this or that pledge and consider the very basics.

We’re told, as with Rawls and the veil of ignorance, that it’s simply wrong for the members of the lucky sperm club to inherit gazillions. Further, that inheritance tax doesn’t actually have any effects upon incentives: it cannot, as the people who face the incentives are by definition dead at this point. The argument then becomes, in some quarters, only about how much to tax inheritances. Should it be at 100% or should the kiddies get some pocket money perhaps?

We exaggerate, but only a little. There really is a consensus that inheritance taxes are not distorting and thus are “good taxes” in a manner that income and or capital taxes are not.

And we’re really not sure about that. For we do think that while logic is all very well it is necessary sometimes to look at what people actually do. This idea of revealed preferences: forget what people should do, what we want them to do, what they say the will do or that they believe and look at what they actually do to divine their thought processes. And the truth there is that just about everyone will do their utmost to avoid (and many to evade) paying inheritance taxes upon their estate, even when they really are dead and gone. We must therefore conclude that this is, despite the logic and the ideas of fairness, something that really does motivate people. And if that is true then such taxation cannot in fact be non-distorting.

This is something that was rather missed by Thomas Piketty. He talks, extensively, of the bourgeois historical novels and their tangled tales of who gets what from which estate. To bemoan the manner in which this stratifies society which might be fair enough. But he misses the point that these were the best sellers of their day and the attention paid by the bourgeois writers and readers back in history shows that who gets what from which estate was important to them. As the stampede to keep today’s inheritances out of the taxman’s hands show it all is today.

New ASI paper: Non-Sense

Out today is a new ASI briefing paper examining Ed Miliband’s proposal to end the non-dom provision in the UK tax system.

It says:

  • Being a UK resident with non-domiciled status simply means that one does not intend to remain indefinitely. The tax system requires residents to be taxed on their foreign income. Non-doms resident in the UK elect to be taxed on either the arising basis (their worldwide income is taxed automatically) or the remittance basis (they are only taxed on worldwide income if they bring it to the UK). 2008 reforms mean that after 7 years of UK residence, non-doms who choose to be taxed in the latter way must pay a yearly fee of £30,000 (rising to £50,000 after more years of residence).
  • Ed Miliband has claimed that there are 116,000 non-doms but this ignores those of the UK’s 400,000 international students and 6 million foreign-born workers who did not have to file a self-assessment form and those who did file it but did not tick the non-dom box. It is estimated that something like 1 million are not permanent residents, so are by definition non-doms.
  • The rules introduced by Labour (and supported by the Tories) in 2008 ended up only hurting less wealthy non-doms and did nothing to really wealthy ones: electing to be taxed on a remittance basis benefits only those with very high foreign incomes.
  • While most countries tax worldwide income of residents, a significant number including the UK have exemptions for certain people (mostly foreigners) so that they only pay taxes on local income.
  • There is a substantial literature showing that tax systems are very important in deciding where top talent goes. It tells us that punitive changes to the UK tax system could discourage the most valuable potential immigrants from footballers to inventors.
  • Changing how we determine someone’s domicile is likely to have unintended consequences. First, making it easier to acquire a new domicile might reduce inheritance tax receipts, as UK domiciled residents of foreign countries currently pay UK death duties on their worldwide estates. Second, changes to the concept of domicile would have repercussions in other areas of law, such as matrimonial matters and determining the validity of wills.
  • The ethical justifications for Ed Miliband’s view that it is immoral that non-doms do not pay tax on their foreign income are deeply contentious. There is no principled moral case for taxing more than local income.

You can read the full paper here