tax

Don't campaign against tax havens: they are good for us

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Thanks to faulty headline-grabbing propaganda, most people think tax havens are outrageous places in which tens of billions of pounds are being stored offshore, denying UK citizens valuable tax revenue that could be used on public services like schools, health care and roads. Nice idea. But like many nice ideas, it veers far from the truth. First off, what of the complaint that if the money stays in the private sector in tax havens then UK citizens are being robbed of vital tax revenue? To answer this, consider if the money stays in the private sector in a tax haven, who else benefits from that apart from the person with the money? On the one hand that money is invested, which generates plenty of jobs and lots of economic growth. On the other, if a British billionaire keeps £500 million in a tax haven then all the time he's not spending it he makes everyone else in the UK better off in terms of more resources and lower prices. This is because money earned but not spent is like conferring a gift to the UK taxpayers. Moreover, it's important to remember that the primary contribution high earners make to society is not in the taxes they pay, it is in the goods and services they produce.

When it comes to tax havens, what is also being missed by a lot of people is that tax havens actually make us better off in another way, in that they provide vital competition to tax rates in the UK. A popular view from the left is that because of tax havens governments have to increase our taxes to make up for all the tax they are not getting from money stored in places like the Cayman Islands. In actual fact, the opposite is true – tax havens keep our UK taxes lower not higher.

To see why, suppose there is just one quite expensive Bakery in town (call it Bakery A). Along comes another Bakery in competition (Bakery B), offering townsfolk lower prices for bread. The very worst thing that Bakery A could do in response would be to raise its prices even more. Their best response would be to try to out-compete Bakery B for custom. This is the nature of competition, and how it lowers prices and improves efficiency.

Similarly, tax havens are like Bakery B: their more competitive tax rates place competitive pressures on governments that might be tempted to tax us highly. Competition for prices occurs with tax just as it does with bread, laptops and cars. Governments must be competitive with their tax rates, otherwise more and more money will be stored in places with lower tax rates. Tax competition is a key driver of economic growth in the world, as this incentivises politicians to keep taxes on savings and investments low. When tax rates are excessive, there is less economic growth. Tax havens provide the necessary competition to militate against this happening.

Finally, tax havens can claim to have some of best standards of living and economic growth in the world. That's precisely because low taxes stimulate economic growth and better standards of living, as the qualities of the free market predominate over party political interests. Instead of calling for politicians to tackle the grave injustices of tax havens, campaigners should be calling for a more fruitful tax system here, based on lower rates, reduced complexity and bureaucracy, and increased market freedom.

Multinational taxes: what do politicians know?

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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.

One tax hike I'll be hoping for in the Budget (and some cuts as well)

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Back home in Ireland, it’s said that asking for directions will often get you the reply, “I wouldn’t start from here.” We might say the same thing about the UK’s tax code. Nobody drawing up a tax system for the country would create anything like what we have right now, and when it comes to reform – well, I wouldn’t start from here. One example, which I talked about on the Today Programme this morning, is VAT. VAT is usually considered to be one of the least bad taxes around: in theory, it doesn’t discourage production, it isn’t very regressive, and it doesn’t distort the economy.

I say “in theory” because in practice the UK’s VAT system is a mess. It is riddled with exemptions (I am including zero-rated and reduced-rated goods in this) that distort people’s spending, which means that resources are being wasted, because people are buying relatively more of the untaxed goods and less of the taxed ones than they would be if the playing field was level.

The usual argument for these exemptions is that they are needed to reduce the burden on the poor. This is a powerful argument but it is wrong.

Many of the exempted items are unlikely to benefit the poor anyway – financial services, the construction of new dwellings, domestic passenger transport – but even for things like children’s clothes and food the argument is wrong. Although poor people spend a greater fraction of their budgets on exempted items like these, total spending on these goods rises with income, so most of the forgone revenue is actually from the rich.

The extra money raised could easily offset the extra cost to the poor by reducing income taxes on them (including national insurance contributions) or by raising the Universal Credit payment level. We could actually offset the extra cost to almost everyone, but except for people on low pay I think there are better taxes we could cut with the money left over.

The IFS estimated in 2010 that scrapping all VAT exemptions would raise an extra £26-28bn, based on 2010-11 numbers. Conservatively, rounding that up to £30bn to account for the larger economy, and spending half on boosting the incomes of the poor, we have £15bn left to play with. We’ve suggested scrapping capital gains tax to boost investment and using the rest to reduce the deficit.

In simplifying VAT we can make one important tax much less destructive without hurting the poor and use the money left over to cut taxes that are even worse.

Politically, this might not deliver good headlines, but if it was done at the start of the next Parliament the boost to people’s living standards by the next election could, improbably, make raising taxes on food and children’s clothes a real winner.

We might not want to start from here to get our sensible tax system, but this is one reform that could be a good step in the right direction.

Economic Nonsense: 21. Inheritance tax is needed to prevent some having an unfair start in life

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This question carries the assumption that life is some sort of race in which we are all struggling to outdo everyone else. Life is not like that. We are not racing against others because we all have different characters and different goals. There is a different finish line for each of us. Even the pace at which we choose to pursue our goals varies with the character of individuals. One widely-held aim of parents is to give their children a decent life, even a better life than they had themselves. Many put effort into achieving this; it seems to be a natural and widespread aim. When society prevents them from passing on their assets to their children after death, they often find other ways of achieving that aim. This can take the form of using influence to place their children in comfortable jobs. It can be done by transferring the assets while they are still alive. It can lead people to set up complex trust schemes beyond the reach of the taxman.

Inheritance Tax is taxing money that has already been taxed when it was earned. The provision parents worked to make for their children, paying tax as they did so, is now taxed again, removing part of their incentive to create wealth in the process. For many recipients, the bequest comes as a lump sum when they are already established and probably own their home. It is thus available for investment or to start a business. Taxing it greatly reduces these possibilities. The capital pools built up by a family business such as a shop, for example, can be dissipated on death by Inheritance Tax, with a consequent economic loss to society, a loss that impacts employees and customers.

People are not equal and cannot be made so. They are differently talented. Some are genetically equipped to develop athletic prowess if they work at it. For others it might be music or mathematics. The notion that 'fairness' requires they should all have equal chances sits ill with what life is actually like. We should not be trying to impose an equality that does not fit, but on extending to everyone the opportunity to better their lives.

Economic Nonsense: 19. Corporation tax is paid by businesses

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It is always attractive to the political classes to impose taxes on business so that people can benefit from the spending this makes possible. Corporation Tax is one of these whose name suggests that it is paid by corporations. Many people suppose that this involves taking money from companies and transferring it via government into services for ordinary people. They suppose that corporations just shrug and accept the loss in profits this involves. This is a naïve myth. The tax levied by government is part of the price that people, not companies, pay. When you buy beer the price of your pint includes the tax the brewer has to pay to government. When you buy whisky it is even more, about 80% of the nominal price. The same is true for petrol and other fuels. VAT is included in what you are charged for goods and services.

The point is that Corporation Tax is paid by people, not by corporations. The tax that companies are charged forms part of their costs, and is reflected in the costs of producing their goods and services. Studies show that about three-fifths of the impact of Corporation Tax falls on the workers, reducing the wages they could otherwise be paid. Of the remainder, some falls on shareholders by way of reduced dividends, making it harder for the firm to attract capital to create more jobs. Some falls on customers, passed on to them in the form of higher prices, which lower demand for the firm's products.

Corporation tax thus acts to curb economic activity, hits growth, and makes people poorer than they would otherwise have been.

If firms tried to absorb the tax without passing it on in lower wages and increased prices, as some critics suggest they could, they would become less profitable and less attractive to investors, who would in turn respond by investing somewhere else instead.

Economic Nonsense: 9. International agreement on tax rates would benefit everyone

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International agreement on tax rates would hurt everyone except those who collect and spend taxes.   Governments have little restraint on the degree to which they can take the money earned by their citizens and spend it on overblown projects designed ultimately to buy votes and secure their re-election.  They meet some resistance as they increase their tax take, but people can do little except grumble.  Very often there is little difference between the major political parties, or between the tax rates they levy while in office, so democratic restraints are minimal. The one effective restraint is the ability of people to move to another jurisdiction.  This is especially true of modern economies which place considerable value on the talents of high-achieving individuals.  Government is restrained on what it can tax them by their ability to move.  When faced with punitive tax rates, they can relocate to somewhere more favourable.  High earners in France, and those with aspirations to become so, began to leave the country in significant numbers when faced by government plans to levy a top income tax rate of 75%.  Similar effects have been observed elsewhere.

What is true of individuals can be true of companies.  They, too, can choose to relocate to areas where tax rates are friendlier.  The Republic of Ireland found its low 12.5% rate of corporation tax attracted companies to base themselves within its borders.  High rates of corporation tax elsewhere added to Ireland's attraction.

Those who support high taxes dislike this restraint and many of them call for international harmonization of tax rates.  The aim of this is to make it pointless to relocate, and to remove the one curb on over-large and over-costly governments.  They dislike what they call 'tax competition.'  But relatively low taxes on high earners and business constitute a business-friendly environment and are conducive to economic growth.  Those who call for harmonization are in effect saying they do not want any countries to be more business-friendly than others.  Denied an escape to less oppressive tax regimes, people become the helpless prisoners of rapacious governments.

Economic Nonsense: 5. Taxes should be increased to fund necessary spending

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Taxation changes behaviour.  Taxes on goods and services makes them more expensive, and in most cases people buy fewer of them as a result.  Taxation on incomes makes work less attractive, motivating some people to do less of it.  Taxes on business usually fall on those who buy the products of those businesses, often reducing demand to below the level it would reach without taxation.  Taxes that people regard as unfair or oppressive will often lead people to take steps to avoid their burden.  Taxes on inheritance lead people to dissipate their wealth early, or they break up the capital pools that enable heirs to invest. Dynamic models of the economy try to take account of this.  Doubling the tax on tobacco products, for example, does not yield twice the revenue.  It might lead to twice the smuggling, though.  Vast increases in the duty on alcohol does not raise revenue in proportion, thought it does lead some drinkers to move down to cheaper booze.  Some tax increases actually yield less revenue because of the behavioural responses they trigger.

Arthur Laffer famously noted that a 0% tax on incomes yields no revenue, as does a 100% tax.  The graph line that links those two zeros is the Laffer Curve, and it has a peak somewhere whose rate yields the most revenue.  Even this moves as people adjust to the new status quo.  If a 50% rate of income tax is lowered to 40%, it is highly likely that it will soon bring in more revenue.  The rate reduction makes work more attractive, so people do more of it.  It also makes complex and expensive avoidance schemes less necessary, as people opt just to pay the lower rate tax instead.

When the economy in question had adjusted to the 40% top rate, however, more revenue might then be raised by lowering it to 35%.  The optimum revenue-raising rate depends on the status quo to begin with.  In many cases it might be appropriate to lower taxes to raise more revenue, rather than to hike them.  It is never likely that higher rates will yield more revenue in proportion to the increase.

The Green spectre

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I was reading the other day that The Green Party Is The Second Most Popular Party For Young People. This popularity surge is probably not that surprising really - we see increased environmental awareness in younger people these days, and it’s often the case that a vote for a minor party means a vote that expresses disenchantment towards the mainstream parties. However, many prospective Green voters would surely be thinking about being a little more circumspect if they saw Andrew Neil's Sunday Politics interview with Green Party leader Natalie Bennett, which stands out for me as one of the most alarming exposures of ill-conceived economic policy I've seen in a long time. It's rare to see a leader having her party's policies torn to shreds without even the smallest ability to defend them or balance them up - instead simply getting in a jam each time and responding with “I would urge your viewers to go our website and see how the figures are worked out.”

Alas, that's the reality, though - their policies are indefensible - economic moonshine of the worst kind I've seen. Not only are they inimical to successful human progression and increased prosperity, they are antithetical to even the basic truths you'd learn about in first year economics.

Their proposed wealth tax is simply a pipe dream. Bennett claims it will generate between £32 billion and £45 billion, when the reality is that wealth taxes in other European countries generated only a fraction of that. Add to that the proposals for import tariffs, business subsidies, increased minimum wage, price controls, and the kind of Piketty-esque redistributive taxation that would be almost certain to hamper innovation, and drive much of our best talent out of the UK, and there is a good case to made that with The Green Party in their current form, we have, in terms of the economy, perhaps the most dangerous fringe party of them all - a party whose policies would severely compromise the global benefits of innovation, trade, competition and the free market of supply and demand far more than all the other parties would.

A vote for the Green Party actually gives every indication of being a vote for negative growth, as they look to free humankind from what they perceive as the disaster of its Promethean economic advances. While it’s true that in some cases people willingly vote for one of the smaller parties because they are disenchanted with mainstream politics, it’s also true that as the landscape begins to shift, and dissection of the minor parties' policies intensifies as more look to get their feet in Westminster’s door, surely very few people could actually bear to envisage what the country would be like if The Green Party's policies were ever made manifest in any kind of sphere of political influence. At the very least Natalie Bennett's car crash defence of the Green policies on Sunday Politics should elicit the well known spectre: 'Be careful what you wish for' young people. Or to use a famous Shakespeare line:

Take but degree away, untune that string, And, hark, what discord follows!

In praise of Standard Chartered and their advice on African tax avoidance

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The perenially enraged over at Action Aid are today enraged about the way in which Standard Chartered bank gave advice on how to avoid (legally, of course) certain corporate taxes upon investments in poorer African countries. We, in contrast, would like to congratulate Standard Chartered on their public spiritedness in advising people on how to avoid certain corporate taxes in poorer African countries. And we do so on the basis of a point made by Joe Stiglitz. The outrage is here:

One of Africa’s most high-profile banks – Standard Chartered – publicised the advice of a Mauritius-based financial company on how to avoid tax in some of the poorest countries in the world, a new ActionAid report states.

The FTSE-100 bank which operates in 15 African countries published the advice in its Standard Chartered Insights 2013/2014. The publication is aimed at company treasury departments.

The tax avoidance advice – which is entirely legal – can be used to avoid potentially hundreds of millions of dollars in tax in some of the poorest countries in Africa. It suggests structuring investments through Mauritius in order to avoid capital gains tax and withholding tax.

You can hear the frothing at the mouth as they shout in rage at this, can't you? However, this outrage is entirely misplaced, presumably as a result of their ignorance of how corporate taxation works.

The most essential thing to grasp about it is that the company itself is never bearing the economic burden of such a tax. It is always some combination of shareholders and workers. In an entirely autarkic economy it will be the shareholders, capital if you like, which will carry 100% of that burden. In a more open economy the workers pick up some of that burden. For taxing capital in an economy where capital can leave, capital decide not to enter, means that there will be less capital in that economy. Capital plus labour is what raises productivity and thus wages, meaning that less capital means lower wages. As the economy becomes ever more open, and smaller relative to the size of the global economy, then the burden on the workers increases.

It never quite reaches zero on capital as Adam Smith pointed out in his one Wealth of Nations use of "invisible hand". Even if people can invest abroad without penalty some will still prefer to invest at home and thus led, as if by that invisible hand, benefit their fellows. For us, here, this means that the impact of corporate taxation on capital will never be zero.

Which brings us to Joe Stiglitz's point. Which is that the burden of a tax can be over 100%. What people lose from the tax being levied can be greater than the amount raised from that tax. That's one of the failures of the Robin Hood Tax of course.

But now to the case at hand. As an economy becomes smaller relative to the global economy the workers carry more of the tax burden. Poor African countries have economies the size of a modest English town: they're small therefore. And given that we are talking about foreign investment here they are entirely open to the global economy. So, the burden of any capital taxation is largely going to fall upon the workers in those poor African economies. And that burden can be (and we would estimate will be) higher than the tax collected.

Meaning that, if you've advised people to dodge that corporate taxation and the investment thus goes ahead, that you've just raised the wages of some of the poorest people in the world. For note that the effect isn't upon just those workers in the investments made. It's upon all of the workers in the economy where the investment is made.

Advising people to invest in sub-Saharan Africa through Mauritius thus raises wages in sub-Saharan Africa by whatever effect on investment happens now it's free of those corporate taxes. All of which strikes us as a bloody good idea.

So why is Action Aid so spittle flecked at the very thought of it? We assume it's just because they're ignorant of how corporate taxation works. Which leaves us with only one last question. Why do they expend so much effort telling us how the tax system should work when they've no clue about how it does?

Never mind the quality of the Green New Deal just feel the width

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The Green New Deal has another of their little reports out. Essentially saying the same as all of the previous ones. Print more money to spend on all that Caroline Lucas holds dear. But it really does have to be said that the level of economic knowledge that goes into these reports is not all that high. We've for some years now had the egregious Richard Murphy shouting that we should just collect all hte tax avoided and evaded in order to beat austerity. He not realising that collecting more tax is austerity. For it reduces the fiscal stimulus as it reduces the budget deficit. And of course, there's a similar gross error in this latest report:

No Need to Repay QE Since QE involves a central bank putting new money into circulation by creating e-­‐money and using it to buy assets, this will not increase Europe’s debt levels according to the originator of the term ‘quantitative easing’, Professor Werner, Director of the Centre for Banking, Finance and Sustainable Development at the University of Southampton. He states that since the central bank can simply keep the assets on its balance sheet then there is no need for taxpayers to pay or to expand public debt. The assets should simply stay on the central bank balance sheet. Furthermore, this debt, which would be owed by the government to the central bank would not have to be repaid, as Adair Turner, the former Chairman of the UK Financial Services Authority has made clear. In the European context, the EIB is the European Union's bank, owned by and representing the interests of the EU Member States and so the debt that the EIB would incur through Green Infrastructure QE would also not have to be repaid.

Well, according to that first paragraph I've no need to repay my mortgage as I used the loan to buy an asset. But leaving that aside note the deep appreciation of matters economic on display here.

QE is the central bank creating money to purchase assets. Therefore the EIB can and should do this. But the EIB is not a central bank with money creating powers. It's an EU development bank that borrows on the usual capital markets for funding. The EIB simply cannot do QE because it's not a central bank.

We might not expect any more insight than this from a combination of Caroline Lucas, Richard Murphy and Colin Hines. But Larry Elliott has always been rather more sound than this: is he still with this group or has he left in disgust?