The curious business of taxation

Wages have stagnated, corporations contribute less to Treasury coffers as their profits grow ever va

Something very odd has happened to the world economy in the past decade or so. With the march of globalisation, real wages have more-or-less stagnated in the developed world, yet returns to capital have shot up.

Moreover, as the benefits of growth have started to accrue more to capital-holders than to workers, the share of government revenue from corporate taxation has fallen.

Across the world, governments have found it more and more difficult to tax corporations, and so the tax burden has instead fallen squarely and heavily onto the shoulders of individuals.

Making sense of how and why this has happened is fairly straightforward. With the emergence of industrial capitalism in the late 19th and early 20th Centuries, governments in the developed world realized a balance had to be struck between the demands of the market and the demands of the broader society in which markets were located.

This realization came sooner in some places – as with Bismarck’s development of the welfare state in Germany in the 1880s.

In Britain, the process of taming the market started perhaps a little later, beginning with Lloyd George’s radical reforms as Chancellor in the early years of the last century, and reaching its zenith in the post-war settlement created by the Attlee Government of 1945-51.

What marked out this earlier stage of the relationship between markets and societies was that it all happened under the roof of one particular state.

A balance could be struck, therefore, between the demands of economic growth and of social protection, because the nation state was in a powerful position to impose whatever regulation it saw as necessary on corporations.

Now globalisation has shattered that balance.

Capital can move jurisdiction at will. The mechanisms of taxation and regulation that can be used by the state have grown useless and atrophied.

States cannot set the terms of operation for corporations that are free to relocate to more benign host countries.

The balance of power has slipped from democratic governments to globally mobile corporations, with states reduced to adopting beggar-my-neighbour policies of tax competition.

It is unsurprising, given this reallocation of political power, that the benefits of the world economy accrue increasingly to the owners of capital rather than to the providers of labour, and that the tax burden in countries like the UK falls disproportionately on individuals rather than corporations.

These problems were illustrated starkly last week, in the Guardian’s investigation into the economics of the world banana industry.

Del Monte, Chiquita and Dole sold over £400 million worth of bananas in Britain last year. Yet these three corporations between them paid only £128,000 tax in the UK.

To put things into perspective, the annual income to the UK Exchequer from taxation of banana companies is less than the income tax paid in a three month period by the Liverpool footballer John Arne Riise (if the copy of his wage slip that has been circulating on the internet is to be believed).

How do these companies manage to pay so little tax? Well, primarily, through the operation of complex webs of financial transactions known as ‘transfer pricing’, whereby semi-imaginary deals between different subsidiaries of the same company are used to move profits from one jurisdiction to another.

As the Guardian article illustrated, the tax avoiding behaviour of UK banana sellers are so Byzantine and complicated that, on its way from Latin America to our supermarket shelves, a bunch of bananas will have passed through virtual balance sheets in the Isle of Man, Ireland, Bermuda, Jersey and the Cayman Islands.

The combination of tax havens and transfer pricing allows large multinational corporations to set their tax rates more or less at will.

As things stand, of course, none of this is actually illegal. Traditionally, the distinction has been drawn between tax evasion, which is the illegal activity of evading one’s full tax liabilities, and tax avoidance, which is the legal activity of arranging an individual’s or corporation’s affairs, within the letter of the law, so as to minimise one’s tax exposure.

Unsurprisingly, it is hard to hold a clear line between the two, and many schemes of tax avoidance shade over towards the borders of tax evasion. Indeed, some writers on tax have coined the term ‘avoision’ to refer to those schemes which fall somewhere in the disputed borderlands.

Large corporations are concerned to avoid downright illegality, and so tend not to practice tax evasion.

But, as the banana example shows, large corporations have no need to get into straightforward illegality when their interests can be served so fully by avoidance strategies using transfer pricing and tax havens.

Tax avoidance is a despicable practice, for a number of reasons. Firstly, it is deeply anti-democratic. It frustrates the legislative intentions embodied in tax legislation, in favour of allowing the distribution of ownership in the economy to be determined by the machinations of tax avoiders themselves.

Secondly, tax avoidance ignores basic standards of fairness. Corporations can make money because they have access to our markets, and make use of our workforce, legal system and transport system. Basic fairness surely dictates that corporations therefore have responsibilities to society, and the very minimum of meeting those responsibilities should be meeting the full expectation of a corporation’s tax contribution?

Tax avoidance enables corporate tax avoiders to fail to live up to their side of the ‘social contract’.

As Richard Murphy, Director of Tax Research LLC, succinctly puts it: "Tax is not a cost to a company. It is a distribution out of profits. That puts tax in the same category as a dividend - it is a return to the stakeholders in the enterprise.

"This reflects the fact that companies do not make profit merely by using investors’ capital. They also use the societies in which they operate, whether that is the physical infrastructure provided by the state, the people the state has educated, or the legal infrastructure that allows companies to protect their property rights. Tax is the return due on this investment by society from which companies benefit." (‘Havens and have-nots’, The Guardian 7.11.2007)

Corporations earn their “social license to operate” insofar as they contribute to the general good of the societies in which they exist.

They can only do this when they contribute both towards the economic health of that society and to the democratic aims of that country’s government, through providing revenue to the state that can be used to pursue valuable social policies.

A corporation which shirks its minimal commitment to uphold the basic rules of society, including its taxation rules, fails to earn its justification for existing, and is in need of urgent reform.

I’ve said that the explanation of why corporations contribute so little to society is straightforward.

What is much more difficult is to understand how this situation can be changed. Once markets are global, the individual state has little room for manoeuvre in its efforts to grab social value from internationally mobile capital.

Indeed, it would seem that tax avoidance is the inevitable result of a co-ordination problem among competing firms. If your competitor is avoiding tax, then you will have to do so as well, if you are not to suffer a sizeable commercial disadvantage by comparison. Moreover, tax avoidance is incredibly wasteful: it consumes the efforts of thousands of high-energy, talented, imaginative people; and it does so for a destructive social end.

If tax avoidance could be structurally outlawed, then the enormous energy and imagination that goes into pursuing it could be redeployed to more genuinely productive occupations, and directed towards technical and managerial innovation, instead of just ‘cooking the books’.

There is, so to speak, something of a Prisoner’s Dilemma in operation. We would all be better off if this practice of tax avoidance could be eliminated, but it is individually rational for each corporation to engage in such practices. The questions to be faced, therefore, are why it might be that such practices are currently legally permissible, and how we might bring it about that such practices could be stopped.

This, it seems to me, is one of the most pressing political issues of our day. How can we re-empower our collective institutions, given their powerlessness in the face of globally mobile capital?

From the problems of tax avoidance to the problems of the ‘sub-prime’ mortgage market, what we see everywhere is a failure of regulatory power by states when facing rampant corporate and financial interests that value quick profits over social progress or even long-run economic stability.

When society and the market are no longer “under one roof” these sorts of problems emerge. There are two ways in which they could be brought back under the same roof. One is a retrograde policy of closed-borders and protectionism, which would attempt to re-localize markets. This approach is likely to throw away the material gains of globalization along with its problems of capital mobility.

The forward-looking approach is instead to look for transnational regulatory mechanisms, operating at an EU level (in the first instance) or eventually perhaps even at a global level. Through this approach, we might hope to keep the material benefits of globalization, whilst rebalancing the relationship between corporate power and the power of democratic governments and our collective institutions.

Politicians of all parties should be addressing this agenda with much more energy than we have seen.

Moreover, shifting the tax burden away from individual income from work, and towards the owners of capital, is a policy that could be highly popular, and surprisingly easy to sell.

People could be brought around to an agenda of clamping down on corporate tax avoidance if they were told that it meant that they could pay less personal tax if only corporate scroungers and tax-cheats paid their fair share.

In the long run, we need a better global financial architecture. In the shorter term, a raft of specific policies could be pursued, hopefully in co-operation with other nations. Firstly, we need better public information.

Companies should be required by law to publish in full their tax payments in every jurisdiction in which they operate, so that individual citizens and voters can see whether those companies are good corporate citizens or scrounging cheats.

Secondly, we need to clamp down on tax havens, especially those in our own back yard, like Jersey and the Isle of Man. If need be, consideration should be given to refusing legal recognition to corporate entities based in tax havens.

Thirdly, we need to move towards international accounting practices that rule out the most shameless examples of financial hocus-pocus such as ‘transfer pricing’.

Moreover, we need to clamp down very hard indeed on accounting firms that market the more exotic forms of tax avoidance schemes, by subjecting them to much tougher regulatory legislation. (If a softer approach does not work, then perhaps we should consider legislative measures that could lead to a few senior accounting partners being banged-up for a few years, pour encourager les autres.)

Most of all, democratic states need to take the power back before things it's too late.

What this will involve is the reorientation of tax laws so that they take more account of where real economic activity takes place, rather than being too bamboozled by the formal paper structures of imaginary subsidiaries and bogus holding companies.

More aggressive regulation, pursued at a European level, could provide more government income whilst reducing individual tax burdens.

Best of all, perhaps, all those clever and ingenious corporate accountants who spend their working days devising ever more complex ways of defrauding their fellow citizens could instead expend all that ingenuity and intelligence on doing something more productive instead.

Martin O’Neill is a political philosopher, based at the Centre for Political Theory in the Department of Politics at the University of Manchester. He has previously taught at Cambridge and Harvard, and is writing a book on Corporations and Social Justice.
MILES COLE
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The new Brexit economics

George Osborne’s austerity plan – now abandoned by the Tories – was the most costly macroeconomic policy mistake since the 1930s.

George Osborne is no longer chancellor, sacked by the post-Brexit Prime Minister, Theresa May. Philip Hammond, the new Chancellor, has yet to announce detailed plans but he has indicated that the real economy rather than the deficit is his priority. The senior Conservatives Sajid Javid and Stephen Crabb have advocated substantial increases in public-sector infrastructure investment, noting how cheap it is for the government to borrow. The argument that Osborne and the Conservatives had been making since 2010 – that the priority for macroeconomic policy had to be to reduce the government’s budget deficit – seems to have been brushed aside.

Is there a good economic reason why Brexit in particular should require abandoning austerity economics? I would argue that the Tory obsession with the budget deficit has had very little to do with economics for the past four or five years. Instead, it has been a political ruse with two intentions: to help win elections and to reduce the size of the state. That Britain’s macroeconomic policy was dictated by politics rather than economics was a precursor for the Brexit vote. However, austerity had already begun to reach its political sell-by date, and Brexit marks its end.

To understand why austerity today is opposed by nearly all economists, and to grasp the partial nature of any Conservative rethink, it is important to know why it began and how it evolved. By 2010 the biggest recession since the Second World War had led to rapid increases in government budget deficits around the world. It is inevitable that deficits (the difference between government spending and tax receipts) increase in a recession, because taxes fall as incomes fall, but government spending rises further because benefit payments increase with rising unemployment. We experienced record deficits in 2010 simply because the recession was unusually severe.

In 2009 governments had raised spending and cut taxes in an effort to moderate the recession. This was done because the macroeconomic stabilisation tool of choice, nominal short-term interest rates, had become impotent once these rates hit their lower bound near zero. Keynes described the same situation in the 1930s as a liquidity trap, but most economists today use a more straightforward description: the problem of the zero lower bound (ZLB). Cutting rates below this lower bound might not stimulate demand because people could avoid them by holding cash. The textbook response to the problem is to use fiscal policy to stimulate the economy, which involves raising spending and cutting taxes. Most studies suggest that the recession would have been even worse without this expansionary fiscal policy in 2009.

Fiscal stimulus changed to fiscal contraction, more popularly known as austerity, in most of the major economies in 2010, but the reasons for this change varied from country to country. George Osborne used three different arguments to justify substantial spending cuts and tax increases before and after the coalition government was formed. The first was that unconventional monetary policy (quantitative easing, or QE) could replace the role of lower interest rates in stimulating the economy. As QE was completely untested, this was wishful thinking: the Bank of England was bound to act cautiously, because it had no idea what impact QE would have. The second was that a fiscal policy contraction would in fact expand the economy because it would inspire consumer and business confidence. This idea, disputed by most economists at the time, has now lost all credibility.

***

The third reason for trying to cut the deficit was that the financial markets would not buy government debt without it. At first, this rationale seemed to be confirmed by events as the eurozone crisis developed, and so it became the main justification for the policy. However, by 2012 it was becoming clear to many economists that the debt crisis in Ireland, Portugal and Spain was peculiar to the eurozone, and in particular to the failure of the European Central Bank (ECB) to act as a lender of last resort, buying government debt when the market failed to.

In September 2012 the ECB changed its policy and the eurozone crisis beyond Greece came to an end. This was the main reason why renewed problems in Greece last year did not lead to any contagion in the markets. Yet it is not something that the ECB will admit, because it places responsibility for the crisis at its door.

By 2012 two other things had also become clear to economists. First, governments outside the eurozone were having no problems selling their debt, as interest rates on this reached record lows. There was an obvious reason why this should be so: with central banks buying large quantities of government debt as a result of QE, there was absolutely no chance that governments would default. Nor have I ever seen any evidence that there was any likelihood of a UK debt funding crisis in 2010, beyond the irrelevant warnings of those “close to the markets”. Second, the austerity policy had done considerable harm. In macroeconomic terms the recovery from recession had been derailed. With the help of analysis from the Office for Budget Responsibility, I calculated that the GDP lost as a result of austerity implied an average cost for each UK household of at least £4,000.

Following these events, the number of academic economists who supported austerity became very small (they had always been a minority). How much of the UK deficit was cyclical or structural was irrelevant: at the ZLB, fiscal policy should stimulate, and the deficit should be dealt with once the recession was over.

Yet you would not know this from the public debate. Osborne continued to insist that deficit reduction be a priority, and his belief seemed to have become hard-wired into nearly all media discussion. So perverse was this for standard macroeconomics that I christened it “mediamacro”: the reduction of macroeconomics to the logic of household finance. Even parts of the Labour Party seemed to be succumbing to a mediamacro view, until the fiscal credibility rule introduced in March by the shadow chancellor, John McDonnell. (This included an explicit knockout from the deficit target if interest rates hit the ZLB, allowing fiscal policy to focus on recovering from recession.)

It is obvious why a focus on the deficit was politically attractive for Osborne. After 2010 the coalition government adopted the mantra that the deficit had been caused by the previous Labour government’s profligacy, even though it was almost entirely a consequence of the recession. The Tories were “clearing up the mess Labour left”, and so austerity could be blamed on their predecessors. Labour foolishly decided not to challenge this myth, and so it became what could be termed a “politicised truth”. It allowed the media to say that Osborne was more competent at running the economy than his predecessors. Much of the public, hearing only mediamacro, agreed.

An obsession with cutting the deficit was attractive to the Tories, as it helped them to appear competent. It also enabled them to achieve their ideological goal of shrinking the state. I have described this elsewhere as “deficit deceit”: using manufactured fear about the deficit to achieve otherwise unpopular reductions in public spending.

The UK recovery from the 2008/2009 recession was the weakest on record. Although employment showed strong growth from 2013, this may have owed much to an unprecedented decline in real wages and stagnant productivity growth. By the main metrics by which economists judge the success of an economy, the period of the coalition government looked very poor. Many economists tried to point this out during the 2015 election but they were largely ignored. When a survey of macroeconomists showed that most thought austerity had been harmful, the broadcast media found letters from business leaders supporting the Conservative position more newsworthy.

***

In my view, mediamacro and its focus on the deficit played an important role in winning the Conservatives the 2015 general election. I believe Osborne thought so, too, and so he ­decided to try to repeat his success. Although the level of government debt was close to being stabilised, he decided to embark on a further period of fiscal consolidation so that he could achieve a budget surplus.

Osborne’s austerity plans after 2015 were different from what happened in 2010 for a number of reasons. First, while 2010 austerity also occurred in the US and the eurozone, 2015 austerity was largely a UK affair. Second, by 2015 the Bank of England had decided that interest rates could go lower than their current level if need be. We are therefore no longer at the ZLB and, in theory, the impact of fiscal consolidation on demand could be offset by reducing interest rates, as long as no adverse shocks hit the economy. The argument against fiscal consolidation was rather that it increased the vulnerability of the economy if a negative shock occurred. As we have seen, Brexit is just this kind of shock.

In this respect, abandoning Osborne’s surplus target makes sense. However, there were many other strong arguments against going for surplus. The strongest of these was the case for additional public-sector investment at a time when interest rates were extremely low. Osborne loved appearing in the media wearing a hard hat and talked the talk on investment, but in reality his fiscal plans involved a steadily decreasing share of public investment in GDP. Labour’s fiscal rules, like those of the coalition government, have targeted the deficit excluding public investment, precisely so that investment could increase when the circumstances were right. In 2015 the circumstances were as right as they can be. The Organisation for Economic Co-operation and Development, the International Monetary Fund and pretty well every economist agreed.

Brexit only reinforces this argument. Yet Brexit will also almost certainly worsen the deficit. This is why the recent acceptance by the Tories that public-sector investment should rise is significant. They may have ­decided that they have got all they could hope to achieve from deficit deceit, and that now is the time to focus on the real needs of the economy, given the short- and medium-term drag on growth caused by Brexit.

It is also worth noting that although the Conservatives have, in effect, disowned Osborne’s 2015 austerity, they still insist their 2010 policy was correct. This partial change of heart is little comfort to those of us who have been arguing against austerity for the past six years. In 2015 the Conservatives persuaded voters that electing Ed Miliband as prime minister and Ed Balls as chancellor was taking a big risk with the economy. What it would have meant, in fact, is that we would already be getting the public investment the Conservatives are now calling for, and we would have avoided both the uncertainty before the EU referendum and Brexit itself.

Many economists before the 2015 election said the same thing, but they made no impact on mediamacro. The number of economists who supported Osborne’s new fiscal charter was vanishingly small but it seemed to matter not one bit. This suggests that if a leading political party wants to ignore mainstream economics and academic economists in favour of simplistic ideas, it can get away with doing so.

As I wrote in March, the failure of debate made me very concerned about the outcome of the EU referendum. Economists were as united as they ever are that Brexit would involve significant economic costs, and the scale of these costs is probably greater than the average loss due to austerity, simply because they are repeated year after year. Yet our warnings were easily deflected with the slogan “Project Fear”, borrowed from the SNP’s nickname for the No campaign in the 2014 Scottish referendum.

It remains unclear whether economists’ warnings were ignored because they were never heard fully or because they were not trusted, but in either case economics as a profession needs to think seriously about what it can do to make itself more relevant. We do not want economics in the UK to change from being called the dismal science to becoming the “I told you so” science.

Some things will not change following the Brexit vote. Mediamacro will go on obsessing about the deficit, and the Conservatives will go on wanting to cut many parts of government expenditure so that they can cut taxes. But the signs are that deficit deceit, creating an imperative that budget deficits must be cut as a pretext for reducing the size of the state, has come to an end in the UK. It will go down in history as probably the most costly macroeconomic policy mistake since the 1930s, causing a great deal of misery to many people’s lives.

Simon Wren-Lewis is a professor of economic policy at the Blavatnik School of Government, University of Oxford. He blogs at: mainlymacro.blogspot.com

 Simon Wren-Lewis is is Professor of Economic Policy in the Blavatnik School of Government at Oxford University, and a fellow of Merton College. He blogs at mainlymacro.

This article first appeared in the 21 July 2016 issue of the New Statesman, The English Revolt