Low rates and flat taxes – why are we avoiding tax reform?
10 April 2015
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We have a tax system that is badly designed in principle and far too complex in practice. It is completely unreasonable for politicians to blame individuals and companies who try to minimise their tax bills using the devices that the government has itself designed. Indeed, much tax avoidance involves the exploitation of loopholes deliberately created by government to encourage certain types of investment.
Lord Fink was recently ridiculed for arguing that everybody undertakes tax avoidance. However, to a large degree, that is true. Avoidance simply involves re-arranging your affairs or changing your behaviour with the purpose of paying less tax. The Church of England – a strong critic of tax avoidance – receives huge benefits from its status as a charity which go well beyond the gift aid scheme. People use the pension system, self-employed status, the rules relating to the importation of cigarettes from the EU and a wide range of other schemes to reduce tax bills. Labour and Conservative donors and prominent politicians alike have used yet more complex ways of reducing the tax they owe by exploiting trusts or capital gains tax wheezes.
It is clear that the public are not happy about this state of affairs. This is partly because politicians and the media – either wilfully or through incompetence – often mix up tax avoidance with tax evasion, the latter being a form of theft. However, people are also aggrieved at what they see as “aggressive” tax avoidance. Unfortunately, there is no hard and fast line one can draw between vanilla tax avoidance, vanilla with chocolate sauce tax avoidance and aggressive tax avoidance. Some people may believe they know aggressive avoidance when they see it but, in reality, the number of cases that fall into that category is small.
In fact, the use of tax avoidance strategies has benefits. It allows companies to circumnavigate very high rates of tax which discourage economic activity or avoid tax systems – of which there are many – which unintentionally tax some types of income twice. Nevertheless, the current position is neither desirable nor stable.
Tax loopholes distort the economy and their exploitation wastes talented people who should be doing something better with their time. If we want to reduce tax avoidance, there is an easy solution. We should simplify the tax system and hugely reduce the rates of the most punitive taxes such as inheritance tax. We could keep exemptions for charitable giving and limited pensions saving but we should stop there.
Furthermore, the whole system of corporate taxation needs to return to an economically rational basis. Instead of a labyrinthine system whereby accountants try to work out in which of several dozen jurisdictions a company has earned its profits, we should simply tax investors in a company on the returns they earn in the tax jurisdiction in which investors live. That is how corporations used to be taxed and how interest on corporate borrowing is taxed. At a stroke this would remove several of the most hotly disputed problems in the corporate tax system.
This article was first published in House Magazine.
Lord Fink was recently ridiculed for arguing that everybody undertakes tax avoidance. However, to a large degree, that is true. Avoidance simply involves re-arranging your affairs or changing your behaviour with the purpose of paying less tax. The Church of England – a strong critic of tax avoidance – receives huge benefits from its status as a charity which go well beyond the gift aid scheme. People use the pension system, self-employed status, the rules relating to the importation of cigarettes from the EU and a wide range of other schemes to reduce tax bills. Labour and Conservative donors and prominent politicians alike have used yet more complex ways of reducing the tax they owe by exploiting trusts or capital gains tax wheezes.
It is clear that the public are not happy about this state of affairs. This is partly because politicians and the media – either wilfully or through incompetence – often mix up tax avoidance with tax evasion, the latter being a form of theft. However, people are also aggrieved at what they see as “aggressive” tax avoidance. Unfortunately, there is no hard and fast line one can draw between vanilla tax avoidance, vanilla with chocolate sauce tax avoidance and aggressive tax avoidance. Some people may believe they know aggressive avoidance when they see it but, in reality, the number of cases that fall into that category is small.
In fact, the use of tax avoidance strategies has benefits. It allows companies to circumnavigate very high rates of tax which discourage economic activity or avoid tax systems – of which there are many – which unintentionally tax some types of income twice. Nevertheless, the current position is neither desirable nor stable.
Tax loopholes distort the economy and their exploitation wastes talented people who should be doing something better with their time. If we want to reduce tax avoidance, there is an easy solution. We should simplify the tax system and hugely reduce the rates of the most punitive taxes such as inheritance tax. We could keep exemptions for charitable giving and limited pensions saving but we should stop there.
Furthermore, the whole system of corporate taxation needs to return to an economically rational basis. Instead of a labyrinthine system whereby accountants try to work out in which of several dozen jurisdictions a company has earned its profits, we should simply tax investors in a company on the returns they earn in the tax jurisdiction in which investors live. That is how corporations used to be taxed and how interest on corporate borrowing is taxed. At a stroke this would remove several of the most hotly disputed problems in the corporate tax system.
This article was first published in House Magazine.
3 thoughts on “Low rates and flat taxes – why are we avoiding tax reform?”
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So, why are we avoiding tax reform? The article doesn’t answer the question it poses.
Taxing produced factors of production, income and capital, transfers wealth from producers to non-producers.
Allowing the non-produced factor of production, land, to capitalise it’s value into selling prices/rental income also transfers wealth from producers to non-producers.
So, we have an economic system that seems custom made to distort incentives and create deadweight costs.
As all taxes are ultimately paid out from land rent, the exact compensation we owe the community is the rental value of land our property occupies. No a penny more, or less.
Thus we get a fair distribution of all the factors of production, so we also get optimal economic efficiency.
It doesn’t get any flatter or more simple than that.
The trouble is, the very wealthiest if our society also own around three times more value than they currently pay in tax.
So, under a fair economic system of not taxing producers and sharing land rent instead, the top 1% of households would pay/loose £100bn per year of wealth/welfare.
To answer Alex’s point, we don’t do tax reform, because this minority of wealthy elite will not let it happen. They finance politics, the media, education and think tanks like the IEA to make sure it never will.
I suspect that we don’t see radical tax reform for three reasons:
1. There would be losers as well as winners. There would always be losers in relative terms. But there would have to be losers in absolute terms too, when the state’s finances had no slack in them. There is obviously no slack at the moment, but I fear that there will always be very little slack because politicians like to spend what they can.
2. There is a risk that things would not work out as hoped. Behavioural effects are unpredictable. And when there is no slack in the state’s finances, politicians quite reasonably do not want to take the risk.
3. Other countries do different things. New opportunities to play off different tax systems against one another would arise. That could present a serious risk to revenue.
Turning to the taxation of corporate profits, one issue with the idea of taxing the shareholder where they live is that you would have a company in one country, benefiting from that country’s infrastructure, healthcare and education for its workforce, and so on, and not contributing anything for those benefits. If all countries had much the same tax rates and if each country’s outward and inward investments were roughly in balance, that might not matter too much. But the world is not like that yet. So if we are to be as radical as not taxing profits in the hands of the company, I would prefer something like the 2020 Tax Commission’s proposal, of taxing money when it flows out of the circle of UK companies, whether as interest or as dividends, and whether to a UK individual or to a foreign entity of any nature – although not, of course, when money flows out because a company is buying goods or services from abroad. (Disclosure: I was a member of the 2020 Tax Commission.)
On degrees of tax avoidance, there are no sharp boundaries, but I think we can easily recognize a lot of the aggressive tax avoidance that goes on. And while the occasions upon which such schemes are implemented may be modest in number, the amounts of money are large. Moreover, it is possible to legislate. We now have the GAAR – although it is a little early to tell how effective it will be.