Tax Research UK

I’ve just reviewed a KPMG paper on tax and CSR. It’s lame.

So why not read something really good instead. Try the paper with the above title available here. This is a fascinating read, well argued and quite simply moves the debate on tax justice forward considerably. I’d call it seminal.

The abstract says this:

Although there is consensus about the need for equity, academics and policy makers disagree about the best tax system because we have ignored the need to first identify equity goals appropriate for a just government and then to design a tax system to help achieve those goals. This article proposes that the principal equity goal underlying a just government is the creation of equal opportunities for all citizens to achieve self realization, i.e. to maximize their potential. It proposes, therefore, that a tax should be designed to achieve equal opportunity for self realization as one of its principal goals. Viewing equal opportunity for self realization as a design issue leads to the identification of another principle that is foundational - the promotion of democracy. Both political philosophy and empirical literature suggest that equal access to the electoral process and participation in the community has to exist in order for equal opportunity for self realization to exist. Designing a tax system to help achieve these goals will not only increase equity, but also may provide efficiency gains that analysts have previously ignored.

To illustrate the importance of designing a tax system based upon these equity principles, this article revisits the debate about the desirability of an income tax versus a consumption tax. It argues that a progressive income tax, which limits loss deductions, is better than an ideal consumption tax in establishing the conditions for equal opportunity for self realization and democracy. A progressive income tax that limits loss deductions burdens investment income, which is a major source of political power. In contrast, a consumption tax cannot burden the disproportionate political power of the wealthy because it only burdens investment income in narrow situations and wealthy individuals only consume a small percentage of their total income. Although taxpayers can use portfolio adjustments to eliminate the burden on investment income in an ideal income tax, they have not used such adjustments in our actual income tax. This behavior may result from taxpayer concern that portfolio adjustments can decrease the after-tax return below that obtained in a fully taxable situation due to our tax system’s limitations on loss deductions and changes in applicable tax rates.

This article also analyzes some other efficiency and equity claims for the two forms of taxes. The efficiency claims for an ideal consumption tax versus our existing income tax are overstated when viewed in the context of real-world systems that take into account taxpayer behavior and transition relief. Given the uncertain efficiency gains of a consumption tax in the real world, there is a strong argument that the equity goals discussed herein should govern the selection of a tax system. Such equity goals favor a progressive income tax that burdens investment income.

The download is free, but you have to register.

If you don’t read it you’ve missed something little short of a gem. If you’re in any doubt read that last paragraph of the abstract again and then believe me that James R. Repetti delivers on his promise to prove this is the case.

I think it’s true that to be great any work of art, film, play, music or article should make you view the world differently after you’ve experienced it. This article does that.

Thanks to Martin Tittle for the recommendation.

Richard Murphy Economics, Ethics, Flat tax, Tax management

The was an article in the Polish press yesterday with the title:

Poland’s progressive tax system could alienate investors

As the story said:

Finance experts and business people are pointing out that Poland is surrounded by countries with low, flat tax rates. If Polish governments refuse to grasp the nettle and lower tax, investment might just head abroad.

The pressure, of course, comes from the so called ‘flat tax’ states - so called because they are nothing of the sort.

But who were the ‘finance experts’? Why, KPMG (of course):

“If ]Poland] doesn’t introduce it, the country lose the foreign investment battle, we’ll be less and less competitive”, Peter Kay, financial expert from KPMG, a worldwide consultancy was quoted in Poland’s Dziennik daily.

As the senior prime minister rightly said though:

Flat tax works like a counter Robin Hood: takes away from the poor to give to the rich

Which is, of course why progressive taxation is essential. But do KPMG care about that? Not one bit. They’ll whistle all the way to the destruction of social justice.

Richard Murphy Ethics, Flat tax, KPMG

I’m delighted to see that enthusiasm for Bulgaria’s new flat tax is underwhelming. I’ve read a lot of Bulgarian material on this over the last week. The follwoing is typical, and comes from the editorial columns of the Sofia Echo:

The agreement announced by the three parties in Bulgaria’s ruling coalition to introduce a flat tax system in 2008 has had a mixed reception.

It goes on to say:

The idea is to tax all individual incomes at 10 per cent, scrapping the current three-bracket system. Prime Minister Sergei Stanishev and his lieutenants, including Economy Minister Petar Dimitrov, say that they believe that the new system, along with a cut in social security contributions, will bring more revenue into the system. They say that they believe that the new system will encourage a higher level of compliance.

It’s clear that the paper does not believe this.

However, the proposal has its detractors. Podkrepa labour federation says that everyone up to a gross monthly income of 450 leva will be hard hit. The federation says that a move that in effect will make people in lower income brackets be required to pay more tax is a negation of the Government’s promises to lower the tax burden for low and medium-income bracket earners.

What is not yet clear is what will become of a number of rebates. According to media reports purportedly based on leaks from those close to the debate about the new system, a number of tax breaks will be eliminated. Among these, again reportedly, is the rebate given to families with children. If this is true, it would in turn seem to be a negation of Government promises to ease the financial burden on those with children, a step that it undertook to encourage people to have children and so move against Bulgaria’s deepening demographic crisis.

So, as is usual, a flat tax is actually increased tax on the poorest in a community and a tax cut for the rich. There’s no surprise in that. Alvin Rabushka, who designed flat taxes, believes that the poorest in a country have a duty to support the richest within it. He’s told me so. See the quote from him here.

But there’s more to the paper’s objection than this. As it says:

It is well known that lack of tax compliance is a serious problem in Bulgaria. It is difficult to imagine that the cut in social security contributions, along with an effective substantial income tax reduction for higher-income individual earners, will be enough to encourage defaulters and those recalcitrant about being honest about their earnings to suddenly go over to the side of the angels.

Further, if it does prove true that the flat tax system will put an additional burden on lower-income earners, this may be a reverse incentive, for them to conceal whatever income they have.

It would seem that the flat tax proposal may not offer any guarantees of improved compliance, and in fact poses the risk of reduced revenue.

It’s conclusion? :

Before any further consideration is put into restructuring the rates of tax, the best course of action would be for the Government to devote energy and resources to ensuring that tax authorities have the will, capacity, skill and personnel to perform effective enforcement of tax compliance. This, along with a campaign to eliminate waste in public spending, and to be seen doing so, along with a positive campaign to explain the benefits of compliance, would seem to be essential actions to be taken before tinkering with any other aspect of the system.

Quite so. Flat taxes do not solve these issues. But they could make the problems much harder to handle.

Richard Murphy Flat tax

There’s a first rate article on flat tax in a Czech publication called TOL today. Adam Cardais says:

Karl Marx might be shocked to see who’s doing what with tax systems in Central and Eastern Europe these days.

After all, it’s the capitalist West that won’t abandon progressive tax systems, which Marx championed in The Communist Manifesto, while the former Soviet bloc countries are lining up to buck their old ideological fountainhead by moving to a more regressive structure: a single tax rate for nearly all earners, regardless of income.

It’s well worth a read. In particular I like this:

If, then, the flat tax is often nothing more than tax cuts in fancy dress, the resulting drop in revenues raises serious questions about how long governments can afford to embrace it.

A good question.

Richard Murphy Flat tax

There’s an interesting comment on the new Bulgarian flat tax at Novinite, which is a Sofia based news agency. It says:

Certainly, [flt tax] has a fair number of supporters and detractors, but even the staunchest advocate of flat tax will agree that it is not a magic wand that will solve all the problems in an economy.

If properly applied, flat tax could go a long way to achieve that goal, but no matter how low you push the taxation rate, it will not attract too many new investors if it is not coupled with measures to fight corruption.

Part of the reason why the flat tax has been an efficient tool in diminishing the “grey economy” in other countries was the willingness of governments to couple it with draconic measures to crack down on tax evasion.

Even though it is a long-term goal, this kind of measures give the foreign companies the feel that things are going in the right direction and makes them more likely to invest their money in those economies.

Bulgaria, on the other hand, has notoriously been sluggish with its fight against corruption and the organised crime.

If the cabinet fails to supplement the flat tax with a package of measures that would make corruption and tax evasion economically unsound, it will only achieve the further erosion of the macroeconomic stability built up by previous governments for the suspect goal of winning another election.

I agree.

Richard Murphy Flat tax

Bulgaria has announced it is to have a flat tax in 2008.

Alvin Rabushka will be cock-a-hoop.

But he shouldn’t be. As I’ve shown for the ACCA, these places have not got flat taxes, and flat taxes don’t work.

Richard Murphy Flat tax

I have to say I thought John Moulton’s contribution to the Private Equity debate this weekend was amsuing, it was so counter-prodcutive. Writing in the Telepgraph on Saturday (because I suspect he could find no one else to take the piece) he said:

It’s been a bad week for private equity. The industry has done an inadequate job of defending itself and is in danger from rushed and politically-motivated regulatory and taxation measures.

How naive can he be? In this case the rush would simply be to ensure that those working in this sector pay tax in accordance with the law of the country. Right now they don’t pay tax by concession, as I demonstrated with the aid of the Sunday Times yesterday.

But that’s not OK for Moulton. He says:

[L]et’s talk about the taxman. First, the use of debt to finance deals means that interest deductions reduce the tax payable by companies. This is undeniable but to the extent that someone receives the interest in the UK then the interest is taxed in the UK for no net loss. (There is some loss as overseas lenders may pay no UK tax).

Second, it can be said that the 10pc capital gains tax payable on the share of the gains (so-called “carried interest”) that the private equity people pay is a “tax-break”. Well, no one in private equity asked for the 10pc rate. Gordon Brown gave it to us and other entrepreneurs benefit from it.

Actually many in the megafunds do not even pay the 10pc rate. They are “non-domiciled”, typically born elsewhere, living in the UK and not liable to UK capital gains tax at all. This is a long-running anomaly - but again not of private equity’s creation.

We would probably be better off with a simple 20pc rate and if Ireland is anything to go by the Treasury would get more.

So Moulton

1) Recognises offshore costs the UK government cash on debt finance (and most of it comes from offshore);

2) Says the industry did not ask for 10%. This is untrue as the BVCA deal with the government proves (see the Sunday Times again - they did very definitely asked for this), and if MPs do not make this the focus of their questioning this week they have missed the most obvious trick in town;

3) He recognises that the domicile rules are an abuse that means most private equity is not taxed at all;

4) He then argues for a further special tax deal or flat tax, it’s not quite clear which. Either is wholly unacceptable.

And how does he end his article? Like this:

A tax rate of 10pc may be too low but by moving to Switzerland (or lots of other places) this rate can be nil. Taxing private equity hard would result in a move offshore and the loss of a valuable and constructive industry to Britain. Doubtless other financial services benefiting from the UK’s strong position in private equity would also move overseas.

Please tread carefully, Mr Brown.

Blackmail seems to be his only bargaining position. How endearing. How inappropriate too. Because the truth is that private equity cannot really go offshore. The businesses it wants are here. And if wealth opts out and seeks to leave you can be sure that in the end the governments of the populous countries of the world will not accept this. Definitions of residence, control, and where capital gains arise will all change. The tax net is as capable of adapting to change as the private equity market is to seeking loopholes in it. And maybe a tipping point is coming where the very apparent abuse of the wealthy that Moulton promotes will trigger such a change.

I think that may not be far off. Switzerland will be welcome to you Mr Moulton. But I suspect we’ll capture your tax. Which, as you suggest, is more than we do now for many in this sector. Which is a compelling reason for changing the domicile and other rules all at the same time.

Richard Murphy Ethics, Flat tax, Private equity

A question on this blog seems to require more significant treatment than a footnote largely hidden from view. Emily Coltman wrote:

If more tax funds are needed for the Treasury then surely the following people should be top of the list to provide those funds:

a) those who can afford it, and
b) those who don’t already pay their fair share of tax.

Would it be true to say that the super-rich exploiters of the non-domicile rules fall into both those categories?

So would the Revenue’s time not be better spent finding out how much tax could be earned if the domicile loophole were closed, than chasing after and hassling honest small business owners?

I suspect I’m preaching to the converted here

Emily ignores one of the fundamental tenets of neoliberal economics. That is that the rich need to pay less tax to make them work more whilst the poor need to pay more tax to make them work more.

I kid you not. This is an argument oft put forward, and it was spotted in all its absurdity by no less an economist than J K Galbraith decades ago, but you will still hear it being repeated (if not so bluntly and with more padding put between the two arguments) by those on the Right. No one has yet told me when in this argument you switch from poor to rich.

But then, of course, the argument makes no sense. The simple fact is that as you have more cash each pound, Euro or dollar is proportionately worth less to you and therefore you can pay more tax out of it without increasing the overall perception of loss you suffer. And yet neoliberal economics, which bases its whole premise on this marginal concept seeks to deny this obvious conclusion drawn from it when it comes to tax. So the rich can pay more tax: they are better off by definition, and their welfare loss from paying that tax is proportionately no bigger than is that suffered by those who pay in absolute terms proportionately less tax out of lower incomes. In other words, progressive taxation does (within limits) make complete sense.

Emily’s also right. Those who benefit from the domicile rules are amongst the richer members of society. My reason for saying so is straightforward. You cannot exploit the domicile rules unless you have non-UK source income. Since it is hard to have that from earned income these days then it must be from investment income. The vast majority of people in this country have minimal investment income, or investment comes to that. Those who exploit this rule must therefore be in the minority who do . And that does, by definition, make them amongst the richer members of UK society.

They will, however, deny it. I have sat, quite often, with clients whose income puts them in the top 1% of UK income earners who have flatly denied they are well off. But you have to remember, it’s tough being rich, and you need all the cash you can get to stay there. That’s why the apologists for the rich put forward the idea that the rich work harder the less tax they pay. It’s a good excuse for securing the means to pursue excess, but it’s nothing more than that.

Put simply, it’s Emily’s logic that is sound. That we hear too often in tax discussion is flawed. And yes I do think the Revenue will have to come to terms with this sometime.

Richard Murphy Economics, Flat tax, Tax management

In view of the previous story I was amused to note that the Hoover press re-issued Hall and Rabushka’s ‘Flat Tax’ book yesterday.

Apparently it’s now achieved ‘classic’ status. A classic con, maybe. A work of folly, perhaps. A contribution to welfare? No, definitely not. But then Rabuska never intended that. In his opinion a tax system should ensure that the 95% of low income earners provide a life of luxury for the 5% of high income earners. He told me so.

Richard Murphy Flat tax

Flat taxes get more absurd by the day, and the injustice they create increases. Take the new Czech proposal as an example. The claim is that they will have a 15% flat tax. Well, that’s not true.

As MSN reports, it’s not a flat tax because the corporation tax rate is to be 19%. That blows the theory apart.

Worse though, for employees the tax will operate on their gross pay INCLUDING employer’s social security contributions. This does, I suppose, recognise the fact that economically these are borne by labour anyway, but as MSN reports, the consequence is an effective flat tax rate of 23% on average. How is that possible? Well, employer’s contributions in the Czech republic are 35% on top of 12.5% paid by the employee.

Now, I can only make the 23% work if the comparison is being made with a 15% rate on earnings after employee social security contributions, so I suspect MSN (and the FT from whom they got this story) have this calculation wrong. But the real ‘flat’ tax rate on earned income is over 20% on the basis of what I think to be correct assumptions, in addition to which there is 12.5% social security, or about 33% in all. Investment income will instead qualify for ‘flat tax’ at 15%.

So much for flat taxes.

It really is time the press stopped calling them by this name. They are a con trick. They are neither flat, or low rate, or simple. At which point none of the claimed advantages of them exist. Unless your objective is to shift the burden of tax onto working people, for which they are excellent.

Richard Murphy Flat tax