Flat tax » Tax Research UK

Why the Bulgarian flat tax won’t work

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Jul 312007

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.

Bulgaria to have a flat tax

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Jul 312007

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.

Goodbye Mr Moulton

Ethics, Flat tax, Private equity Comments Off

Jun 182007

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.

Progressive taxation makes sense

Economics, Flat tax, Tax management 4 Responses »

May 082007

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.

Flat tax – definitely not a classic

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Apr 042007

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.

When is a flat tax far from flat?

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Apr 042007

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.

Who are you kidding?

Development, Economics, Flat tax, Tax Havens 5 Responses »

Feb 132007

I’m told I was in Le Monde this weekend, being quoted about Bono. But what added a touch of irony was that on the opposite page was an advert for the new ‘tax heaven’ (paradis fiscaux) of Macedonia. I can’t find an on-line version of the ad, so I’ve made it available here and I’m sure they won’t mind; it’s simply a synopsis of their web site.

Ignore for a minute some of the absurd factual claims in the ad. Just look at the CIA fact book to see they don’t stack. Concentrate on the tax instead. It’s a fiscal heaven, they say. But then look on the web site for discussion of labour costs and note that they say:

An educated and qualified labor force is available to investors in Macedonia. The average gross monthly salary is 370 Euros, out of which 220 Euros are net salary, and the remaining 150 Euros are for payroll taxes.

Which looks like an effective tax rate of over 40% on annual income of £3,100 in Macedonia. When the investor will be paying nothing what sort of labour relations is that going to create?

The reality is that this is no low tax state. This is a desperate state. So why invest? No doubt that’s what Macedonia asked of itself before making such an absurd investment proposition. And I suspect anyone with any sense has failed to find an answer. The reason’s simple. Tax competition is the badge of a failed state. That’s what Macedonia is promoting. I feel really sorry that someone sold them such a bad deal.

There is no myth about the Tax Gap – it’s real

Economics, Ethics, Flat tax Comments Off

Feb 022007

The Wall Street Journal published an editorial on 30 January (hidden behind their subscription wall) in which they challenged the assumption, inherent in recent Senate hearings, that tackling the Tax gap is a good idea. According to reports, the WSJ says:

The problem is that most of the financial and social costs [of tackling the Tax gap] end up being borne by those who already dutifully pay their taxes, in the name of catching the few who evade the law.

It apparently goes on to say:

The more complicated a tax system, the more likely taxpayers won’t understand, or will try to dodge, the rules. Simple tax regimes, such as a single flat rate, encourage compliance and efficiency, not to mention economic growth. This has been the experience of many Eastern European countries after they imposed a flat tax, and the United States had similar jumps in reported tax income from “the rich” following the 1986 tax reform that cut rates and closed loopholes.

This is nonsense. Taxpayers will dodge the rules whatever they are. As a spokesperson for Moore Stephens said in the UK in 2005:

No matter what legislation is in place, the accountants and lawyers will find a way around it. Rules are rules, but rules are meant to be broken.

I wish it weren’t true, but right now I believe that this is too common to accept the WSJ argument. And the rest of their ideas on flat tax are debunked by the IMF, amongst others. Eastern Europe has recovered as its come out of chaos: no more.

So what’s the real WSJ agenda? I’m afraid it’s to support tax competition, which its supporters claim to be a process where :

individuals can choose among jurisdictions with different levels of taxation when deciding where to work, save, and invest. This ability to avoid high-tax nations makes it more difficult for governments to enforce confiscatory tax burdens. In effect, tax competition pressures politicians to be fiscally responsible in order to attract economic activity (or to keep economic activity from fleeing to a lower-tax environment).

Note what this means though:

Tax havens are good, although they can only work in secrecy and usually involve the use of criminal tax evasion practices;
Secrecy is itself paramount – which places a higher value on individual property rights than government property rights, which is inappropriate;
Inefficient markets are best, because this secrecy favours multinational companies over domestic ones, and old companies over new ones;
The wealthy are favoured, since you cannot benefit from this process if you are not.

Nor has anyone ever proven the claims made, which are counterintuitive given these requirements – even of market theory in neoclassical economics, of which this theory is anyway a logical distortion since the assumptions required to make it work cannot and do not hold true in practice.

So, anyone who says the tax gap is a myth is actually saying that the tax evaders who criminally free-ride the world’s economy, ably assisted by the suppliers of corruption services, should be allowed to carry on. I’m sorry: I think that’s criminal.

The Economist on flat tax

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Jan 232007

A surprisingly well balanced review of the current state of flat taxes is to be found in last week’s Economist. It concludes:

On balance, it would seem that the flat-tax revolution is more likely than not to slow, and even reverse eventually, as the income gap between western and east-central Europe narrows.

In other words, the phenomena is a simple one that has been required to assist the transition from disorder to order, but has nothing to offer developed economies. That may well be true.