Economic Perspectives – 25

REFLECTIONS ON RECENT TAX HYSTERIA

[Early December 2017]

Where we are now on the subject of taxation – clueless and lost!

Widespread “tax-dodging” is the surest sign that our “tax-raising” process is seriously defective!

Why doesn’t our existing tax system raise enough money to meet all government commitments? The reason is that, instead of applying a principles-based method of levying taxes, our government engages in a “bottom-up” process that starts by identifying “needs” that have never been mandated electorally, nor subjected to the rigour of reliable costing.

These needs rapidly morph into ”entitlements”, then “demands”, only to finish up as state “commitments”. Since the state’s coffers are already over-stretched, further tax increases and government credit expansion (money-printing and/or borrowing) are invariably resorted to, in order to placate a restive electorate.

[Just a thought: If, by contrast, the Chancellor managed the state’s fiscal affairs in the same way that its subjects are obliged to manage theirs, he would have no alternative but to do it the other way round – which would mean limiting his spending programme to the Treasury’s projected tax revenues – which would have to be determined by reference to a transparent and reliable method.]

 

Blaming tax-dodging

 

But, as always happens when treasury reserves fall short of requirements, it is fashionable to blame the nefarious practice of “tax-dodging” for all the state’s funding shortages. In this binary world-view, the money needed for more schools, hospitals, housing, health, transport, overseas aid, infrastructure, public sector pay, and every other need in this period of so-called austerity, would be available if only – oh, if only – the “rich” paid their share of taxes!

Avoidance and evasion

In 1929 Lord Clyde sounded a clarion call that retains its practical relevance to tax law, even today:

“No man in this country is under the smallest obligation, moral or other, so to arrange his legal relations to his business or to his property as to enable the Inland Revenue to put the largest possible shovel into his stores. The Inland Revenue is not slow to take every advantage open to it under the taxing statutes for the purpose of depleting the taxpayer’s pocket. And the taxpayer is in like manner entitled to be astute to prevent, so far as he honestly can, the depletion of his means by the Revenue.”

In the light of that clear and irrefutable statement, consider those dirty words, “offshore” and “haven”.

 

you will hear the mindless bile

 

Any country whose taxes are lower than yours is, from your perspective, both “off your shore” and a “tax haven”. Yet just listen to BBC’s “Question Time” and you will hear the mindless bile that is heaped on those whose financial arrangements include investments in businesses thus advantageously located. Do none of these rabid attackers have pension funds? Did they ensure, before sounding-off so self-righteously, that the managers of their funds had invested exclusively in businesses located in high-tax jurisdictions?!

Avoiding double-tax

Offshore hedge funds or investment funds are so located to ensure that their income, from a wide range of international companies, is not taxed at source. As the fund’s shareholders may reside in any number of jurisdictions, and will be taxed on income when it is received in their country of residence, this arrangement simply prevents income being taxed twice. It is emphatically NOT designed to assist tax evasion. But try explaining that to a scandal-sniffing journalist!

The distinction between (i) arrangements that legitimately reduce tax bills (“avoidance”) and (ii) unlawful exploitation of “loopholes”, such as using confected transactional business networks (“evasion” par excellence), is becoming blurred. The media can be relied upon to attach pejorative epithets to entirely legitimate avoidance on the grounds that it is, in their eyes, “morally reprehensible”.

Where to draw the line? The usual, exceedingly narrow, vision conveniently disregards all the cases of avoidance that is encouraged by the state itself – giveaways such as “duty-free” shops whose lure facilitates trade that might otherwise not occur; investing in an ISA that provides tax-free returns on savings; the fact that riding safety hats carry no VAT if sold to children; and all the other grubby “tax breaks” that every Chancellor builds into every budget to curry favour with the electorate.

Thus does the rapacious state, in this upside-down world, suddenly become your benefactor for no reason other than that it is not grabbing money that is yours anyway.

Principle versus bribery

 

his thought process is geared to buying votes

 

When the Chancellor plans his annual balancing act, the notion of economic principles might, for practical purposes, not exist; his thought process is geared to buying votes instead. An example is the previous budget’s grant of tax-free childcare, under which government adds £2 to every £8 invested by parents in a childcare savings account. As it happens, only 10% of eligible parents have taken up this barefaced electoral bribe.

A similar subterfuge occurs whenever a tax that was obscenely stupid in the first place is suddenly removed – or even, as with stamp duty, partially removed. Stamp duty is a pernicious tax that clogs up the market and inhibits people’s freedom to move when they need to. Stamp duty, like VAT, punishes indiscriminately. Their effect is simply to increase costs.

(Note, incidentally, that a terrible tax is always betrayed by its mendacious name. A tax based on the amount for which a property is being sold has nothing to do with either stamps or duties; just as VAT is plainly just a sales tax, and has nothing whatever to do with “value added”.)

Maze of complexity

The UK tax code has tripled in size over the past 20 years and now stands at more than 17,000 pages. Its voluminous complexity has spawned a massive tax avoidance industry whose chief benefit is to keep legions of “experts” off the streets, since it adds nothing per se to the nation’s wealth.

Thousands of clever accountants and lawyers thrive on its unfathomable intricacy, and it expects that a bemused public will take advantage of any treasury-contrived wheeze, such as inheritance tax exemption for agricultural landowners. Indeed, even if you didn’t know about it, they will soon ram it down your throat, with persuasive assistance from the media, and make you feel guilty at the very thought of disregarding such state-sponsored gifts.

Yet – if you dare take the initiative in laying down your own tax-reduction agenda, your actions are somehow cast as morally reprehensible!

Judgmental moralizing is at work whenever high achievers are quizzed in the press or on TV: “You have done very well – don’t you feel it’s right that you should give something back?”

You can see what’s implicit here: the fact that decent rewards flowed from your years of hard work is simply not good enough. To do so well you must havetaken” something! Why else would they speak about “giving back”?

This, of course, is nothing other than a product of “either/or” doublethink. Economics is not a “zero-sum” game. If it were, standards of living worldwide would have stagnated rather than rise continuously, year after year.

 

Perverse thinking

Indeed, why do these morons stop there? Why not assume that it all belongs to the state anyway, leaving you with an obligation to hand over all earnings that you don’t actually “need”?

Forget your own charitable preferences: in this “compassionate society” the state is the self-appointed agency for orchestrating the whole of the public’s “giving” priorities. Consider for a moment how wonderfully the state spreads its munificence: the largest beneficiary of the UK’s £13 billion annual aid budget is that haven of sanity and scrupulous integrity: Pakistan.

But what if you decide to take early retirement rather than earn even more money that you don’t need? Have you not failed in your moral duty to the state? If, after all, you are still young enough to carry on working, surely it is your moral duty to do so, and pass your earnings to the state? Next stop, by default, is the Gulag…..

….. or possibly Venezuela?

Forgive this deviation, but it demonstrates the endgame of all this perverted logic. Until recently Venezuela held the largest proven oil reserves in the whole world. Then what happened? No, not natural disasters – just a national disaster in the form of a government whose warped ideology inspired it to nationalise over a thousand companies since 1998.

It is now the world’s fastest shrinking economy, with prices rising by 50 per cent per month. The productive structure of the country has been utterly destroyed. It is unable to keep its once bustling refineries in operation, and it has been forced, unbelievably, to become a net oil importer. None of this is exactly according to plan, but absolutely predictable!

Nicolas Maduro, the genius in charge, has passed a new law to cure inflation, the “law of agreed prices”. It sets maximum prices for all products regarded as “essential” – and minimum jail sentences of five years for any wretched trader who doesn’t comply.

The basically law-abiding population are, of course, forced to rely for survival on the black market of unrecorded trading. In the words of one long-suffering citizen, “he will next claim that the law of gravity needs to be changed!”

Fortunately Maduro’s law enforcement record is as pathetic as his laws – 95 per cent of murders have never been solved.

(Ill) – disguised behavioural engineering

Successive UK Chancellors muddle and meddle their way through this minefield of petty regulation, rife with virtue-signalling distractions. For example, setting the price of labour is emphatically not a matter for the Chancellor. How would he know, anyway?

Here we identify yet another feature common to every stupid enactment: its effect is invariably the opposite of its intention. Enforcing a minimum wage on industry will always create unemployment at the margin. Yes, there are some businesses that simply cannot afford to pay it!

Or, imposing minimum alcohol pricing to cure youthful drunkenness? Are there no limits to the level of interference to which our nanny-government will stoop? This inane enactment will impact low earners, while the more expensive brands favoured by the wealthy will be unaffected by it.

This ubiquitous propensity for behavioural engineering, disguised as rules for taxation, has no place in the fiscal code. It serves as a distraction from the Chancellor’s proper job of raising funds for legitimate state expenditure.

It is obsessed with the demand side of the economic equation, without a clue how to satisfy it!

 

 

NEVER FORGET SAY’S LAW

Remember that Say’s Law is irreversible: we produce in order to consume. Fiscal legislation should do nothing to impede individuals and businesses from freely producing the goods and services required by the community. The unintelligent meddling that fills every “Budget” has the opposite effect.

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Supplement to Economic Perspectives – 25

The main focus of this issue of Economic Perspectives is state provision through the tax system.

Since the UK tax system is so riddled with anomalies, and suffers from such dire complexity and confusion, it seems sensible to consider whether a simpler alternative exists.

What follows indicates no more than an outline.

A WELL-ORDERED TAX SYSTEM

In the ordinary state of a healthy economy, comparatively less state funding would be required for the welfare of the most needy citizens because, in the first instance, their needs would quite naturally be taken care of by their families and by the provision of dedicated private charities.

Again, in a well-directed economy, cutting-edge technology and new infrastructure projects would automatically be subjected to cost-benefit analysis by freely competing private sector firms to assess their viability – before government is permitted to risk public money wastefully on multi-billion pound projects on the slender pretext that they appeared to have popular support, and “seemed to be a good idea at the time”!

Such a well-functioning economy would be based on the solid libertarian principles of unilateral free trade; sound money; low regulation; minimal state interference; and low taxes. It is obvious that, in such a state, the level of taxation required is bound to be low relative to national income. Hence there would be little of the furore and controversy surrounding taxes that we see all around us right now.

Added value, not profit

The method of raising such taxes as are necessary in our ideal state would follow classical economic principles and hence cause as little distortion as possible.

Here’s broadly how:

The turnover of a business, minus the cost of all inputs purchased from other businesses (ie their turnover) represents the “value it has added” – or, in classical terms, its “product”.

This product is the natural fund from which returns may be distributed to each of the factors of production (land, labour and capital) that combined to produce it in the first place.

The “products” of all businesses (their total added value) should, logically, equate to the nation’s gross domestic product, GDP – indeed, they would so equate, if government statisticians understood anything at all about the phenomena they purport to be measuring!

Taxable capacity

The added value of any business is of course the only fund from which the government’s share – taxation – may be taken. However, it is necessary first to establish the “taxable capacity” of each business, or that portion of its product, or added value, that remains after paying wages, rent and interest charges – as well as a depreciation charge for replenishing its capital equipment – that is, if it is to stay in business!

By definition, the amount of tax that any business is able to contribute cannot exceed its “taxable capacity”.

Business taxes are currently calculated by reference to “profit”, which is a hopeless measure for determining a just and equitable tax levy: for a start, the concept of profit is infinitely susceptible to manipulation and distortion at the hands of clever accountants.

If therefore, instead of profit, an “added value” accounting model were to be used for establishing a rational tax base, it would be possible for tax assessments to be related to the taxable capacity of every enterprise.

A low, and certain, percentage rate applied to taxable capacity would be both straightforward and transparent and would provide the basis for tax assessments.

Furthermore, since the marginal business, by definition, adds value that is sufficient only to pay wages, interest on borrowings and allow for asset replacement (depreciation), it has no taxable capacity. Any intelligent tax regime would therefore recognize that the taxable capacity of a marginal business is, by definition, zero.

Once again we see the crucial role of the marginal business in ordering economic actions in a non-distortive manner.

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Emile Woolf

[Early December 2017]