Multinational taxes: what do politicians know?

This election has ratcheted up the calls for Starbucks and other multinationals to pay more taxes on their British revenues.  Politicians give no indication of how they will achieve that; one suspects their silence is based on ignorance. This blog is a brief explanation of why multinationals are fully entitled, under present laws, to push profits into lower tax regimes.  If the UK wants to change, it may need multinational legislation.

If a brand owner in one country sells to a distributor in another, they split the total profit between them.  If the companies are independent, the presumption is that the split is “arm’s length” and that is accepted by the tax authorities in both countries.  The game gets tricky when both companies are owned by the same group and the brand ownership is switched from one country to another.

The practice began with Bailey’s Irish Cream which was launched in 1972 to accept the Irish Finance Minister’s offer that any export profits for a new Irish agriculture-based brand would be free of tax for 10 years.  The brand became a huge global success and, come 1982, the ultimate brand owner, Grand Metropolitan, was about to be hit by a sharp jump in taxes.

By coincidence, the concept of “brand equity” as a marketing asset which could go on a balance sheet was also being developed in the 1980s.  Why not move the brand equity from Dublin to the Netherlands which was, then anyway, offering low taxes on Dutch earnings by foreign-owned assets? Why not indeed?

As you can imagine, the British and Irish tax authorities were less that thrilled with that and Grand Metropolitan had to justify that the Netherlands company really was marketing the brand globally.  In effect, the distributor company is renting the use of the brand equity asset from the brand owner and has to pay for that.  If the transfer price is “arm’s length” it is all perfectly legitimate so, for two companies both parts of the same group, what exactly is “arm’s length”?

The multinational can count on the support of the tax authorities in the brand owning country.  Their take decreases by the amount of profits switched to the distributor (or franchisee) country.  And if the brand owning company can show it sells, on the same terms, to (or franchises) companies which are not part of the same group, the case for “arm’s length” is strengthened.

HMRC has spent a huge amount of time and money on this issue.  Whilst it is possible they have not been tough enough, it is much more likely that the law is not on their side.  It is also likely that any unilateral action by the British government would lead to even more expensive legal costs on appeal.

With corporation tax down to 20% the UK is closing the low tax gap, but unless politicians can show they understand the game, and come up with a credible big stick, HMRC is going to have to settle for goodwill payments by the multinationals.

Some really bad ideas just keep staggering on, don't they?

One of those really bad ideas being the financial transactions tax. Never mind that it's a very bad tax, that transactions taxes themselves are a bad idea, and concentrate on the most important point of it all:

Think what Labour could do, if it chose, to revitalise public services. A 0.01% financial transaction tax would raise £25bn a year.

That's George Monbiot missing that important point. And he's quoting the IPPR who also miss that major point. That major point being that an FTT won't in fact raise any tax revenue. In fact, it will decrease the amount of tax revenue raised. At which point there's no point in thinking about all the lovely things you can go and spend the money on, it's necessary to start thinking about what of current spending you're going to cut. Which would rather temper peoples' enthusiasm for this tax one would have thought.

The mechanism is that transactions taxes are really, really, bad taxes. Their deadweight costs soar above those of other methods of taxation: that is, for each unit of revenue raised they kill off more economic activity than other taxes. And an FTT could, in theory, be so bad in this manner that it would shrink the entire economy. Shrink it so much that total tax revenues would fall, despite our being able to see this new money coming in from the FTT.

That is of course an empirical question: would those deadweight costs be sufficiently large so as to reduce the total tax take? And fortunately someone has gone and done this work for us. It was the European Union itself, reporting on the idea of an FTT implementation. And the answer is yes. The economy would shrink so much purely from the effects of the FTT that overall tax revenues would fall.

This does, of course, still leave room to argue in favour of an FTT. Maybe you want to screw the banksters, perhaps you just hate everyone and want to make them poorer, possibly even you could make a tortured argument that this will shrink the state. But you can't go around talking about all the lovely stuff you can do by spending the FTT revenues: for there won't be any.

Which isn't, when you come to think of it, all that much of a recommendation for a tax.

We think we'll chalk this up as a win

We here at the ASI are of course politically partisan: you can't work in the think tank world without meeting many politicians and making decisions about who is worthwhile and who isn't. However, we here at the ASI are not politically partisan when we're here at the ASI. Because, as Madsen has said, our job is to be the loons howling out in the wilderness over some policy that is seemingly ridiculous and to keep arguing for it until it becomes simply the accepted wisdom of the day. It is much easier to do this without being in the pocket, or being seen to be in the pocket, of one party or another. At which point we think we'll claim a victory over one such policy for it's now in three of the four major manifestos for this coming election. That's as close to being the received wisdom as anyone is likely to get. We refer to this:

Under a Conservative government the minimum wage will be linked to the personal allowance, which the Tories want to increase to £12,500 by the end of the next Parliament.

It means that if the minimum wage increases faster than expected, workers will always be exempt from paying income tax.

We know how this got into the UKIP manifesto for when away from the ASI one of us is so politically partisan. We also know how it got into the Lib Dem one, we can track the activist who read about it here and marched it through the party's policy making process. And of course that's also how it arrived in the Tory one. We can even identify it as absolutely coming from us because of the figure being used. £12,500 was the full year minimum wage in the year that we wrote about it: it's a little bit higher now.

Our basic analysis has always been that we do not in fact have "low wage" poverty in the UK. Rather, the State makes depredations into the incomes of the lowly paid and thus causes them to fall into tax poverty. The solution to such poverty is thus to tax those lowly paid less: after all, if you want the poor to have more money then the answer is to stop taking bloody money from them.

We can also check this with the Living Wage. This is, by construction, the amount that one needs to be able to live not in poverty, that poverty level being calculated as in Adam Smith's example of the linen shirt. The difference between that Living Wage once it is taxed and what an untaxed minimum wage would bring in is roughly zero, perhaps a few pence an hour. We thus don't have low wage poverty, we have tax poverty. It is the tax taken from the lowly paid that puts them into poverty.

So, obviously, simply stop taxing those lowly paid and they won't be poor. We thus welcome this move.

At which point there are three things to note. The first is that this needs to apply to national insurance as well, raise the allowance for that to the same as the income tax allowance (while, as with the very low paid already, crediting them with amounts deemed to have been paid so that pensions accrue). Secondly, those advocating this might want to point out that this does indeed produce the Living Wage for all minimum wage workers. And thirdly, of course, we need to find something else to go and howl about in the forests in time to make it the received wisdom for the next election.

The problem with inheritance tax

Now that inheritance tax is back in play in this election season perhaps time to think about the basic problem with it:

The Tories suffered a blow on Sunday when the Institute for Fiscal Studies warned that a pledge to raise the inheritance tax threshold on family homes to £1m would disproportionately benefit richer people.

As David Cameron tried to reset the faltering Tory campaign by declaring that he was championing the “Conservative dream”, the IFS described the inheritance tax pledge as “rather odd” special treatment for homeowners.

Leave aside the specific details of this or that pledge and consider the very basics.

We're told, as with Rawls and the veil of ignorance, that it's simply wrong for the members of the lucky sperm club to inherit gazillions. Further, that inheritance tax doesn't actually have any effects upon incentives: it cannot, as the people who face the incentives are by definition dead at this point. The argument then becomes, in some quarters, only about how much to tax inheritances. Should it be at 100% or should the kiddies get some pocket money perhaps?

We exaggerate, but only a little. There really is a consensus that inheritance taxes are not distorting and thus are "good taxes" in a manner that income and or capital taxes are not.

And we're really not sure about that. For we do think that while logic is all very well it is necessary sometimes to look at what people actually do. This idea of revealed preferences: forget what people should do, what we want them to do, what they say the will do or that they believe and look at what they actually do to divine their thought processes. And the truth there is that just about everyone will do their utmost to avoid (and many to evade) paying inheritance taxes upon their estate, even when they really are dead and gone. We must therefore conclude that this is, despite the logic and the ideas of fairness, something that really does motivate people. And if that is true then such taxation cannot in fact be non-distorting.

This is something that was rather missed by Thomas Piketty. He talks, extensively, of the bourgeois historical novels and their tangled tales of who gets what from which estate. To bemoan the manner in which this stratifies society which might be fair enough. But he misses the point that these were the best sellers of their day and the attention paid by the bourgeois writers and readers back in history shows that who gets what from which estate was important to them. As the stampede to keep today's inheritances out of the taxman's hands show it all is today.

New ASI paper: Non-Sense

Out today is a new ASI briefing paper examining Ed Miliband's proposal to end the non-dom provision in the UK tax system. It says:

• Being a UK resident with non-domiciled status simply means that one does not intend to remain indefinitely. The tax system requires residents to be taxed on their foreign income. Non-doms resident in the UK elect to be taxed on either the arising basis (their worldwide income is taxed automatically) or the remittance basis (they are only taxed on worldwide income if they bring it to the UK). 2008 reforms mean that after 7 years of UK residence, non-doms who choose to be taxed in the latter way must pay a yearly fee of £30,000 (rising to £50,000 after more years of residence).

• Ed Miliband has claimed that there are 116,000 non-doms but this ignores those of the UK’s 400,000 international students and 6 million foreign-born workers who did not have to file a self-assessment form and those who did file it but did not tick the non-dom box. It is estimated that something like 1 million are not permanent residents, so are by definition non-doms.

• The rules introduced by Labour (and supported by the Tories) in 2008 ended up only hurting less wealthy non-doms and did nothing to really wealthy ones: electing to be taxed on a remittance basis benefits only those with very high foreign incomes.

• While most countries tax worldwide income of residents, a significant number including the UK have exemptions for certain people (mostly foreigners) so that they only pay taxes on local income.

• There is a substantial literature showing that tax systems are very important in deciding where top talent goes. It tells us that punitive changes to the UK tax system could discourage the most valuable potential immigrants from footballers to inventors.

• Changing how we determine someone’s domicile is likely to have unintended consequences. First, making it easier to acquire a new domicile might reduce inheritance tax receipts, as UK domiciled residents of foreign countries currently pay UK death duties on their worldwide estates. Second, changes to the concept of domicile would have repercussions in other areas of law, such as matrimonial matters and determining the validity of wills.

• The ethical justifications for Ed Miliband’s view that it is immoral that non-doms do not pay tax on their foreign income are deeply contentious. There is no principled moral case for taxing more than local income.

You can read the full paper here

Abolishing non-doms; welcome to the Laffer Curve

It's election season so, yes, obviously, all sorts of things are going to be promised. Which gives us Ed Miliband's idea that Labour, if elected, will abandon non-domicile as a tax option. This is an interesting example of where reality meets the Laffer Curve:

The last Labour government toyed with abolishing the non-dom system but simply tightened the rules instead - which were then tightened further by Conservative Chancellor George Osborne.

That is because non-doms still have to pay tax on their UK earnings so successive governments have calculated that, on balance, it is better to have them here making a contribution to the exchequer than to see them flee abroad.

That's a wide reading of Laffer of course, that lower tax rates can lead to higher revenues, higher tax rates can lead to lower. It's something that is obviously true at the extremes and successive administrations, having done those scribbles on the back of the envelope, have assumed that taxing non-doms on their worldwide income would lead to lower revenues.

Miliband thinks this isn't true and so boo yah! to that. However, there's another point that we've not seen anyone mention as yet. Which is that residence and domicile interact in more than one manner. Yes, it is odd that the UK makes this distinction in a way that almost all other countries don't. But that interaction is more complex than just allowing non-doms resident in the UK to not be taxed in the UK on their worldwide income.

The complication is that the distinction allows many who are domiciled in the UK, but not resident, to still be claimed in part by the UK tax system. This is the situation with one of us in fact: not resident in the UK and hasn't been for a couple of decades, but still in part in the grips of the UK tax system as a result of continued domicile.

Further, there's many many more such domiciled but non-resident Brits out there (millions of 'em, million and millions of 'em) than there are the roughly 120,000 resident and non-dom.

Abolition of domicile as a determinant of taxation status would therefore have a much more complex effect than most seem to think. Logically, it might being that hundred thousand odd into the domestic tax net but it's equally going to release every expat from it.

That Laffer Curve really does exist you know, and even in the real world sometimes it bites.

Raising the NI threshold would have cross-party support

In Wednesday’s Budget we saw the personal allowance threshold rise again; starting April 2016, earnings up to £10,800 will be tax-exempt. The coalition knows that raising the personal allowance is a politically popular idea (not to mention good public policy). It’s great to see them inch slightly closer to taking minimum wage earners out of income tax all together.

But given how in-tune they are with the tax relief this policy provides to low earners, it’s hard to make sense of their decision to ignore the National Insurance threshold, which currently sits well below the personal allowance threshold at £7,956/year. 

Especially when it would be politically popular to address it.

A pre-Budget poll from YouGov asked Conservative, Labour, Lib Dem and UKIP respondents which policies they would support or oppose if the Chancellor were to announce them on Wednesday. The policy that received the most support (83%) was raising the personal allowance threshold to £11,000, followed by “raising the National Insurance threshold, so it is no longer paid by the lowest earners”, which received 71% support.

It gets even more interesting if you break it down by party. On NI, both Conservatives and Lib Dems supported the policy with a 75% majority, followed closely by Labour at 72%. UKIP brought the average down slightly, but with a significant majority still favouring the policy at 68%.

Getting the poor out of tax has strong cross-party support and the Chancellor should, in theory, be able to implement changes to the NI threshold without extreme push back from any opposition parties. Yes, the coalition should be credited for their reforms to the personal allowance, but now is hardly the time to go soft on a bad tax that continues to hit the poor hard.

One tax hike I'll be hoping for in the Budget (and some cuts as well)

Back home in Ireland, it’s said that asking for directions will often get you the reply, “I wouldn’t start from here.” We might say the same thing about the UK’s tax code. Nobody drawing up a tax system for the country would create anything like what we have right now, and when it comes to reform – well, I wouldn’t start from here. One example, which I talked about on the Today Programme this morning, is VAT. VAT is usually considered to be one of the least bad taxes around: in theory, it doesn’t discourage production, it isn’t very regressive, and it doesn’t distort the economy.

I say “in theory” because in practice the UK’s VAT system is a mess. It is riddled with exemptions (I am including zero-rated and reduced-rated goods in this) that distort people’s spending, which means that resources are being wasted, because people are buying relatively more of the untaxed goods and less of the taxed ones than they would be if the playing field was level.

The usual argument for these exemptions is that they are needed to reduce the burden on the poor. This is a powerful argument but it is wrong.

Many of the exempted items are unlikely to benefit the poor anyway – financial services, the construction of new dwellings, domestic passenger transport – but even for things like children’s clothes and food the argument is wrong. Although poor people spend a greater fraction of their budgets on exempted items like these, total spending on these goods rises with income, so most of the forgone revenue is actually from the rich.

The extra money raised could easily offset the extra cost to the poor by reducing income taxes on them (including national insurance contributions) or by raising the Universal Credit payment level. We could actually offset the extra cost to almost everyone, but except for people on low pay I think there are better taxes we could cut with the money left over.

The IFS estimated in 2010 that scrapping all VAT exemptions would raise an extra £26-28bn, based on 2010-11 numbers. Conservatively, rounding that up to £30bn to account for the larger economy, and spending half on boosting the incomes of the poor, we have £15bn left to play with. We’ve suggested scrapping capital gains tax to boost investment and using the rest to reduce the deficit.

In simplifying VAT we can make one important tax much less destructive without hurting the poor and use the money left over to cut taxes that are even worse.

Politically, this might not deliver good headlines, but if it was done at the start of the next Parliament the boost to people’s living standards by the next election could, improbably, make raising taxes on food and children’s clothes a real winner.

We might not want to start from here to get our sensible tax system, but this is one reform that could be a good step in the right direction.

Ed Miliband proposes double taxation of incomes

This is a woefully bad policy proposal from Ed Miliband:

The Labour leader pledged to cut tuition fees from £9,000 a year to £6,000 from September 2016.

It will apply to students mid-way through their courses, meaning a student in their first year of university today will pay less in their third and fourth years.

The programme will be funded by a £2.9 billion raid on middle class pensioners, and by making graduates earning over £42,000 pay a higher rate of interest on their loans.

We've struggled for a number of decades to encourage people to save for their own old age. The current debates are surrounded by plaintive cries of how we're going to pay for all of that care that the elderly are going to need in the future. So then someone proposes to reduce the amount people save for the future by taxing it more?

Come along now, it's not April 1st yet.

Pensions experts have criticised proposals from the Labour leader Ed Miliband to cut the tax-free amount Britons can contribute to their pensions in order to fund a reduction in tuition fees to £6,000 a year.

Mr Miliband said that he would cut the lifetime limit on tax-free pension savings from £1.25m to £1m, and reduce the tax-free sum saved per year from £40,000 to £30,000 a year, if he wins the general election.

For savers earning more than £150,000 a year, Mr Miliband proposed cutting the pension tax relief from 45pc, the same rate they would pay on earnings, down to the basic income tax rate of 20pc. The Labour leader said these measures would raise £2.7bn to fund the pledge on tuition fees.

But the real problem is not that it's a deeply stupid idea. It's that it's a deeply unfair one.

There is in fact no such thing as "tax relief" upon pensions savings. What there is is "tax deferral". Your pension contributions come from your gross income, before tax. Your investment gains within the pensions wrapper are tax free at the time they are made. But the income you derive from your pension pot pays income tax just like any other income. You do not therefore get "relief" from the taxation, you get deferral of it.

Which is, of course, why that tax "relief" has to be at whatever the marginal income tax rate on income is. Because, and yes this is obviously so, those who do manage to save up to that limit are going to be enjoying pensions that pay one or other of the higher rates of tax. But they will have had that "relief" only at the standard rate.

They are, therefore, paying income tax twice on that same income, once when earned and saved for a pension and again when drawn down as a pension.

It's deeply stupid to dissuade people from saving for their own old ages. But it's grossly unfair to insist that the same income pays income tax twice.

All of us here have our own ideas about party politics but as an organisation we are not, and resolutely so, party political. But of the ideas thought up to gain support at this coming election for one or other political party we'd award this our coveted "worst we've seen yet" prize. Admittedly, we've not yet read the Green Manifesto but seriously, double income tax for those who save for their own pensions?

Absurd.

Today's crazed loon idea

So, we know very well that the government is spending very much more than it is raking in in taxes. There should be some solution to this at some point. At least we hope there will be. But perhaps not this solution:

What might be fairer would be to treat capital gains in houses just like any other financial asset and tax it at 28pc.

Given the turnover of the UK housing market and the gains built into it, it isn’t fanciful to think that, in a good year, the Government could raise £20bn to £30bn a year alone from this source.

For those inflamed by the inequities of the North-South divide, they will be pleased to know that the bulk of anything raised in this way would hit the south east of England hardest.

How wonderful: increase the taxation of the most successful part of the economy. And it's worth pointing out that the SE already pays much more tax: because the higher salaries earned there are taxed under national income tax rates, not regional ones. but then this is just mad:

As far as pension funds go, a simple 1pc levy on the value of schemes would be easy to administer and collect. This would raise an additional £20bn each year and given that pension fund contributions are subject to income tax relief, it doesn’t seem unreasonable to pay some of those investment gains back to the nation.

We specifically grant income tax relief because we want people to save for their old age. So now we're going to charge a wealth levy on people who save for their old age? Even knowing that wealth taxes have much larger deadweight costs than income taxes (or consumption ones)? Meaning that if you think pensions savings are undertaxed then it would be more economically efficient to simply reduce the income tax benefits of doing so rather than instituting a wealth tax.

Of course what's really interesting about the proposals is that no one at all believes that government could ever just curt back its spending to the amount of tax revenue that it has available. Sadly.