27 March 2014
Why a Competitive Tax System is a Bad Tax System
I suppose I could also start with Monty Python. It is hard for me to assess the audience here, but I imagine that I am in front of a partially, hostile crowd. Perhaps “Always Look on the Bright Side of Life” would be an appropriate song to start with. But that is certainly the feeling I would have had five years ago. One of the things that I and my colleagues, who are very hostile to the whole concept of offshore and tax havens, have found that, particularly in the area of secrecy, we are, to our surprise I think, we have been pushing against very much of an open door. You know, just five years ago, people were laughing at us for suggesting that we would see automatic information exchange processes coming in worldwide, in our lifetimes, and just recently, the OECD has just put together its new project for putting together the nuts and bolts of such a scheme. So, things have really changed dramatically in this respect.
What I want to talk about today I think covers a different, but related, area, and I think that the arguments I want to present, I feel that they are strong enough to have the potential for pushing at another open door on tax. I think that since particularly, in the UK, since Tony Blair, Gordon Brown, but also George Osborne and David Cameron, are guilty of what I regard as economic illiteracy on the issue of tax competition, that is, the process whereby jurisdictions compete with each other to create tax offerings to attract international capital from around the world, and I believe that is a mistake. It is harmful both on a global level but I believe that countries such as Britain that are engaging in this are making a mistake for themselves. I believe that the whole notion of competitiveness, not only on tax but on financial sectors, on various other aspects of economic policy, the whole notion of competitiveness, as it is discussed in public debates by politicians, is a complete nonsense. That is what I want to talk to you about today.
Offshore centres are kind of the sharp edges of this axe. They are the ones that are racing fastest towards what I would regard as the bottom.
So, very briefly, I just want to start by exploring what I regard offshore to be - I take a very broad view of what offshore is - and then go on to tax havens and tax competition, this idea of tax competition, and then to look at what a competitive tax system means for a country that implements such a thing.
So, while writing “Treasure Islands”, I spent a long time thinking. I was trying to drill down to what exactly is a tax haven, what is an offshore centre, we use the term “secrecy jurisdiction”, depending on the emphasis we want to give – what is it that these places offer? Because it is not just about tax, it is about information exchange, it can be about financial regulation, it can be about criminal laws, tolerance for criminality – it can be about a whole range of things. And drilling down, I come to two words, and one is “escape” and “elsewhere”, and both of these words, if you think about it, have something of the offshore about them. Effectively, people take their money, and sometimes elsewhere, to escape the rules of society, whether those rules be taxes or whether those rules be criminal laws or disclosure requirements or whatever. You take your money elsewhere and you escape the rules of democratic society, and I think that is one of the central kind of problems we have with offshore centres. So, that, for me, is the essence of offshore.
The other thing that surprised me when I was in my early times discovering this was where offshore is, and I get the impression from your presentation that you think offshore centres are kind of small places, generally – we can discuss that later. But, basically, I do not see offshore as being a big versus small thing. I think what you are saying about the United Kingdom and the United States is absolutely correct, the ability to cover up all sorts of crimes via Delaware shell companies and UK companies, are horrendous, and there seems to be a lot of evidence that is just as bad as in the British Virgin Islands or wherever. I do not think this is a big against small thing. I think this is an economic phenomenon and a process that is growing faster than the global economy, and it has steadily – something that was regarded as a place of Switzerland, alpine jurisdictions, or little small islands in the Caribbean, is just something that, during the era of financial globalisation, has been pushing its way steadily into so-called onshore centres, and we are getting into a confusion of terminology of what we exactly mean by this, but I do not mean small financial centres when I say offshore.
I am just taking the Cayman Islands because it is a famous small tax haven. When the Cayman Islands offers certain legislation that allows multinational corporations, say, to avoid tax, those laws, if they are designed deliberately to attract that kind of activity, it is designed not for locals, but for foreigners. It is not designed for local Caymanians directly. The problem with offshore, with this “elsewhere” problem, is that there is always this separation between the people making the laws and the people who are affected by the laws. That is almost by definition, so the democratic consultation that we expect in the creation of laws, and the people who are affected by them, is always broken. So this, for me, is a fundamental problem of democracy, the whole concept of offshore is fundamentally anti-democratic.
This is something from 1969, in the very early days. This is a Bank of England discussion about the emergence of the West Indies tax havens. “We need to be quite sure that possible proliferation of trust companies, banks, etc. which, in most cases, would be no more than brass plates manipulating assets outside the islands, does not get out of hand. There is, of course, no objection to their providing bolt-holes for non-residents.” So, a lack of care about the impacts that happen elsewhere, so we have a problem. This is, again, a very fundamental, conceptual issue, that encapsulates what is going on: we like the money and we do not really care about the impacts it has elsewhere.
Now, onto the main part of my talk; so-called ‘tax competition’.
I am going to be pretty robust about this because there is a form of consensus out there. I think it is almost unquestioned in the UK, and in many other countries, that it is important for a country to be competitive on tax. Being – at the beginning of my presentation, I said an attack – I called it, somewhat tongue in cheek, an attack on motherhood and apple pie, because, I mean, who could be opposed to a competitive tax system? It sounds ridiculous, does it not?
But the first point I want to make is, if we are talking about tax competition – this is nothing to do with competition between firms in a market. People, politicians, ordinary people, journalists, conflate the two processes, jurisdictions jostling with each other to offer tax incentives to attract money, and market competition between firms, and people think, well, because market competition between firms is generally regarded as a good thing, it keeps firms on their toes, gets them continuing to produce better and cheaper widgets for people, and there is the creative destruction, it is all a positive process, and it is associated with positive processes. This is not at all what we are talking about. This is a completely different beast. This is not competition at all.
Just consider, for example, if a firm cannot compete, it goes bust, and that is sad for the people involved, but it is part of this creative destruction process, which many would regard as generally being a beneficial force in the world. But what does it mean for a country, and what happens if a country cannot compete? What do you get then? A country cannot go bust, it cannot go out of existence. What do you get, a failed state? I mean, it is just a completely different economic beast. I am not saying that countries that cannot compete become failed states. I am just using this to illustrate how this is nothing to do with competition. This is the wrong word.
So, a country that cuts taxes to attract international businesses, this term that is so popular in the UK, we are “open for business”, this notion that the UK can be competitive on tax, is victim to basic economic fallacies which first-year undergraduates would understand very well.
The first is the fallacy of composition. Tax cuts, of course, are just one side of the equation. The fortunes of one sector of the economy are not the end of the story. It is the fortunes of the economy as a whole that matters. So, if you are cutting taxes on businesses, you may provide benefits for businesses. I would argue that, generally, what is happening at the moment is that those benefits are heavily overstated, but that comes at a great cost. It comes at the cost of tax revenues which are used to fund infrastructure, the rule of law, courts, schools, healthy and educated workforces, all of these things which, again, you could argue are the foundation of a country’s competitiveness.
So, if you are cutting taxes on businesses, there is no a prior reason why on earth that should make your country more competitive. A tax is not a cost, it is a transfer. It is not a cost to an economy. It is a transfer within it, and there is no reason why that transfer necessarily is going to do anything to make your country “competitive”. I keep putting this word “competitive” in quote marks, and I hope that people will also start doing this, because this word “competitive” is a weasel word par excellence.
People may say that Foreign Direct Investment is special and that this is the dynamic part of the economy. Well, I will get onto that in a second, but before going there, there are some people – I have some kind of code words here, which I am sure probably will not mean much to people in the audience, and I do not really have time to get into them now, but I hope we can perhaps have a discussion about them because each can be explained.
There is a famous paper by an economist called Charles Tiebout, written in 1956, which is the intellectual underpinning for the notions that nations can compete. I am being aggressive here, but I think his arguments are a joke, and the assumptions underlying them are, quite frankly, ridiculous.
There is another whole set of arguments about a thing called the Laffer Curve, where people assert that if you cut taxes enough, there will be so much business expansion that the tax revenues will eventually be enough. Revenues will be generated to make up for the tax cuts, which is, again, it is not only a joke with me, it is a joke with George W Bush’s former Chairman of his Council of Economic Advisors, George H W Bush, and many others. The Laffer Curve is not serious, at least for large economies. When we get down to the level of very, very small economies, small islands and so on, then we do start seeing Laffer effects, but, for Britain, it is a joke.
There is another argument called the Incidence Argument, which again is a very complicated set of arguments and I am happy to discuss it later, but I do not want to get into it. I do not have time now. But that is an argument that the incidence of corporate taxes do not really fall on wealthy people, they fall on workers. You can easily unpick this argument – it is a nonsense.
This is Martin Wolf, the chief Economics commentator for the Financial Times, who wrote a book a while ago called “Why Globalisation Works”, and this little quote I have pulled out of it, the notion of the model of the competitiveness of companies is nonsense. Just underlining the fact that this notion of competitiveness, particularly in the way it is wielded in the political arena and among journalists here, in this country, and in many other countries, is, as Martin Wolf says, nonsense.
So, if it is not tax competition, what are we going to call this process? Well, that is easy. This process is nothing like competition between companies in a market, but it is a lot like currency wars - countries jostling for position in a race to the bottom, trying to get ahead, like trade wars. So, the more economically literate term for this process, hitherto known as tax competition, is tax wars – it is a better name for the process, and it more accurately reflects the fact that this process is harmful. “Competition” conjures up warm feelings. “Tax wars” tells you like it is.
My colleagues and I, over the next little while, are going to start gearing up to start using this term, and I think you will see it more and more often, but I think this is the economically literate term to use. If you really have to use the term “tax competition” when you are writing about it, at least put it in quote marks to signal that you understand that this is nothing to do with competition, and we are going to be calling out people who use this term.
So, I have covered this already, motherhood and apple pie – who could oppose a competitive tax system?
As I have mentioned, tax is not a cost to an economy but a transfer within it, and if you think about it, you start to think about it. If you are thinking about real genuine foreign investors, people who want to come in and build a car plant or something like that, what do they want? They want the rule of law, as I mentioned, and they want roads, healthy and educated workers – these things require tax.
Corporations that are facilitated in avoiding tax, either through the use of offshore centres or otherwise, are wanting to free-ride on the taxes paid by others, which, among other things, is profoundly anti-democratic, but it also, what does it do? It rewards the large multinational at the expense of the small domestic business. In a sense, the multinationals are being facilitated to compete – and here, I am using the term “compete” because we are talking about firms competing with each other – to compete against local businesses, against domestic businesses. This is not international competition, this is local – this is multinational killing small businesses on a factor, tax, which has the factor is receiving tax subsidies – that is what they are getting. They are killing them on this factor, which has nothing whatsoever to do with productivity, nothing to do with innovation, nothing to do with producing better and cheaper products. It is simply a transfer of wealth. That is what they are competing – and they are killing the smaller firms in markets, and smaller firms are very often the job-creators and the real innovators. They are killing them in markets on this completely unproductive factor. And tax competition, tax wars, as I prefer to call it, is a key part of this. Countries are perpetually offering new facilities allowing multinationals to do this, and offshore centres are big parts of this game.
Now, there is a lot of academic literature out there about what I will now call tax wars, and I have read through quite a bit of it. I have not read through all of it. I have come to the conclusion that, if you get simple models, you get very simple answers that are very clear. I have got a couple of graphs of my own which are very simple. But I do get the sense – it is very hard to prove these things – that when the academics do not get the answer they are looking for, they just use cleverer and cleverer models, and the complexity out there is remarkable.
This is a somewhat humorous cartoon to illustrate the point. This is an impression I have.
One of the reasons why so much of the literature, in my view, is a waste of time is that they spend so much time trying to measure Foreign Direct Investment and the response it has to competitive tax systems. Foreign Direct Investment, generally, is regarded as a good thing. It is useful. People like it because a car plant or whatever will bring long-term transfers of skills and knowledge and create local supply chains, real embeddedness with the local economy. The trouble with tax sensitive foreign investment is that it is flighty. Because it is tax sensitive, it is therefore not embedded in the local economy. If it was embedded in the local economy, it would not be tax sensitive. It would not flee the moment the tax rate rises. So, that portion of Foreign Direct Investment which responds to tax is precisely the portion you do not particularly need, and if you attract it at the expense of a large tax give-away, your country will suffer.
But the academics, so many of them, do use FDI as a metric. Again, this is fallacy of composition. The fact that something may increase FDI or not does not necessarily mean that is a good thing for your economy as a whole because it is a transfer. So, these kinds of studies, I regard as being like the drunk looking for the car keys under the street-lamp at night, rather than where they actually lost the car keys.
The only valid measures, I would say, really, are country-wide measures that look at the whole picture. GDP growth would be the most obvious one.
I am now going to have to go a little bit faster…
Do tax cuts boost economic growth? There is a whole load of people who believe fervently that they do. I went and found the simplest possible model. I found a bunch of countries that could be compared with each other, OECD countries above a certain income level. This is the graph that I got. I think you would agree that - the one up the top there is Ireland, but the rest of them, that is a pretty flat line, if you try and draw, and that is huge differences in taxes as a share of the economy between Japan, at the bottom, under 30%, and the Scandinavian countries up towards 55%, massive differences in tax in the economy, and yet, long-term per capita economic growth, no difference. Tax is neutral, and that, again, is consistent with the idea that tax is not a cost but a transfer.
That is overall tax as a share of GDP. What about corporate tax as a share of GDP? I would argue that this is impossible to measure, unfortunately. It would be nice if you could. But there are so many different ingredients to growth that choosing corporate taxes, which are a very small part of the overall tax mix these days, particularly as a result of tax wars over the years, these are going to be insignificant in the big picture, so it is not going to be possible to measure this, which, as I said, is unfortunate. For what it is worth, FWIW is, for what it is worth, here is a correlation… This is just a plot I made, average corporate tax revenue as a share of GDP, against long-term per capita growth. The trend line goes upwards. It seems that more corporate taxes is in GDP…it suggests possibly that more corporate taxes in GDP could lead to higher growth, but, you know, I do not want to put much on this graph because I think there are so many things you can say about it. This is not a very robust graph. I am basically saying that you cannot really say anything from economic studies that is very useful.
So, how do we judge success? Well, there are other measures. They are not quite as mathematically satisfying. Common-sense… This one, I will discuss, hopefully we will get a chance to discuss it. This is about cash piles. I am going to have to move on more quickly.
But what do real businesspeople say about tax cuts and competitive tax cuts? Just a story the other day, Fiat said it was moving its tax domicile to Britain. Reuters reported and they said it would have no impact on headcounts in Italy or elsewhere. Again, this is the jobless response. You know, you attract the corporations. WPP has made a huge song and dance about Britain’s supposedly competitive tax regime, but at the end of the day, not too much has been attracted to Britain as a result of this widely trumpeted, these widely trumpeted tax measures, and the job impacts have been very, very small indeed, so far.
Here is Paul O’Neill, the screaming left-winger, ex-US Treasury Secretary under George W Bush. “As a businessman, I have never made an investment decision based on the tax code. If you are giving money away, I will take it. If you want to give me inducements for something I am going to do anyway, I will take it. But good businesspeople do not do things because of inducements.”
Warren Buffett: “I have worked with investors for 60 years and I have yet to see anyone, not even when capital gains rates were 39.9% in 1976-77, shy away from a sensible investment because of the tax rate on the potential gain.”
Tax is not really what investors are interested in. It is a lower order consideration.
There is a story by Tom Bergin of Reuters, not so long ago, who surveyed a lot of UK companies, big and small, and he said he asked them about the impact of tax cuts on his business, and no company would identify a single business project which had gone ahead because of cuts in the headline rate. The same applies for any jobs that were created or saved from loss.
All of these – please ask for these slides. Are they going to be online afterwards? All the links to these stories are in here, and you can find them.
This is getting to the end of my talk. This is a wider survey. There is a consensus in the academic literature – I do not want to damn the whole of academic literature. There is a lot of useful stuff out there, but there is a consensus in the literature about the main factors affecting foreign investment location decisions. As I said, the most important ones are market size, real income levels, skill levels, infrastructure, and so on. Again, many of these things are heavily tax-financed.
And the new one that, in the debates about having a competitive tax system, is completely absent or pretty much absent, is the issue of inequality. Inequality is the new story on the block. Tax obviously has a huge impact on income and wealth inequality. This has never been considered, but corporate tax cuts boost inequality and it is increasingly recognised that inequality, economic inequality, is bad for economic growth. The IMF has rapidly been changing its mind recently about that.
I would recommend – I have not read it yet, but I have read a lot of reviews of this book, “Capital in the 21st Century” by Thomas Piketty. It seems to be the new one that everybody is talking about, looking at some quite scary trends, long-term trends in inequality.
So, the end of my presentation really is just to return to this notion that there is no such thing as a competitive tax system really. You could make some arguments. They would be complicated, they would be difficult, you could point to some successes, I am sure, but, to quote Paul Krugman, “National economic competitiveness of any kind is a nonsense.”
And I would, as a last point, the corporate tax has come under ferocious attack as inefficient and double-taxation and so on. Again, we can discuss this later, but I would argue strongly that it is one of the most precious taxes there is, one of the most important taxes in any tax system. Again, this issue of tax wars, with offshore centres at the vanguard of these tax wars, is right at the heart of this.
Thank you very much.
© Nicholas Shaxson, 2014