Saturday 10 November 2012

The economic case against tax dodging

The case against tax-dodging is more often made by those on the left than it is by those on the right, hence the tendency for tax-dodger apologists to deride the fair tax movement as a bunch of 'loonie lefties'. In this article I will attempt to explain that tax-dodging should be considered a major problem by economically literate people on either side of the political spectrum. The best way to make this point is to describe what tax-dodging actually is, and to explain the effects in economic terms. I'll try to provide explanatory links whenever I use complex sounding economic terms.

I'll start off with a brief explanation of my political position so that you know exactly who is explaining this stuff to you. To crudely oversimplify my stance, I'm a liberal social democrat. This means that I try to occupy the genuine middle ground. I try to see the value in diverse political and economic theories and pick the best aspects. I am sympathetic to elements of socialist theory, but I'm not a socialist. I'm sympathetic to elements of libertarian theory but I'm not a libertarian. I am however, a liberal and I oppose totalitarianism wherever I see it. I also believe that the best way to make a political argument is to base it on research and critical analysis and to back it up with evidence, something that makes me rather old fashioned since the current trend is to make political arguments based on Thinktank conclusions and the results of opinion polls and to back them up with simplistic justification narratives.

Right then, on with the article:

Tax-dodging can be split into two distinct types, tax evasion which is an illegal avoidance of due taxation and tax avoidance, which is a method of avoiding due taxation through the creation and use of elaborate tax-loopholes. They are distinct in that one is punishable by law and the other isn't, but they are basically the same thing, because they result in the same economic outcomes, in fact there is a case to be made that legalised tax avoidance via offshore tax havens is actually significantly more damaging at the national scale than tax evasion (but I'll have to cover that at a later date, this article is plenty long enough already).

The primary concern with tax-dodging is that the practice denies revenue to the government, which leaves the government with three options. They must either borrow more in order to meet their obligations (increase the deficit), they must cut back on spending and investment (by closing hospitals, by sacking police officers, by cancelling infrastructure investment, by releasing prisoners early, by cancelling flood defence schemes, by slashing legal aid...) or they must raise taxes on everyone else to make up the shortfall. In reality the modern state usually uses a combination of the three to cover the cost of tax-dodging.

The UK Prime Minister David Cameron is extremely unlikely to
 do anything  meaningful to reduce tax-dodging, given that the
Tory party accept political donations from tax-dodgers and
Cameron's own father was a tax-dodging Tory party donor.
The scale of tax-dodging in the UK is absolutely enormous. It is difficult to put a precise figure on the amount of tax that is dodged each year because of the inherently secretive nature of tax avoidance and evasion schemes. The total tax gap between what is owed and what is collected has been estimated by Richard Murphy of Tax Research UK at £120bn a year, which would be more than enough to wipe out the entire UK budget deficit. 

Another indicator of the scale of tax-dodging is research that has concluded that 98 of the 100 companies listed on the FTSE100 have subsidiary companies based in tax havens. The current Conservative led government have a very relaxed attitude towards tax-dodging, which is hardly surprising given that a number of their biggest donors are tax-dodgers, and because the Prime Minister David Cameron's family fortune was built upon his father's tax-dodging empire. The last Labour government were not much better, in fact they even signed off on a ludicrous deal to privatise the HMRC property portfolio (mainly tax collection offices) into the ownership of a company based in a tax-haven!

I don't want to base my criticism of tax-dodging on the moral case, because I know that appealing to the 'unfairness' argument simply doesn't wash with a lot of right-wing people, however it would be remiss of me not to even mention it. Many people, myself included, believe that it is simply immoral for one company or individual to dodge their social responsibilities and create the situation where others must pay more through increases in their tax burden or cuts to their services.

I want to focus my criticism on the economic case against tax dodging, but first I must address a right-wing concern that is often used as part of the tax-dodging justification narrative; the concern that the state is 'too big'. This is the idea that by dodging their taxes, people are actually 'helping' the country by incentivising the state to shrink. 

Well, even the most right-wing libertarians still perceive a role for the state, admittedly there isn't much for the 'libertarian state' to do but to protect property rights, but this would still necessitate taxation of some kind. Another form of state spending that very few right-wing people would argue for the abolition of, simply in order to reduce their own tax burden, is military spending. Whatever economic system is envisaged (other than anarchism, proto-economic barter systems or nihilist dystopias) there will always be a necessity for taxation. 

If one company or individual dodges their tax contribution, they either transfer the burden of taxation to others, they cause the elimination of state services or they cause an increase in the national debt. Given that the state can only ever be 'rolled back' so far, there will always be some kind of tax expectation, and because the kind of right-wing people that believe in the 'small-state' (minarchists), are the kind of people currently engaged in the sovereign debt fear-mongering campaign, this means that borrowing more is simply out of the question. The only remaining option for the economically literate right-winger is to transfer the tax burden to others, which, under libertarian theory is an infringement of other people's economic freedoms and an act aggression.

Even though many tax-dodgers employ the simplistic justification narrative that they don't use the NHS or receive any welfare benefits from the state, the fact is, that if they are engaged in any kind of economic activity within the state they are beneficiaries of government spending. By refusing to pay their share, they are expecting others to subsidise them through the direct and indirect economic benefits of state spending. I'll list just a few examples:
If the tax-dodger is a corporation or an employer, it is almost certain that some of their employees benefited from a taxpayer funded education (93% of Brits attended state funded schools), and continue to benefit from access to taxpayer funded universal healthcare (only a minority of jobs come with private health insurance). Without these provisions, the tax-dodger would have to select their employees from amongst the diseased and illiterate, or invest fortunes in educating their employees and providing private health insurance. By dodging tax, these employers are demonstrating that they are happy for others to keep their workers healthy and reasonably educated, but they won't contribute themselves.

If the tax-dodger runs a business, their customers benefit from taxpayer funded infrastructure (public roads and footpaths, the taxpayer subsidised rail network, the London Underground) to even get there, or for the services to be delivered to them. By dodging tax, these enterprises are demonstrating that they are happy for others to fund the infrastructure that contributes to their profit margins, but they won't contribute themselves.

Whenever a crime is committed and a tax-dodger calls the taxpayer funded police or makes recourse to the publicly funded courts, the tax-dodger is demonstrating that they are happy to benefit from the taxpayer funded justice system, whilst expecting others to fund it for them.

Now we begin to get to the crux of the economic argument against tax-dodging, which is based on this transference of the burden of taxation. In business, the most prolific tax-dodgers are the multinational corporations. They have the financial means to employ expensive tax lawyers and to establish subsidiaries in tax havens for the express purpose of avoiding taxation. The majority of small and medium enterprises in the UK do not have the financial means to hire tax lawyers, to establish complex tax loopholes or to set up subsidiary shell companies in tax havens, so they are left carrying the greater burden of taxation. We'll call this difference taxation asymmetry. 

One of the strongest and most regularly cited arguments in favour of the capitalist system is that 'the market' creates efficiency through competition. Used as a general rule of thumb, this argument is OK, however there are plenty of examples of state systems outperforming the market (the "socialised" universal healthcare systems of Europe vastly outperform the private sector dominated US healthcare system, both in terms of lower economic burdens and superior health outcomes) and also plenty of examples of grotesque inefficiency in the private sector (the G4S Olympic shambles, where the company had months to prepare and train security staff for the London 2012 Olympics, but ended up failing badly, leaving the state sector to efficiently pick up the pieces at extremely short notice through the deployment of thousands of police and military personnel). These counterexamples clearly demonstrate that private sector efficiency is more of a rule of thumb than a hard and fast economic law. I'll modify the private sector efficiency premise with the word 'potentially', so as to account for counterexamples of the aforementioned type. Leaving us with the (more-or-less acceptable to everyone) capitalist theory that through competition the capitalist market can potentially create greater efficiency than bureaucratic central state planning.

This brings us to the subject of what 'competition' actually is. It is a generally accepted economic principle that in order for competition to actually work, there needs to be a 'level playing field'. There are many clearly defined examples of anti-competitive practices that are used to create unfair market advantages, which include; monopoly formation, corruption, information asymmetry, cartel formation, price fixing, financial doping, dumping, tying, fraud, refusing to deal, political patronage and dividing territories. 

Taxation asymmetry is another form of anti-competitive practice, which is related to political patronage. It is easy to see how taxation asymmetry leads to unfair competition. If a government allows a large corporation to use explicit tax avoidance vehicles, whilst smaller competitors are left paying the standard tax rates because the establishment of tax avoidance schemes is beyond their means, this is essentially a form of political patronage to allow large corporations to develop a large cost advantage over their smaller, tax paying competitors.

If the ruling establishment allow taxation asymmetry to continue over the course of decades (as is the case in the UK), many of the smaller tax-paying competitors are driven out of business, leaving the large tax-avoiders to hoover up greater shares of the market for themselves. As the smaller competitors are eliminated or bought out, the large tax-dodgers begin to form oligopolies and monopolies, which reduce the need for efficiency. They can simply raise their prices to cover any inefficiency costs because they can get away with it in a market denuded of competition.

Taxation asymmetry is obviously bad for the small and medium sized enterprises that find themselves at a competitive cost disadvantage, but it is also bad for the economy as a whole. There are several reasons, including the fact that the aforementioned small and medium enterprises (SMEs) are the real drivers of innovation, demand and economic growth and because as the tax-dodgers hoover up ever greater proportion of the market, tax revenues will obviously fall. The elimination of SME demand and falling tax revenues drive the state back to the choice of deficit spending, destruction of services and investment or loading the tax paying elements of the economy with an even greater tax burden, thus further intensifying the downward spiral of taxation asymmetry.

In the current economic climate, it is absolutely clear that the act of dodging taxes is both against the national interest and an infringement on the economic freedoms of others, the ones that must make up the shortfall. The basis of the argument against tax-dodging is that in order to have a free market, you must first have a fair market because without a fair market, the driving forces of capitalist efficiency are diminished, and that taxation asymmetry is clearly anti-competitive and incompatible with the fair market.

I believe I have clearly established that if you believe in the competitive free market, you must see taxation asymmetry as a barrier to competitivity and efficiency. Whether you believe in a low-tax economy or a high-tax economy, you have to accept that the burden of taxation must fall equitably, otherwise unfair and inefficient market conditions are created.

If taxation asymmetry is as anti-competitive and economically damaging as I have described, the question must be asked; what should we do about it? Here are two proposals to reduce taxation asymmetry
1. A Ban on taxpayer funding of tax avoiding companies. There is absolutely no justification for allowing taxpayer generated funds to be provided to tax-dodging companies (in the form of subsidies, outsourcing contracts, R&D loans, procurement contracts, health contracts, IT contracts, training schemes, PFI deals...). If an enterprise won't demonstrate that they are a British based company (or registered subsidiary) that pay their fair share of taxes, they mustn't get a penny from the government. They should also have to demonstrate that all employees are paid in a tax transparent way, with no personal service companies, offshore dividends and the like.
2. A blanket ban on all tax avoidance schemes. After the government spending regulations have been brought into effect, a simple change to the tax code should be made to legislate that if a scheme is designed for the explicit purpose of avoiding tax, then it is by definition a criminal activity.
These relatively simple rules should be acceptable to left-wing and right-wing thinkers alike. After all, they would establish both a fairer and a simpler tax system. The creation of a simpler tax system is basically a form of deregulation, to be applauded by the right-wing. These policies should also be popular across the political spectrum because they would help to reduce the deficit, which could significantly reduce the scale of service and investment cuts (popular with the left) and reduce the deficit without resorting to tax rises (popular with the right).

Under the current economic circumstances, a clampdown on tax-dodging is the best possible approach to closing the budget deficit. Increased taxation at a time of economic stagnation would only worsen the economic situation by reducing demand, the extremely right-wing IMF announced in October that austerity is a self-defeating policy because "in today’s environment of substantial economic slack, monetary policy constrained by the zero lower bound, and synchronized fiscal adjustment across numerous economies" government spending creates much higher returns than previously expected, meaning that government cuts end up destroying much more economic activity than previously estimated. This leaves a clampdown on tax-dodging as the only viable option.

The right-wing really have to decide whether they are more interested in protecting the UK economy and reducing the fiscal deficit by attempting to reduce taxation asymmetry, or whether they are more interested in serving the interests of tax-dodgers and the wealthy elite.

The revelations about Starbucks tax-dodging exploits and the
boycott Starbucks campaign have seriously
damaged their brand reputation.
You may have noticed that the two proposals I mentioned are both political proposals. You may be thinking "but what can I, as an individual, do about it?" The answer is firstly to put pressure on your MP or your political party to implement 'fair tax' reforms, but you can also take direct action against tax-dodging companies.

Direct action works, you only need to look at the spectacular success of the Olympic Tax Dodge campaign, or at the rapidly declining Starbucks brand identity reputation after their scandalous tax-dodging activities were exposed by Reuters, to see that direct action like boycotts and social media campaigns can work.

The problem with direct action is that there is actually no way to boycott certain tax-dodging enterprises. Imagine that every single provider in a market is engaged in tax-dodging (not difficult to imagine given that 98% of FTSE100 companies are tax-dodgers). If you require a service or commodity in that market, you have no choice but to deal with tax-dodgers. 

Another example can be seen in government services: If the government are buying products or services from tax-dodgers on your behalf, you have no direct capacity to intervene. Take the tax-dodging Mapeley Steps deal on HMRC properties as an example. You can hardly boycott HMRC. I mean you can't boycott paying your taxes, especially if your boycott is inspired by your opposition to tax-dodging!

These problems with direct action bring us back to my 'fair tax' proposals. Our political parties must be implored to end taxation asymmetry and create a fair, 'level playing field' so that the capitalist market can function efficiently. If the government refuses to do this, it is essentially an admission that they are simply abusing libertarian free-market theories as empty rhetoric to justify the corporatisation of the state and the serving of wealthy establishment interests.

In conclusion: The only people that could continue making excuses for tax-dodgers are the tax-dodgers themselves or the half-witted Ayn Rand inspired anarcho-capitalist neoliberal pseudo-economic brigade; the kind of people that are so economically illiterate that they believe that stable economic systems can be built upon the foundations of a bunch of simplistic and loosely related adages like "private good, public bad", "all regulation hinders productivity" and "taxation is theft".

If you believe that the capitalist system creates prosperity through competition and efficiency, you must accept the case that taxation asymmetry is a barrier to competition as much as any "red tape" regulation, and that the tax code must be dramatically simplified and reformed to criminalise explicit tax avoidance schemes, and that the government must introduce a fair tax requirement to prevent taxpayers' money being used to boost the profitability of companies and the personal wealth of individuals, that refuse to pay their fair share of tax.

See Also