10 March 2017

Hammond prepares for the coming taxpocalypse


In the days since Philip Hammond’s Budget, acres of newsprint and gallons of vitriol have been devoted to his decision to raise National Insurance contributions for the self-employed.

Yet what almost nobody’s paid any attention to is the explanation.

During his speech, Hammond warned that “the challenges of globalisation, shifts in demographics, and the emergence of new technologies” had seen a transformation in the labour market which was robbing the Treasury of vital revenue.

It was a point picked up by Theresa May, when she came to her Chancellor’s defence. The decision was, she said, “taken in the context of a rapidly changing labour market in which the number of people in self-employment is rising rapidly” – and, in the process, “eroding the tax base”.

In other words, while the Government is talking about fairness, what it’s actually worried about is affordability: the prospect that the taxes on which the vast superstructure of the state depends are becoming harder and harder to collect.

And this, in turn, is only a symptom of a deeper problem. A 20th-century tax system is in the middle of a juddering collision with the 21st-century economy – and policy-makers are desperately trying to prevent an almighty pile-up.

The general idea of taxation is to collect the money the state needs (or thinks it needs) in a way that’s as simple, straightforward and non-disruptive as possible: plucking the goose so as to get the most feathers with the least hissing, as Colbert said in history’s first and only bon mot about tax collection.

In the 20th century, this process used to be rather easy. Most people stayed in the same jobs, working for the same companies. And it was easy for the taxman to spot the big office blocks full of white-collar wage slaves, and the factories full of blue-collar ones.

What Hammond and other finance ministers are wrestling with is that this system is gradually breaking down. Economic activity is becoming more mobile, more international, more digital. And tax collectors are finding themselves in the position of big game hunters who have suddenly been asked to bag wasps instead of elephants.

You can see this tension running through almost every section of Hammond’s speech on Wednesday. Early on, for example, he boasted that the Conservatives were wringing more money out of the rich than Labour ever managed: the top 1 per cent of earners are now paying 27 per cent  of the income tax.

Yet as I pointed out before the Autumn Statement, there’s another way to look at this, which is that the tax burden is resting on ever fewer shoulders.

Out of a UK population of 64 million people, there 50,000 or so who earn more than £500,000. This 0.07 per cent of the population end up paying 13 per cent of the income tax – some £22 billion in total. And these are precisely the kind of people who can easily up sticks if they don’t like the Government’s policies, or pay thousands to fancy lawyers and accountants to save themselves millions.

The business rates revaluation will have the same effect.

The changes have caused enormous controversy: people moan that even as Amazon crushes the high street, taxes are being lowered on the bohemouth’s warehouses and raised on city-centre delicatessens.

The next revaluation is set for the far-off date of 2022. It is a racing certainty that by then, more business will have migrated online, or to distribution centres that no customer will ever actually set foot in. Yet property prices in affluent city centres will, presumably, have soared – meaning that rates will rise further, or shops will turn into homes and the rates revenue will vanish. Either way, the tax regime will be increasingly divorced from how business actually operates.

Then, of course, there is self-employment. As May and Hammond have pointed out this week, the job market is changing. You might hold one position for a few years, then retrain because technology has made it obsolete. You might do one main job and a couple of casual ones, or work as a consultant for a few different companies.

Or, as Martin Vander Weyer points out, you might work in what used to be a traditional job which has been turned into self-employment or even a zero-hours gig by a rapacious, exploitative employer like Uber, Sports Direct or, er, The Guardian. Already, 15 per cent of the workforce are self-employed. And those numbers are likely to rise, not least because companies and workers will have heard the Chancellor talking about its tax advantages and speed-dialled their accountants.

Yet the really strange thing about this is that, compared to the economic advantages of self-employment (whether voluntary or forcible), Hammond’s vastly controversial, manifesto-shattering tax rise is, in fact, a fiscal pinprick.

The Chancellor claimed in his speech that the changes he is making will end up raising an extra £145 million a year by 2021-2. Yet moments before, he had put the annual cost to the Exchequer of self-employment at £5 billion. In other words, the economic incentives will still overwhelmingly favour self-employment: instead of levelling the playing field, he’s very slightly reducing the tilt.

What we’re seeing, in other words, is that many of the traditional pillars of the tax system – business rates, income tax, National Insurance – are becoming weaker, and will grow weaker still.

Yet the real symbol of these changes – the biggest and baddest horseman of the taxpocalypse – is corporation tax.

Most of the recent headlines about corporate taxes have concerned themselves with how it is being cut (due to politicians’ disgraceful kowtowing to corporations) or being avoided (likewise).

It sometimes seems like we’re caught up in a race to zero. In the UK, George Osborne cut corporation tax from 28 per cent to 20 per cent, and Hammond has confirmed that he will keep on cutting to 17 per cent.

The centrepiece of Malcolm Turnbull’s economic policy in Australia is reducing it from 30 per cent to 25 per cent. Donald Trump came to power promising to slash America’s rates from 35 per cent to a potential 15 per cent. Even the French are getting in on the act – both Emmanuel Macron and Francois Fillon want to move from 33.3 per cent to 25 per cent.

It’s not just a recent phenomenon, either. Since the 1980s, rates of corporation tax across the Western world have slid inexorably.

The problem with the “evil corporations, spineless politicians” narrative is that, at the same time, revenues have gone up – as Daniel Mahoney pointed out this week.

This is the Laffer Curve in action. Corporation tax, for all those years, was set at a level that discouraged economic activity. Lowering the rates turned out to stimulate people’s appetite for profit. And, of course, there was an element of beggar-thy-neighbour, as countries competed to be the most friendly environment for investment.

So why not cut it to zero? As Helen Miller, head of tax at the Institute for Fiscal Studies, points out, “corporation tax at the lower end bumps up against the rest of the tax system”. If companies pay less tax than people, then people will turn themselves into companies: Dave the Builder becomes David Bloggs Construction Enterprises Ltd. The work is the same, but the money comes out as a dividend rather than a salary – and the taxman gets far less of it.

Hammond put the current cost of such “incorporation” to the Treasury at over £6 billion a year – but said it would soar to £9.5 billion by 2021-22. Hence the decision to reduce the tax-free allowance for such dividends from £5,000 to £2,000, in order to push people back into PAYE.

But the real problem with corporation tax is not its level, but its basic design.

The advantage of such a tax for government, says Gavin Ekins of the Washington-based Tax Foundation, is that it is fairly easy to administer. You have large companies, with good records, which are easy to monitor.

But there’s also a problem: namely, where is the value you’re taxing actually created? If Apple builds an iPhone in Taiwan, using raw materials from Australia and advanced components from Brazil, to a design thought up in California (but partially in Oregon), then markets it in the UK, via a company based in Ireland, where is the value created? (This is without even getting into the licensing and buying-back of intellectual property rights, or any number of other accounting dodges.)

The international tax system, says Helen Miller, “is designed for manufacturing companies that ship physical goods”. It’s based on trying to assess the value added at every stage in the supply chain – but “trying to measure where the value is created is a fool’s game in today’s world”.

And the weird thing about this – the very weirdest thing of all – is that the person who’s speaking most sense on this turns out to be Donald Trump. (Or at least the Republicans who are doing his policy thinking for him.)

Everyone is talking about Trump’s plans for “border adjustment” as part of his general and nakedly terrifying war on free trade.

But actually, it’s something rather different. At its heart, as Republican leader Kevin Brady explains, border adjustment is based on the idea that you forget about all the rest of the fiddle-faddle and take your tax where you can be absolutely sure that the economic activity happened: when someone bought or sold something.

“It basically works like a VAT,” says Diego Zuluaga, of the Institute of Economic Affairs. “What you’re doing is taxing the domestic cashflow of companies, so whatever they buy from suppliers at home and abroad is taxed, and whatever they sell abroad is not.”

The headline change under this system is that imports are taxed, but exports aren’t – which would, in turn, push up the value of the dollar sharply. But the real significance is that instead of trying to follow products around the world and along the value chain, you forget about what’s happening abroad and just tax what’s bought and sold in your own country, with foreign and domestic products competing on a level playing field.

And this has other benefits, says Ekins. With a consumption tax, you know exactly where a sale takes place: you don’t have to figure out where the value was created along the supply chain. But this also removes the incentive for firms to play games with borders, by parking intellectual property overseas or setting up offices in Dublin or Luxembourg that sell into the rest of Europe but avoid paying as much tax as local firms.

Border adjustment would be enormously disruptive. But it would also trigger a chain reaction. In order to avoid losing out to a newly competitive America, other countries would have to start shifting from value-based taxes to consumption-based taxes as well. And this, in turn, would encourage growth.

A few years ago, Zuluaga called for corporation tax to be abolished and replaced with a tax on dividends. His argument was twofold. First, that the costs of corporation taxes were often born by workers (via lower salaries) and consumers (via higher prices) rather than shareholders, as intended: in fact, workers turned out to bear 57.6 per cent of the burden.

But second, taxing consumption rather than income was more economically sensible, because it made more money available for investment. “Taxing consumption is much more efficient because you’re not taxing the future at the expense of the present,” he says. “When you tax income or capital, you’re discouraging future consumption.”

All of this might seem a long way from Philip Hammond’s Budget speech. But multinational supply chains and self-incorporating white van men are macro and micro aspects of the same problem.

Nationally and internationally, for both companies and individuals, the economy is moving away from rigidity and towards mobility, away from the physical and towards the digital.

If we stick to our increasingly obsolete taxation systems, the end result will indeed be a “taxpocalypse”, as more and more economic activity moves out of government’s control or even sight. But this process also holds out a great prospective benefit: that even as it makes it ever harder to patch up the existing system, it makes it ever more tempting to build a better one.

Robert Colvile is Editor of CapX