Do nations or states ‘compete’ with each other in a meaningful way? We have already explored the thinking of Paul Krugman, Adam Smith, Robert Reich, and the Tax Justice Network on this question. Their answers are, to summarise broadly: ‘no – or at least not in the way people commonly suppose.’
This ‘competition’ between states, we’ve argued, bears no economic relation to the microeconomic competition between firms or companies in a market. The shortest way to illustrate this, perhaps, is to note that a failed company is one thing: a failed state is another beast altogether.
But there are influential people who disagree.
Following last week’s blog on top-end income tax rates by Prof. Matthew Watson, today’s blog highlights a detailed new report (summarised here) which is launched today, on the same subject. It looks closely at the evidence behind claims about the revenue effects of cutting or hiking top income tax rates in the UK.
The report was launched (ahead of the May 7th election) by the Tax Justice Network, with the help of today’s Fools’ Gold blogger, and it shows how the official evidence on these revenue yields is subject to such huge, irreducible uncertainties that they are essentially meaningless. Perhaps more damningly these estimates are, as the report’s author John Thompson notes:
Where the parties stand on top income tax rates
The Labour government increased the top income tax rate for anyone earning above £150,000 per year from 40 to 50 percent from April 2010, the first increase since 1974. The coalition government cut the rate to 45 percent in April 2013.
Current manifesto pledges are:
- Conservative: haven’t ruled out a cut in the top rate to below 45p in the £
- Labour: will restore the top rate to 50p
- Liberal Democrats: no specific pledges on top rate.
- Green Party: a top rate of 60p in the £
- SNP: has said it supports a top rate of 50p.
- UKIP: a 40p top rate.
- Plaid Cymru: a 50p top rate
“so selective as to be unreliable and, if relied upon, worthless or worse.”
In his latest essay for us, Prof. Matthew Watson of Warwick University looks at the utterings of John Redwood, one of Britain’s most vociferous proponents of the idea that tax cuts for the very wealthiest will make an economy more ‘competitive.’ (Take a look at this article to get a flavour of Redwood’s ‘competitive’-tax-cuts-for-all-ailments stance.)
Watson’s article precedes an in-depth report that we will be co-publishing next week, skewering the evidence that UK politicians are using when they make claims about what happens when you change top income tax rates.
An earlier version of this post appeared on the Politics Reconsidered blog in April 2014. Permission to re-post is very gratefully acknowledged.
Competitiveness myths, Income Tax and expansionary austerity
By Matthew Watson
Some small signs of growth for the British economy here, some small uptick in numbers in work there, and the nature of modern party politics seems to dictate that dubious claims about the expansionary nature of austerity will come marching back into view. Throw in some spurious comments about the endorsement of competitiveness policy and they tend to stifle further political debate.
I had convinced myself that I was too long in the tooth to ever see anything new in these tired old arguments. However, in this respect at least, I am now approaching the first anniversary of the day when the words ‘thank goodness for John Redwood’ entered my head for the very first time. This was such an unexpected occurrence that it requires some explanation.
The British Conservative Party describes Redwood as “a hard-hitting campaigner” and, in an attempt to vest this hard-hitting campaigner with authority, visitors to its website are told that he is a “businessman by background”. Last spring, he did what I had thought was impossible in the peddling of competitiveness myths. He put two and two together to come up with something well in excess of four when suggesting that the Treasury had been proved “utterly wrong” in its prediction that a five-percentage-point income tax cut for the richest 1% would lead to reduced overall tax revenues. Here was proof, should there have been a need for it, that if the lens through which you view the world is sufficiently skewed then you can make even the most basic statistics say anything you please.
Redwood’s variant of the expansionary austerity thesis took the following form. Ripping the heart out of the welfare system to fund top-end tax cuts, he seemed to be saying, places the British economy on a level of competitiveness that would otherwise be unattainable: it has reawakened a dormant entrepreneurial spirit to such an impressive degree, he was saying, that more rather than less tax was paid overall in the first year of the new lower rate. More people have been put into work through releasing society’s highest fliers from the “anti-competitive” burden of funding the welfare state, and they paid the Government back for its courageous pursuit of austerity to the tune of a whopping extra £9 billion in tax.
Well, perhaps he didn’t express himself in quite such grandiose terms. However, this was still the gist of his comments.
Two points should be made in response.
(1) Redwood managed to take one thing that was true – HM Revenue and Customs did indeed collect £9 billion of additional tax receipts in 2013/2014 compared with 2012/2013. But he then proceeded to turn it into a series of claims for which he had no evidence.
The increase in tax receipts did not follow a proportionate increase in the number of people paying tax. As the UK’s Office for National Statistics and even the Government’s own Office for Budget Responsibility have shown, the greatest difference resulted from existing taxpayers paying more of what was due. The pre-announced reduction of the top rate of income tax from 50% to 45% was accompanied by a loophole big enough for any competent accountant to drive a bus through it.
The real issue here is the outbreak of tax-switching that ensued. High earners delayed payment on tax that was due at 50% in 2012/2013, so that it could be paid instead at the lower rate of 45% in 2013/2014. The country’s highest earners, in other words, simply refused to look a gift horse in the mouth. This tax-switching artificially depressed revenues in the earlier time period and enhanced them in the later one, so there is no need to search too far for explanations of 2013/2014’s bumper crop of tax receipts. And certainly there is no need to embrace Redwood’s particular brand of expansionary austerity alchemy and the competitiveness myths that serve to sustain it.
(2) Even if his argument could be made to stand up in its own terms, however, does it not reveal a startling lack of ambition at the heart of UK Government economic policy? Redwood is, after all, a former Shadow Secretary of State for Trade and Industry and Prime Minister David Cameron’s specially selected appointee to head the Conservative Party’s Policy Review Group on Economic Competitiveness. But the only thing he seems to be able to say having held those briefs is that innovation is incentivised by tax cuts. [If so, they might like to answer each of these points, in turn.]
Surely, though, there is more to the likelihood of having a marketable idea than whether or not you live in a low-tax environment. Are we really likely to believe that entrepreneurs keep all their best ideas to themselves if personal tax rates are set above a certain threshold? Austerity has not only placed a blanket of conformity over British economic policymaking. It now also seems to be encroaching upon what politicians are willing to say about the nature of modern economic life more generally.
Redwood’s intervention into the debate about tax competitiveness and top-end tax cuts was as instructive in this regard as it was unhelpful if a serious debate is finally to be had about the necessary supporting conditions for economic innovation. Desperately needed debates of this nature would appear to be yet another victim of UK austerity politics.
By Matthew Watson, Professor of Political Economy, University of Warwick.
The Presbyterian Church in the U.S. has put out a press release entitled “Tax Justice: A Christian Response to a New Gilded Age”.
As the report’s summary notes, it
“provides a framework for engaging in discussions about the large and growing concentration of income and wealth in U.S. society and about the tax structure as part of an agenda for addressing economic inequities.”
We have no religious affiliations of any kind, but we feel the report itself contains plenty of good sense, calling for tax systems to be based on progressivity, transparency, solidarity, sustainability and adequacy. But what is of interest here is that they weigh in directly on the issue of tax ‘competition’. For example, they recommend:
“reducing the use of tax expenditures, shelters and havens, and supporting more adequate international standards to reduce tax competition within and among nations
. . .
[a] communal sense of gratitude prompts measures to restrain jurisdictional tax competition (a “race to the bottom”) that beggars neighbors and makes it impossible for governments to address even the most pressing social needs.
. . .
States themselves should seek to reduce competition among their own cities, suburbs, and rural areas”
Our emphasis added. The report, written by a former World Bank economist, doesn’t contain anything that is analytically new. The reason we point to it is just to illustrate that initiatives that recognise these problems exist all over the place (see this, too, from the Uniting Church in Australia.) One of our goals is to try and stimulate debate and encourage more people to engage directly in this terrain.
The term “UK PLC” — the ‘PLC’ bit standing for Public Limited Company — evokes notions that whole countries behave like corporations. It is routinely trotted out by politicians in the United Kingdom: why, this FG editor even heard (and gnashed teeth at) this very term on the BBC’s Today Programme this morning, on a day when 100 UK business leaders signed an open letter suggesting that the UK must display that it is “open for business” by supplying further tax cuts and other goodies to large corporations.
Versions of these kinds of slogans, implicitly equating the interests of large corporate players with the wider national interest, can be found in most countries.
In our latest article, Will Davies asks how slogans such as these – which are intimately intertwined with notions of ‘national competitiveness’ – have managed to achieve such sway over policy-making, around the world.
Fools’ Gold has begun publishing a series of articles and documents asking the question: What is Competitiveness? We’ve already looked at the work of Paul Krugman and Robert Reich; now we will look at the views of the Tax Justice Network on a slightly different but related animal: so-called “tax competitiveness.”
One of TJN’s core points is that, as in other areas, tax ‘competition’ between countries bears no relation to the kind of competition that people are most familiar with: the micro-economic phenomenon where firms compete in markets. And yet these two utterly different processes so often get conflated, simply because they share the same word: ‘competition.’ The arguments usually don’t get very far beyond the ‘competition is good, so tax competition must be good, right?’
Well, TJN has been unpacking ‘tax competitiveness’ for some years now; it generally prefers the term ‘tax wars’ instead of ‘tax competition’. Tax wars conveys the harm and highlights the fact that these processes are more akin to currency wars or to trade wars than to anything that might be called ‘competition.’
TJN has three key outputs in this area:
A document entitled Ten Reasons to Defend the Corporation Tax, whose fourth point outlines the arguments in detail;
An earlier report entitled Mythbusters: “A competitive tax system is a better tax system;” and
A permanent webpage entitled Tax Wars, which contains these documents and a series of other articles and blogs looking at different aspects of these issues.
The most fundamental element in TJN’s arguments, perhaps, is that while international co-operation on international tax issues is almost always a good idea, it is often unnecessary. Countries can go it alone, and take a lead by continuing to tax capital and to preserve progressive tax systems.
TJN argues that – particularly for larger economies – tax-cutting generally will not help the local economy. So many of the pressures that countries feel to cut taxes or provide other subsidies to mobile international capital are founded simply on a false understanding of the concept: this myopia is itself the result of lobbying, bamboozlement and woolly and wishful thinking.
TJN’s uncompromising arguments in this area can be summarised as follows:
- Tax is not a direct cost to an economy, but a transfer within it. Tax cuts transfer wealth from one part of the economy (e.g. tax-financed roads or courts) to another part (e.g. corporate shareholders). This transfer does not automatically help the local economy. Tax levels may affect investment levels, but that is another matter (see below).
- The fallacy of composition. A closely related point. People assume that what is good for corporations must be good for the economy. But if benefits or giveaways to one sector come at the expense of costs to another sector, as is the case with (for example) a corporate tax cut, then this logic fails. When considering a national tax policy it always makes sense to consider it from the perspective of the country, rather than from the perspective of international investors. It is in the interests of sectional interests, of course, to equate their interest with the national interest.
- Tax wars redistribute wealth upwards. Capital is mobile across borders; workers aren’t. So governments feel pressured to cut taxes on mobile capital, which ultimately, and in aggregate, means cutting taxes on wealthy people. Poorer people must pay higher taxes or suffer degraded services as a result.
- The process of tax cuts and subsidies does not stop at zero. There is no limit to which the owners of capital wish to free-ride off benefits provided by society. Think of the arguments like this:
- If it’s generally a good idea to shower investors with tax cuts, why not cut their effective tax rate to zero?
- Why stop there? Why not effective negative tax rates, or net subsidy packages?
- Where does this downwards path stop?
- Tax cuts tend to attract the wrong kind of investment. Real investors don’t chase tax breaks. Countries need the “good stuff” which involves greenfield investment creating jobs, local supply chains, knowledge transfer, and which is generally embedded in the local economy. If it is embedded like this, then almost by definition it isn’t very tax-sensitive.
- Many studies are irrelevant or wrong. The ‘fallacy of composition’ point above suggests that many studies measuring whether a tax cut boosts “investment” are of little use, in isolation. The perspective that matters is whether they provide economy-wide benefits, rather than narrow sectoral benefits. In addition, many studies suffer from other problems: poor assumptions, circular reasoning (p24 col. 3), a failure to take into account ‘round-tripping’ (Section 4.4); to take into account timing issues (Section 4.4) and other problems. Some studies, of course, are influenced by those who would directly benefit from tax cuts.
- In many sectors, it doesn’t matter too much if particular investors exit, because others will take their place. This is particularly true for natural resources: an oilfield isn’t going anywhere and if there’s an after-tax return to be made, the investors will likely come. If investment slows that isn’t ultimately a loss to the country, in the long term: the value remains stored in the ground. But it’s not just about natural resources: where there is an Indian telecommunications licence, for instance, or permissiont to run a Turkish supermarket business, investors who see an after-tax opportunity will come. Don’t start from the perspective of individual investors: start from the perspective of the country.
- Tax cuts generally don’t affect economic growth rates much. They do have an impact on inequality, but there is no clear evidence that they affect growth, particularly for larger economies. (Section 4.5) What is more, the poster children for tax-cutting aren’t what they seem. Ireland did not get rich from cutting its corporate taxes to 12.5 percent, as one of our inaugural blogs It got rich essentially for other reasons.
- Tax wars distort markets. A pursuit of so-called ‘competitiveness’ leads countries to cut taxes on mobile capital; this generally means lower effective tax rates for large multinational corporations (MNCs), at the expense of more locally-based smaller players. This helps MNCs out-compete their smaller rivals on a factor – tax – that does nothing to promote genuine productivity or innovation. This favours the large over the small and boost monopoly and oligopoly, increases economic (and therefore political) inequalities, and hurts fair market competition.
- As already noted, tax ‘competition’ (or tax wars) bear no relation to competition between firms in a market. TJN takes the strong view that the former, a macroeconomic and political phenomenon, is always harmful: a race to the bottom. Yet because tax wars share the word ‘competition’ with the more beneficial microeconomic processes where firms constantly innovate and cut costs to stay in business, many people assume they are healthy. Academic arguments to this effect, originally based on a 1956 paper by Charles Tiebout; lack any solid foundation (Footnote 26, p29). It turns out that Tiebout was probably joking when he first proposed his model.
This is a distillation of the main arguments that TJN has made for many years.
The main documents at the top of this blog, particularly its Tax Wars page, provide pointers to supportive references and quotations.
Disclosure: TJN is a supporter of the Fools’ Gold project.
We’ve already noted that the words ‘competitive’ and ‘competitiveness’ (as applied to whole nation states) are backed by a supportive cast of various other weasel words and terms. One of the commonest is ‘anti-business’ – a term that we’ll dissect in the near future. This UK-focused article highlights prominent usage of the term, in the run-up to next May’s General Election, focusing on the case of Stefano Pessina, boss of the retail pharmacy giant Walgreen Boots Alliance. As Matthew Watson argues, voters should check the evidence on both sides of the argument for tell-tale signs of self-serving use of such competitiveness mantras.
The Two Sides of Speaking Up for Business
By Mathew Watson, Professor of Political Economy and ESRC Professorial Fellow, University of Warwick. An earlier version of this post appeared on the Speri Comment blog in March 2015. Permission to re-post is very gratefully acknowledged.
The Tax Justice Network has just published a major report entitled Ten Reasons to Defend the Corporate Income Tax.
The press release is below, but the part that is of particular interest for the Fools’ Gold blog is Section 4, which talks about the corporate tax in the context of so-called ‘competitiveness.’
Here is the press release:
Recent research from the UK suggests that such policies constitute hand-outs, rather than effective means to shape firms’ investment decisions.
By Matthew Watson, Professor of Political Economy and ESRC Professorial Fellow, University of Warwick, UK. An earlier version of this post appeared on the Speri Comment blog in November 2014. Permission to re-post is very gratefully acknowledged.
It is now more than a generation since British politicians first discovered how the image of globally footloose firms might be used to make the case for establishing a business-friendly environment. Whatever the commitments given at the time that hard-won social rights would not be bargained away on the altar of competitiveness demands, tax cuts for firms that might otherwise threaten to relocate overseas still had to be paid for somehow. That, after all, is the logic of the ‘race-to-the-bottom’ dynamics unleashed by an increasingly globalised economy.
- Update: reposted on Naked Capitalism site in the U.S., and the Angry Bear tax and economics blog, and the Middle Class Political Economist.
- Update 2: See also Ireland’s Recent Success Not Built on Low Taxes, by Kenneth Thomas, author of Investment Incentives and the Global Competition for Capital. In which he makes similar arguments.
Did Ireland’s 12.5 percent corporate tax rate create the Celtic Tiger?
Ireland has long been a poster child for corporate tax-cutting. The standard argument goes something like this. “Ireland has very low corporate taxes . . . Celtic Tiger . . . just goes to show that corporate tax cuts grow your economy.” This argument is popular in Ireland too where government officials like to call the flagship 12.5 percent corporate income tax rate a “cornerstone” of industrial policy.
But is any of this even true?
Well, now take a look at this little graph that we created for this blog. We aren’t aware that a graph like this has been made before.