Sunday, 18 November 2012

Tax Avoidance, And A Clever Way Of Minimising The Debt

The grossly dislikeable Margaret Hodge, who chairs the parliamentary committee for Public Accounts, has condemned the favourable European tax jurisdictions that Google, Amazon and Starbucks use for their UK businesses. Now while I agree that it would be good to get the full quota of tax from these companies, the Government's (and shadow Government's) insistence that those millions would help reduce the UK debt are remiss.  I could make an argument (although it's a bit oversimplified) that says Amazon pays its taxes, it then puts up its prices, meaning the consumer pays more - therefore given the choice between paying £2 less for a book on Amazon, or the Government having that money (to probably spend at least some of it unwisely), one might prefer things as they are.  Certainly at an individual level, I'll bet most people would rather buy a book from Amazon for £8 than pay £10 and be assured that an extra £2 is going to the Government. 

In reality, though, the Government has a contingency plan for this - they simply smuggle in stealth taxes to obtain from the taxpayer the money they are not getting in revenue from tax avoiding companies.  But they should do two things with the money obtained – they should spend it on services that will benefit the country (NHS, Education, Social Services, Planning and Transportation, etc) and they should pay off the debt interest but not the debt itself.  The first is obvious, the second not so obvious, but here’s why.  If the Government sets up a policy whereby they approximate future outlays of debt interest but suspend payments on the debt aggregate itself they can set our tax rates so that those revenues match those outlays on an annual basis and not inhibit the spending on services that will benefit the country. 

Here’s the important distinction between paying off the debt and the interest attached to the debt.  In the future the debt aggregate is going to be a lot more trivial (and a lot less painful) to future generations than it is to us – so if we keep up the interest payments but have a moratorium on the aggregate debt payment, then paying it off for future generations will seem a lot like to charity to them (and we all like charity, don’t we?).  Think of it this way – suppose our UK bankers had run up the equivalent debt (pro rata) in the 1880s, and suppose William Gladstone had had the foresight to set up a policy immediately to pay off the interest every year for 120 years up to our present day – our current Government would be faced with a meagre debt of tens of thousands of pounds.  Much better to pay off that than see our great-great-grandparents’ generation miss out on important Government spending because they were yoked to a crippling debt.

The other important factor in this idea of future benevolence is that it minimises deadweight loss (deadweight loss is the damage done to the economy through raising taxes to combat tax disincentives).  The deadweight loss value is approximately proportional to the square of the tax rate, so paying interest for the foreseeable future but not the debt is the best way to minimise deadweight loss*, because it doesn’t negatively impact present day spending, and it enables future (much richer) generations to pay it off for us at a smidgen of the current aggregate. If the Government is going to waste taxes from big corporations on slicing off the debt aggregate, then you may as well cheer on Amazon’s tax avoidance policy and enjoy cheaper books. 

* Here’s the maths: every £100 in outstanding debt commits the Government to paying it off with a present value of £100, and hence to collecting tax revenues with a current value of £100. In a world in which the interest rate is 3%, the options include the Government collecting (and paying off) £100 immediately, or £50 this year and £51.50 next year, or £11.38 a year for ten years running, or £3 a year for the long term foreseeable future until our progeny can pay it off at a cheaper rate that won’t cripple them.