Prem Sikka says getting taxation policy right is critical for Labour
Tax revenues are the life-blood of all democracies. Without these, no state can alleviate poverty or provide healthcare, education, security, transport, pensions and public goods that are necessary for all civilised societies. They are of critical relevance to the next Labour government as it will inherit an economy broken by Brexit and the erosion of its manufacturing base. It will need to invest extensively in education, housing, healthcare and public ownership of railways and utilities. Yet tax revenues are under relentless attack from wealthy elites, large and small corporations, accountants, lawyers and financial experts.
The challenges for Labour are all too evident and a detailed analysis would require several books. In the space here I examine some issues relating to corporation tax, capital gains tax and wealth tax.
Companies like Apple, Amazon, Google and Facebook pay little or no corporate tax in the UK despite making huge profits. Most recently, Amazon paid corporation tax of £1.7 ($2.2 million) on its UK sales of $11.37 billion. A recent study by Thomas Tørsløv, Ludvig Wier and Gabriel Zucman estimates that around 40% of the profits of giant corporations are shifted to tax havens through intragroup transactions, such as royalty payments, management fees, interest payments and other practices. The trend is increasing. The EU and developing countries are amongst the biggest losers.
Here is how Thames Water shifted its profits to virtually eliminate its UK corporation tax bill. From December 2006 to March 2017, Thames Water was owned by Macquarie Bank. For 11 years Thames operated through a labyrinth of companies, with some registered in the Caymans. Returns for Macquarie and its investors averaged between 15.5% and 19% a year. For the period of its ownership Macquarie received an estimated £1.2 billion in dividends, but this was not the only return. Thames Water was loaded with intra-group debt through entities in the Cayman Islands and elsewhere and the debt did not have to be used in the UK.
Its debt ballooned from about £2.4 billion to £10 billion and interest payments swelled the charges for customers. Tax relief on interest payments reduced corporate tax liability. For the period 2007 to 2015, the company’s accounts show that it paid £3.186 billion in interest to other entities in the group alone. This would have been paid without deduction of any withholding tax. Entities in the Caymans and other low/no tax jurisdictions would have received the amounts tax free. At the same time, Thames Water would have been able to claim a tax deduction for the interest payments. Thames Water paid about £100,000 in corporation tax for the period 2007 to 2016.
The current system of taxing corporations is dysfunctional. It was crafted more than a century ago and before the advent of corporate globalisation and e-commerce. There are now three key problems.
Firstly, under the rules companies are generally taxed at the place of their residence and control rather than where economic activity took place.
Secondly, each entity in a group of companies is treated as a separate taxable entity. Thus, if Amazon has 500 subsidiaries they are treated as 500 taxable entities. This gives companies enormous scope to shift profits and reduce their tax obligations. They play one country off against another and large proportions of corporate profits escape taxes altogether.
Thirdly, the authority of any nation state is confined to its defined geographical boundary, but in search of profits corporations roam the world and their operations are often integrated. Their subsidiaries in far flung places are part of an integrated supply chain. The big question is about the proportion of corporate profits which could be attributed to each country so that it could then tax it to raise revenues. This is done by using arm’s length prices of various inputs under a system known as transfer pricing. But the problem is that in the era of global monopolies, independent arm’s length prices are hard to obtain. This has enabled companies to play games with tax authorities.
A way forward is offered by the Common Consolidated Corporate Tax Base (CCCTB) system advocated by the European Union. It sweeps away the above problems. Under this, a company like Amazon, regardless of the number of subsidiaries, will be treated as a single integrated entity. Its global profits would be apportioned to each country on the basis of a formula which takes account of sales, number of employees and other factors. CCCTB merely allocates profits and each country can set whatever rate of corporation tax that it wishes.
CCCTB can negate profit shifting and early estimates suggest that the biggest losers will be tax havens, including Ireland and Luxembourg because they rarely have a large volume of sales or number of employees. To make the change the EU needs to secure unanimous agreement and may have to offer sweeteners to the opposing member states.
There is a long way to go, but Labour should support CCCTB. It can also act unilaterally and disallow certain expenses for tax purposes on the basis that they do not represent any independent economic activity. The Organisation for Economic Co-operation and Development (OECD) has examined profit shifting under its Base Erosion Profit/Shifting (BEPS) project. It recommended that tax relief on corporate interest payments be restricted to between 10% and 30% of corporate earnings before interest, taxation, depreciation and amortization (EBITDA). Last year, the government enacted legislation to restrict it to 30% of EBITDA. This won’t stop the tax games and the next Labour government should consider abolishing tax relief on interest payments altogether. Ordinary individuals cannot claim tax relief on interest payments whether for the purchase of sole residence on anything else. The rationale is that tax relief on interest payments distorts markets, creates bubbles, unfairness and financial instability. Well, the same logic should apply to businesses too.
Progressive Taxation to Tackle Inequalities
The next Labour government would need to address the inequalities exacerbated by Conservative economic policies. In 2003, households on the lower half of incomes earned £14,900, after inflation and housing costs, but by 2016/17 it declined to £14,800. This is translated into wealth inequalities. The most recent data published by the Office of National Statistics shows that the UK’s wealthiest 10% of households owned 44% of aggregate total wealth.
In contrast the least wealthy 50% of the households owned just 9% of total wealth and middle wealth households (51% – 90%) had 44% of wealth. Yet the government has done little to check the inequalities. It reduced the highest marginal rate of tax on income above £150,000 from 50% to 45%. The wealthy make capital gains on their investment and the government policies again favour the well-off.
Currently, income and capital gains are taxed at different taxes. For the tax year 2017-18, the UK levies a basic rate of income tax (20%) on taxable income of up to £33,500 (£31,500 for Scotland), 40% on taxable incomes between £33,501 and £150,000 (between £31,501 and £150,000 for Scotland) and 45% for incomes above £150,000. At the same time the rates for capital gains tax (CGT) are 18% for basic rate taxpayers and 28% for higher rate taxpayers.
The tax rate differentials have created opportunities for accountants and lawyers to use their energies to convert income to capital gains, and even vice-versa if the circumstances are considered to be advantageous. If wealthy individuals succeed they can pay tax at 28% rather than at the marginal rate of 45%. These crazy policies further exacerbate inequalities.
Labour’s 2017 manifesto is already committed to raising the highest marginal rate of income tax from 45% to 50%. It should consider curtailing capital gains tax avoidance strategies by abolishing the distinction between capital gains and income. Capital gains are windfall gains and increase the purchasing power and potential consumption of the individual. There is no qualitative difference between the two. Capital gains should be added to the individual’s total income for the year and taxed at the appropriate marginal rates to reduce opportunities for avoidance.
Labour should also consider forms of wealth taxation. There are numerous forms of wealth – some arising from trade, innovation and production, which arguably confer some benefit on society at large. Others arise from speculation or windfalls where the recipient has done little or nothing to generate any wealth. There is some attempt to tax inherited wealth, but the rich have been very adept at avoiding inheritance through offshore ownership and trusts. Labour would need to examine the whole issue of tax on various categories of wealth.
All too often some individuals and companies have made fortunes from the effects of public expenditure. The construction of HS2, M25, the Jubilee line and other publicly funded projects has made land and infrastructure around these projects extremely valuable. The owners of land have become richer without spending anything. The next Labour government should demand a share of those gains so that the public purse also benefits from the gains arising from the public. Labour’s 2017 manifesto promised to look at land tax.