About tax

No matter how much modern libertarians might fantasise about small government, the size is never zero and so governments need to raise tax.

In determining tax policy there are three objectives that need to be met.

The first is to raise the revenue required to deliver the services demanded (plus or minus any desired surplus or acceptable deficit).

The second is to raise the tax efficiently. This means both the technical efficiency of raising the tax with the least expense in raising taxes and the allocative efficiency of trying to minimise the effect of the tax on price signals and incentives.

The third is equity, to ensure the tax system is equitable in its treatment. Usually two principles are considered here. The first is that two individuals in the same circumstances need to be taxed equally. The second is that tax should be rendered relative to an individual's capacity to pay.

The unfolding story of the growth in tax minimisation strategies by the largest corporations in the world shows how current tax arrangements fail all these tests.

The AFR this morning pulled out Amazon as a particular case. Amazon in Australia has two direct lines of business, and then it has its third role as an importer. Amazon Web services is a cloud hosting service that counts among its clients (possibly indirectly) both the Liberal Party and the Labor Party. It is selling these services domestically and has facilities here.

The second business is the sale of e-books for Kindle. Today as a registered Kindle shopper in Australia I can only order from amazon.com.au, not amazon.com. At least the pricing looks the same (one is designated in $AU the other in $US). I'm prepared to be that delivery also happens from a local server but I can't prove that.

But the transaction by me with Amazon is occurring - in fact required to occur - in an Australian domain. Yet somehow for tax purposes the transaction doesn't occur in Australia. I wonder if it occurs ANYWHERE for goods and service tax purposes or is deemed in each country involved to have occurred in another.

The short answer is "probably not." The topic globally goes under the name of "Base Erosion and Profit Shifting" or BEPS for short. The OECD BEPS project however seems to be mostly focussed so far on inter-administration identification of the transaction flows rather than discussion of how to make sure the "proper" tax is paid. Australian action seems to be similarly limited.

How does the Australian business community react to this issue. The Chief Executive of the BCA addressed the question this week. In doing so she outlined her own view of the objective of the tax system, namely:

Digital technology and increased interconnectedness in the global economy has had a profound impact on our lives and the way we do business....The Business Council has called for a global mindset from Australian businesses to capture these opportunities, specialise within supply chains and access new markets.

In an increasingly competitive business environment, taxation arrangements influence where we work and invest. International tax laws should not be an obstacle in the unstoppable evolution of the global economy. They should not be so excessive or complex such that they hinder trade, investment and innovation. 

Rather they should be modernised to ensure they remain fit for purpose in achieving their dual objectives of revenue raising, and incentivising growth and investment.

It is worth noting the extent to which the issue of BEPS is directly associated with the Digital Economy. It provides both the transactions that are problematic, but also provides the means to make other transactions become problematic.

But far more telling is the BCA's understanding of the objectives of tax design. Firstly it is NOT an objective of tax policy to "incentivise growth and investment", the objective is to limit the distortionary effects of taxation. The second is that there is no recognition of the role of equity.

The BCA then advances this flawed thinking into its own proposals. After first cautioning Australia about doing anything alone, and how everything needs to be managed within international tax arrangements, the BCA goes on to assert that Corporate Australia is over-taxed. (That this argument sounds like the defence of copyright piracy - we only steal because you charge so much - is just delicious irony).

So as far as the BCA is concerned the real issue is simple:

But in listening to the OECD on BEPS, it is important to hear the message in the context of its overall advice on tax reform and its role in economic growth. This is about getting a better tax mix between direct and indirect taxes to better encourage investment, innovation and entrepreneurialism – key drivers of growth.

Competition in global corporate tax rates has intensified. Japan and Spain recently announced corporate tax cuts to boost investment and growth. If we look back a decade, our corporate tax rate of 30 per cent was a little above the averages of the OECD and our competitors in the Asia-Pacific region – which were about 29 and 28 per cent, respectively. Since then, these averages have fallen around 5 percentage points while we have stood still.

In a nut-shell, because corporations choose where to invest (or more importantly where to pay tax) Australia needs to lower its corporate tax rate. To make up the revenue indirect taxes need to increase.

This is where the PM comes in having been duped by this argument. So he has initiated his discussion about Federation as a means to get the States to demand the rate of the GST increase...as part of fulfilling the BCA agenda.

But it is all absolute rubbish.

Firstly, by ignoring the equity argument the BCA is ignoring the fact that some of its members are paying far higher tax rates than others - depending a lot on their corporate structure. Secondly, a lot of the Digital Economy transactions are simply escaping the nett of indirect taxes - as my e-book example shows. And finally, in a result owing to Ramsey that for a mark-up on prices to have minimum economic distortion the mark-up should be in inverse proportion to the elasticity of demand.

The most important feature of the BCA's own tax paper is that Australia is a low tax economy.

We need a decent discussion on tax, but the BCA should not be at the centre of it. Personally I doubt that any of the CEOs who actually comprise the BCA would have the slightest clue about tax as a policy issue. They understand it as a private issue - if the company pays less tax I can pay a higher dividend the share price goes up and I get a bonus.

And the first thing we need to agree globally is that shifting transactions and notional company locations for the purposes of tax minimisation are economically distortionary and to be eradicated. It can be done. A challenge is that a country that sets a low tax level can have actually increased its total tax take as a consequence and will be reluctant to change. But the change can be effected by the countries at the ends of the transactions (for example, by jointly agreeing that the intermediate transactions did not exist).

Note: Interesting question what impact the lack of a GST has had on the prices of education and health services discussed yesterday. It is possible that the relative price has been able to rise because of the lack of tax...