The way less travelled...
How can governments use the tax system to promote economic growth?
When I first wrote on this in the wake of the Global Financial Crisis, and ahead of the OECD BEPS project, the stock answer was ‘reducing the burden of taxation on business’, or some similar form of words. Historically that was pursued by cutting the rates of tax, and in some cases, the base on which that tax is levied. And the result was concerns about the race to the bottom, and a focus on who may be making up the shortfall in domestic treasury receipts if companies weren’t paying the tax.
But in the 2020 landscape of economies and societies trying to respond to the shock of Covid-19, the narrative is more focused around tax rises to pay off debts incurred in the pandemic response, rather than cuts to assist business recovery. But is there still a way that the tax system can be tweaked to reduce the impact on business without compromising government revenues?
2013 research from the World Bank suggested that governments might be missing a trick in focussing on the direct tax charge recorded in the accounts as the key to the impact of taxes on business. Although the correlation hasn’t been tested to scientifically confirm the link, economic growth across the hundred or so economies measured in the annual ‘Paying Taxes’ survey is linked more closely to reductions in the administrative burden of complying with the tax system than it is with the actual rates applied. (You can find the 2013 survey, which sets out the conclusions, here ) To put it another way, business is more worried about how hard it is to fill the forms in than it is what numbers actually go into it.
There’s an obvious logic when you think about it – time spent on tax compliance is specifically diverted away from the productive efforts of the business. Reducing the time spent on administration will increase the time available for creation of economic wealth. On the other hand, changing tax rates (the distribution of the profits already earned) simply reallocates the existing wealth in the system. For that reallocation to actually promote growth, it needs to be reinvested by the business, and for it to promote the maximum amount of growth the business return has to be greater than the multiplier effect of the equivalent public spending funded by the taxation.
And while you can argue about the relative multiplier effects of private or public sector investment, the fact remains that any growth based on that investment is only going to come on stream some time in the future; the extra hours spent on making product, or chasing sales, this year will have an impact straight away. The opportunity cost of wasting business time on sterile administrative bureaucracy is, or certainly should be, clear – and especially so in a world where many businesses are facing losses and won’t pay any profits taxes at all, regardless of rate or base. Reducing the deadweight cost of administration affects every business registered for taxes, and the benefits are likely to be felt even more keenly in those who are otherwise struggling and watching every element of cost, whether cash or resource based.
So what can governments do to reduce that administrative burden? Well, keeping taxes simple is the answer. Of course that’s easier said than done, and as ACCA’s paper on Simplicity in tax explores how there is a tremendous amount to think about. Key to the whole affair though is clarity of mind and clarity of purpose from the policy makers. If a single tax is expected to perform several roles, then it’s inevitable that there will be tensions in how it is set up, and between the different outcomes it is supposed to deliver. Society as a whole pays the price of undue complexity in the tax system, and politicians owe it to us all to think more carefully about the broader impact of every tweak to the system, every tinker at the edges – and to shift the direction of travel towards simplification.
*This blog is a lightly updated version of a post originally written in 2014.