Global capital markets, direct taxation and the redistribution of

income

Valpy FitzGerald, Oxford University

First draft of paper presented to the conference “Economic Policies of the New Thinking in

Economics” at St Catherine’s College, Cambridge 14 April 2011

Presentation content

Rather than go through whole paper, I will focus on four (hopefully interesting) points:1. Relevance of direct tax issues to New Economics2. Theoretical weakness in the orthodox model3. Level and trends of capital taxes4. Global tax collection, information exchange and

the potential redefinition of development ‘aid’

1a. Relevance of capital tax issues to New Economics

In the field of theory these include• Chance to break grip of intertemporal

optimisation model with complete foresight or insurance by representative household/agent

• Reintegrating distributional (political economy) criteria macroeconomics; and public institutions to cope with uncertainty

• Reinstating investment, public as well as private, human as well as fixed (rather than saving) as the driver of growth/development

1b. Relevance of capital tax issues to New Economics

In the field of policy they include• underpinning social democracy in capitalist

economies by keeping lower income groups at acceptable distance from median

• effective regulation of international capital flows for fiscal purposes => externalities for prudential regulation and policing of illegal activities

• a sustainable replacement for non-humanitarian international development cooperation based on tax cooperation rather than “charity”

2a Orthodox Tax Theory• Development of original Ramsey (1927) optimal

‘elasticities’ tax model by Mirrlees, Lucas etc ‘proves’ capital taxes should be low/zero in closed economy

• Very strong assumptions about high elasticity of capital supply (saving) to net return; and low elastricity of labour to real wages (except at top of course!)

• Argument strengthened in 1990s by globalisation: OECD policy shift from mobile (capital income, corporations and top earnings) towards immobile (consumption and real estate) tax bases.

2b Problems with orthodox theory

• Lack of any intra-generational distributional criteria (inter-generational through social discount rate, despite Ramsey)

• Wrong on capital markets (smoothing); human capital as asset (Aghion & Howitt); inter-generational tax impact (Buhlig & Yanagawa); and infrastructure

• Incorrect to separate fiscal income from expenditure (governments credit constrained) so capital tax can be positive for investment/growth (see Appendix)

3a. Capital/labour tax burdens have changed in UK; but capital tax base has fallen too (tax

avoidance)

UK Implicit Tax Burdens (% of relevant income base; source OECD 2006)

1965 1975 1985 1995 Labour income

24 31 30 29

Capital income

32 55 50 34

Corporate income

30 115(!) 74 64

Consumption 12 10 14 15

3b Current EU pattern fairly stable; though very low corptax base (6% of GDP?)

3c International political economy of secrecy

• High cost of secrecy on ownership of income and assets: – global accounting systems of international firms

(“transfer pricing”)– unregistered assets of households (“tax evasion”)

• Different tax rates are not the main problem (covered by taxation treaties) but do promote damaging competition for FDI and complicate revenue sharing.

• Interest in secrecy from a powerful lobby of those– Avoiding regulation– Maximising wealth– Engaging in crime

3d Inter-governmental coordination failure

• The familiar problems of all intergovernmental cooperation (free riders, sovereignty, asymmetric bargaining etc); compounded by speed of finance.

• Serious technical issues (data handling, legality of access, beneficial owners etc) where most (but not all) developing countries are well behind.

• But developing offshore financial centres (“offshore”) not the only opaque jurisdictions, nor the largest traders in financial services -OECD (“onshore”) centres are.

4a Recent steps to improve cooperation

• UN International Tax Committee efforts to improve information exchange are limited; but do emphasise mutual debt collection

• OECD and the EC increasing cooperation; taking first steps towards automatic information exchange and witholding taxes

• But these measures do not include developing countries – even those of G20.

4b The problem

• Profits easily be shifted internationally due to disconnected tax/accounting jurisdictions.

• Foreign corporations reduce domestic tax liability as part of global “tax planning”

• Domestic wealth holders hold large undeclared assets overseas

• Large loss of potential tax revenue and lack of transparency

4c The solution

• Tax cooperation between all jurisdictions should support the emerging global financial architecture – not just within the OECD

• International tax models should be equitable between levels of development; through DTTS and full information exchange

• Development cooperation should be redefined as a fiscal relationship involving tax revenue sharing and budgetary support

4d Systems for information exchange rather than tax harmonisation

• Key issue: give developing country tax authorities information on residents’ assets abroad plus country-by-country accounts of MNCs

• In essence, this would involve building on the OECD system, adding lessons from the US and EC systems, and extending it southwards.

• Tax harmonisation to prevent a “race to the bottom” is best pursued regionally; but sharing of revenue should be redistributive north-south

4e Regulating revenue sharing instead of “aid”

• Full accounting of taxable income and assets between two countries; plus a DTT; is in effect a revenue sharing system due to deductables.

• Revenue sharing is the basis of ‘aid’ within states to poorer regions; with performance indicators and incentives for local resource mobilisation

• Tax revenue sharing would generate far more than ODA; though reallocation needed for LDCs. Above all, aid would no longer be charity.

THANK YOU

3. A simple “AK” model of profits tax in an open economy

• The assumption of an overall expenditure constraint is in fact very restrictive; as increasing one tax just reduces another.

• More realistic to assume that extra revenue allows extra expenditure, and that his can increase productivity in an AK model

• But we retain the full freedom of capital movement in response to post-tax profit differentials (i.e. high “Ramsay” elasticity)

What is the optimal rate of taxation on profits in a small open economy?

(1) JKLAY .

return on capital, r, is

(2) K

Yr

Equilibrium set by domestic corporation tax rate (t), and international rate of return (r*), and the international corporation tax rate (t*):

(3) *)1(*)1( trtr

But once we allow for “t” funding “J” then 𝝏𝒀 𝝏𝒕Τ is ambiguous and in fact a solution 𝒕= 𝑻> 0 is optimal

(9) 1

1

)1(*)1(* tttraLY .

With “J” exogenous, then 𝝏𝒀 𝝏𝒕< 0Τ ; and thus 𝒕= 𝟎 is best

(6)

1

1

*)1(*

)1(

tr

tJALY

(10)

T

which depends on relative marginal productivity of public/private capital stock.

Figure 1: Composition of the Tax/GDP Ratio in SSA, 1980–2005 (IMF 2009)

Figure 2: CIT Rates and Nonresource CIT Revenues in SSA, 1980–2005 (IMF 2009)