Whether we look at developed countries, with aging populations and growing health and social security bills, or at developing countries needing funds to finance the UN Sustainable Development Goals, it is clear that there is pressure to widen and deepen the tax base. Furthermore, it is often said that current tax systems — particularly corporate tax ones — are no longer fit for purpose in the 21st century. And in some countries the question of ‘fair taxation’ is a hot topic.
Before looking at some of the issues, it is worth thinking about the purpose of tax and the principles of a good tax.
There are no exhaustive definitions but the following is a rough guide:
Discussions on the principles of a good tax system often start with Adam Smith’s The Wealth of Nations. These can be summarized as:
It is, of course, possible to add more principles. For example, in today’s environment, the following are important.
If the answers to what and how to tax were obvious, somebody would have produced a blueprint for a perfect tax system. That this does not exist is due in part to the fact that different countries have different social, cultural and economic characteristics, and there are varying individual views on how to balance all the factors and set priorities.
Tax on the creation of wealth
It is often noted that it is becoming harder to assess and collect corporation tax in an increasingly global environment with mobile capital. Furthermore, there are concerns that the current system allows multinational enterprises (MNEs) to shift profits from high tax to low tax jurisdictions. This undermines not only the principle of redistribution but also the one of horizontal equity and makes corporation tax an inefficient tax. A proposed solution is to adopt formulary apportionment of global profits. However, formulary apportionment carries its own difficulties and suggests, borrowing from Winston Churchill’s dictum, that the current arm’s-length principle may be the worst of all systems “except the rest of them”. The solution may be to improve the current rules instead of completely changing the system.
The impact of digitalization increases the pressure on the corporate tax system, data revolution is remaking capitalism in radical ways and innovative approaches to data taxation may be needed. The real issue is not more to do with identifying the location of investment rather than the use of digital technology. Nevertheless, many countries are now introducing specific digital taxes with the EU Commission, in particular, making this part of its ‘fair tax’ agenda. Blockchain developments will enable users to own and trade their data, which may make it a taxable commodity in the future. Will blockchain assist with certainty, convenience and economy in tax collection?
The debate about taxing corporations is complicated by the fact that there is no clarity about who ultimately bears the cost. Corporation tax should be a charge on the capital invested, and so should apply to the investors; but it is often argued that a significant proportion is borne by the consumers or employees. Economists generally agree that taxing employment creates a drag on the economy; and whether it is possible to move part of the tax burden from employment to capital. This would be in line with the principle of proportionality as capital is held disproportionately by the well-off. However, taxing capital can also adversely affect employment, and there are concerns that it is more mobile than employment, making it less efficient to tax.
Tax on holding wealth
A potentially efficient tax would be on the potential annual rental of all land, and this would also recognize that land is a public asset and should not be the absolute possession of private individuals. While they tend to be the least popular of taxes, they are particularly appropriate for financing local government. The emphasis however should be on annual property taxes rather than transactional taxes.
There is a proposal to replace traditional inheritance tax rules with a lifetime allowance and restricting pension contribution tax relief to a flat rate so as to make the tax system more proportional. However, in practice net wealth taxes have been found to create issues of neutrality, efficiency and equity; the best approach to taxing wealth could be through annual property taxes.
Tax on spending wealth
Many economists would argue that moving to taxing consumption is the most efficient form of tax as it is least distorting of behavior. However, this is widely considered to be regressive. There are suggestions to make consumption taxes more progressive; while some may argue it may be more efficient to lower the rate but broaden the base and then use the revenues generated to drive progressivity through other parts of the tax system. When it comes to digital transactions, the issue is not what to tax but who should collect it? Another key issue is: Should indirect tax be applied to the growing number of consumer to consumer transactions?
Tax and sustainability
Finally, no review of what to tax would be complete without looking at green issues and how green taxes can be used to improve health, protect nature, increase tax revenues and drive competitiveness and innovation. Green taxes, though, do have a sustainability paradox, the more successful they are at changing behavior, the less revenue they generate.