The coming generation of tax vehicles
Taxation can be a powerful policy instrument, influencing social as well as economic change. And as Gavin O’Toole finds, a growing number of governments are using fiscal tools to shape the behaviour of consumers and businesses – whilst boosting flagging tax revenues
“Some people say that on the issue of fairness, the IMF is now ‘out-Piketting’ Thomas Piketty,” says Zsolt Darvas. “There has been a very strong shift on the issue of social fairness as one of the objectives of taxation among the multilateral organisations.”
In referencing the left-wing French economist Thomas Picketty, Darvas – a senior fellow at the Bruegel European think tank – is emphasising how far the international debate has moved on the use of taxes to tackle inequality. Indeed, Darvas believes that global financial bodies such as the International Monetary Fund are increasingly ready to back the use of fiscal tools to achieve a wide range of public policy goals – including improving public health, stimulating investment and reducing environmental damage.
A recent overhaul of value-added taxation in the European Union, for example, will give member states far greater leeway in using consumption taxes to achieve wider policy objectives. “The European Commission has said very explicitly that one goal of VAT is to achieve public policy goals,” says Darvas.
Stimulating growth
Zsolt Darvas, senior fellow at the Bruegel European thinktank, says that global financial bodies are increasingly using taxes to achieve public policy goals (Image courtesy: Bruegel).
The core role of taxation is, of course, to fund public services and the operation of government – but for centuries, taxes have also been used to alter people’s behaviour and influence economic development. And the use of fiscal tools to realise wider public policy goals is becoming increasingly widespread and sophisticated.
At its simplest, this can mean cutting business and personal taxes to stimulate economic growth by freeing up cash for investment and consumer spending. Reforms to tax systems in 2016 across the 35 Organisation for Economic Co-operation and Development (OECD) members, as well as Argentina and South Africa, were designed to catalyse growth by reducing the burden of corporate and income taxes. The recent batch of dramatic tax cuts by US president Trump’s had the same goal.
Beyond that, governments often use tax incentives to stimulate investment and attract foreign direct investment. According to the World Bank, a record 137 economies in 2017 had adopted tax reforms and other policies to make it easier to start businesses.
Exploring the opportunities
David Bradbury of the OECD’s Centre for Tax Policy and Administration says many factors make it difficult to be creative with taxation – “but that said, there is a growing awareness that tax policy can not only achieve revenue-collection functions, but can also be complementary to many other policy objectives.
“Yes, tax systems are all about collecting revenue – and hopefully we can do that in a way that supports ongoing investment and growth, minimises distortions and improves efficiency. But at the same time there are a range of other important policy objectives that the tax system can support – such as ensuring a fairer society and correcting for market failure.”
In February, for example, the Platform for Collaboration on Tax – a multilateral initiative formed by the United Nations, IMF, OECD and World Bank – will hold its first global conference in New York to discuss how taxation can help to achieve the Sustainable Development Goals (SDGs).
An adaptable tool
The changing tax mix across the world demonstrates these other policy goals of taxation. Taxes are used for redistribution by reducing income disparities. Inequality has increased in the OECD, and in 2016-17 enhancing fairness was another important driver of tax cuts. And taxes have a role in deciding gender equality: studies suggest that tax structures can limit women’s economic autonomy and widen pay gaps, so reforms can help here.
David Bradbury, Head of the Tax Policy and Statistics Division of the Centre for Tax Policy and Administration at the Organisation for Economic Co-operation and Development (OECD) (Image courtesy: OECD).
Many countries are also using fiscal policies to correct market failures, directing capital to neglected areas or correcting ‘negative externalities’ in the form of environmental degradation (see box). Taxes on energy use, vehicles and carbon are among the main ways countries seek to fulfil environmental pledges. Mexico, for example, is seen as a leader in the developing world for its carbon tax and pricing strategy.
In the field of public health, taxation has long been used to constrain the use of tobacco and alcohol. And in recent years, some governments have introduced taxes to curb the consumption of damaging foodstuffs – the so-called “sin taxes”. Levies have been imposed on products with high sugar, salt and fat content, and research suggests these reduce consumption.
Some countries are taking these tools into new fields. Greece and Finland, for example, have created new taxes on coffee, with Finland adding e-cigarettes to the mix. In Belgium, reforms in 2016-17 shifted the tax burden away from income towards forms of spending that generate ‘negative externalities’, including excessive stock market speculation.
Balancing policy and revenue goals
John Cullinane, tax policy director at the Chartered Institute of Taxation (CIOT) in London, points out that a tension always exists between the public policy objectives of a tax and its revenue-generating capacity. And in some cases, he suggests, governments may be happy if behaviours don’t change – ensuring that new taxes remain strong revenue streams.
“Most governments have been on the hunt for more revenue since the credit crunch,” he says. “Typically, you don’t want to say openly to people: ‘We are going to put up your taxes’. You want to say: ‘We have a national problem of excessive sugar intake and we are going to do something about it’. Then sometimes government comes to rely on the revenue and doesn’t necessarily want you to cut your sugar intake. It’s a big temptation.”
But such taxes can be remarkably effective in changing the behaviour of companies and consumers, so governments are unwise to rely on these revenue streams. As former UK chancellor George Osborne pointed out earlier this month, the government’s spring statement revealed that the UK’s new soft drinks sugar tax is generating only half of the anticipated cash because “producers are reformulating their drinks sooner and more aggressively than previously assumed”.
Hypothecation
In some cases, the use of ‘hypothecation’ – the ring-fencing of a particular tax’s revenues for spending in a relevant field – can help build public support for new taxes. There’s some evidence that earmarking revenues for popular causes can reduce resistance to tax rises, and some governments have found the approach effective in generating support for environmental taxes.
In New Zealand, for example, fuel duties are earmarked for spending on roads. And in the UK, the health service’s funding crisis has prompted calls for a hypothecated tax from Tory MPs including Nick Boles, left-wing think tank the Fabian Society, and former Treasury permanent secretary Sir Nick Macpherson.
Advocates of hypothecation argue that it can strengthen trust between the state and its citizens, while sceptics say that it limits government discretion over spending and leaves services dependent on unpredictable revenue streams. But on the whole, the advocates appear to be gaining ground.
Tax with care
John Cullinane, tax policy director at the Chartered Institute of Taxation (CIOT) in London (Image courtesy: CIOT).
While such innovations are changing the tax landscape, Cullinane of the CIOT says governments need to be cautious when considering the use of taxation for goals other than revenue collection: he worries about the potential to create “perverse” unforeseen consequence and opportunities for tax avoidance.
“Governments frequently introduce taxes, tax changes or tax reliefs where there is some economic or social purpose other than revenue-raising, but what they are not really good at is establishing a very clear link between the features of the tax or its rules and the purpose,” he says.
At the OECD, Bradbury warns that taxation alone is rarely effective at achieving objectives beyond generating revenue: it should always be used within a basket of tools, he says, and needs to be clearly justified.
“There are many in the community that will be sceptical, believing that any tax is focused solely on revenue collection,” he says. “Given that, where governments seek to put more emphasis on other policy objectives, they need to explain and communicate the reasons for that – and that’s something it’s not always easy to do.”
Nonetheless, as governments struggle to rebuild their tax bases – whittled away by flatlining household incomes, tax avoidance and slow growth – a growing number are trying to sidestep public resistance and accounting tricks by linking new taxes directly to popular services or policy goals. These new fiscal tools may be hard to implement successfully, but many of the traditional instruments are simply not as lucrative as in times past.
Tax innovations – new approaches to revenue
Tax expenditures (TEs)
Reduced tax rates, exemptions, exclusions, deductions and credits – together known as TEs – are routinely used by governments to promote policy goals. In the United States, for example, the federal government was estimated to have foregone over $1.4 trillion in 2016 – 36% of direct government spending – through TEs. And the IMF estimates that TEs in African economies range in overall value between 3.3% and 7.5% of GDP.
One popular goal in using TEs is tax relief on research and development, and this approach wins the backing of both Bradbury and Cullinane. Among other countries, France has had substantial success in boosting R&D spending.
Land-value taxes (LVTs)
Taxes on the value of land – as opposed to the property on it – have gained attention as a means of curbing urban sprawl and discouraging speculative hoarding. Forms of LVT exist in a number of countries, from Denmark to Singapore, and have been discussed in the UK. During the 1980s land value taxes in Pittsburgh sparked a building boom, but were abandoned after a land revaluation. Until 2016 Altoona, also in Pennsylvania, was the only municipality in the US to rely on land value taxes alone for local revenues – but this was also repealed, in part because investors from outside the city struggled to understand it.
Waste taxes
Environmental taxes have grown in popularity, and provide examples of how taxation can be used to change behaviour. In the EU, for example, governments are working towards a target for green taxes to account for 10% of compulsory levies by 2020.
About 95% of green tax revenue comes from energy and transport, but taxes on pollution and resources designed to encourage waste treatment or recycling are growing in popularity, with evidence suggesting landfill taxes are a significant driver for reducing waste. In the US, the city of San Jose is seen as a pioneer in using tax innovations in an effort to achieve its strategic target of zero waste.
Landfill taxes have been supported by broader taxes on packaging in countries such as Denmark, and debates are focusing heavily on the issue of plastic waste. Many countries now charge for plastic bags in supermarkets or ban them, and the issue of plastic bottles and containers has risen up the agenda. The EU is assessing ways to tax plastic products, and the UK parliament’s Environmental Audit Committee recently called for a 25p “latte levy” on disposable coffee cups.
Congestion charging
Surcharging drivers to ease pressure on roads in cities is a form of usage taxation that aims to reduce congestion. And several governments have found it useful in boosting income from transport as vehicles become more fuel-efficient – depleting fuel duty revenues.
Singapore is at the forefront of technological developments in congestion charging, and North America is expected to be the next hotspot for distance charging. Since 2015, for example, Oregon has been testing a per-mile charge to substitute for fuel-tax revenues in an experiment called OReGO.
About Gavin O’Toole
Gavin O’Toole is a freelance writer and editor in London. He has written for leading newspapers, magazines, wire services and business schools about financial markets, business and regulation around the world. He has a particular interest in international relations, and a specialism in Latin American affairs. He has conducted research on this region’s political economy and has also published a number of books about its politics and natural environment. His latest title, Environmental Security in Latin America, will be published by Routledge in September 2017.
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