Brexit will leave Brussels €10 billion a year poorer: that makes the divorce bill a critical issue in the negotiations

In the end, it will all come down to the money. The UK might not be paying £350 million a week to Brussels, as Vote Leave claimed, but our contributions to the EU do come to over €10 billion a year. That is a substantial fiscal hole for the European Commission to plug after we leave. The Commission would prefer not to reduce expenditure since the structural funds and agricultural subsidies it distributes help to justify the EU’s existence. Besides, any new budget needs unanimous agreement, and Eastern European countries can be relied on to block cuts in their grants as surely as France will veto reducing farmers’ subsidies.

If reducing the budget is out of the question, the EU will have to increase its revenue. A recent ‘reflection paper’ issued by the European Commission presented a number of ways that it could do this. The Commission takes it for granted that countries won’t increase the amounts they pay to Brussels under the current funding system. The EU needs new sources of money.

Top of the wish list are Europe-wide green taxes. Climate change has long been a favourite cause in Brussels because it lends itself to supranational action. If the member states could agree a new energy or environmental tax, it would be easy to divert some the revenue towards the EU’s coffers. While such a tax would only have a trivial effect on Europe’s ability to meet its commitments under the Paris Agreement, greenery does provide useful political cover for a tax increase. Imposing the tax over the whole of the EU would also assuage competitiveness concerns to some extent. And, given the preponderance of its manufacturing sector, it would hit Germany disproportionately hard. If Angela Merkel gets behind the tax, she might convince other countries to go along. But the German industrial lobby is strong and won’t accept an increase in its costs without a fight. In any case, no strategic decisions can be expected of Germany until the after the September general election, when Mrs Merkel is seeking another term.

Another possibility floated by the Commission’s reflection paper is a share of a new EU corporate tax. Brussels has been pushing for what it calls a ‘common consolidated corporate tax base’ since 2011. The idea is that multinationals use a single method to calculate their total European taxable profits. These profits are then allocated to the individual countries in which the multinational operates. The proposal was shelved five years ago when it became clear that many member states were opposed. The Commission has since repackaged its plan, with the enthusiastic support of the European Parliament, but badged it as an anti-tax avoidance measure. In the current environment, where tax avoiders are the new bête noire, ‘anti-avoidance’ is as effective as ‘climate change’ as a justification for bad policies. Nonetheless, several governments, including Ireland’s and the Dutch, are still raising strenuous objections. So would the British, if anyone bothered to ask them.

Far from preventing avoidance, a common consolidated corporate tax base would increase tax competition within the EU. Because taxable profits would be calculated in the same way everywhere, the only difference between countries would be the actual rate of corporate tax. Companies would be keen to base themselves in the member state with the lowest tax, and there would be relentless downward pressure on rates. Despite this, the French and German finance ministers, Bruno Le Maire and Wolfgang Schäuble, are actively working on harmonising corporate taxes with effect from next year. If the Franco-German integration engine really has restarted, the European Commission’s aspiration to slice off a portion of the cake from the new tax may still come to fruition.

If the common corporate tax doesn’t work out, the European Commission hopes it might get a share of a new European financial transaction tax. However, plans for a ‘Robin Hood’ tax across the EU, to be paid by banks when they buy and sell shares, bonds and derivatives, have also hit the sand. When agreement couldn’t be reached among all 28 EU members, ten of them decided to press ahead anyway under the enhanced cooperation procedures. But these ten enthusiasts have been unable to close the deal either and a crunch meeting scheduled for this month was postponed until the end of the year by France. There is a good deal of suspicion that the French, keen to attract banking business from London after Brexit, are getting cold feet about the financial transaction tax.

The conclusion of the reflection paper is that the Commission doesn’t really know where its new money will come from. So, with a €10 billion pit to fill, it is not surprising that the Brexit divorce bill is a central preoccupation of the European Commission’s chief negotiator, Michel Barnier. If the amount is big enough, it could tide the EU over for a few years. In Brussels, a problem kicked down the road is treated as a problem solved. This gives the British some leverage because it is most unlikely that the Commission will have lined up any new sources of funding, or agreed what it can cut, before 29 March 2019, when negotiations have to be completed. With no deal, the EU might end up with nothing at all.

 

The Robin Hood tax is a good idea that will never happen

John McDonnell is due to give a speech about Labour’s plans for a financial transaction tax tomorrow. As a warm up, here’s a article I wrote for Reaction explaining why it could work, but only if implemented everywhere.

The Labour Party is suggesting that that UK introduce a financial transaction tax, often called the ‘Robin Hood’ tax, to raise a whopping $26 billion. The idea has been around for some time and there are even pressure groups set up to push for such a levy. The EU has been considering how to introduce a such a tax for some time, although Member States have found it hard to agree on the specifics. However, the UK has had a well-designed financial transaction tax for over a century – it’s called stamp duty.

The idea of a financial transaction tax was originally put forward back in the 1970s by the Nobel-Prize-winning economist James Tobin, which is why it is sometimes called a Tobin Tax. He envisaged it as a levy charged every time one currency was exchanged for another. The idea has since been extended to other sorts of financial trading. The EU financial transaction tax would require a small amount to be paid over to the authorities each time a share or a bond is sold. The amount is a sliver of the price of the share or bond, somewhere between 0.1% and 1%. More ambitious versions of the tax would also tax exotic financial instruments called derivatives. Such is the enormous volume of trading in today’s financial markets, even very low rates could lead to a substantial tax take.

Campaigners have dubbed the financial transaction tax the ‘Robin Hood’ tax because they imagine it would be paid by rich bankers and the proceeds given to the poor. James Tobin suggested the money raised should be given to developing nations. Certainly, a Robin Hood tax sounds good on social justice grounds. But sadly things are not that simple. Yes, a financial transaction tax would primarily be paid by banks, but they would pass the cost on to their customers. So a Tobin tax would not be borne by bankers. The people who would end up paying are bank customers like you and me. However, noting that financial transaction taxes are paid by ordinary people is not an argument against them. All taxes are paid by people, it is just that some are better concealed than others. There are strong political arguments for taxes that we don’t notice since we are less likely to complain about them. The argument that a financial transaction tax would be suffered by banks in a convenient fiction for a government that desperately needs to raise more money.

So, a financial transaction tax with a low rate might be a good idea. It is a potential small tax that, if set at the right level, few people will notice. But you have to be careful. Bond traders don’t have to operate in London, Paris or Frankfurt. They can trade from the beaches of the Caribbean or the bars of Hong Kong or their living rooms in Sydney. When Sweden brought in a tax on selling bonds in 1989, with a rate of just 0.003%, the number of transactions fell by 85% in the first week. The tax ended up raising less than a tenth of what was expected and was scrapped in little more than a year. If the EU imposed a Tobin tax, financial traders might gradually drift away to more welcoming shores.

Likewise, the effect on the City of London of the UK unilaterally introducing a financial transaction tax would be catastrophic. That’s why the British Government opposed the EU’s plans for a financial transaction tax unless the rest of the world implements one too. This is sensible. Since a vast amount of business is done through London, the British exchequer would be a major beneficiary of an international tax. But it would have to apply everywhere or any country that didn’t implement it would quickly steal London’s financial pre-eminence. These objections meant that, even before Brexit, the UK was not part of the plans for an EU financial transaction tax. Even the countries that are interested in taking part are finding it very hard to agree exactly how it should work.

Luckily, there are some financial instruments that are not as mobile as bonds and derivatives. If you want to own shares in a listed UK company, almost the only place you can buy them is on the London Stock Exchange. Admittedly, there are special financial products called depositary receipts that can be traded in other countries and some companies, like Shell and HSBC, have dual-listings in more than one country for historical reasons. But generally speaking, UK shares have to be bought and sold in London. Since it is impractical to buy UK shares anywhere but in the UK, the Government can tax share sales without worrying about all the business moving elsewhere. For many years, selling UK shares has been subject to a special levy called stamp duty reserve tax. This is collected automatically by the electronic settlement system of the London Stock Exchange. The rate is 0.5% of the price of the shares.

This means there is hope for a slimmed down version of the European financial transaction tax if it is restricted to shares. Both France and Italy have jumped the EU gun and enacted their own version of the UK’s stamp duty (Spain and Portugal have plans to do the same). Since quoted French and Italian shares are traded at the Bourse de Paris and Milan’s Borsa Italiana respectively, these provide a captive market that Governments can trim. Basically, other European countries are adopting the system that the UK has had for decades. When introducing new taxes, copying a successful model from elsewhere in the world is often a good idea.

Stamp duty includes various exemptions that prevent the market from seizing up. There is no reason that a more general financial transaction tax should not work just as well and raise lots of money. The fundamental problem remains that the market would move to avoid the tax, which means it would have to be introduced everywhere at the same time. Since that is not going to happen, the Robin Hood Tax is one of those good ideas that will never happen.

Social care: in politics no good deed goes unpunished

Social care is one of the key reasons that the Tories believe they lost their majority in the general election. Everyone agrees that more money is needed to pay for the care some of us will need in old age. That money can either come from taxation or from the individuals who actually need the care (with a safety net for those who can’t afford it). This debate cuts to the heart of political differences between the left and right; between universalism versus means testing; and on the difficulty of selling tax rises to the people who will actually have to pay them.

If the money for social care is to come from tax, everyone will get care from the state free at the point of use, but taxes will go up to pay for it. A few years ago, Labour’s Andy Burnham, now the Mayor of Greater Manchester, suggested that the extra tax should be raised by a large increase in inheritance tax. Mr Burnham was honest enough to explain that raising significant revenue from estates required that the nil rate band and many other inheritance tax reliefs were curtailed. People who assumed that they’d pay little or no inheritance tax would be hit by a big bill.

The tabloids immediately branded Mr Burnham’s plan as a ‘death tax’, but, in fact, it has a lot going for it. Firstly, inheritance tax is (in my view, at least) a fundamentally fair tax on windfall gains we make when our parents die. By far the largest chunk of inherited wealth is residential property which has never been taxed because of its exemption from capital gains tax. There are moral issues with taxing money we earn from our own efforts, but surely not from taxing accumulated gains on houses that don’t even belong to us. Secondly, under Mr Burnham’s idea, everyone gets the care they needed regardless of ability to pay. This is a fundamental principle of the NHS which, for better or worse, is dear to the hearts of the British people.

Still, a new national care service financed from taxation was never going to appeal to the Tories. One alternative, proposed by a commission chaired by the economist Sir Andrew Dilnot in 2011, was for all care costs up to a set limit to be paid for by the state. Sir Andrew suggested a cap on care costs of £35,000. We would all be expected to take out insurance to cover costs in up to that limit, but the state would pay the rest. There are a number of problems with this approach. For instance, not everyone would have insurance and be able to pay for care costs up to the cap. The State would end up picking up their tab anyway. Second, if the cap were too low, it would be very expensive for the Government to pay for all the costs over that level. In any case, the level of the cap would quickly become a political football. This means the idea is one that appeals to policy wonks (like Sir Andrew) but is likely to come unstuck in the real world. Theresa May’s advisor Nick Timothy realised this and proposed an alternative social care plan in the Tories’ 2017 manifesto. That the Labour Party immediately adopted the Dilnot plan rather than Mr Burnham’s proposal (after mentioning neither in its manifesto) suggests that it gave the issue no thought at all.

This brings us to Mr Timothy’s proposals in the Conservative manifesto that have caused so much controversy. The idea is essentially a rightwing spin on the Burnham plan. In line with Burnham, everyone is covered because there is a safety net that pays the care for people with assets below £100,000. Also echoing Burnham, the plan is financed from people’s estates when they die (essentially residential property wealth, which is currently undertaxed). This means no one has to pay cash upfront for the care they need. However, people will be able to buy the care they want from their own assets rather than relying on what the state choses to provide them with. The disadvantage of Mr Timothy’s idea is that the children of people who need expensive longterm care will have smaller inheritances that those whose parents crash their Porsche the day after retiring. This is unfair. But I am not convinced it is any more unfair than having wealthy parents in the position to hand down the money in the first place, not to mention all the other advantages of a financially secure upbringing.

Whether you prefer the Burnham or Timothy plan probably depends on what you think about the relative advantages of a universal system financed by taxation, or people paying for themselves with a safety net for the poor. But it is very unlikely that this consideration is what has hit the Tory lead in the polls. Instead, people are simply reacting to a Government telling them they’ll have to pay for something they previously imagined they’d get for free. Some commentators are saying that Mrs May should have avoided the controversy by suggesting a Royal Commission or just keeping mum about her plans. But the issue is hugely controversial and massively expensive. In my view, it was completely right that the Conservative Party should present their proposal to the voters. Only by doing so would they have had mandate to push them through Parliament. Inaction and silence might have been the easier option, but not the right one.

That’s not to say the Timothy plan is better than Mr Burnham’s. The latter’s ideas were just as brave and financially credible. That neither of these sensible plans for social care have been given a fair hearing by the public reflects poorly on our democracy. Most alarming of all was Mrs May’s U turn as soon as the pressure got too much. She now appears to be advocating a Dilnot-style cap: the worst of both worlds. But quite what the policy is to be following Mr Timothy’s departure and the loss of the Conservative majority is anyone’s guess. And with taxes bound to increase in the next few years, the social care fiasco bodes ill for grown-up public debate in general.

Why Labour’s Corporation Tax Increases Will Hurt the Many, not the Few

The Labour Party is pledging to fund much of its grandiose spending plans by increases in corporation tax, intended to raise £20 billion or so. Rises in company taxes are less unpopular than income tax increases because we imagine that people don’t actually pay company taxes. This is wrong. It is one of the golden rules of tax that no matter what name is on the bill, all taxes are ultimately suffered by human beings. It’s true that companies are taxed on their profits rather than on the money they pay to their employees and directors. Nonetheless, it turns out that corporation tax is really levied on people. Companies are just legal fictions: a way of organising businesses that are ultimately owned and carried on by humans.

To understand how this can be, consider what a company can do with its profits. Firstly, it can pay them out as dividends to its shareholders. If those shareholders are people, they have to pay income tax on the dividends they receive. Corporation tax is just a down payment on the tax paid by shareholders. By shareholders, I mean anyone with a pension plan, insurance policy or other investments. ’Shareholders’ in the collective are very much an example of ‘the many’ rather than ‘the few’. An attraction of corporation tax for governments is it’s a way of taxing them that they don’t notice. Also, many shares are held in pension funds or other tax exempt vehicles like ISAs, which don’t pay tax. Corporation tax is a way to tax this income indirectly even though it is supposed to be tax free.

The other thing a company can do with its profits is invest them in growing its business. In other words, corporation tax is a tax on investment. Directly taxing the investment the country desperately needs to improve productivity is not a terribly good idea. Most politicians realise this, which is why the rate of corporation tax has been cut from 30% in 2007 to 20% from 2015, and 17% in 2020. It was 52% in the 1970s. Jeremy Corbyn is proposing to reverse this trend.

Alternatively, the company might feel it needs extra profits to pay the extra tax. To do that, it either has to pay its staff less or charge customers more. Again, we see that the increase in corporation tax is actually being passed on to real people. All the money that the company has really belongs or is owed to someone else. Some economists have argued that it is workers who take the biggest hit from corporate taxes. But whether that is true or not, the fact is someone has to pay them. And that someone is you and me.

In essence, the only way to raise large amounts of extra money from taxation is by increasing how much ordinary people pay. Corporation tax is just a stealth tax which the Labour Party hopes ordinary people won’t notice that they are paying.

General Election 2017: The big questions on tax

Although it’s already been dubbed the Brexit election, tax is likely to be as important as ever in the 2017 poll. So here are my initial thoughts on the main tax issues up for debate in the coming weeks.

No pre-election Budget

Governments usually use the Budget before an election campaign starts to stoke the feel-good factor and set the tax agenda. This time, there won’t be one. The Budget in March was something of a political non-event, except for the rise in national insurance that was so quickly reversed. The Chancellor of the Exchequer, Philip Hammond, didn’t lay out a long term strategy on tax, and the Prime Minister, Theresa May, has given few hints about her tax philosophy. The next Budget is due in the Autumn, although an immediate post-election Budget, as happened in 2010 and 2015, can’t be ruled out.

This means that the Conservatives will make their promises on tax without first having put them in context with a Budget. They won’t be able to present their new ideas as being part of a continuing strategy that is already being implemented. Furthermore, work has been going on in the background that was supposed to inform policy going forward. Matthew Taylor’s review of the rights for people working in the gig economy should have helped inform changes to national insurance. And during his Budget speech, Mr Hammond hinted at long-term plans to rebalance the tax treatment of online and bricks & mortar businesses. None of this work is complete enough to provide policies ready to go into the manifesto. This matters because future tax reform will be made more difficult if it part of the mandate given to the winners of the election campaign.

Conservative pledges

The Tories made wideranging promises in their 2015 general election manifesto. Mr Hammond’s plan to increase the national insurance contributions of the self-employed, which he announced in this year’s Budget, came a cropper as a result. Even though his proposal did not infringe the letter of the 2015 manifesto, he had to ditch the rise within days.

Simply abandoning all the promises they made last time would open the Tories up to accusations that they are planning to raise taxes. I think they would be wise to maintain their pledges not to increase the main rates of income tax, national insurance or, especially, VAT. However, they should include a specific promise to increase Class 4 NICs so that Hammond can do what he proposed in the Budget. Where the Tories are planning to increase taxes, honesty would be the best policy and burnish Mrs May’s no-nonsense image (which has been dented by the announcement of an election when she said there won’t be one).

The Conservatives should drop the ruinously expensive commitment to increase the rate of the income tax personal allowance to £12,500 by 2020. I suspect this pledge resonates much less with the public than the one on income tax rates. Help for the just-about-managing would be better targeted by cuts in employees’ national insurance as this would not cut the taxes of wealthy pensions with lots of investment income.

Labour tax rises?

Labour has already promised to impose VAT on private school fees to fund free school meals for primary school children. They are likely to propose further tax rises to pay for other aspects of their programme.

I expect a mansion tax, just like Labour proposed in 2015. The mansion tax generally works well in focus groups as most voters imagine they’d never have to pay it. However, the scope of any wealth tax (which is essentially what a mansion tax is) needs to be wide if it is to raise significant amounts of money. Additionally, any mansion tax would bite hard in London, which is one of the few parts of the country where Labour might hope to do well.

Other options include restoring the 50% income tax rate for income over £150,000. This could be popular because people support increases in taxes they won’t have to pay. Again, the money raised is likely to be negligible. Another option is a windfall tax on the energy companies, or some other unpopular sector of the economy. New Labour did this back in 1997. The problem is that a windfall tax must, by definition, be a one-off. Hikes in corporation tax also seem relatively painless in electoral terms (although they shouldn’t be, as corporation tax is levied on people as much as any other tax, just at a further remove from their wallets). Shadow Chancellor John McDonnell has already declared that companies bidding for Government contracts would have to follow ‘best practice’ in tax compliance and multinationals will be forced to publish their tax returns. Neither measure would raise any new money. Mr McDonnell has also hinted at increases in capital gains tax and inheritance tax, which HMRC also don’t think would lead to significant tax receipts.

A final option for Labour is to go for a truly socialist manifesto, squeezing the rich till their pips squeak. Given the party is going to lose anyway, there seems little harm in its leader, Jeremy Corbyn, giving his leftwing instincts full reign. He could promise to increase the current 40% income tax rate (paid on all earnings over £45,000) to 50%. HMRC estimates that this would raise £12 billion and so deal with Labour’s fiscal credibility problem at a stroke. Of course, it would be poison with the electorate, as Labour found with a similar policy back in 1992, but this time it has nothing to lose.

Some brief notes on imposing VAT on private school fees

The Labour Party is proposing to impose VAT on private school fees. Here are a few notes on the technicalities of such a policy.

  • Education, including private tuition, is exempt from VAT. This is enshrined in the European Directive on VAT so couldn’t be changed until Brexit. However, once we have left the EU, the UK would be free to impose VAT at whatever rate it pleased, as long as our exit agreement allows us to. That Labour is suggesting a policy that contravenes EU law is, if nothing else, crossing a Rubicon of sorts.
  • The difference between exemption from VAT and zero-rating is important. Generally, where a taxpayer makes exempt supplies, like education, it has to pay VAT in full on things it buys. Where it makes zero-rated supplies, like food, it can claim back the VAT in incurs on its purchases. Thus imposing VAT on school fees is likely to mean private schools can reclaim the VAT they suf6fer on their purchases, reducing the net amount of VAT that the change will raise.
  • Many pupils at private schools are from abroad, some 200,000 by some accounts. University and school education of foreign students is treated as an export (as it is foreigners paying us for something we supply). Exports are outside the scope of VAT, since this is supposed to be a tax on domestic consumption. If we impose VAT on private education, we would also need to decide whether to charge VAT to foreign students as well. If we did, it would damage an important and growing export industry. If we didn’t, the yield from the tax would be lower and we would open a divide between UK and non-UK students.
  • It is unlikely that many parents will turn to the state system as a result of the VAT rise as private school usage appears to be quite inelastic on price. However, some parents will send their children to state schools, which will both increase the cost of providing state education and reduce the amount of VAT raised from private schools.

In summary, whatever the tax yield that Labour expect from imposing VAT on private school fees, the reality is likely to be a lot less.

Questions on Google’s UK tax bill

The financial statements of Google’s UK operations for the year ended 30 June 2016 show UK turnover of £1.03 billion, profits before tax of £149 million, and a UK corporation tax bill of £36.4 million on those profits. In addition, the financial statements show that Google is owed a £31 million tax refund from HMRC. This has led to much speculation in the media, notably the BBC and The Times, about whether Google is paying enough tax. This article is intended to shed some light on that question. I am a tax consultant of 24 years experience and a specialist in international tax. However, I have no inside knowledge or contact with Google whatsoever. If I did, I would not have written this article. My comments below are based on my general experience of international tax and publicly available information.

How much tax should Google have paid in the UK?

In short, it should have paid 20% of its UK taxable profits in corporation tax. Note that corporation tax is charged on profits. When you hear a journalist or politician comparing tax and turnover, rather than tax and profits, you can guarantee they have no idea what they are talking about.

Although profit before tax in the financial statements is not the same as taxable profits, they are often reasonably similar. In this case, the figures in Google’s UK accounts show an effective tax rate of 24%, or 17% after various deductions. This is fair enough, but not really the point. The controversial question is whether Google actually recognises enough of its profits in the UK.

So, how much profit should Google recognise in the UK?

If we have a look at the financial statements of Google’s parent company, Alphabet Inc, we find that total UK sales are reported as being £6 billion (here). And yet, Google’s UK operations only show turnover of £1 billion. Where has the other £5 billion got to and should it be taxed in the UK?

An analogy might help to explain what is going on here. It is a basic principle of international tax that you pay tax where you have the people and know-how making the profits. You are not taxed where you happen to sell your products. For example, Mercedes sold about 170,000 cars in the UK in 2016, but paid all the tax on the profits from building them in Germany. The exception is the dealer networks, which are UK based (and, in any case, independent franchises). The profits they make buying cars from Germany and selling them to UK customers are UK profits subject to UK tax.

Google’s UK sales operation is not independent of Google, but the same principle applies. It should only pay UK tax on the stuff it actually does in the UK rather than on the basis of its overall sales here. Google says that the turnover attributable to its UK operations, being sales and marketing, is £1billion out of their £6billion UK sales. That is not an unreasonable figure and would be subject to serious scrutiny by HMRC.

Google recognises some of its turnover in Ireland and will make a proportion of its profits there. This should be based on work done by people actually based in Ireland. However, most of its profits will be attributable to the US where the ‘magic’ of Google is created. It is the search engine algorithm itself, not the sales people, which represents the true value of Google. Profits attributable to that should be taxed in the US.

So why does HMRC owe Google £31 million?

My guess is that this could well be Diverted Profits Tax (DPT) aka the Google tax. DPT was introduced in 2015 to catch profits that were being artificially diverted from the UK. Google was alleged to be doing this by booking sales in Ireland and ensuring the related profits were taxed there and not in the UK. It claims that it has changed its procedures and no longer does this.

The way DPT this works is as follows: HMRC gets to guess the tax bill it things a company owes and then the company has to pay the amount HMRC guessed. It is then up to the company to prove to HMRC that the guess is wrong. If, after going through all the documentation, HMRC agrees its guess is wide of the mark, it has to pay back some or all of the DPT to the company. It is possible that the amount HMRC is paying back to Google is the £31million in the accounts.

The UK Government introduced DPT to force international groups to come clean about their structures. That is why HMRC demands payment in advance and makes companies demonstrate that they should get it back. If DPT is a success, no one will actually pay it. Ideally, if all multinationals recognise the correct profits in the UK, they would be subject to corporation tax and not DPT. It is an anti-avoidance measure only.

So is Google avoiding taxes?

I can’t see much evidence that Google is avoiding material amounts of UK tax. That’s not meant as a defence of Google, but rather of HMRC and the UK tax system. We tax consultants spend a lot of time slagging off HMRC but, secretly, we rather admire them. The Government is also serious about fighting avoidance. HMRC asked for DPT to be introduced to give it the tool it needed to force multinationals to pay the right amount of tax in the UK. And the Government gave them exactly what it wanted.

However, Alphabet Inc’s financial statements suggest a very different picture in the US where most of Google’s profits should be taxed. We find that its effective tax rate is only 20%, far lower than the US corporate tax rate of 35%. It looks like it is paying a lot less US tax than expected. It is likely that Google has schemes in place so that the revenue they make outside the US is not remitted to its head office and so is not subject to US tax. These unremitted profits are probably contained in its ‘cash pile’ – a mountainous $86 billion according to Alphabet Inc’s financial statements. Much of this cash is held offshore and is not subject to US tax. The Trump tax reform plan is aimed at getting this money back to the US and taxing it (although at nothing like the full rate).

In summary, my best guess is that Google is not avoiding a material amount of UK taxes because our tax system is now robust enough to stop it. In contrast, there is evidence that it is avoiding vast amounts of US tax.

Confused by National Insurance? That’s not a bug: it’s a feature

First, let me make clear that Philip Hammond’s decision to compensate the Treasury for the abolition of flat rate Class 2 national insurance contributions (NICs) by increasing progressive Class 4 contributions is a sensible and moderate policy. The trouble is, for most people, that sentence doesn’t make much sense. What are Class 2 and Class 4 NICs? What happened to Classes 1 and 3? And did you know there is also a Class 1A? In any case, what is national insurance insuring against?

NICs are a mess, but an artful mess that exists for good reasons and because reform is not worth the candle. Fundamentally, the tax system is designed to extract cash from us with the minimum of fuss and without our understanding what is really going on. To achieve that, the machinery of tax collection is kept under the radar. For employees, that means we pay income tax and national insurance through the pay as you earn (PAYE) system. Under PAYE, our employers deduct the income tax and national insurance we owe from our pay packets. Effectively, the Treasury gets paid each month at the same time as we do. Better yet, we never possess the money that we pay in taxes and so never really miss it.

Employers also pay NICs on top of the tax that we see deducted from our wages. Make no mistake about employers’ national insurance. This is a tax on our salaries just as much as income tax. It is just that it is effectively invisible, which suits the taxman fine. In fact, if you earn £45,000 a year, you pay over 40% more in national insurance than you do income tax. Employees’ and employers’ national insurance taken together are Class 1 contributions. Class 1A NICs are paid on employee benefits like company cars.

As everyone now knows, Class 2 NICs are a flat rate tax of about £150 a year on the self-employed. George Osborne abolished these with effect from next year. All Philip Hammond has done is claw this money back by increasing Class 4 NICs on the self-employed, which are based on a percentage of profits rather than a flat rate. But, despite the recent fuss, the big difference between the employed and self-employed is those employers’ NICs, which the self-employed don’t pay. For example, a banker taking home £60,000 a year pays over £41,000 in income tax and NICs. A self-employed doctor, also getting £60,000, pays just £28,000. Given the fuss that Mr Hammond’s modest change has caused, we can be confident that the Government won’t be evening up the scales between the employed and self-employed any time soon. Instead, HMRC tries to reclassify people who are self-employed as being employed by someone else. This enables the taxman to extract more tax from them. Expect more action on this front involving Uber drivers and other workers in the gig economy.

There’s another reason that the self-employed tend to pay less tax. Because they don’t pay through PAYE, they have to write a cheque, or at least make a bank transfer, direct to HMRC. That means the self-employed know exactly how much tax they pay and resent it accordingly. Most employed people haven’t got a clue.

The complications don’t stop there. NICs are only paid by people in work. They don’t apply to savings income, which means that the leisured rich enjoy much lower effective tax rates than the working poor. You also don’t have to pay NICs once you get past the state retirement age, even if you are still in work. This means we tax the productive part of the economy far more heavily than we do the unproductive part. Sloth is tax efficient compared to toil, provided you have money in the bank.

The major benefit for taxpayers paying NICs is to ensure they get the full state pension. You need 35 years of contributions to be entitled to the full amount (Class 3 NICs can be paid if you miss a few years of the stipulated 35). Nonetheless, having to pay NICs to access the state pension is not a terribly good deal. It is currently worth about £8,000 a year, increasing each year by the higher of inflation, earnings growth or 2.5% (the so-called triple lock). Meanwhile, if a worker on the average wage could invest all their NICs in a private scheme, he or she could expect an index-linked pension of over £14,000 a year. Worse, pensioners are dependent on the largesse of future taxpayers to fund the state pension and keep the current triple-lock indexation going. There is no money invested by the Government to pay tomorrow’s pensioners.

The awful complications of national insurance make reform very difficult. As Philip Hammond has found, for every change you make, there are winners and losers. The winners are quietly satisfied while the losers are apoplectic. In the present case, these losers include a lot of self-employed columnists who can make their annoyance very public. Thus, even a tax change that has genuine public support (as the NIC changes do) can be portrayed in the media as a disaster.

Some have suggested that we should abolish national insurance completely and replace it with equivalent rates of income tax. This would be a transparent and rational reform. But politically, the change would be a disaster for the Chancellor foolish enough to implement it. Lots of people would suddenly realise that their income tax bills were much higher than they thought. Worse, the manifest unfairness of the employed and the self-employed paying very different rates of tax, not to mention the lower rates for rich pensioners and savers, would be out in the open.

Perhaps the events of the Spring Budget 2017 will serve as a lesson for future Chancellors who think that there is anything rational about reactions to tax reform.

Business rates: the anatomy of a controversy

This article was originally published at Reaction.

Even the Daily Mail is splashing business rates on its front page. What has this most unglamorous of taxes done to deserve that?

For many businesses, rates are a bigger headache than corporation tax. After all, they only have to pay the latter if they are profitable. There is no such escape from rates. The trouble is the way they are levied. To figure out how much it owes, a business first needs to know the theoretical amount that someone would pay to rent the premises it occupies. This ‘rateable value’ is determined during a periodic exercise by the valuation office agency. The business has to pay roughly half of the rateable value as a tax each year. It doesn’t matter if the business is doing well or seriously struggling, it still has to cough up.

At the best of times, the tax is unfair in the way that it hits some kinds of trade harder than others. A bookshop in the High Street of a pretty country town might not make much money. But it has to pay business rates that reflect the gentrified area in which it is located. Conversely, a small office in an out-of-town development might contain a few highly paid executives for whom the business rates are not a significant cost.

In short, business rates are oppressive for a retailer which has to locate close to its customers. One result is that charity shops, that get an automatic 80% rebate, have colonised high streets where regular stores are priced out. The Government periodically promises a review of business rates but the chance of serious reform founders on the need to raise the same amount of money after any changes. Nonetheless, there are plenty of exemptions and reliefs, such as those for village shops and pubs, which mean everyone else has to pay even more.

The current hullabaloo, reflected in the Daily Mail and other papers, is simply the regular revaluation exercise intended to keep rates fair. Although the total amount to be raised isn’t increasing much, there are, inevitably, winners and losers. The winners, which allegedly include Amazon’s warehouses, are quietly satisfied. The losers, comprising popular brands and small shops, are outraged. Numerically, it also looks like the losers may outnumber the winners, further increasing the volume of their complaints. The Government itself has made matters worse. The revaluation was supposed to happen in 2015 but, since it did not want the resulting controversy to hit just before a general election, it postponed the changes until this year. As a result, many ratepayers are seeing much bigger revaluations than they would have done had the exercise taken place two years ago as scheduled.

In some ways, business rates are the commercial equivalent of council tax. Like with council tax, the revenue raised goes to fund local government. A total of £26 billion a year is collected and, through a complicated formula, it is redistributed to local authorities. Unlike council tax, business rates are not automatically spent in the same area in which they are collected. My local authority of Tunbridge Wells, being quite a wealthy borough, keeps a tiny proportion of the rates it collects. Councils don’t even get much say on what the level of rates should be. Since the 1980s that has be set by central government. Going forward, local authorities will get to keep increases in the money raised from business rates in their patch, but conversely they are on the hook if they do not manage to collect enough.

The Government will be very keen to face down the current resistance. Assuaging those seeing increases in their rates will cost money that it does not have. David Gauke, Financial Secretary to the Treasury and a politician who radiates seriousness, has been dispatched to calm things down. Number 10 will be hopeful that when Article 50 is debated by the House of Lords next week, public attention will be distracted from business rates (that most people know nothing about) and the Daily Mail will come back onside.

However, all this could merely be a dress rehearsal for what would happen if there was ever a council tax revaluation. Council tax is calculated from the value of our homes in 1991, which is now hopelessly out of date. But given the regular angst caused by business rates changes, it is no surprise that ministers have repeatedly refused to countenance a revamp of residential property taxes. That would just be asking for trouble.

World food prices are not (yet) showing any effects from climate change

Our ancestors lived in fear of famine. A failed harvest caused hardship and rocketing food prices. Two failed harvests was a disaster that could lead to widespread starvation. Today, starvation is mercifully rare. It is much more likely to be caused by war or the deliberate policy of despotic governments than a lack of food. The world produces quite enough for all of us to eat, just as long as we can transport local surpluses to make up for shortfalls elsewhere.

Nonetheless, there may be trouble ahead. It is hard to imagine anything more vulnerable to climate change than food production. Increases in temperature could lead to encroaching deserts, salt water flooding from rising sea levels, and crop-destroying weather wiping out the harvest. Material falls in global food production would be catastrophic if as the population continues to increase. Most dangerously, water shortages would decimate modern irrigation-thirsty agriculture. The question is whether there is evidence that these potential calamities are coming down the road. Of course, we read about many of the alleged effects of climate change in the newspapers. But the media is dominating by bad news, driven by short-term considerations and riven by political agendas. We are woefully short of objective information.

Luckily, for the global food supply, we do possess an unbiased source of data: the United Nations’ world food prices index, which has been running since the early 1960s. Markets, such as the one measured by the world food index, contain a vast amount of information. In the case of the food index, that information includes the total amount that all participants in the global food supply chain know about production in their own areas. That’s far more information than any individual could glean from the newspapers or scientific journals. If one person knows that there is a glut in grain in the Midwest of the US, while another expects a bad harvest in Romania, the market processes that information and adjusts prices accordingly. Crucially, and unlike in the media, good news and bad are afforded equal weight. If we are heading for a world food crunch, the markets will tell us.

Does the food prices index reveal any effects from climate change? In short, no it doesn’t. On the contrary, it shows that, in ‘real’ terms, food still costs roughly what it did fifty years ago. Sure, there have been ups and downs, but the overall trend is flat. Remarkably, over the same period, the world’s population has increased from three billion to over seven billion, while food production has gone up even more as calorific intake per head as increased. Even though 2015 and 2016 were the hottest years on record (thanks in part to the El Nino effect), it is reassuring that this does not appear to be reflected in food prices. In fact, as you can see here, there is a closer correlation to economic circumstances (such as the world financial crisis in 2008/10 and the first oil shock in the mid-1970s) than to climate. In fact, oil prices seem to effect food costs significantly, as we’d expect from the importance of hydrocarbons in the production of fertiliser. So, the half a degree increase in average global temperatures since the 1960s appears to have had no effect on the price of food. Interestingly, one possible driver of increased food prices from climate change is an indirect one: the wrongheaded drive to grow biofuels has driven out food crops like sugar, inflating its price.

The flat trend in the world food prices index doesn’t mean that climate change is having no effect. After all, the media is feeding us a near constant stream of research and anecdotes about the damage that global warming is doing. They can’t all be wrong. However, no one would call the media objective. Any positive effects of climate change are, at best, ignored and more often deliberately buried (see Matt Ridley’s experience on his reporting of global greening here). That’s what makes markets such valuable sources of information. The good news and the bad are given equal weight while actual events are more important than predictions. Of course, markets are not infallible. But because they are made up of vast numbers of individuals whose biases cancel out, they are more objective than any single information source.

For that reason, we should look to markets rather than the media, or even scientists, for the best information about the effects of climate change. For the moment, the evidence for impending disaster isn’t there. Nonetheless, we should keep an eye on the world food prices index for an early warning of trouble ahead.