Re-framing tax spillover

Andrew Baker - Professorial Fellow at the Sheffield Political Economy Research Institute (SPERI)

Richard Murphy  - Professor of Practice in International Political Economy at City University

We have now proposed that alternative methodology in our new paper for the All Party Parliamentary Group on Inclusive Growth (we’ll present the key findings at the APPG’s event in Parliament tonight– register a place here).  At its core our new system is a perceptions index which both tax experts and those with informed interest in the tax system of a country could complete.  We suggest spillovers are considered, at present, for four taxes.  These are income tax, social security, corporation tax on profits and capital gains taxation.  The first two are subject to frequent tax attack in our experience; the last two are taxes originally introduced with the primary purpose of defending these taxes from attack.  If we want a better sense of the vulnerability of particular tax regimes, and the vulnerabilities certain tax regimes generate for others, we need to look at how tax regimes hang together as a whole and the potential relationships between these different taxes.

Our system ranks the risk of spillovers between taxes on a scale of one to five.  If a score of five is awarded then the tax is very vulnerable to spillovers.  This means it is likely that taxpayers will try to divert part of the income that should be subject to this tax to another tax or location, or both.  If a score of one is awarded then the tax in question in the jurisdiction being assessed is likely to attract the income or gains that should be taxed under the rules of another tax or in another place.

There are several important dimensions to this.  First, the risk can be assessed domestically.  So, for example, is the design of UK corporation tax likely to undermine the tax base of national insurance?  This assessment measures the risk of tax spillovers through tax avoidance within the jurisdiction.  Second, the risk can be assessed internationally.  So, again as an example, is the fact that the UK has a relatively low corporation tax rate likely to attract the corporation tax base that should be recorded in other countries into the UK?  Third, it is not just tax legislation that can be assessed: the spillover assessment can also be extended to tax administration.  This process would ask, in effect, whether or not abuse is likely to be detected since this very obviously has an impact on spillovers. The analysis can, fourthly, be extended beyond tax.  So, for example, considerations relating to corporate law and its implementation can also be added to the assessment matrix. Each score can be allocated in two ways.  One is the domestic impact and the other international.  These scores may be different.  Taken together, the result is that scores for each tax can be generated domestically, while scores for the jurisdiction as a whole can be marked internationally.  The domestic score is a measure of the overall deviance within the system from a neutral score of three between all taxes – which would imply no shifting was likely between tax bases.  The spread is the important issue here, indicating the level of risk that exists.  Internationally, the overall average may be more important: a low score indicates an aggressor jurisdiction.  A high score indicates a vulnerable jurisdiction.

We stress, this idea is at an early stage of development at present.  We think the system will work as a means of ranking and evaluating domestic and international tax vulnerabilities.  We have designed it so that one jurisdiction might be capable of assessment many times by members of different stakeholder groups whose perceptions may then be weighted to deliver an overall balanced score across a range of opinions.  The difference between stakeholders might itself, we suspect, be revealing.  But, and we stress this, those trials have not yet happened.  We are simply suggesting a design concept at present.

That said, we think this is a design concept of importance.  The evidence that the IMF econometric approach to spillovers does not work is already compelling.  This does not, however, discredit the idea of spillovers because they undoubtedly exist. What it instead demands is an alternative method.  Our proposal is a start to that process.  It certainly warrants further refinement, scrutiny and discussion.