Category: Economics: Ch 11

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Avoiding taxes

Tax avoidance has been in the news since the publication of the Panama papers, which show the use of offshore tax havens by rich individuals and companies, partly for tax avoidance, partly for money laundering and other criminal activities – some by corrupt politicians and their associates – and partly to take advantage of lower regulation of financial dealing.

There are many tax havens around the world, including Switzerland, Hong Kong, British overseas territories (such as the British Virgin Islands, the Cayman Islands and Bermuda), Jersey, Singapore and certain US states (such as Arizona, Delaware, Nevada and Wyoming).

Here we focus on tax avoidance. This is the management of tax affairs by individuals or firms so as to avoid or minimise the payment of taxes. Tax avoidance is legal, unlike tax evasion, which is the practice of not declaring taxable income.

In a statement from the White House, directly after the publication of the Panama papers, President Obama spoke about the huge international scale of tax evasion and tax avoidance:

“A lot of it is legal, but that’s exactly the problem. It’s not that [people are] breaking the laws, it’s that the laws are so poorly designed that they allow people, if they’ve got enough lawyers and enough accountants, to wiggle out of responsibilities that ordinary citizens are having to abide by.

Here in the United States, there are loopholes that only wealthy individuals and powerful corporations have access to. They have access to offshore accounts, and they are gaming the system. Middle-class families are not in the same position to do this. In fact, a lot of these loopholes come at the expense of middle-class families, because that lost revenue has to be made up somewhere. Alternatively, it means that we’re not investing as much as we should in schools, in making college more affordable, in putting people back to work rebuilding our roads, our bridges, our infrastructure, creating more opportunities for our children.”

Tax avoidance, whether in tax havens, or through exploiting loopholes in the tax system may be legal. But is it fair?

Various principles of a tax system can be identified. These include:

• Horizontal equity People in the same situation should be treated equally. For example, people earning the same level of income and with the same personal circumstances (e.g. number and type of dependants, size of mortgage, etc.) should pay the same level of income tax.
• Vertical equity Taxes should be ‘fairly’ apportioned between rich and poor. The rich should pay proportionately more taxes than the poor.
• Equity between recipients of government services Under the ‘benefit principle’, it is argued that those who receive the most benefits from government expenditure ought to pay the most in taxes. For example, it can be argued that roads should be paid for from fuel tax.
• Difficulty of evasion and possibly of avoidance If it is desirable to have a given tax, people should not be able to escape paying.
• Non-distortion Taxes alter market signals: taxes on goods and services alter market prices; taxes on income alter wages. They should not do this in an undesirable direction.
• Convenience to the taxpayer Taxes should be certain and clearly understood by taxpayers so that they can calculate their tax liabilities. The method of payment should be straightforward.
• Convenience to the government Tax rates should be simple to adjust and as cheap to collect as possible.
• Minimal disincentive effects Taxes may discourage people from working longer or harder, from saving, from investing or from taking initiative. It is desirable that these disincentives should be kept to a minimum.

Of course, not all these requirements can be met at the same time. One of the most serious conflicts is between vertical equity and the need to keep disincentives to a minimum. The more steeply the rich are taxed, it is argued, the more serious are the disincentive effects on them likely to be (see the blog post from 2012, The 50p income tax rate and the Laffer curve). Another is between vertical equity and equity between recipients of services. Some of the people most in need of government support are the poorest and hence pay the least taxes.

The crucial question is what is regarded as ‘fair’. What is vertically equitable? According to the second article below, people’s preferred tax rates depend on how information is presented. If information is presented on how much tax is paid by the rich, people generally feel that the rich pay too much. If, however, information is presented on how much income people are left with after paying tax, people feel that the rich still have too much and ought to pay more tax.

The majority of people in the UK feel that tax avoidance, although legal, is morally wrong. According to the results of an HMRC survey in 2015, “the majority (63%) of respondents felt that the use of tax avoidance schemes was widespread. However, the majority (61%) also responded that it was never acceptable to use a tax avoidance scheme. The most frequent reason given as to why it was unacceptable was that ‘it is unfair on others who pay their taxes’.”

In making judgements about the fairness of tax, people generally have inaccurate knowledge about the distribution of income, believing that it is more equal than it really is, and about the progressiveness of the tax system, believing that it is more progressive than it really is. Despite this, they want post-tax income distribution to be more equal.

What is more, although people generally disapprove of tax avoidance, it is the system that allows the avoidance of taxes that they want changing. As long as it is possible to avoid taxes, such as giving gifts to children to avoid inheritance tax (as long as the gift is made more than seven years before the person’s death), most people see no reason why they should not do so themselves.

The following articles look at tax avoidance and people’s attitudes towards it. They are all drawn from The Conversation, “an independent source of news and views, sourced from the academic and research community and delivered direct to the public.”.

Articles

Explainer: what are ‘tax havens’? The Conversation, Tommaso Faccio (5/4/16)
When it comes to tax, how do we decide what’s fair? The Conversation, Stian Reimers (8/4/16)
Six things a tax haven expert learned from the Panama Papers The Conversation, Ronen Palan (6/4/16)

Documents
The Panama Papers The International Consortium of Investigative Journalists
Exploring public attitudes to tax avoidance in 2015: HM Revenue and Customs Research Report 401 HMRC, Preena Shah (February 2016)
2010 to 2015 government policy: tax evasion and avoidance HMRC/HM Treasury (8/5/15)

Questions

  1. Distinguish between tax avoidance and tax evasion.
  2. Give some examples of tax avoidance.
  3. Look through the various principles of a tax system and identify any conflicts.
  4. What problems are there in having a highly progressive tax system?
  5. What is a ‘shell company’? How can it be used to avoid and evade taxes?
  6. What are bearer shares and bonds? Why were they abolished in the UK in 2015?
  7. What legitimate reasons may there be for a company or individual using a tax haven?
  8. To what extent might increased transparency in tax affairs discourage individuals and companies from engaging in aggressive tax avoidance?
  9. What light does/can behavioural economics shed on people’s perceptions of fairness?
  10. How might the use of absolute amounts or percentages influence people’s thinking about the fairness of a tax system? What implications does this have for politicians in framing tax policy?
  11. In the principal–agent problem, where the principals are the tax authorities and the agents are taxpayers, why does asymmetric information arise and why is it a problem? How do the tax authorities seek to reduce this problem?
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A soft target for a tax

Back in October, we looked at the growing pressure in the UK for a sugar tax. The issue of childhood obesity was considered by the Parliamentary Health Select Committee and a sugar tax, either on sugar generally, or specifically on soft drinks, was one of the proposals being considered to tackle the problem. The committee studied a report by Public Health England, which stated that:

Research studies and impact data from countries that have already taken action suggest that price increases, such as by taxation, can influence purchasing of sugar sweetened drinks and other high sugar products at least in the short-term with the effect being larger at higher levels of taxation.

In his Budget on 16 March, the Chancellor announced that a tax would be imposed on manufacturers of soft drinks from April 2018. This will be at a rate of 18p per litre on drinks containing between 5g and 8g of sugar per 100ml, such as Dr Pepper, Fanta and Sprite, and 24p per litre for drinks with more than 8g per 100ml, such as Coca-Cola, Pepsi and Red Bull.

Whilst the tax has been welcomed by health campaigners, there are various questions about (a) how effective it is likely to be in reducing childhood obesity; (b) whether it will be enough or whether other measures will be needed; and (c) whether it is likely to raise the £520m in 2018/19, falling to £455m by 2020/21, as predicted by the Treasury: money the government will use for promoting school sport and breakfast clubs.

These questions are all linked. If demand for such drinks is relatively inelastic, the drinks manufacturers will find it easier to pass the tax on to consumers and the government will raise more revenue. However, it will be less effective in cutting sugar consumption and hence in tackling obesity. In other words, there is a trade off between raising revenue and cutting consumption.

This incidence of tax is not easy to predict. Part of the reason is that much of the market is a bilateral oligopoly, with giant drinks manufacturers selling to giant supermarket chains. In such circumstances, the degree to which the tax can be passed on depends on the bargaining strength and skill of both sides. Will the supermarkets be able to put pressure on the manufacturers to absorb the tax themselves and not pass it on in the wholesale price? Or will the demand be such, especially for major brands such as Coca-Cola, that the supermarkets will be willing to accept a higher price from the manufacturers and then pass it on to the consumer?

Then there is the question of the response of the manufacturers. How easy will it be for them to reformulate their drinks to reduce sugar content and yet still retain sales? For example, can they produce a product which tastes like a high sugar drink, but really contains a mix between sugar and artificial sweeteners – effectively a hybrid between a ‘normal’ and a low-cal version? How likely are they to reduce the size of cans, say from 330ml to 300ml, to avoid raising prices?

The success of the tax on soft drinks in cutting sugar consumption depends on whether it is backed up by other policies. The most obvious of these would be to impose a tax on sugar in other products, including cakes, biscuits, low-fat yoghurts, breakfast cereals and desserts, and also many savoury products, such as tinned soups, ready meals and sauces. But there are other policies too. The Public Health England report recommended a national programme to educate people on sugar in foods; reducing price promotions of sugary food and drink; removing confectionery or other sugary foods from end of aisles and till points in supermarkets; setting broader and deeper controls on advertising of high-sugar foods and drinks to children; and reducing the sugar content of the foods we buy through reformulation and portion size reduction.

Articles

Questions

  1. What determines the price elasticity of demand for sugary drinks in general (as opposed to one particular brand)?
  2. How are drinks manufacturers likely to respond to the sugar tax?
  3. How are price elasticity of demand and supply relevant in determining the incidence of the sugar tax between manufacturers and consumers? How is the degree of competition in the market relevant here?
  4. What is meant by a socially optimal allocation of resources?
  5. If the current consumption of sugary drinks is not socially optimal, what categories of market failure are responsible for this?
  6. Will a sugar tax fully tackle these market failures? Explain.
  7. Is a sugar tax progressive, regressive or proportional? Explain.
  8. Assess the argument that the tax on sugar in soft drinks may actually increase the amount that people consume.
  9. The sugar tax can be described as a ‘hypothecated tax’. What does this mean and is it a good idea?
  10. Compare the advantages and disadvantages of a tax on sugar in soft drinks with (a) banning soft drinks with more than a certain amount of sugar per 100ml; (b) a tax on sugar; (c) a tax on sugar in all foods and drinks.
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City life

Two surveys have been released looking at the quality of life in cities and the levels of happiness of their residents. The first is a three-yearly Eurobarometer survey by the European Commission focusing on 83 European cities/conurbations. This survey finds that, despite growing concerns about immigration, terrorism and stagnant real incomes, levels of satisfaction have remained stable since the 2012 survey. In all except six cities, at least 80% of respondents say that they are satisfied to live in their city. The highest scores (above 98%) are in the north of Europe.

The second is the 2016 Quality of Life Survey (an annual survey) by the consultancy firm, Mercer. This looks at cities worldwide, particularly from the perspective of employees of multinational companies being placed abroad. The survey found that the top ten cities by quality of life include seven in Europe, and that the five safest cities in the world are all in Europe.

So what is it that makes the quality of life so high in many European cities, especially those in Germany, Austria, Switzerland, the Netherlands and Scandinavia? Is it that income per head is higher in these cities? In other words, is the quality of life related to GDP?

The answer is only loosely related to GDP. What seems more important is people’s income relative to other people and whether their income relative to other people is rising.

But people regard the quality of life in cities as depending on other factors than simple relative income. One factor common across all cities is household composition. People are least happy if they live on their own.

Other factors include: a feeling of safety; how well integrated different ethic and social groups are felt to be; the quality of public transport; the cleanliness of the city; health care provision and social services; the quality of schools and other educational establishments; sports facilities; cultural facilities; parks and other public spaces; the quality of shops, restaurants and other retail outlets; the quality and price of housing; the ease of getting a job; trust in fellow citizens; environmental factors, such as air quality, noise, traffic congestion and cleanliness; good governance of the city. The top three issues are health services, unemployment and education and training.

Although cities with higher incomes per head can usually afford to provide better services, there is only a loose correlation between income per head and quality of life in cities. Many of the factors affecting quality of life are not provided by the market but are provided publicly or are part of social interaction outside the market.

Articles

Happiness in Europe The Economist (25/2/16)
Happiness in Europe: What makes Europeans happy? It depends on where they live The Economist (27/2/16)
Rating Europe’s Most and Least Happy Cities CityLab, Feargus O’Sullivan (9/2/16)
Europe’s Nicest Cities Aren’t Its Happiest Ones Bloomberg, Therese Raphael (2/2/16)
Vienna named world’s top city for quality of life The Guardian, Patrick Collinson (23/2/16)
Vienna named world’s best city to live for quality of life, but London, New York and Paris fail to make top rankings Independent, Loulla-Mae Eleftheriou-Smith (23.2.16)
The world’s most liveable cities: London and Edinburgh rank in top 50 The Telegraph, Soo Kim (23/2/16)

Reports

Quality of Life in European Cities 2015 Flash Eurobarometer 41 (January 2016)
Quality of Life in European Cities 2015: Individual Country Reports Flash Eurobarometer 41 (January 2016) (This may take a short while to download.)
Quality of life in European Cities 2015: Data for Research Flash Eurobarometer 41 (January 2016)
2016 Quality of Living Rankings Mercer (23/2/16)
Western European Cities Top Quality of Living Ranking Mercer, Press Release (23/2/16)

Questions

  1. Why, do you think, is the quality of life is generally higher in (a) most northern European cities than most southern and eastern European ones; (b) most European cities rather than most north American ones?
  2. To what extent is (a) absolute real income per head; (b) relative real income per head an indicator of quality of living in cities?
  3. Why, do you think, are Italians less satisfied with the quality of life in their cities than residents of other western European countries?
  4. What factors affect your own quality of living? To what extent do they depend on the city/town/village/area where you live?
  5. Look at the list of factors above that affect quality of life in a given city. Put them in order of priority for you and identify any other factors not listed. To what extent do they depend on your age, your background, your income and your personal interests and tastes?
  6. Identify a particular city with which you are relatively familiar and assume that you were responsible for allocating the city’s budget. What would you spend more money on, what less and what the same? Provide a justification for your allocation.
  7. Discuss the following passage from the Bloomberg article: “What is striking is that there appears to be a correlation between those who report high levels of satisfaction and those who view foreigners in their city as an advantage. Conversely, respondents who complained loudest about transportation, public services, safety and other issues tended to view the presence of foreigners far less favorably.”
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Equal pay for equal work?

The earnings gap between men and women is well-documented and depending on how we measure it, we get different figures. One of the most common measures is mean earnings per hour. The latest estimates suggest that women are paid around 20% less than men, though other data does give lower figures. Though actions have been taken to reduce the inequality between men and women, it still persists in many areas and this has led to plans for new league tables from Nicky Morgan.

The inequality gap has certainly come down. Back in 1970, the wage differential was around 37 per cent, so progress has been made, although the wage gap in the UK has stabilised somewhat. The gender wage gap is at least in part explained by occupations, as women have tended to be prevalent in some of the more poorly paid occupations. However, significant earnings differentials still exist within occupations. We see fewer women in the more senior positions; women tend to take career breaks and hence this can cause more investment into training and promoting men. Furthermore, we often simply see some form of prejudice or discrimination whereby women are just paid less than men, despite the Equal Pay Act.

As a means of combatting this inequality, Nicky Morgan, the Women and Equalities Minister, has announced plans that will require private companies and voluntary organisations employing more than 250 workers to reveal their pay gap. They will have to produce this information online and this will a means to bring down the inequality that exists between men and women in the same occupations. The first League Table of this pay gap will be published in April 2018 so companies will have to begin compiling the information from April 2017. This has received criticism from some, as it is not starting soon enough, but it is seen as a step in the right direction.

Carolyn Fairbairn, CBI Director-General warned that these League Tables shouldn’t be used to name and shame firms, as many factors might explain wage differentials. She noted:

“Where reporting can be useful is as a prompt for companies to ask the right questions about how they can eradicate the gender pay gap … The government should consult closely with business to ensure that this new legislation helps close the gender pay gap, rather than ending up as a box-ticking exercise.”

Clearly there are some close links between the gender pay gap and concerns about poverty and minimum wages and although the League Tables perhaps should not be used to name and shame, one might think it is inevitable that this is how they will be viewed. The following articles consider Nicky Morgan’s inequality plans.

Reports
Gender Pay Gap European Commission
Annual Survey of Hours and Earnings, 2015 Provisional Results Office for National Statistics (November 2015)
Pay gap reporting Equal Pay Portal2016

Articles

Gender pay gap reporting for big firms to start in 2018 Guardian, Rowena Mason (12/02/16)
Gender pay gap to be revealed by employers to tackle inequality Financial Times, Sarah O’Connor (12/02/16)
Firms forced to reveal gender pay gap BBC News (12/02/16)
Gender pay gap League Tables to ‘name and shame’ companies Telegraph, Steven Swinford (12/02/16)
UK companies must reveal gender pay gap under new plans Independent, Oliver Wright (12/02/16)
Companies told to publish gender pay gap Sky News (12/102/16)
Gender pay gap: Business groups mixed on Nicky Morgan’s new name-and-shame plans International Business Times, Bauke Schram (12/02/16)
Now every firm with more than 250 staff must put gender pay gap data online in move to encourage companies to reward staff equally Mail Online, Jack Doyle and Rosie Taylor (12/02/16)

Questions

  1. Use a labour market diagram to explain how gender pay gaps can emerge based on different marginal products.
  2. How can gender pay gaps emerge because of women taking career breaks and being less geographically mobile?
  3. Use information on the ONS website to compare pay differentials across occupations. Are the biggest and smallest differentials where you would expect?
  4. There are numerous reasons why men have traditionally been paid more than women. Which reasons could be said to be irrational and which are rational?
  5. If employers were forced to give genuinely equal pay for equal work, how would this affect the employment of women and men? What would determine the magnitude of these effects?
  6. Do you think this naming and shaming will be effective in reducing the gender pay gap amongst the largest companies? Can you suggest any other policy options?
  7. If the Equal Pay Act is in place, why can companies still pay women less?
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Finish at 3.30?

There are countless people who work 12-hour days – some get rewarded with huge salaries, while others are paid peanuts. A key question is: are these people happy? With 24 hours in a day for both rich and poor, the more hours we work, the fewer hours we have for leisure time. So, how do we choose the optimal work-life balance?

In economics, we often talk about the concept of diminishing marginal utility and this concept can be applied to working life. For many people, each additional hour worked is tougher or adds less to your utility – we get tired, bored and the job may seem more unpleasant the more hours you work. The typical day of work is around 7-8 hours, but across Sweden, some offices are now closing at 3.30, with a 6-hour working day, but with salaries remaining the same. It’s not a new idea in Sweden and trials of this shorter working day concept have proved successful, with higher reported profits, better service to customers (or patients) and happier, more productive staff.

This shorter working day is not a common occurrence across Sweden or other countries, but it’s a practice that is certainly garnering media attention. Companies will certainly be keen if this means an increase in productivity, but one key concern will be the potential loss of business from companies who do keep working after 3.30 and expect phones to be answered.

It would certainly be an attractive prospect for employees and perhaps is a good way of ‘poaching’ the best staff and hence of boosting worker productivity. With more free time, perhaps an employee’s happiness would also increase, which could have significant effects on a range of variables. The following article considers this shorter working day.

The truth about Sweden’s short working hours BBC News, Maddy Savage (2/11/15)

Questions

  1. Explain the concept of diminishing marginal utility with respect to hours worked. Can this be used to explain why overtime often receives higher rates of pay?
  2. Using indifference analysis, explain how a change in the number of hours worked might affect an individual’s happiness.
  3. Why might a shorter working day help to increase a firm’s profits?
  4. If a shorter working day did increase happiness, what other factors might be affected? Does this explain why other countries are so interested in the success of this initiative?