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Solving tax avoidance will not cure the Eurozone of stagnation

There was an article in the French-language edition of Huffington Post last last week (December 10, 2014) – Sans Europe fiscale, le projet européen est condamné (Without taxes, the European project is doomed) – written by the President of the French Socialist delegation in the European Parliament, Pervenche Berès. Her committee role as a member of the EP includes the Committee on Economic and Monetary Affaris. She has been active in the debate over tax avoidance in the Parliament. Her substantive claim in the article is that the European Project, by which she includes retention of the Eurozone, will fail unless national governments work out how to raise more taxes to balance their fiscal positions. The article qualifies for inclusion in my – Friends list this – series. Although I accept it could be reasonably argued that the French socialists gave up any pretensions to progressive agendas some time ago and could reasonably be included among the groups we would consider to be neo-liberal. But that issue, while important, is not the topic of this blog.

The argument put by the French politician is as simple as it is misconstrued. Her concern is the 1,000 billion euros that escapes the national states in Europe every year through tax evasion (“1000 milliards d’euros ! C’est la somme colossale qui échappe aux États chaque année en Europe. Jamais l’évasion fiscale n’a été aussi forte dans le monde.”).

The ‘loss’ of tax revenue arises from the operation of tax havens (“paradis fiscaux”) in the Caribbean and elsewhere and involve European companies, banks, and American digital companies producing income in one place but being structured for tax purposes in a low tax regime.

She claims that only a political response scale will militate against the tax losses (“Seule une réponse politique d’ampleur permettra de combattre ce fléau”) and restore national sovereignty (” la souveraineté des États et de l’Union”).

The problem that she ignores is that the Member States of the Eurozone surrendered their national sovereignty for all intents and purposes when they gave up their currency monopolies and entered the common currency arrangement.

At that point, the capacity to run their own fiscal policy was severely compromised. The states then conspired to further undermine their own capacities by agreeing to the fiscal rules embedded in the Stability and Growth Pact (SGP) and its subsequent iterations, and cede all currency operations to the European Central Bank (ECB).

Her point is that with increased tax revenue, governments can avoid austerity and still meet the SGP rules as members of the monetary union but, importantly avoid the choice between debt and impoverishment:

Plutôt que de répondre par la seule austérité face à des États tiraillés, depuis la crise des subprimes, entre endettement et appauvrissement, l’Europe doit tout faire pour empêcher le contournement de l’impôt.

There are several points. First, it is mostly true that a government can spend more if its tax revenue is higher and the economy is operating at full employment.

For a currency-issuing government, this has nothing to do with the tax revenue providing more ‘money’ to the government, which then would allow it to spend more.

The point is that the higher tax revenue implies that the non-government sector has less spending capacity and more real resources are left idle so that the government can bring them into productive use by spending more.

The qualification is if the higher tax revenue only comes from unspent non-government income or other tax bases and there is no impact on non-government spending.

Modern Monetary Theory (MMT) articulates clearly that a government that issues its own currency does not have to raise taxes or issue a financial asset (bond) in order to spend. So the government in a fiat monetary system is not said to be “revenue-constrained”.

It is a common retort that if taxation is not required to raise revenue, which permits the government to spend, then what function does it serve?

In the context of – Functional Finance – we know that government should seek to maintain a reasonable level of aggregate spending at all times. If there is too little spending and, thus, excessive unemployment, the government shall reduce taxes and/or increase its own spending.

If there is too much spending, the government shall prevent inflation by reducing its own expenditures and/or by increasing taxes.

So taxation is what we consider to be one spoke in the macroeconomic steering wheel that the government uses to regulate economic activity.

It follows that taxation and the incidence of mass unemployment are intrinsically related in a monetary economy.

In such an economy, taxation functions to promote offers from private individuals to government of goods and services in return for the necessary funds to extinguish the tax liabilities. This involves the direct offer of labour to the public sector (to allow public production to take place) as well as privately-produced goods that are purchased by the government to advance its socio-economic programs.

The private sector supplies a myriad of goods and services to the government every day and in return, as well as generating income it gains the capacity to relinquish its tax liabilities.

This train of thought leads to the insight that taxation is a way that the government can elicit productive resources and final goods and services from the non-government sector that it needs to advance its political mandate.

It is clear that the non-government sector has to get the dollars before it can pay its tax bills. Where else could the non-government sector get the dollars from to meet its legal liabilities to the government, if the latter did not purchase goods and services provided by the non-government sector or make transfers to that sector?

So the reality is the opposite of the intuitive view that conceives of taxation as providing revenue to the government, which permits it to spend. In fact, government spending provides revenue to the non-government sector which then allows them to extinguish their taxation liabilities. So the funds necessary to pay the tax liabilities are provided to the non-government sector by government spending.

This insight allows us to see another dimension of taxation which is typically not well understood. Given that the non-government sector requires fiat currency to pay its taxation liabilities, in the first instance, the imposition of taxes (without a concomitant injection of spending) by design creates unemployment (people seeking paid work) in the non-government sector.

The unemployed or idle non-government resources can then be utilised through government spending, which amounts to a transfer of real goods and services from the non-government to the government sector.

While real resources are transferred from the non-government sector in the form of goods and services that are purchased by government, the motivation to supply these resources is sourced back to the need to acquire fiat currency to extinguish the tax liabilities.

Further, while real resources are transferred, the taxation provides no additional financial capacity to the government of issue.

For a Eurozone nation, the situation is different because they do not have currency-issuing capacity and so taxation provides euros to such a government that allows it to spend. It can run fiscal deficits only if they can borrow funds from the private bond markets.

Each of these elements are voluntary restrictions that the Member States imposed on themselves when they entered the Eurozone.

So in this case, closing down tax avoidance will give the governments more tax revenue and more spending capacity.

But the relevant points for the Eurozone governments is not a shortfall of tax revenue or the capacity of the governments to spend in a fiscally neutral fashion (where extra spending is accompanied by an extra dollar of tax revenue).

The relevant point is the overall capacity to net spend rather than to spend more.

The Eurozone is billions of euros of extra spending below full employment. Inflation is falling and there is entrenched mass unemployment of overwhelming proportions.

To move the Eurozone onto a full employment growth path would require the fiscal deficits (that is, net public spending) in most nations to increase substantially and well above the fiscal limits defined by the SGP.

In other words, spending more while offsetting it with increased tax revenue will mostly alter the mix between government and non-government command of real resources (more public, less private). I would argue that that is a desirable goal.

But with entrenched unemployment over the last 6 or more years, there is hardly the necessity for the public sector to deprive the non-government sector of access to real resources in order to expand the public command over real resources.

There are so many idle productive resources that governments should just be increasing their purchase of them without trying to raise further tax revenue.

But then, the scale necessary to achieve any reasonable boost to real economic activity, is so large now, given how remiss the European Commission and its Troika mates have been, that the SGP fiscal limits are not feasible.

Further, in some cases, the Member States would not be able to access the private bond markets at reasonable yields to increase their fiscal deficits to the scale necessary and the ECB is reluctant to play the role of lender of last resort – such is the ideological grip that the German fear of inflation has had on the design of the monetary system.

So the issues are – the loss of currency sovereignty exacerbated by the SGP fiscal rules and the creation of a central bank, with the currency monopoly, that does not operate in the specific best interests of the individual Member States.

That is what the Socialist member of the EP should be focusing on. Not trying to extract more purchasing power from the non-government sector via taxation revenue.

I am not saying that there might be good reasons – not the least important could be equity and fairness considerations – for closing tax loopholes. Clearly, Europe has an issue with that, especially given the rather odd role played by the new lear Jean-Claude Juncker while he was the Finance minister and then Prime Minister of Luxembourg in encouraging tax shifting.

The Socialist EP member offered the typical European left argument these days – that they aspire to a political Europe – but there would not be a “d’Europe politique sans Europe fiscale” – that is, the political project will crumble unless they sort out the tax avoidance.

Nothing could be further from the truth. Putting aside history, culture and language considerations and assume for a moment that there was a genuine agreement within each Member State to surrender their national independence (in a political sense – and not considering the global capital conspiracy that undermines such independence) and create a federation.

They could easily do that and move fiscal policy into a position that could stimulate growth and employment without the need for an extra tax dollar being raised.

Of course, they would have to abandon the neo-liberal pretensions which manifest in the fiscal rules. They would have to ensure the federal interest was served by the ECB and there were no fundamental differences in prosperity across the regions etc. That is, behave like a true federation.

The implication of the Socialist member’s call for more tax revenue is that she wants to hang on to the neo-liberal ideology and maintain the restrictions on net government spending and debt issuance.

That is the nub of the problem that Europe faces. Even the left is neo-liberal when it comes to economic policy.

Conclusion

The socialist member goes on to outline the way in which the tax havens can be closed down. She emphasises the need for “the restoration of public accounts” (“le rétablissement des comptes publics”), but doesn’t mention the destructive impact on the Member State government’s capacity to maintain full employment of the SGP and related rules and restrictions.

There is no recognition that high deficits are needed to restore equity and productivity in the Eurozone via falling unemployment.

Increasing tax revenue is likely to reduce private spending further and create the need for even larger fiscal deficits – deficits of a scale which are prohibited under the Eurozone rules.

That is the problem. And the related problem is that the progressive polity is incapable of recognising it or articulating a strategy that would eliminate these destructive voluntary constraints on monetary sovereignty.

That is enough for today!

(c) Copyright 2014 William Mitchell. All Rights Reserved.

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    This Post Has 14 Comments
    1. One has to ask how people who are (demonstrably) economically illiterate are able to become political leaders. And also how they are then permitted to become spokespersons on economic matters. Are these political leaders vain and foolish enough to imagine that they understand issues far better than do the professionals who provide advice, or is the problem that the entire collection of their economic advisers are equally ignorant and misinformed?

    2. “Increasing tax revenue is likely to reduce private spending further”

      I agree, but what about if the taxation targets the confiscation of saving – assuming such a tax could be constructed.

      After all deficits are caused by net saving over investment, with that ‘excess saving’ permitted solely by the fiat monetary system and the government deficits. ‘Naturally’ those excess savings would be destroyed in a depression – along with lots of sound capital. And we may see that if governments in the Eurozone go to balanced budgets.

      So one of the alternative propositions is that rather than the excess savings being destroyed ‘naturally’ they could be destroyed ‘artificially’ via a taxation mechanism – Euros having a ‘use by’ date or something.

      This contrasts with the MMT position where the excess savings are accommodated by the government sector simply expanding its deficit.

      The viewpoint difference is that some people see excess savings as ‘bad’, whereas MMT seems to see them as ‘neutral’ to ‘positive’ (if you have savings you feel more secure).

      Could the Eurozone pull itself out of the malaise by confiscating financial savings that are not invested in a timely manner?

    3. On a sidenote re:The ‘loss’ of tax revenue arises from the operation of tax havens (“paradis fiscaux”) in the Caribbean and elsewhere and involve European companies, banks, and American digital companies producing income in one place but being structured for tax purposes in a low tax regime.
      Could the Australian Govt be added to the list?
      http://www.smh.com.au/business/the-economy/leak-reveals-future-fund-and-multinationals-secret-offshore-tax-deals-20141106-11hrf5.html

    4. I think it is high time we begin paying attention to Marxian political economists again. Note, I said “Marxian” not “Marxist”.

      First, I want to draw your attention to the paper;
      “How Monopoly-Finance Capital Leads to Economic Stagnation
      (Who’s harmed when monopoly-finance capital outpaces real production? Find out why, under the resulting economic stagnation, everyone suffers.)” by John Bellamy Foster and Robert W. McChesney, October 2012.

      Second, I want to draw your attention to the paper;

      “How will capitalism end?” by Wolfgang Streeck.

      Now, I am a little afraid that two actual links will put me in moderation but if your search the net these papers are easy to find. The first is on the utne dot com site. The second is on the philosophersforchange dot org site.

    5. Dear Bill

      Isn’t the root of a lot of tax evasion the fact that we have a separate corporate tax? If corporations were taxed like partnerships in Canada, then the problem might disappear. In Canada there is no partnership tax. Suppose that Peter, Paul and Patrick have a partnership in Canada. Each has 1/3 of the partnership, and the partnership has a profit of 600,000. Then all 3 partners pay income tax on 200,000, regardless of what the partnership does with the profit.

      Corporations could be treated in the same way. If Corporation XYZ has 200 million dollars in profits and 20 million shares, then the profit per share is 10 dollars. If someone owns shares of Corporation XYZ at the end of the year, then for each share he will pay income tax on 10 dollars. Dividends would of course be tax-free. The corporation itself would not pay any tax. My view is that institutions shouldn’t pay income tax, only individuals should. Incorporation should never be done for tax purposes. Whether a farm is an individual proprietorship, a partnership or a corporation should make no difference in its tax liability. This may go a long way in eliminating all these legal constructions designed to avoid corporate taxes.

      As to capital gains, I think that inflation should be taken into account. Suppose that I bought shares in 2000 for 100,000 and sold them this year for 250,000. The capital gain is then 150,000. If inflation from 2001 to 2014 has been 25%, then the 150,000 will be divided by 1.25, so the taxable capital gain will be 120,000. To make it even fairer, there should be the possibility of averaging. For instance the gain could be divided over the current year and the previous 7 years, with 15,000 per year.

      The issue here is one of equity. All income should be treated in the same way, but irregular income should not be taxed more heavily than regular income. If Peter made 40,000 per year in the last 5 years while Paul made 120,000 this year but only 20,000 per year in the previous 4 years, then both have 200,000 in a 5-year period, and Paul shouldn’t have to pay much more than Peter.

      While we can agree that taxes should primarily serve the macro-economic purpose of reducing aggregate demand and avoiding inflation, equity is also an important issue in taxation.

      Regards. James

    6. Could the Eurozone pull itself out of the malaise by confiscating financial savings that are not invested in a timely manner?

      The easiest way to devalue people’s savings is simply by inflation, no assessment of individual’s wealth, no crackdown on tax havens required.

    7. Taxation in the Eurozone works closer to the way that most people in the UK or Australia think their taxation system works. In other words the Eurozone govts do have to get money to be able spend money. That’s not been a problem, so far, for the big exporters like Germany and the Netherlands. They’ve got money coming in from exports and so there is enough to allow their savers to save and have the tax revenue they need too. That wouldn’t be a surprise to those who consider that the Euro rules were set up to suit Germany anyway.

      So net importer like France can only partially solve its deficit problem by taxing its own private sector , and raising money by closing loopholes etc. If the French government could get hold of money that wouldn’t otherwise be spent and spend it instead that wouldn’t be deflationary. It could theoretically do that with its own citizens and companies with companies which are subject to French law, but it still has the problem that it cannot with others in the Eurozone. If money is draining from the French economy to pay for German imports that must represent a loss of taxation revenue too.

      It’s rather like if all the EZ countries are on a gold standard. However, they aren’t allowed to impose tariff barriers to control their trade and they aren’t allowed to change the value of their currencies. In addition they aren’t allowed to borrow more than a certain amount even if they can find willing lenders. Maybe its even worse than a gold standard. There is always the possibility of finding more gold in the ground.

      It’s a crazy system. Why on earth did anyone think it would ever work?

    8. Judith Sloane attacks Bill Shorten in the Oz for saying: “Revenues have to match our spending”. She claims that under Labor spending increased 35% but revenue only 19%. If I understand you correctly, this may be true in the Eurozone but makes no sense for a sovereign economy such as ours.
      This raises an interesting point. If we have been running such large deficits then why did unemployment jump 50% from a low of 4% in 2007 to about 6% now!
      But about the tax avoidance – does it matter? Its all demand, it doesnt matter who spends it really, unless you’re a socialist!

    9. ” If we have been running such large deficits then why did unemployment jump 50% from a low of 4% in 2007 to about 6% now!”

      Probably because taxes have been too high (and/or spending too low) If taxes are lowered then the deficit may not necessarily increase. Those spendings, which are trapped in the tax net, still end up going back to government but end up being gathered after more transactions rather than fewer. More transactions = more economic activity = lower unemployment.

    10. Neil Wilson,

      some of the so called “saving” is paying back loans that destroys assets and leaves nothing to tax. It would be difficult medicine but I would tackle the pension saving systems that requires lots of funding. “A money flow problem” seem to be itself manifestation of a simpler problem: inadequate wealth. What changed from 2007 to 2009 was price of houses, not quantities of financial assets. They just seem to follow.

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