Gareth Howlett: Tax liability set by law, not fairness

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‘I SPEAK my mind; you are blunt; he is rude.” We all know the conjugation game, how we excuse or ignore in ourselves the faults we find in others.

Much of the overheated language used about tax is in fact a giant communal version of the conjugation game. “I pay the right amount of tax; you pay no more than you have to; he doesn’t pay his fair share.”

The feeling that we are paying taxes which others are unfairly avoiding is highly corrosive. It fosters resentment and suspicion, and weakens the notion of collective solidarity on which the tax system rests.

That is why circulars from the taxman emphasise the “fair share” theme.

The problem with this approach is that while support for laws and rules needs to be based on the feeling that they are fair, fairness and legality are quite distinct things. You and I may have very different ideas about what is or isn’t fair, but – at least in theory – we both know what the law is, and it is the law that sets out how much tax we have to pay.

This mismatch is relevant to us as investors because of the current furore over some high-profile multinational companies which, allegedly, exploit complicated loopholes in order to pay much less tax than they should.

If we are shareholders, we are better off – and the same goes for various other interested parties, as I’ll explain in a minute – but if this practice alienates customers and provokes governments into tightening the rules, we may end up worse off.

And there is also the ethical issue: do we want to condone behaviour seen by many to be unethical by investing in such companies?

The dilemma can be seen in a new light (if not resolved) by the insight that corporation tax, the tax that companies pay on their profits, is not really paid by companies at all.

The observation is not original, but just as the council tax isn’t paid by houses but by the people who live in them, corporation tax is not paid by companies but by the four groups of real people who are brought together when a company does business: employees, customers, suppliers and shareholders.

Every penny in corporation tax means lower wages for workers, higher prices for customers, lower incomes for suppliers and lower dividends for shareholders.

And the reverse is true: a reduction in tax actually benefits all of these groups.

There are three reasons why corporation tax survives despite its inherent irrationality.

One is good, the other two aren’t. The good reason is that it is sometimes technically easier to tax at this level than to try and catch the underlying real people.

Multinationals have worldwide supply chains and investor bases, and their hundreds of thousands of employees and millions of customers are similarly global.

The two bad reasons are that no-one likes big companies so taxing them is popular, and that virtually all governments impose corporation tax so the pressure on any one government to abolish it is minimal. Indeed, any developed world government, such as Ireland, which reduces corporation tax significantly is likely to face criticism for “unfair competition”.

Fairness, as we’ve seen, is a slippery and subjective idea, but after the expenses scandal you would have to be tone deaf to irony not to laugh at politicians criticising companies for following the letter but not the spirit of the law.

If politicians make the rules so complicated that they are a snare for the unwary and a dripping roast for the well-advised, whose fault is that?

The really important questions about tax, which go well beyond transfer pricing, offshore tax havens and other picturesque side issues, are, first, how much do we need to raise, and, second, who is going to pay it?

On the first question, if we demand services from the government that cost, say 45 per cent of GDP, then that is the proportion of national income which the government will have to squeeze from us in tax, less a few per cent that it will borrow.

That is the amount that the notional average taxpayer pays – in income tax, national insurance, VAT, petrol and alcohol duties, capital gains tax, inheritance tax, council tax and so on, as well as indirectly through corporation tax.

The second question is even more explosive, but let’s not assume that there is a huge unexploited reserve of unpaid corporation tax which we could tap into without adverse consequences.

• Gareth Howlett is fund manager director at Brooks Macdonald Asset Management