Tax neutrality
A key principle of the tax consensus is tax neutrality, which means trying to avoid changes that may distort the market. As a result, tax neutrality manifests in an increase in consumption taxation over trade taxation or direct taxation on income. The key issue with tax neutrality is that it assumes that as long as distortionary taxes are absent, for example taxes that would affect business practice, the economy will deliver an efficient & optimal allocation of resources. Tax neutrality also assumes that governments have a range of other instruments at their disposal to tackle inequality, however in the case of many countries, but in particular developing ones, these assumptions do not hold. This is because due to already weak tax collection systems, weakened by debt burdens for example, the pre-tax economy will not be efficient, & governments typically will not have available to them a range of instruments to mobilise revenue & redistribute wealth.
Trade liberalisation & its relationship to tax
The tax consensus also supported trade liberalisation, in other words the reduction of both export & import taxation. According to the neoclassical school, trade liberalisation increases market efficiency. The logic behind import-tariff reduction is that if a small economy reduces its tariffs, it increases the flow of imports which will have domestic consumption taxes placed on them. An accompanying well-administered rise in the consumption tax that is equal to the drop in the tariff will therefore leave prices at the same level while raising greater revenue from a broader tax base. However, the revenue response has proved to be very weak, particularly so in the poorest countries where trade taxes had constituted a significant proportion of revenue. Many southern countries rely heavily on the taxation of imports, as these taxes are relatively easier to collect & less costly to administer than other forms of taxation, in particular tax on informal economic activity which is prevalent in southern countries. Removing this option has meant the removal of a key method of generating tax revenue for many countries. Despite this situation, many countries have progressively lowered trade tariffs during the last few decades because of World Bank & IMF conditionalities.
Supply-side fiscal policy
According to the neoclassical school, lowering taxes & enacting tax consensus policies is that by doing so, the economy is stimulated. The argument is that by being ‘pro-business’ (i.e. by lowering corporate tax), the financial benefit will trickle down to all individuals in society. This theory is known as supply-side economics or supply-side fiscal policy. The theory is as follows: By lowering individual tax, people will have more money in their pockets & therefore more money to spend, encouraging production & economic growth. By lowering corporate tax, businesses have more profit, & will have more funds to hire more labour & invest in improving their service, benefiting society as a whole. As they employ more & increase wages, they continue to add more money to consumers’ pockets. This cycle continues (it is surmised), resulting in more economic growth, compensating for the lost tax revenues. Supply-side economists believe that high tax rates strongly discourage efficiency of resource use & they have historically focused on promoting corporate income tax reductions rather than personal.
This theory does not always hold however. For example, Bill Clinton’s tax increases on top earners caused economic growth to increase for 8 years & created over 20 million jobs. In contrast, in 2001 & 2003 George W. Bush lowered the top tax rate & cut top rates on capital gains & dividends. Despite the forecast in line with supply-side economics, the economy barely grew. Additionally, in Kansas in 2012, tax cuts on top earners & business owners were drastically cut, while in California taxes were raised on top earners to the highest rate in the USA. Kansas has now fallen behind most other states in terms of economic growth, while California has progressed in the rankings. However, that said, there are many related factors & it can be difficult to pinpoint effects with a high level of confidence & to determine the exact outcome of any one theory or set of policies.
A further argument against supply-side fiscal policy is that there is a growing trend among corporations to engage in stock buybacks rather than reinvesting in line with the theory’s assumptions. Buybacks occur when companies place the cash they may gain from lower taxes back into the pockets of their shareholders rather than investing in new plants, equipment, innovative ventures, or their workers. According to the Tax Policy Center, in 2018, US corporations spent more than $1.1 trillion to repurchase their stock rather than invest in new plants & equipment or pay their workers more.
Competition is good for the economy
Further neoclassical rationale for the tax consensus is that increased competition is good as it encourages companies to make better products & drives the cost of goods down to attract consumers. However, in recent decades there has been a shift from companies competing, to countries competing. The globalised nature of mobile capital means that tax systems that exist in one part of the world can influence economic activity in another. The result of this is that even if sovereign tax laws tend to be within the remit of one country, the tax laws that exist in country A can influence the economic activity that takes place within the borders of country B. Governments are now competing with one another to attract private investment. There are many ways they do this; via reduced regulations so that companies can operate more freely without so-called ‘red tape’. Or tax concessions, tax breaks & tax ‘holidays’ are used to attract investment. For example, ‘maquilas’ in Latin America can, in some countries, be exempt from import duty, income tax, taxes on the repatriation of profits, VAT, asset taxes & municipal taxes.
The logic behind cutting corporate tax rates is that by doing so, it is surmised that countries can attract capital, which therefore will make workers more productive because of the increase in machines, plants & equipment, resulting, it is theorised, in increased wages for workers. As a result of this logic, between 1985 & 2018, the global average corporate tax rate fell from 49% to 24%. Since the 1980s, the corporate income tax rate, the top inheritance tax rate & the top personal tax rate have all been in decline. Examples abound globally of corporation tax being reduced. For example in the UK, the rate dropped from 28% in 2010, to 19% in 2017, to 17% in 2020. In the US, it dropped from 35% to 21% with the Tax Cuts & Jobs Act of 2017. This reduction has been even more significant in southern countries. The logic & laws which initially were used to attract investment in order to develop certain countries, have now transmogrified into mechanisms that firms can exploit to avoid paying taxes. In Guatemala in 2005 for example, the fiscal losses due to the existence of maquilas was almost 16% of total tax collected that year.
As a global trend, when corporation tax decreases, VAT increases, which is a regressive tax which tends to impact women & girls disproportionately. In low-income countries, two thirds of tax revenue is raised through indirect taxes like VAT. While high-income states have by & large been able to protect their revenue flows by shifting the tax burden to relatively immobile economic factors such as labour, income & consumption (with predominantly regressive effects), low-income states have generally been unable to offset the decrease in corporate income tax revenue.
Despite arguments for tax competition claiming that lower tax regimes are essential for attracting investors who will in turn provide jobs, revenue, infrastructure, & increased wages, a number of cross-country studies have concluded that the costs of tax incentives in terms of lost revenue frequently outweigh the benefits in terms of increased productive investment. The winners of tax competition are the MNCs that can play governments off one another as they vie for investment by continuously lowering their tax rates. Those who lose in this dynamic are the citizens whose governments are deprived of revenues with which to fund public services.
