We can attack the excessive wealth creation for certain sectors, we can even attack the wealth creation or wealth ownership for a certain individual, but we have to find a balance between the individual, the corporate, and the state, and at the moment that balance is clearly out of kilter.
Kim: Hello, and welcome to another edition of the AFTERMATH. Today we are talking taxation and to help me with that I have Mike Browne from our London office who runs the European Long/Short product. Mike, really good to see you.
Michael: Nice to be here Kim on a difficult subject.
Kim: Absolutely, that's why it's so much fun. So, lets kick off, I mean, the way I would frame it, is that even before COVID-19 induced increase in debt that we are seeing, tax was increasingly a priority for governments all around the world. As an average, the OECD countries generate about 34%1 of revenue as a percentage of GDP from taxation, but collection has always been an issue. So, you know the developed world, including OECD, we are looking at around about 20%2 of GDP coming in as revenues, and then in emerging markets around 14%3. Mike, what's your take on where the governments go from here?
Michael: Well, the global taxation requirement has obviously risen dramatically, as we see debt to GDPs in particular in the developed world they are shooting through a 100%, the grades are back up to 200% and at some stage or other they are going to have to be a running of some sort of small surplus even at very low interest rates to stop the ever spiralling level of debt, which will eventually consume most of a country’s GDP. And that of course means that the growth rates will slow if we look at any of the analysis' that’s out there, because the private sector becomes relatively small to the overall public sector. So, the question is; how do we finance the next five to 10 years given the commitment we just made for COVID, which came on top of the commitments we had to make during the GFC?
Kim: Absolutely right and I guess one place to start will be the taxation of multinationals and technology giants. Europe has been pretty vocal about this or at least France within Europe. What's the latest there?
Michael: Well its interesting isn't it because it's the UK that's come along with the first turnover tax and beaten, should we say the French and others to it. Can I put the issue in a slightly different way? There are certain sectors that are perceived to have done very well in the last decade, and particularly well since the March of this year who are seen as paying no tax, and that is seen as unfair or indeed unrealistic in the current environment and so the FAANG’s are clearly straight in the firing line on that particular point and the flip side of course is the damage that they are doing to domestic retail industry at the same time and retailers paying tax on the building, tax on the cars, tax on the petrol, tax on their employees, which the internet shopper doesn't or not to the same degree. So, we've got this huge disparity in tax take. If we think about it more simplistically, yes we can attack the excessive wealth creation of certain sectors, we can even attack the wealth creation or wealth ownership of certain individuals but we have to find a balance between the individual, the corporate, and the state, and at the moment that balance is clearly out of kilter. And I would argue it is the corporate being the beneficiary of sharply falling taxation rates for the last decade and more is going to have to step up to the plate or be forced to step up to the plate.
Kim: I think that's absolutely right, I mean we have seen already we are in pre-election mode in the US, the Democrats platform calls for tax, corporate tax to go back up from 21% to 28%, I mean that on its own sounds a big number but it doesn't actually net that much more. I've seen numbers in the region roughly around $340 billion as a tax paid annually on that front. Other countries could also do this, but I guess one of the key problems we have is that multinationals, the tax regulations, the government were set up in the 1920's and 30’s, you know they basically are down to treaties between one country and another so it's going to be quite difficult and complex to address that properly, so I will put to you that it's probably the national champions that get taxed in the first instance almost as a kind of national service.
Michael: Well there's an interesting piece in that Democratic taxation proposal for corporate positions as you say 28%, but there is also a piece that says it would place sanctions on countries that facilitate the illegal corporate tax avoidance on engaging in unfair tax competition, which is a much broader definition of what the US are going to do to the Netherlands, Liechtenstein, Switzerland, those places that have traditionally been very good, Luxembourg, have facilitated very low corporate tax rates. So, I think it opens up a very new perspective and alongside of that the EU have been talking in similar terms but with their eyes on a different element and that is green taxation. If we are going green here, and you export me a high carbon consuming product you are going to have to pay a significant tax rate to allow it into my zone. So, I think we’ve got some subtleties around the taxation here coming from governments at a corporate level which actually could amount to a really significant amount.
Kim: I like particularly that EU side to it, because I do think we generally tend to forget that the EU is still the biggest trade zone in the world and as a result has become the setter of spec, specification that is you know for goods and services, so could easily become the setter, the trend setter for carbon tax and that kind of thing. So, I would expect that to be something that's going to come through pretty quickly in the next five years or so.
Now taking a different direction, Mike, you know, what’s the outcome do you think, how would you think about things like inflation as an outcome of this?
Michael: Well the issue around inflation is very interesting because at the moment corporates don't want to cut prices on goods because they are not selling very much anyway, so they just want to hold the price up. So, I think we have got that inflationary bubble that I was expecting in the last quarter of this year. But that's going to fall away as we look at the labour market and the weakness in the labour market because the same companies are still cutting labour. The question is what will drive inflation over time because inflation will drive interest rates and interest rates will drive budget deficits for this enormous level of debt that's sitting there. Now I'm slightly more optimistic than most, because about half of all the inpulse of inflation, up or down, came from oil prices, so if we move to a very heavily sustainable economy, which is not utilising carbon in the production of energy, we immediately reduce or at least take away that inpulse. So, I've got to be a little more optimistic about inflation and the risk of inflation, the government balance sheets from this very high level of debt.
Kim: Mike, another point, if you think about corporate tax policies, you know, interpretation of, corporates, stakeholders are thinking about maximising profits, how did you think that might change in the context of ESG as in the G of ESG, Governance.
Michael: I think it's really quite straightforward, that underpaying of tax and obvious underpaying of tax is clearly breaking both the social responsibility of a company and is perhaps illustrative of poor governance. Now I'm not saying companies should over pay their taxation but I am saying they should pay a full and fair taxation rate, and I think you will see us building that into those social responsibility and governance questionnaires going forward and I think it's going to make an awful lot of CFOs very uncomfortable, and it’s time this question was asked.
Kim: And I guess very sharp tax lawyers will also be uncomfortable.
Michael: They have had a good run for a long time. Maybe it's time for us to stop their, should we say, sharp practice.
Kim: Mike, thanks very much indeed that's been very helpful. And thank you all for tuning in, please tune in again next week for something completely different.
1 Source: OECD Global Revenue Statistics Database - page 5
2 Source: Martin Currie proprietary country risk framework, World Bank 24/01/20
3 Source: Martin Currie proprietary country risk framework, World Bank 24/01/20
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