The Bear’s Lair: The global tax regime becomes ancien

Modern “big data” systems are allowing tax authorities to gain full knowledge of sales transactions in their jurisdiction, thus pushing VAT tax collection rates close to 100% on small businessmen and the middle class in general. Meanwhile, Western income tax systems collect steadily less tax from large corporations and the very rich, who use loopholes and tax havens to minimize their tax liability. We have seen this type of tax system before – in the French ancien regime, where the nobility benefited from tax exemptions and the poor paid through the nose. That didn’t end well, and nor will this.

The true nature of the new surveillance and collection techniques is revealed when we realize, according to the Financial Times, that Russia is the global leader in this area. With the new partly-completed Russian system, if you confess you had a coffee at the hotel last night, the system can recognize it from the hotel’s records as one of three cappuccinos, a latte and an American.

The FT’s enthusiasm for this new technology, and its ability to increase tax yields both in Russia and worldwide, is somewhat chilling, it must be said – it’s a little like admiring the professionalism of the new torture techniques being developed by the KGB. It should be noted that the FT freely admits that Russia will never get the full whack of tax out of its oligarchs but hopes to make up the loss by squeezing every last pip out of the modest oranges of small traders and the middle class.

Technologically, I can understand how Big Data techniques enable the world’s tax authorities to improve compliance with VAT, which is already a difficult system to evade except for the very smallest traders. Employees in large companies will rejoice that their neighbor the dodgy plumber can no longer get away with tax evasion; he will be forced to charge VAT on all his sales. Of course, the big-company employee will be less happy when he discovers that the effective cost of plumbing services has risen by 20-25%, as they are no longer available “off the books.”

This increased efficiency of collection through Big Data is less completely shared by income tax systems. Whereas transactions involving large domestic companies are already fully covered, transactions involving foreign parties will only be covered when there is complete seamless cooperation between the tax authorities of the world and that, one hopes is a long way away and, with rising protectionism, becoming more distant. For the poor and the middle class, the income tax system can no doubt be made almost as leak-proof as the VAT system; for the very rich, who can afford to route transactions through dummy companies and tax havens, the coverage is inevitably far lower, and will continue so.

There is a huge injustice in a system where VAT is collected more efficiently than income tax. VAT is an inherently regressive tax; it collects the same percentage from all transactions and hence bears more heavily on the poor, for whom the necessities of life form a substantial part of their expenses. In some systems, such as the United Kingdom, food is exempted from VAT to prevent it falling so heavily on the poor. However, we are informed by the FT that this makes the “Big Data” analysis inefficient; it is hence preferable to include all items in VAT and then make larger welfare payments to the very poor. Naturally this will increase the state’s take, while employing an army of extra bureaucrats and making the economy still more sluggish through public-sector bloat.

Income tax, on the other hand, is generally not collected on the smallest incomes, and is then graduated to higher rates on higher incomes. (The Russian system, with a flat tax at 13%, draconian new methods of collecting VAT and huge unofficial exemptions for Mr. Putin’s most special friends, is truly spectacular in its level of regressiveness.) Hence even if the income tax system were fair and collected the same percentage of tax due from the very rich as from the poor, a tax system which was more effective in collecting VAT than income tax would still be inequitable. To Americans, used to sales taxes of 8% or so at most, this unfairness may not seem extreme, but it must be remembered that EU countries generally levy VAT at rates above 20%, and have discovered that VAT is the simplest tax to increase every time the finance ministry does its sums wrong.

There is an additional problem with a tax system that levies VAT more effectively than income tax, and that is the host of exemptions and dodges in the income tax system available to those with very high incomes. With good accountants, they can structure their earnings to be routed through tax havens. More disgracefully, there are exemptions in the domestic tax code that can be utilized by the very rich but not by those with ordinary incomes.

The most egregious of these is the wide range of exemptions available for charitable contributions. While ordinary people who perhaps tithe to their church incur a real cost to be offset against the tax benefit, the very rich can structure foundations and events in such a way as to benefit personally from the contribution made, as well as deducting it from tax. The Clinton Foundation, for example, appears to have provided a mechanism to route charitable contributions to the Clintons from people who could benefit in some other way from the Clintons’ political connections and offices. It is notable that the Clinton Foundation’s revenues fell to $38 million (against $53 million of expenses) in 2017, compared with $249 million in 2009, Ms. Clinton’s first year as Secretary of State.

We have seen before a system in which all the taxes were paid by the middle classes and the proletariat, while the aristocracy got off scot free – it was the pre-1789 French ancien regime. Under that system, the population was divided into three “estates” – clergy, nobles and commoners. The nobles were exempt from most taxes, the clergy were not only tax-exempt but got to levy tithes themselves, and the commoners bore the vast majority of the state’s tax burden. Add a crazy proto-Keynesian funny-money banking scheme that effectively bankrupted the emerging mercantile class in 1720, and you have an almost perfect recipe for economic and social collapse, which came in 1789.

There were many reasons for the French Revolution (the work of a noisy and destructive intellectual class for half a century – the “trahison des clerques” — was a major contributor) but the ancien regime’s irrational, unfair and hopelessly inefficient tax system was perhaps most to blame.

Needless to say, the combination of “funny money,” which will bankrupt the middle classes through making their savings and pensions worthless, and an irrational and unfair tax system brings us altogether too close for comfort to the pathology of the French ancien regime. The main difference is that while the court of Louis XV was a global all-time high point of art, music, architecture and decoration, the current era is nothing of the kind. “Louis Quinze without the furniture” is how our present era will be remembered by history.

The solution is twofold. First, we must fight against the power of computer systems to know every detail of our lives. Just as we are increasingly resenting Google, Microsoft and Facebook knowing our every movement, so we should resist the ubiquitous prying of the taxman. The fact that the new system is pioneered by Vladimir Putin’s Russia, not a bastion of civil liberties, is sufficient indication that it needs to be fought, not welcomed as the FT would apparently do.

Second, we must remove the current Bourbon-friendly financial system, which by elevating asset prices to the stratosphere while preventing the productivity growth that benefits the wages of ordinary people, is turning the world’s big cities into a noisier version of the Petit Trianon. The advent of Donald Trump and the 2016 Brexit vote ought to be sufficient indication to the global elite that we are onto their self-enriching ways. They may dislike populism, but as France demonstrated, thwarted populists will eventually reach for the guillotine.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)