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.