Compare living standards, not tax
Monday 26 April 1999
Oskar Lafontaine, who resigned as German finance minister, was the notorious exponent of the false belief that taxes had to be harmonised within the European Union. He combined this with the other false belief that British business paid too little tax and should pay as much as German business.
On the British side, we have compounded the error by boasting about how low our social security charges are, and how we shall achieve faster economic growth by having a lower total tax burden than our competitors.
Tony Blair, the Prime Minister, got the Germans to tone down their demands from harmonisation to co-ordination. This means a narrowing of the band between different national rates of indirect taxation to even out prices in the single market for goods and services, and similar treatment of withholding tax on interest, to create a level playing field in the single financial market.
Fiscal policy as a whole also needs to be co-ordinated, so that countries do not breach the Maastricht deficit ceiling of 3 per cent, and so that their combined fiscal stance fits in with the European Central Bank's monetary policy. Apart from that, governments have freedom to tax and spend as they wish, and will need to use it more actively as they have lost control of monetary policy.
It is a myth, fostered by successive Chancellors of the Exchequer, that British business is lightly taxed. Corporate taxes on income are 3.9 per cent of GDP in the UK, above the EU average, but only 1.5 per cent of GDP in Germany. The UK pays the highest tax on corporate property, with business rates and capital gains tax at 2.1 per cent of GDP. Business rates are a regressive tax, unrelated to profits, whose main merit is to guarantee that all businesses pay some tax. If they are included, UK business pays 6 per cent of GDP in tax, the highest rate among industrial countries.
It is an illusion that low employers' national insurance contributions redeem British business. These amount to only 3.4 per cent of GDP, or half the EU average, and just over a quarter of the high French and Swedish figures. With employers' social security, British and German business look lightly taxed, both paying just under 10 per cent of GDP.
The big error is to omit the burden of private social security, or employers' contributions to pension schemes. The UK claims to be in a much better position on pensions that most other EU countries, because it relies more heavily on funded schemes and does not have such big unfunded future pension liabilities. Another way of looking at it is that a low public social security burden gives the UK the meanest state pensions in Europe, and that private pension schemes impose a burden on the economy so as to supplement meagre state payments with more generous private provision.
Employers' contributions to private pension schemes are 3.6 per cent of GDP in the UK, above the average of 2.5 per cent for other countries. The British corporate tax burden, including these, comes to 13 per cent of GDP, slightly higher than the German burden, although well below that of other countries, notably the US, where employers' private health and pension contributions are 7 per cent of GDP.
Corporation tax rates are a poor guide to the size of tax burdens. The UK has a lower rate than most countries of 31 per cent of corporate profits. Sweden, with one of the heaviest corporate tax burdens, has an even lower rate of 28 per cent. The EU average is 36 per cent, and Germany has a high rate of 50 per cent (the average of the two separate rates for undistributed and distributed profits). The British tax rate is lower, but the UK has fewer tax-free allowances than Germany and other countries, and thus a wider tax base and a bigger tax burden.
When Nigel Lawson, then Chancellor of the Exchequer, changed the corporate tax system in his 1984 Budget, he slashed both capital allowances and tax rates. He may have made the system more efficient, but the UK has not had the same incentive as other countries to modernise its capital stock. Gordon Brown, the present Chancellor, has taken away much of the advantage of lower corporation tax rates by accelerating payments.
The effective tax rate on the income on business capital (including property but excluding social security taxes) corresponds more closely to the corporate tax burden. It is 45 per cent in the UK, far higher than the 31 per cent EU average, or the low 24 per cent rates in France and Germany, but not that much higher than the 40 per cent rate in Sweden and the US.
Government policy in the UK falls back on the false Thatcherite doctrine that a low total tax burden is good for enterprise and economic growth. If we exclude social security, Britain's tax burden is almost exactly the EU average of 30 per cent, and well above that of France, Germany and the US. If social security taxes are included, then Britain looks like the lowest taxed country in Europe, apart from Ireland and Spain, with a burden of 36 per cent. Yet private social security provision must be added in, otherwise differences in tax burden become due mainly to differences in the public-private mix of social provision.
The UK's total burden rises because employee and self-employed contributions to life insurance and pension funds are a high 8.4 per cent of GDP, well ahead of France, where they are 5.7 per cent of GDP, and Germany, where they are only 2 per cent. Not all such contributions are used to finance retirement, but it is an advantage to be able to use long-term savings before normal retirement age. Nor do all savings go into long-term forms, and the boundaries between different kinds of personal saving vary widely across countries.
Arguments about the tax burden are in any case beside the point. There is a clear positive correlation in the EU between the total tax burden (including public but not private social security) and the standard of living as measured by GDP per head. The UK, with a low tax burden, has a relatively low standard of living. Denmark, with the highest tax burden, has the highest standard of living. Is it any wonder that so few Danes leave Denmark because of high taxes?
High taxes do not cause a low standard of living. A high standard of living enables a country to levy high taxes, and to finance high public expenditure. Taxation is progressive, rising with income, across countries as well as within them.
Christopher Johnson is UK Adviser to the Association for the Monetary Union of Europe.
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