Reshaping Obsolete Tax Systems: Government’s Role

Reshaping Obsolete Tax Systems: Government’s Role

Senior finance leaders from 12 countries attended the Global Government Finance Summit, hosted in 2023 in Rabat by the General Treasury of the Kingdom of Morocco

The digital economy, advanced tax avoidance techniques, organised fraud and the demands of net zero are rendered our international tax architecture increasingly obsolete. At the Global Government Finance Summit, finance leaders from around the world debated how to fix it

In an era of slow global growth and high inflation, finance departments face ever-growing pressure to maximise tax revenues – but also fresh obstacles, hampering their ability to raise the money required for public services.

So when civil service finance leaders gathered in Rabat for the Global Government Finance Summit, the group was keen to explore some of the structural, behavioural and technological challenges ranged against them.

One obvious challenge is the rise in sophisticated accounting techniques, employed by the very rich to minimise tax burdens; this is a particular problem given that, in many parts of the world, median wages haven’t risen for a decade, depressing income tax receipts. The tax avoidance industry, of course, is not a new phenomenon. But the economic changes created as digital technologies disrupt and dominate an ever-growing portion of developed world economies have given the topic a new and potent salience.

While digital technologies and the big tech firms have transformed vast swathes of our economies, our tax systems have remained largely unaltered: we are stuck with an international architecture decided decades ago, and which cannot be substantively reformed without the support of the USA – which hosts many of today’s tech giants. As a consequence, our tax rules and regulations can leave countries ill-equipped to extract money from their digitally transformed economies.

A tilted playing field

In the field of online retail, for example, small and medium-sized enterprises selling imported goods online often disguise the volume of their transactions to avoid customs charges. And at the other end of the corporate scale, many of the tech giants allocate their value creation to parts of the business registered in tax havens, leaving them with far smaller tax bills than similarly-sized companies with more traditional production processes.

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The digital transformation of advanced economies also alters how workers contribute to – and call upon – public services. With many tech business models dependent on the use of freelance staff, hired on low-paying zero-hours contracts in the ‘gig economy’, workers often have far less job security or access to employer benefits – leaving the state to pick up costs traditionally held by employers, even as low pay rates squeeze income tax receipts.

While many participants were reluctant to comment publicly within this session, Jakob Wegener Friis, deputy head of Cabinet for the European Commissioner for Economy, illustrated some of the problems by highlighting gaps in the EU’s VAT system. This “relies on principles and techniques of taxation that are maybe 30 years old,” he said. “We have not been able to capture the platform economy.” The EU’s VAT in the Digital Age programme, he added, aims to reform VAT rules – closing up a revenue gap estimated at €93bnand “gathering revenue that can be used to provide services for some of the platform staff who are not always recognised as workers in social security systems.”

“It harms taxpayer compliance to see a lot of tax evasion and avoidance going on.” Jakob Wegner Friis, deputy head of cabinet, Commissioner for Economy, European Commission

Tech as a weapon – offensive and defensive

Alongside these problems of ‘base erosion’ and ‘profit shifting’, digital technologies also present more direct threats. Many tax offices are coming under attack from cyber criminals – including gangs backed by state actors – while the transition of benefits, grants, loans and tax systems onto digital platforms creates new opportunities for fraud.

So digital technologies have fostered a host of new problems for tax authorities; but they can also provide some solutions. Analytics techniques can be applied to financial transactions and tax submissions datasets, for example, to detect fraud or the use of new tax avoidance schemes – enabling tax agencies to target inspections, and to block emerging avoidance techniques.

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The digitalisation of tax systems can also cut administrative costs, both for tax agencies and for their subjects – saving taxpayers’ money, while reducing the drags on economic growth. Simplification is another important goal, participants commented: reducing the number of taxes and exemptions can squeeze the opportunities for fraud and avoidance, ease administration and encourage compliance. As one participant noted, corporate income tax receipts are depressed in their country “because of the exemptions; there are many ways in which corporations are capable, because of the loopholes, of not paying tax.”

Efforts to simplify tax systems often encounter resistance, most obviously from those firms and sectors benefiting from the status quo. However, change is possible: one participant nation’s work to create a “clean slate in your tax system, putting together something that is absolutely coherent and modern,” was very impressive, commented Friis. “Many of us would really like to do that.”

Ireland has worked hard to strip out exemptions, commented John McCarthy, Chief Economist of Ireland’s Department of Finance. “We have a relatively low corporate tax rate of 12.5%, but very, very few exemptions,” he explained. “So the effective rate of taxation on total profits is about 11%. Lots of countries in Europe talk about their high rate, but nobody pays it: they have loopholes and exemptions, and their effective rate is close to Ireland’s.” This latter approach enables politicians to tell their electorates that they’re squeezing the corporates, he suggested, but fails to generate revenues matching the rhetoric.

Collaboration, carbon and compliance

In part, the solutions here lie in international coordination: the EU’s VAT reforms should squeeze carousel fraud and cut the costs of compliance, while the OECD’s Base Erosion and Profit Shifting (BEPS) initiative aims to update the global tax regime for a digital age. Ireland has signed up to the BEPS process, commented McCarthy, noting that “one of the opportunities is that we will have global tax certainty for ten or 15 years.”

Looking ahead, finance leaders are working on ways to incentivise the shift to net zero – and to replace the rich revenue streams generated by hydrocarbons. “We’ve introduced an environmental tax on non-reusable plastic packaging and a waste deposit tax, and we are studying more changes in our tax system,” commented the Spanish delegate.

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Further reforms will be required to keep up with the dramatic economic changes wrought by digital technologies. The BEPS framework represents a long-overdue first step in addressing the impacts of digital, but the process moves slowly – and the pace of technological and social change is only accelerating.

Meanwhile, argued Friis, by focusing on tightly policing the current rules, finance leaders can maintain public confidence in the system as well as maximising revenues. “I think it harms taxpayer compliance to see a lot of tax evasion and avoidance going on,” he said. Digital technologies can both help identify those abusing the system, and make it simpler and easier for people to pay what they owe. “We can put data and digital solutions at the service of the 95% of people who do want to pay their taxes, making it as simple as possible to comply,” he concluded. “I think there’s a big gain there – not just in terms of revenue, but also in re-establishing the social contract.”

This is the fourth report on the Global Government Finance Summit held in Rabat, Morocco in June 2023, covering the discussion on ‘a 21st century tax system’. The first report covered Irish finance department Chief Economist John McCarthy’s analysis of his country’s economic strengths and weaknesses; the second how finance departments can support the drive for net zero; and the third, the huge power of data-based decision-making. The final report will be published here soon. To ensure that participants feel able to speak freely at the Summit, we give all those quoted the right to anonymise, edit or delete their comments before publication.

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