Whether they be city states or countries, all jurisdictions that experience growth rates and increases in prosperity that, for a time, dwarf those of their neighbours tend to have deployed an innovation, a resource or a policy that gives them a unique economic advantage.
For France, that policy might have been mass and brutal colonialism in Africa. For Holland it could have been the wholesale plunder, at gunpoint, of the natural bounty of Indonesia and Borneo. For Belgium, early 20th-century wealth came with the gruesome hacking-off of the hands of men, women and children in the Congo in order to force the enslaved African population to produce more rubber.
One of the UK’s wealth-appropriation tricks was to impoverish India: when the British arrived, India’s wealth constituted 31 per cent of global GDP; by the time Britain left it was barely above 2 per cent.
Other jurisdictions have been far less brutal in pursuit of their interests.
Medieval Florence, for example, rediscovered the magical commercial properties of urine. In 12th-century Asia, the Florentines stumbled upon dyeing techniques using the potassium in human urine combined with local lichens to create florid dyes. This innovation propelled the Florentines to become the dye and textile centre of Europe.
But Florence wasn’t the first to appreciate the magical power of pee. The Romans, who washed their teeth with the stuff, due to ammonia’s whitening capacity, were so enamoured by urine that they taxed it. In fact, the tax on urine led to the wonderful Roman expression, attributed to the emperor Vespasian: “pecunia non olet”, meaning “money has no smell”.
In defending his decision to tax the “piss collectors” (yes, a real job in Rome), Vespasian declared that it didn’t matter where the tax came from, as long as it raised money, so taxing urine was fair game.
He was a pragmatist, not an idealist, and pragmaticism is an essential attribute when devising economic policy in a competitive world. Tax is strategy. It is not just a revenue-raising exercise.
Dynamic is a key word here because, when talking about tax, we are not referring to a static specific balance sheet for a specific company pertaining to a specific year. We are talking about a dynamic, complex multigenerational strategy that has contributed enormously in dragging Ireland out of economic backwardness.
Tax strategy is about relative prices and relative abundance of labour and capital. For the first 70 years of independence, Ireland did not have enough capital and as a result it had too much labour. This meant that capital was hoarded, as evidenced by low levels of investment, and labour was exported, as evidenced by high levels of emigration.
Ireland exported people and, at the same time, hoarded capital, measured by ridiculously high levels of interest rates. High interest rates in a fixed-exchange-rate regime with low growth are usually emblematic of capital flight fears, so interest rates are high to keep the capital here.
When interest rates are high, the cost of capital is high, so it’s not used productively. It sits in the deposit accounts of the small amount of already wealthy people, exacerbating colonial levels of inequality. This was Ireland, minus the 500,000 people who emigrated in the 1950s and the continuing emigration in decades to follow.
Another problem with living in an economy with a fragile capital base is that levels of productivity are low because workers without capital are less productive than workers with capital. Low productivity means low wages, and low wages mean not only a diminished standard of living, but also depressingly low expectations about what can be achieved in this country.
The implication of this is that even people who might otherwise have created businesses here chose to do it elsewhere – taking their ideas, dreams and abilities to the UK, US or Canada.
An economy with no capital has to import it, or it collapses. How do you import capital? You make it cheap. How do you make it cheap? You don’t tax it, or you tax it at rates that are much lower than those of your neighbours who, for reasons of internal ideology or the existing size of their corporation tax take, may not be inclined to follow suit.
For the poor country with no capital, not taxing capital has no downside because it never had capital to tax in the first place.
The lower the capital tax rate, the more capital should flow in. This capital, when fused with the existing population, provides job opportunities and a more dynamic economy, which in turn throws off tax revenue in a variety of other areas that previously didn’t flourish: VAT, excise duty, income tax and the like.
A vibrant economy
Vibrant tax is a function of a vibrant economy. This larger tax take can then be spent on social objectives, such as education, health and social welfare. Such elevated public spending would not have been possible without the initial capital catalyst.
Capital tax revenues rise because capital taxes are low, not in spite of low capital taxes. This is because of “network effects” as much as tax policy. When a region, be it Silicon Valley or medieval Florence, becomes a cluster in any industry, it experiences network effects, where other companies and players want to be there simply because others are there too.
Clustering or networking is one of those dynamic, hard-to-pin-down, elements in economics. Networks are ephemeral and constantly changing, but maybe the best way to regard clustering in terms of capital taxation is to look at the approximate numbers in Ireland.
Ireland’s corporation tax take is heading towards €10 billion per year. With a population close to 5 million, that’s €2,000 per year per citizen. Obviously, this comes on top of the incomes, share options, capital transfers and career opportunities for the 300,000 people who work in these companies.
The economist Seamus Coffey estimates that US companies in Ireland every year pay €8 billion in wages, spend another €4 billion on Irish contractors and another €4 billion on capital projects – on top of their corporation tax.
Tax is a legitimate part of a country’s economic arsenal. Indeed, some might argue that independent tax policy is the definition of sovereignty for a country.
This battle is not over between the European Commission and Ireland. The commission has lost the state aid argument but will come after us on the internal market argument next.
Given the significance of foreign investment here, it would be wise for us to eliminate some of the loopholes that infuriate the commission. But moderating and tinkering around at the margin is not the same as abandoning tax arbitrage to boost economic growth.
Taxation is and will remain a legitimate policy tool. Let us not forget this.