Rethinking Tax Systems for a Post-Covid Social Contract

This blog is based on an article in Social Policy and Society.  Click here to access the article.

Our recent paper, ‘Modern Monetary Theory (MMT) and the Changing Role of Tax in Society’ grew out of two concerns. One was to demonstrate that MMT’s most important, but much neglected, potential contribution is to help reframe the way tax is commonly understood, with important implications for how tax systems should be designed and evaluated. A second was to explore what that means in terms of new practical policy frameworks required to make MMT understandings of tax operational, while simultaneously enabling the macroeconomic and social policy functions of taxation to flourish. Both will be more relevant than ever in a post-coronavirus world.

One of the consequences of the current covid-19 pandemic and the associated economic slowdown is that the UK government will likely face a record annual fiscal deficit and a consequent increase in so-called government debt. Calls for another round of austerity are already gathering pace. Our paper helps to explain why such calls are misplaced, while pointing towards an alternative future path that rehabilitates both the macroeconomic and social policy roles of tax.

MMT challenges conventional understandings that tax funds government spending. Government spending, like all other bank-based spending, is undertaken on the basis of credit. In the UK, government credit is provided by the Bank of England. The security for the Bank, if it were to demand it, would be the future tax revenues of the government. This was recently acknowledged by a member of the Bank’s Monetary Policy Committee in April 2020, noting that it is routine for the Bank of England to fund government spending in this way. No concerns arise, providing inflation is kept under control. What this discussion makes clear is that central banks will be providing much more fiscal financing in the future. That discussion did not cover the MMT insight, that tax effectively withdraws money injected into the economy by the government. When interest rates are close to zero and may remain there, tax can operate as a useful counter inflationary tool by effectively ‘cancelling’ increased central bank credit.

Consequently, it is both more accurate and useful to think in terms of a spend and tax cycle, rather than the tax and spend cycle, we tend to hear about in conventional political and media narratives. Messages equating government spending with ‘taxpayers’ money’, suggesting spending is an imposition depriving citizens of funds make little sense in this context. It also means governments have more capacity to fund deficits providing inflation is kept in check, and if interest rates are low, than is commonly believed. In macroeconomic terms, it does mean that if deficits are to be sustained and carried after the crisis, then tax can play a vital role in lessening inflationary pressures.

The Financial Times recently identified that the covid pandemic and its economic impact, necessitates the reversal of the policy trends of the last four decades and a systematic revamp of the social contract. Part of this effort it notes will require public services being seen as investments rather than liabilities, but will also require redistribution to help make labour markets less insecure, including developing basic income and the taxation of wealth. These are noble and welcome aspirations, not least because they emanate from the most financially literate, but traditionally market friendly of media voices. But if these aspirations are to have substance they also need to be underpinned by a framework of economic thought that overturns conventional wisdoms and gets to grip with the realities of a world of central bank credit provision. Taxation’s role will be pivotal in offsetting benefits arising to the already asset rich, but also in underpinning a more cohesive and resilient post covid social order.

In our paper we identified that the current UK tax system is far from socially neutral, but rather weakens the social contract, in a fashion that has little macroeconomic rationale. Over £400 billion of tax reliefs and allowances are given away each year and 81% of UK wealth is held in heavily tax incentivised assets. The UK’s system of allowances and reliefs has a substantial redistributive effect, subsidising the already wealthy. When as MMT recounts, savings are not required to fund investment and reliefs potentially create leakages that may interfere with taxation’s cancellation function, it is time to engage in a systematic evaluation and overhaul of the UK’s system of allowances and reliefs.

These reliefs effectively constitute a system of Social Tax Expenditures (STEs). These STEs cost the government money, undermine taxation’s anti-inflationary potential by interfering with the integrity of the spend tax cycle, largely serve no verifiable investment purpose, advantage income from asset ownership over income from employment, and further exacerbate wealth inequality.

In recent work, we created a framework for assessing ‘tax spillovers’ or the vulnerabilities and weaknesses within tax systems posed by the pursuit of tax competition. From an MMT perspective such a system of evaluation can help to identify weaknesses that might impair a taxation system’s aggregate ‘cancellation function’ and suggest reforms to rectify that. Such tools will be essential in the post covid world, if governments are to assess whether their tax systems are delivering ‘cancellation’ effectively. The framework also enables a more precise appreciation of how specific reliefs can undermine the redistributive integrity of tax systems as a whole.

In the emerging covid economy, the challenge is to overhaul tax systems so that they are no longer weighted towards the wealthy, but redistribute towards those whose precariousness has been exposed by economic shut down, while becoming more effective in relieving potential inflationary pressures. Government has both the spending and monetary levers to take the larger role in the economy demanded by the current emergency and called for by the Financial Times, but a lasting more resilient social contract, requires an accompanying rethink and reassessment of both the macroeconomic and social policy roles of tax. The qualified application of MMT to questions of tax reform and imbalances we offer, provides a starting point for that.


About the authors

Andrew Baker is Faculty Professorial Fellow in Political Economy at the University of Sheffield.

Richard Murphy is Professor of Practice in International Political Economy at City University.

 

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