Tax Freedom day

Every year right-wing ideologues and libertarians declare a particular day ‘tax freedom day.’ I am firmly of the belief that this is nonsense that serves a very pernicious ideological agenda.

Tax freedom day is not a complex thing to calculate. You can simply take the percentage of the economy that goes through the government’s accounts as a percentage of the total economy and apply this percentage to the 365 days of the year.

Of course, it is assumed that people will be unhappy at having ‘worked’ so long and presumably got NOTHING in return. Ignoring of course the fact that people will have gained all sorts from the government spending, and also that those who are very fortunate might be happy to be contributing to their societies and the lives of those who are less fortunate than them. 

People get things in return for their taxes, and some people benefit from government spending more than others. Hopefully those with greater needs will be those who benefit the most. This is the first problem with the idea of a ‘tax freedom day’ – everyone’s tax freedom day would be slightly different from everyone else’s.

The fundamental flaw in the whole concept is that in elevating private earnings and denigrating government spending it ignores the fact that these are both part of a whole system. If the tax system were radically different then the entire economic system and society as a whole would be different—people would be in different positions and make very different decisions.

To illustrate this point think of David Lewis’ possible worlds or science fiction storylines involving parallel universes within the “multiverse.” If the tax system were different this would mean a different economic system. The important question is which of these possible worlds has the most just distribution of the resources of society and how we can move to this scenario.

The important issue is the counterfactual policies that are available to government and which will be better and worse. The proportion of the economy going through the treasury in a given year is of no real relevance; what matters is whether the system is working as well and as fairly as possible for the members of the society.

So the idea of tax freedom day is nonsense. However, I do think that one good thing has come out of this nonsensical “event.” It was my anger at this led me ten years ago to think of a better way of calculating tax than on an annual basis.

It seemed to me that working out an annual average amount was unhelpful and that if you wanted to work it out it should be done on a personalised basis and then compared to the amount that you should be paying given your position in society and your ability to contribute.

Indeed, rather than work it out on the basis of one’s income per year it would be better to work it out on the basis of one’s income for each hour worked. This led me to develop my hourly averaging system which I explain in my book. After all, (most) people are offering their time to the economic system and yet some get a lot more in exchange for this time than others.

In summary, I would suggest treating with suspicion any “think tank” or news outlet which peddles tax freedom day. They show their intention is to impose a particular kind of attitude to taxation and state spending rather than (what would be legitimate concerns regarding) the effectiveness of the tax system or government spending.

Technology and Tax (and Benefit) Fraud

Perhaps the most serious worry for the tax and benefit proposals I present in Rethinking Taxation is that they would open up the possibility for fraud. One reason is because the introduction of hour credits that impact upon people’s income also creates a new form of fraud, hour credit fraud.

I have several responses to such a concern, several of which are presented in my book, as well as in past and future blogs. One point is that there would be a maximum amount of hour credits each person could claim in a given period, and another is that the fraud of over-claiming on hour credits would in some cases replace existing forms of over-claiming on benefits and tax exemptions.

I also propose a demanding comprehensive acquired income tax base, which also creates new forms of tax fraud. This is more demanding, but I think that it is more principled and that it is better to have a principled tax base that people defraud rather than one that gives in to difficulty.

You might wonder what this has to do with my current series of blogs about technology. I wish to emphasise how technology can help to find instances of fraud, make the above forms of fraud much less likely and therefore allow a more progressive and principled tax regime.

Here are five ways technology can make tax collection simpler, improve compliance and detect fraud.

1.       Greater links between financial transfers and taxation.

In a recent blog "technology and tax-collection" I outlined my proposal for financial institutions to withhold tax. If this were the case, then there could be a presumption that any income is taxable unless it is proven otherwise. Those engaged in tax base fraud would have to either go to great lengths to convince the authorities that their income was not in fact taxable income, and doing so repeatedly would arouse suspicions.

This would push fraudsters further away from mainstream forms of finance and thereby make such activities less rewarding.

2.       Electronic transfers rather than cash.

Another point highlighted in previous blogs is the trend towards the use of electronic transfers rather than cash and that I would expect this trend to continue. Cash is preferred for those engaging in tax fraud and other criminal enterprises and so a reduction in the amount of cash in society means that it will become more and more difficult to generate income from illicit activities and to then utilise these gains in the mainstream economy.

One counter-argument to this is to say that a black market would spring up that would use an alternative currency—like cigarettes in prisons. However, this would be a risky option. The value of such a currency (or currencies) would be unstable without government backing and it would be easily possible for the authorities to disrupt the currency. Furthermore, when it is disrupted those reliant upon the currency will lose all.

The ultimate point is that the effort that people would have to go to would mean that most would find it easier to just join the mainstream economy (after all being at the bottom of the mainstream economy under the CLIPH-rate tax would not be so bad).

3.       Employer’s use of IT can be helpful.
a) HR and Personnel systems

Both employers and the tax authorities have an incentive to make it possible to share data electronically in order to save labour time at both ends. For example, transferring information from accountancy and human resource software to the tax authority

I think one of the strongest responses to claims that there will be a lot of hour credit fraud alongside hourly averaging is to highlight that firms want to get as much as possible from the workers they employ. We can expect firms to compete for workers and so firms engaging in hour credit fraud will have a different internal and payment structure than their competitors. This should be picked up using the methods outlined below.

The point to make under this heading is that employers are going to use IT systems to improve productivity and generate data that would be useful to verify hour credit claims.

One worry is that firms engaging in fraud could create two systems, just as dodgy firms can have a fake set of accounts for the tax authority in addition to their real ones. So this method won’t guarantee to catch fraudsters on its own, but it would at least make the process of assessment easier and give fraudulent firms a disadvantage over honest ones.

b) Monitoring job applications and company structures.

Another suggestion in Rethinking Taxation to counter hour credit fraud is to record and monitor job application processes and internal job changes. Employers should provide some basic information during the job application process (again, easily transferrable electronically if systems are designed to be minimally compatible or produce files of the required kind), the kind of work and the hourly pay rate or salary offered.

Similarly, the information listed in 3a) and 3b) (along with information about who is approving hour credits for whom where relevant) will enable the tax authorities to build up a profile of the structure of the organisation.

Investigators could use this information to find organisations which are atypical in their industry and help to target investigations to find suspicious firms and suspicious departments within otherwise typical firms.

c) Cross-referencing employer and employee statistics.

The tax authority could cross reference hourly average pay for different workers performing similar roles to see whether some firms are paying much less per hour. Those firms which are can be investigated to see whether they are over-claiming hour credits for their part-time workers and therefore defrauding the rest of society.

The penalties for firms engaging in such practices would be severe, and managers and directors involved would lose their right to hold such positions for a while.

d) Using Data analysis and cross-referencing to detect abuses

Another way technology can help uncover those engaging in tax base fraud is to cross reference income and spending patterns and to analyse this in order to pick out those who are most likely to be receiving income fraudulently.

As the options for spending and laundering money outside of recorded transactions reduce those with illicit income will be easier to detect as their income and spending habits might be atypical.

The methods outlined above should help uncover hour-credit fraud as well as tax-base fraud. People and firms whose hourly average payments change in unexpected ways can be flagged up for further investigation.

A lot of the points I have raised above are about directing investigations towards the most suspicious individuals and employers. This may result in false positives, of course, but directing investigations in the above manner will be much more effective than reliance upon random investigations and regularly scheduled audits alone (and these are also important).

The point is not that these measures will always be effective, but that they will also require fraudsters to go to greater lengths to cover their tracks and make them seem legitimate. Going to these lengths greatly increases the costs of the illicit activities and therefore discourages them.

Furthermore, in a society with hour credits fraudsters would need to obtain hour credits in order to receive any income and partake in the society (people who do not receive any official would only be able to get by if they are beggars, beachcombers or smallholders). This means that they will have to try to launder their gains through registered employers and provide a lot of information to the authorities.

This leads on to another advantage, namely that:

4.       Using the above information will help uncover and disrupt criminal organisations.

This means not only that criminal enterprises would have to put huge amounts of resources into creating front activities, but also that they would end up linking all of their associates together through the web of transfers and false employment  contracts and hour credit claims.

I believe the above listed anti-fraud detection procedures would have a powerful impact on fraud. This would make large scale organised criminal activity, which is often the most violent and harmful, very difficult. There might be more ways in which people could commit fraud, but criminals would need to keep their fraudulent activities at a very small scale in order to avoid arousing suspicion.

It would be hyperbole to claim that the CLIPH-rate tax would stamp out organised crime and corruption, but it would certainly make it much harder to benefit from such activities. The additional costs of doing so, and the greater likelihood of catching those who do engage, could be expected to greatly reduce the amount of crime taking place.

There are legitimate concerns that big business and big government will use technology to monitor consumers and citizens in order to have more control over them. However, rather than attempt to stop the tide of technology, I think that the best way to stop these developments getting out of hand is to use these technologies to create a more equal and transparent societies with strong checks and balances. 

Technology and Property Ownership

In my previous blog in this series “Technology and tax collection: Withholding by financial institutions” I explained that financial institutions could take on the role of withholding tax currently largely undertaken by employers (in the case of personal taxes like income tax) and businesses (in the case of sales taxes/VAT/duties).

While on this subject, and discussing technology, I think I should take the opportunity to explain how I think the recording of property ownership can be transformed by advances in Information Technology.  

With regard to financial institutions, my assumption is that all financial accounts should be registered with (and hence linked to the details of) an owner. This owner should be an individual citizen (or taxable couple/family), a public enterprise, a private enterprise, or a charitable enterprise.The record of the account owner could be held by the financial institution who would link it to all transactions, in a centralised database linking every account to a list of owners, or both of these. 

Essentially, all accounts should be traceable back to a taxpayer or entities with a clear purpose/indication of beneficiaries. This goes against the secrecy that has been utilised increasingly apparently in recent decades by some of the ultra-wealthy and corrupt people of the world in, which would be no bad thing.

My thinking is that even though money and other property changes hands all the time, modern computing equipment should be able to keep a log of these ownership changes in such a way that people should be charged the correct amounts of tax at the most appropriate point in time.

Linking all accounts held with financial institutions to particular taxpayers (or other entities) is a very good idea, and this can be extended to other kinds of property as well. I suggest that there should be asset registers covering all property of particular types. These already exist to various degrees in the case of vehicles and land and these existing databases could be developed and integrated with the tax system so that tax is withheld on the profits made when these items are exchanged.

I would also suggest similar asset registers for items that are of high value and that tend to increase in value. So for example jewellery, antiques and art works can be recorded on databases and their ownership (and the amount for which they change hands) recorded.

Such a system should be considered advantageous to the owners of the property as it provides them with a way of registering that something is theirs. As with the land registry this should reduce the scope for disputes and make it easier to recover items that have been stolen and prove that they are the rightful owners.

Should this information be made public?

My view is that limited pieces of information about property ownership and taxpayers can be made available to the public (for example via internet access to these databases). So people could find out how much a particular item of property exchanged for without knowing the owners. Some broad tax information about taxpayers at particular addresses could be discovered such as lifetime income and lifetime tax-rate.

Some will object to the idea of making this kind of information available, for one or more of a number of reasons. However, I will not discuss this here as I plan to discuss do so in a future blog.

Is such a system overly bureaucratic?

Some may feel that the idea of adding more processes and information recording will make owning these forms of property extremely bureaucratic. This would be the case if the information was recorded by civil servants in huge centralised ledgers as they would have to have been in the past. With IT technology, however, there need not be any human involvement or physical recording.

The parties to the transaction can simply record on the relevant website that they wish to exchange a particular item and the amount changing hands. This amount can either be sent via the registry to verify the exchange or by linking the information to a particular financial transaction. It can all be done via secure websites and all the information can be updated and (if the seller has gained from the transaction) the correct tax can be calculated without any intervention.

Conclusion
I have explained how I have envisioned that information about property ownership (financial and physical) can be recorded and updated in a highly useful and relatively painless way. Linking this information to the tax system should make taxation simpler to administer, fairer and more accurate.

Farnham Street map with one way system

I've been making a map of Farnham, Surrey for our wedding invitations.

Since I could not find a suitable one I've made one from scratch and it has taken me ages.

To save others taking this amount of time I thought I'd post it here for anyone who wants to use it.

Electronic Transfers

My current series of blogs is about technology, tax calculations and anti-fraud measures.

It is therefore timely to see another news story containing the latest news that Cashless payments have overtaken the use of notes and coins for the first time. 

This outlines the trend that an ever smaller proportion of transactions are taking place with cash.

In this series of blogs I argue that this makes radical tax proposals such as mine more feasible. This is because it will push those engaging in illicit activities to launder their gains into the official economy. At the same time, it becomes easier to record what people spend and use this data to check that they have declared all of their income.

Technology and tax collection: Withholding by financial institutions

One of Adam Smith’s principles of taxation is that it should be as convenient as possible for the tax collector and the taxpayer. Withholding tax at source (as with PAYE systems) is a good way to do this. What the taxpayer receives is theirs to keep and (ideally) they will not have to pay any further tax on it.

It is common to withhold tax on wages, but I think that technological advances open up the possibility of a new paradigm here; tax withholding on all financial transactions. If the tax and financial transfer systems were integrated then it would be possible to withhold tax as soon and accurately as possible. There would be no need to withhold taxes on wages as tax would be withheld at the second stage of the transaction - when received rather than when sent. 

How would this work? A financial company receiving a payment intended for one of their account holders would send an electronic message to the tax authority informing them of the amount involved and the account number for the source of the funds. The tax authority would need to have a record of the owner of all other financial accounts to do things this way around, but this should be easy to maintain and update.

If the person receiving a payment is transferring money from another of their personal accounts then no tax would be payable. However, if the income comes from another individual or entity (such as their employer) then it would be taxable.

This fits in with my tax base proposal whereby all income would be taxed, irrespective of source (though spouses with joint tax accounts could transfer money between them tax-free, and there would be a process by which people could receive refunds and loans). However, if different sources were to be taxed differently then this can be accounted for by adding a table to the database indicating the sources and linking to different tax rules.

The tax authority would calculate how much of the income should be taxed and which should be forwarded to the person involved. This would be integrated with real time tax calculations so the amount withheld would ensure that the person has paid the correct amount of tax and received the correct amount of income up to that point.

This process could be undertaken on a single transaction or the financial institution could process batches of many calculations at once.

Are there any downsides in using Financial Institutions to withhold tax?

The first potential problem I can foresee is that financial corporations might delay the submission of the money to the tax authority. However, it this was a problem it would simply have to be legislated that this should be transferred within a particular (very short) timeframe. After all – the money should be transferred immediately to the account of the recipient so there would be no justification for delays to either payment.

The second potential problem is the reliability of the system. If there was a problem with the tax authority computer system, or with the connection between this system and the financial institution then it would appear that no transactions could take place. However, this need not be the case. A backup system should be possible by simply using the last tax rate applied for the taxpayer in question and informing the tax authority of the amounts involved. The financial institution could make reference to either the percentage of tax withheld on their last transaction with the institutions, or the publicly available lifetime tax percentage paid by the individual up until that point.

The third concern is that taxing all transactions automatically might encourage people to do make payment in cash or non-financial forms of property (like precious metals or other goods). Issues of fraud are serious ones that I discuss in my book and will discuss in future blogs (including the next one). However, one point I would make is that the idea of a cashless society is a real possibility in the future – do they have cash in Star Trek? Contactless debit cards and online transactions are recent examples of this gradual shift.

I’ve indicated how these downsides can be overcome, and I will develop some of these themes further in future blogs. The question for readers is, as so often the case, to point anything important I have overlooked.