The tax avoidance rule that favours cronyism

 
Jamie Whyte
WHAT may you do without being punished by the state? With 25,000 pages of new legislation every year, and many laws expressed in hopelessly vague language, no one can be sure. But there is a more straightforward reason we cannot know what will land us in trouble. The authorities might punish us even though we have broken no law.

Last month the government passed retrospective legislation allowing it to confiscate hundreds of millions of pounds from British banks. It declared that earnings that were not taxable when made would be treated as if they were. People who were obeying the law by not paying tax on these earnings will nevertheless be punished if they do not pay them now.

Some government ministers regretted that retrospective legislation was necessary to get their hands on the money. In future, they hope, retrospective legislation will be made unnecessary by their proposed general anti-tax avoidance rule (GAAR). So it will. But this hardly improves matters, because a GAAR is nothing but an explicit suspension of the rule of law in taxation.

To get the gist of a GAAR, you need only understand the tax regime of Malawi while Hastings Banda was “President for Life”. Malawi had corporation tax, but a businessman would discover his tax bill only when Banda’s henchmen visited to let him know the “donation” the president thought appropriate.

Similarly, Britain’s GAAR will empower government officials to decide whether you should pay the amount of tax required by law or whether you must pay more. Retrospective legislation will be unnecessary because tax demands will no longer need to be backed by specific legislation. It will be pointless arguing that, according to the law, you owe only £100 in tax. If an official deems the spirit of the law demands £100m from you, then that is what you will have to pay.

Many Brits will celebrate anything that hammers “fat cats”, even replacing a literal interpretation of the law with a spiritual one. Yet they should fear a GAAR, for it will create costly uncertainty. Because a company’s tax rate may end up higher than the specified rate, prudent managers will raise the pre-tax hurdle rate of return they require before making an investment. And higher hurdle rates mean less investment and less economic activity.

Even the Treasury may lose out, since less economic activity means less tax revenue. David Cameron may end up emulating Banda not only in his method of tax collection but also in the quantity collected.

Like most of this government’s economic initiatives – such as appointing ministerial buddies to large corporates and subsidising lending to favoured industries – a GAAR invites crony capitalism. Firms that want to avoid having a tax surcharge slapped on them will be keen to help government ministers with their various political causes. Many have already signed “social responsibility” deals.

Perhaps the Conservatives have undergone an ideological conversion, abandoning the rule of law and market capitalism in favour of the kind of state-directed capitalism favoured by the likes of Banda. Or perhaps their new policies reflect nothing more than populist opportunism. Whichever it is, anyone who values his liberty and prosperity had better hope they soon change course.

Jamie Whyte is a senior fellow of the Cobden Centre