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  • 15 mins
  • Level 1: Introductory

Currency wars and tax regimes

Updated Thursday 10th February 2011

As nations battle by printing currency, and the coalition struggle with how much to tax the banks, Janette Rutterford and Evan Davis take a cool look at the questions.

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Jeanette Rutterford
Well one of the terms that’s been talked about a lot recently is the term currency wars, which is this idea where countries are competing to have the cheapest currency, why do you think that is?

Evan Davis

Well let’s first think about what currencies are about and exchange rates are about.  If you’re a country, when your exchange rate goes down it reorients your economic activity towards exports, it makes your export relatively cheap in your global markets because your currency is purchased more cheaply.  It makes your local businesses think more about exports, because they can make bigger margins now on exports than perhaps they could before.  So if you’re in a recession you’ve got all sorts of imbalances in your economy, you’re thinking to yourself what we want to do is get exports to keep our economy fully employed, so we need to bring our currency down so we’re competitive and we export our way out of this.  That works.  Now if you’re one country and you have a problem and you want to lower your currency, everything is fine, it’s a textbook policy, you’re going to find a way of getting your currency, pushing your currency down, perhaps you print more of it.

Jeanette Rutterford

That’s what the UK did in a sense isn’t it, relative to the euro?

Evan Davis

Indeed.  And you would probably print your local currency to make it more available, that will tend to make it less valuable, that pushes it down, everything works fine.  The reason why we have the currency wars is because everybody at the moment sees exporting as the way out of any economic difficulties they’re in.  So not only do we have countries like the UK and the US who’ve been importing rather more than they can sustain saying what we now need to do is export, not only do you have those sort of debtor countries like ours trying to export you’ve got the big exporting countries, like Germany and China, saying my goodness we can’t not carry on exporting, for goodness sake if we don’t export we’ll have a terrible time and we’ll be like all those other countries that are in recession.

Jeanette Rutterford

So how does Japan manage it?  Because Japan’s got an expensive currency.

Evan Davis

Well Japan is just so good at what it does that of course its goods seem to be competitive at any price.  It runs up a surplus even with quite an uncompetitive currency, but Japan is perhaps a little bit of an exception in that regard.  But at the moment everybody’s trying to export, the bulk of countries are trying to export and they’re trying hard to get their currencies lower as the means to getting there, and that means you have the United States trying to devalue and China trying to stop its currency devaluing.  Now that has an interesting consequence of course, because it just means the United States prints dollars to try and devalue, the Chinese try and intervene in the markets to keep their currency from going down, the United States print more dollars to try and devalue.  So you do end up with a general loosening of monetary conditions around the world, the net effect of all of this is there are just going to be more dollars out there.

Jeanette Rutterford

Is there more inflation on the back of that?

Evan Davis

And that will lead to more inflation, unless the world economy is capable of producing goods to keep up with the currency that’s been printed.  Now if the world economy is in a deep hole typically you can print a load of currency and it’s not going to cause inflation, because companies will just produce more rather than put their prices up.  At some point probably companies when faced with lots of demand or faced with lots of currency will put their prices up and stop producing more, but my guess at the moment is that we’re not in danger of immediate inflation, that the net effect of this currency war is everybody’s printing perhaps more money than they otherwise would to get their currency down, the net effect is we have more currency out there, more money out there, more liquidity and that is, if you like, keeping the world economy going.

Jeanette Rutterford

So in a sense if I’m a company based in the UK or the US I’m happy if I’m an exporter and I’m unhappy if I’m an importer.

Evan Davis

Or you’re unhappy if your market is the local market.  In many respects the exchange rate is the thing that regulates how many companies try and service the local customers, things like restaurant meals, you know, that’s a local business, you can’t import restaurant meals.  The non-tradable sector, the service sector, the restaurant meals sector, that becomes relatively less attractive when the exchange rate goes down and the export sector, the bit that can actually make things, ship them off and then sell them to foreigners that becomes more attractive when the currency goes down.  So as the exchange rate goes down it sort of tilts economies away from the domestic market towards the export market.

Jeanette Rutterford

And the other thing that countries do is they try and compete on tax rates, corporate tax rates and so you have countries like Latvia with a 10% tax rate or you have Ireland, which actually didn’t charge companies for quite a long period at all, and that leads to certain clustering.  So for example in the UK we had advantage R&D, so pharmaceutical companies like putting their R&D here, Ireland have financial services.  I mean is that a way to go?  Is that going to end in tears? 

Evan Davis

I think there is a worry about that, because I think it can potentially end in tears, you can get into a sort of race to the bottom.  If you stand back you might say, maybe you wouldn’t but I think you might say a good tax system will have some taxes on companies and some taxes on individuals and maybe some taxes on property, I don’t know, but you could have a balanced portfolio of taxes.  Now suppose one kind of activity is mobile, companies are mobile, but property isn’t mobile, or imagine that workers are not terribly mobile, they can’t choose where they live because they have to get visas and immigration rights and such like.  But let’s suppose companies are mobile then the company can say look, car company, I’m going to build a new factory or pharmaceutical company, I’m going to build a new research centre.  Bank, I’ll build a new headquarters, where shall I put it?  They can play off different jurisdictions against each other, those jurisdictions will be competing to attract that activity, knowing that it’s good for the economy overall to have activity and to have that kind of activity, and they’ll in the end, if you like, skew the tax system of the host country towards taxing other things and not taxing them.  So it does make it quite difficult to get a really good balanced tax system if some people are able to secure through negotiation and good negotiation and secure a better price if you like for their services.  So what you’d ideally want is you’d want the nations of the world to sort of gang up and say okay.

Jeanette Rutterford

It’s 30%.

Evan Davis

Yeah, let’s all agree, we won’t undercut each other, to form a cartel really against companies that are shopping around and then they’d obviously be able to sort of hold the price and make their tax systems balanced.  But of course, as in any cartel, it would always be attractive for one nation to say I’m not signing that, I’m not signing that agreement, my tax rate is 28% instead of 30%, why don’t you come to me?  And everyone’ll go to them.

Jeanette Rutterford

That sort of happened in the Eurozone too, because certain countries didn’t behave as they should’ve done with their public sector deficit.  But let’s move onto that, because as a company okay, even if it’s 30% or 20% I don’t have to pay tax at all, because I have a very simple thing I can do, I can borrow loads of money so that my interest payments once deducted from my profits I get zero after debt interest profits and I don’t pay tax.  So why is it that companies pay tax at all?

Evan Davis

Well that is a very big question.  So you could imagine a tax system that was completely neutral in the treatment of corporate profits, it didn’t matter whether you borrowed the money or raised it from shareholders, you know, however you got the money in the first place the profits you were going to earn was going to be taxed in a particular way.  That would be I suppose in an ideal world sort of the fiscally neutral, it would be the ideal actually.  Now governments for various reasons have tended to have more complicated corporate tax systems.  And the truth is there are reasons for some of that complexity.  So for example, you have to take into account not just the company tax, but the income tax on the part of the people who receive the profits from the company.  Companies don’t exist remember, Jeanette, remember they’re just legal fictions.

Jeanette Rutterford

Yes.

Evan Davis

So the company pays its tax, but I might be a shareholder in the company, I’m going to pay tax on the dividend it pays me when I take money out of the company or capital gains tax on selling of the shares, and basically you can get your knickers in quite a twist on how to make the tax system neutral between all forms of income, labour income and profit income, all forms of entity, self-employed people, employees, incorporated entities, all kinds of investment and all kinds of physical investments and capital allowance that you give them.

Jeanette Rutterford

So in a sense countries choose really how much they take from the corporate sector direct or how much they take from individuals.

Evan Davis

Yes.

Jeanette Rutterford

Either as investors or as workers.

Evan Davis

Yes.

Jeanette Rutterford

And so it’s a sort of political decision, and maybe it’s tied up with the fact that corporations or companies, sort of people feel they ought to be taxed, because somehow, you know, they’re big, they’re powerful maybe we ought to tax them and certainly that’s true in the US, people are quite anti sort of certain corporations.

Evan Davis

But I mean I would actually say there’s a very good argument for saying look, let’s not tax companies at all, there’s a perfectly credible argument that says companies aren’t just a legal entity, when we tax a company we’re really taxing some people, we’re either taxing their shareholders or we’re taxing their employees or we’re taxing their customers, there’s no-one else who pays the tax when we so-called tax the company.  So there’s a good argument but in principle for saying why don’t we just tax the shareholders, the employees and the customers and not worry about taxing the company.  The reason why I think you might tax a company is that it is very, very convenient to tax a company, I mean it is one entity, it tends to obey the law, you can sort of see what it’s up to much more easily than you can 1,000 or 10,000 employees.  

Jeanette Rutterford

And the sums are bigger, bigger lumps.

Evan Davis

Yeah.  Getting one cheque out of BP rather than worrying about all its employees, customers and shareholders much easier.  So I think there are good practical reasons for why you’d say, for example you might say look, let’s not charge income tax on dividends, let’s just charge corporation tax on them and then we don’t have to worry about who gets the dividend or how much tax they pay, we just have to collect one cheque from a corporation.  But I think it is very important to remember, and it’s a mistake a lot of people make, that a company is a legal entity, it’s not a real thing, but it’s a very useful legal entity that you can rely on in certain ways.

Jeanette Rutterford

Yeah.  I mean there are interesting differences between UK and France, because I was reading this morning that the French are thinking of taxing capital gains and dividends, because at the moment they give them really good tax advantages.  So I think they’re coming round to this idea that in the end it’s the end user or the end receiver of the money who ought to be paying the tax rather than the intermediary.

Evan Davis

Right.  And if you talk to a lot of tax experts they’ll say there’s really only one thing you ultimately want to tax, which is people’s consumption. You could abolish everything and just have a VAT that was across the board on everything at a uniform rate, quite a high rate it would be, and you would just do that and that will be the simplest neatest tax system you could devise.

Jeanette Rutterford

But we’re not starting from that.

Evan Davis

Exactly.

Jeanette Rutterford

We’re starting from here.

Evan Davis

And you would never want to have one tax, because the incentive to then, you know, to evade that particular tax become very high, whereas if you have four or five taxes, income tax, National Insurance, VAT, corporation tax, it becomes much harder for people to evade one or other.  But these are very interesting questions.  But on the bigger point though about countries being competitive and attractive to companies, countries competing for the business if you like of global commerce, it’s a real trade-off because you clearly want the overall tax burden to be low on the companies that are internationally mobile, but at the same time you need to raise the money to make the environment conducive to those companies.  So you can overdo it in racing to the bottom, because if as a result of keeping your tax rates too low your roads are useless, your population is uneducated and everybody’s unhealthy and you have a rife crime problem and the police never solve anything or deter any of it, you know, you’re not an attractive place to do business.  And so people like government, you know, they don’t want to put business in Somalia, Somalia is not crowded with businesses wanting to go in even though there’s very little functioning government there.  People and companies like government, they just don’t like too much of it.

Jeanette Rutterford

But you’re sort of arguing for a two tier tax system here, which is the international ones can get away with a low tax rate, but the ones who operate domestically the restaurants or whatever or the retail and supermarkets they have to pay the tax.

Evan Davis

And I think that is a problem.  I mean I don’t think it looks fair and I don’t think it is fair and I wouldn’t advocate it, but it is a problem that if some people are mobile, some companies are mobile they will tend to get a better deal than the ones that are not, in much the same way that people who shop around tend to get a better deal than customers who just go and buy at the first shop they walk into.

Jeanette Rutterford

But in the end the easiest thing to tax is land, because land you can’t take away.

Evan Davis

You can’t take it away, you can’t hide it, disguise it, you know who owns it and if nobody owns it you confiscate it, and land is a very attractive thing to tax.  And it’s very interesting that one of the most successful economies in the world, that of Hong Kong, has a very interesting revenue model for government in which all land is effectively owned by government, it leases it out for 99 years, every 100 years, every few years more land comes back into the possession of government and government sells it again.  It is actually rather like a land tax and that has all sorts of positive incentive effects and it’s very hard for people to evade.

Jeanette Rutterford

So what’s interesting is we’re seeing countries operating in a competitive world like companies and actually fighting for the best strategy, the best tax strategy, the best overall strategy to win.

Evan Davis

Indeed.  Absolutely, but I do always slightly recoil at the comparison between companies and countries, because I think it’s a good metaphor and it does work and there are similarities, but companies are different to countries, because it is more zero sum between companies, you know, often one company’s loss is another company’s benefit.  It’s something, if I win business I’ve often taken it away from you.  So it’s kind of competition really does I think matter to companies, whereas countries it doesn’t have to be zero sum, it doesn’t have to be that one country wins and the other loses.

Jeanette Rutterford

They all grow together.

Evan Davis

In the long term each country can develop and they can all develop and they can all succeed.

Jeanette Rutterford

In the long term.

Evan Davis

In the long term.

Jeanette Rutterford

But not necessarily in the short term.

Evan Davis

In the short term there are always tensions and matters in which they’re going to compete about.  Yeah.

Jeanette Rutterford

Thanks very much Evan.

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