By Dr. Jonathan Gillham, Chief Economist, Director, PwC UK, and Carol Stubbings, Global Tax and Legal Services Leader, Partner, PwC UK
Even before the COVID-19 crisis, many economies were in a difficult situation. Labour markets across much of the developed world still had not fully recovered from the financial crisis of 2008–09, after which real-terms wage growth remained weak and millions were obliged to take low-paid, low-skill service-sector jobs to support household incomes. Many of these same people were working in the sectors worst affected by the pandemic: retail, hospitality, travel, leisure and the office supply chain—cleaners, security guards and takeaway food.
The reduced levels of business activity and low wages had already eroded the tax base. Cue COVID-19. The crisis has only exacerbated the problems in many countries’ tax systems. Governments in the developed world have been forced to provide huge ad hoc support for their economies, including funding highly disruptive lockdowns. Budget deficits have ballooned, and millions of jobs are being shed, leading to a much less sustainable fiscal position.
This is both a developed- and developing- world problem, but in many respects the developing world has been hit harder. More households lack the financial cushion to weather the COVID-19 storm, and few developing-world governments have the resources to subsidise household incomes and corporate payrolls to the extent that has happened in the wealthier nations. There is a risk in the future that the tax base in developing countries could be significantly eroded if large numbers of workers migrate into the already considerable informal economy in search of income. The outlook over the next six to 12 months is therefore worrying, despite the encouraging news of vaccines.
Governments will face stark choices in the future about how to pay back the rising debts forced on them by COVID-19. Deciding how to balance incentivising growth with raising revenues could reshape national and international tax systems and force a rethink of a model that has barely changed for decades. The Total Tax and Contribution Rate, the total taxes borne by a company as a percentage of its commercial profit, as measured by the World Bank and PwC’s Paying Taxes study, has stayed between 41% and 45% for nearly a decade. During that time, labour taxes have consistently accounted for around 40% of the Total Tax and Contribution Rate.
As countries have focused on the immediate challenges of responding to COVID-19, longer-term economic planning has largely ceased. Even the value of medium-term forecasting is in question. This is understandable, given the unprecedented situation facing finance ministries around the world, but it has important knock-on effects. Suspension of economic planning effectively stalls many potential fiscal reforms that could improve longer-term sustainability and therefore prevents much of the investment in technology and people that is needed to achieve those reforms.
The pressures on governments to protect their revenue base may force them to delay tough choices over tax reforms that, although desirable in the longer term, could reduce revenues in the shorter term. Eventually, however, they will need to find a balance between the sustainability, equity and certainty of their tax systems. Though many of the issues can be tackled at a national level, some, such as the taxation of digital activity, have an international component, and as we’ve argued before, resolving these will require a degree of compromise and collaboration.
Mass job loss and shifting demographics affect the sustainability of the system, while the gap between the wealthy and the low-paid fuels calls for greater equity. Postwar prosperity and the rise of globalisation in the 1990s saw more people lifted out of poverty than ever before. COVID-19, however, has stalled that progress, with projections that 150m people will fall back into poverty in 2021. But even before the pandemic, we saw the decoupling of economic progress with the gap between rich and poor rising exponentially. Ensuring an ‘inclusive recovery’ is widely considered vital to addressing these inequalities that have, for example, seen low-income families face increased hardship while better-off households used the opportunity of lockdowns to cut back their consumption and reduce debt.
Part of the solution to this wealth gap—credited by some with fuelling the rise of populist politicians around the world—could be incentives to train and reskill workers who have been forced out of badly affected sectors of the economy. Initiatives of this sort might be complemented with measures to make up for lost domestic spending - for example, by office workers on transport, food and leisure. There have even been suggestions of a tax surcharge on people working from home to replace spending of these sorts. Equally, taxes on digital services or on online retail are being introduced and considered in order to capture a proportion of rising online spending.
However, any changes designed to address issues of sustainability or equity, especially if rapid or radical, will undermine the certainty that individuals and companies require if they are to save and invest with confidence. Rather, the challenge for governments will be to reform their tax systems in ways that help to provide certainty during extremely uncertain times and encourage companies to commit capital to investment projects.
If unemployment rises and the income tax base shrinks, governments may well be tempted to shift the burden of taxation towards consumption and corporate profits. There are drawbacks to this strategy, however, since taxing corporate profits is less economically efficient and potentially more damaging than taxing incomes, because it acts as a disincentive to investment, which is in short supply. But if corporate tax increases are matched with increased incentives to invest in R&D and training, for instance, then they are less likely to have a negative impact on investment.
There are also issues to confront with consumption taxes. Unless these are carefully designed, they tend to be regressive. Poorer households spend a larger proportion of their income on consumption than well-off households and so are more heavily exposed to consumption taxes. To address this problem, governments will need to consider ways to target their measures carefully, increasing taxes on products and services that wealthier households are more likely to purchase.
Taxes on wealth and capital gains are another option that has been put forward to address issues of wealth inequality and the need to create greater equity in tax systems. Any increase in capital gains taxes will inevitably involve imposing a greater burden on the people putting capital at risk during an economic crisis. This may prove a difficult position for governments, which need to encourage entrepreneurs and people taking investment risks.
It is also important to recognise inherent difficulties in taxing certain sorts of wealth, especially where it is held in the form of equity stakes in successful companies. Using the tax system to interfere with the well-established models of corporate ownership and control could discourage entrepreneurialism and risk-taking in areas that can benefit the wider economy greatly.
Governments face extremely difficult choices in how to rebalance tax systems and put them on a more sustainable and equitable footing. Much of the work of addressing budget deficits following the financial crisis was accomplished through spending cuts. This time, the scope for cuts is more limited. Instead, tax reform must take centre stage.