Insights

Fiscal Tilting—a Horrible Name for an Idea Whose Time has Come

Founder & CEO of ClearlySo, Rod Schwartz shares his ideas on how we can we can tackle the fiscal crisis we are finding ourselves in and how we can come out better than before.

By Rod Schwartz, Founder & CEO · October 15, 2020

Recently I attended a webinar (I believe it is for the host to disclose whether they want to take credit for this webinar). The discussion was about how we can come out of the COVID-19 recession and do so in much better shape than before. The people participating in the webinar were of very high quality (author excluding) and were definitely “part of the solution” rather than being part of the problem. Comments all around were hopeful and optimistic, there were lengthy mentions of progress made, positive changes in mindset underway, etc. You know the type of conversation I am talking about—and many physical conferences like this in prior days.

I just felt like I had been here many times before over the last few decades. Great people, great progress, great ideas. Then I hang up the phone/leave the conference hall and confront the real world. I look around and see a planet melting and society in dire straits. I had no qualms with the excellent points made by the illustrious attendees but I felt the time for optimism and hopeful thinking had long since passed and that simple, dramatic action was required to take us out of this recession and to do so in a way that would make the future better than the present and the past.

How to do this is not the only problem, there is a fiscal crisis as well—how can we fund this “build-back”? In addressing COVID-19, global government coffers have been emptied and debt levels are at record highs. This too is unsustainable. So, we confront a double dilemma of how to recover sustainably and how to pay for the recovery. And I would add—how to do so in a way which is simple. In my mind complexity is the brutal enemy of progress.

The only way I can think of solving both problems at once, simply, is to use existing tools more effectively. The most powerful is the tax system, which is partly the way by which governments fund themselves but also how society manifests its preferences—what it likes and does not like.

I did some analysis of taxation in the United Kingdom, (which is where I live) and found something particularly interesting. Roughly 10% of taxes in 2016/17 were generated from things we are trying to have less of like landfill or excessive drinking or cigarette smoking (although not a technical term, let us call these “bad things”). These “sin taxes” represent just 1/10 of the revenues raised by government[1]. I doubt it has changed much since then. About 57% of taxes come from things that technically we want more of like income or capital gains. Another third come from taxes on items which I would describe as neutral, mostly VAT, which reflects all of our purchases.

To me this seems perverse. Why are we using the tax system to penalise things we want more of and only penalising to a very limited degree bad things. If we used the tax system more assertively, we could not only raise more funds for government, which is desperately needed, but use relative prices and capital markets to amplify the impact of these changes. I will explain how this might work below.

I have called this idea “fiscal tilting”, which is probably a bad name. If it were a better name, maybe it would have made more progress in the 12 years I have been talking about it. Essentially, it is about shifting the playing field in a way which heavily incentivises people to do the right things and disincentivizes people to do the wrong things. It is about targeting externalities, both good and bad. If you think of externalities as a cost or benefit to society that is unintended, maybe a better name for this approach is “fiscal levelling”, as it evens the playing field by internalising societal costs and benefits to those generating them.

In essence, I would steeply increase taxes on bad things (perhaps they can go from 10% to 20% or 30% of taxes raised over time). Taxes on various forms of pollution are already in place in a small way—we should make them MUCH larger. I have already mentioned excessive drinking and smoking above but there are others. The judgement of what to tax is up to politicians, presumably acting on behalf of the people. A twist on this idea though, which is part of my proposal, would be to take a percentage of the incremental revenues and use it to provide tax credits to those companies that generate positive externalities—good things. For example, if a company is involved in training, or reducing homelessness or planting trees—things which we all generally think of as good, then they would receive tax credits in the same year. At present, given massive fiscal deficits, we might make the percentage of the new tax take spent on credits relatively small—say 30% at first—but this too would be for government to resolve.

The benefits to such an approach would be significant:

  • It would raise revenue at a time when this is desperately needed and do so in a way which might be less politically unpopular then, say, raising income tax
  • This proposal would have the effect of discouraging bad things by raising their cost. I suspect that companies generating these negative externalities might absorb some of the hit but would also pass on some of the incremental costs to consumers. In any event, the prices of these goods would rise, and demand would fall so the bad things would diminish in number
  • As the government is primarily responsible for sorting out the mess created by bad things (for example, the NHS picks up the cost of treating alcohol abuse), any diminishing of the negative externalities would be a further cash savings to government
  • Fiscal tilting would encourage good things because the firms generating these would receive a tax credit. They could pocket the credit or share some of it with end-consumers but in any event, such a system would encourage more good things
  • As the government is responsible for providing good things, the tax credits used to encourage companies to produce these will further ease the burden on government, because companies will be providing some of what government would otherwise have to do
  • If the government were to do this and announce that it was starting on this path and that such an approach will continue, then capital markets would immediately anticipate more penalties for firms doing bad and more credits for firms doing good. This would further amplify the effects of this plan by lowering the cost of capital for firms doing good and increasing the cost of capital for firms doing bad. I am aware that astute observers would point out that as ClearlySo works only with companies and funds doing good things, this would be good for our clients and therefore good also for us—but this does not make what I have said above less useful generally
  • Such an adjustment in the capital markets, which further encourages good and discourages bad, would further ease the burden on government for the reasons I mentioned above. These capital market changes thus also amplify the impact on relative prices

Although the words used above are overly simplistic, I think that is part of the appeal of the plan. Furthermore, it can be rolled out gradually—although not too gradually, as we are running out of time. Critically, this proposal does not rely on good intentions (remember, the road to hell is paved with these). One of the things I realised as I sat and listened in on the aforementioned webinar was that the people speaking had terrific intentions but represented a depressingly small minority of the population. If we continue to rely on good intentions the planet will just burn, as is already happening in the US and elsewhere.

This proposal relies on an existing tax system and infrastructure—however the idea of a credit to firms generating positive externalities would be relatively new. The system is also easy to explain—it also works within the grain of the capital markets. Furthermore, because it leverages what is already existing it has the potential to work instantly.

There is an obvious question, which is why, if it is all so simple, has it not happened already? I think the answer is obvious. There are powerful interest groups—corporations in particular, whose profits would be adversely impacted in the short run—some enlightened firms see the long-term benefits, but these are few and far between given the short-term orientation of equity markets. Although all of society suffers at present from their behaviour, society is too dispersed an interest group to have much clout. A few large companies, who would suffer greatly from such a change, have a significant incentive to make sure it does not happen—and they have been successful at minimising the impact of such attempts. This is very hard to prevent and I am not so naïve as to imagine that such pressures will disappear, however, the current situation, and the grave fiscal challenges may mean that hard decisions can get made. Some unprecedented things have already been happening. In this environment it is very hard for corporate interests to easily defend the bad if it is so visible. Furthermore, my proposal is different in that it also encompasses a tax credit for companies that do good things. My hope is that by doing so we will create a narrow interest group of winners which are also incentivised to work the levers of government in their own self-interest—and that of society as a whole.

 

[1] https://www.ifs.org.uk/bns/bn09.pdf. IFS, “A Survey of the UK Tax System”, November 2016. Thomas Pope and Tom Waters.