Article by Éric PICHET in the magazine PCGP (Profession Conseils en Gestion de Patrimoine).

The financial crisis of 2007-2009 mutated into a generalised economic crisis, with some people regularly referring to the system’s social, moral and even existential crisis (and others - driven by worthy but seemingly excessive enthusiasm - going as far as to envisage the complete reconfiguration of capitalism). Out of all this collateral damage, what we hear less frequently is how today’s public debt levels are going to affect future fiscal policies, i.e. discussion of the inevitable rise in taxation and pitiless lawmakers’ no less inevitable efforts to hunt and kill any remaining tax niches. The present analysis tries to ascertain how the crisis impacts on taxation, together with the consequences for asset managers and their customers.

Increased public debt today, higher taxes tomorrow

Under the dual impetus of governments’ banking support measures and economic stimulus packages, state debt in Europe and elsewhere has exploded through the Maastricht Treaty threshold of 3% of national GDP to reach 6% in the more virtuous countries like Germany, and rising as high as 12% in less careful regimes like Greece or more interventionist ones like the United States.

An inevitable consequence of these current debt levels was the spectacular rise in public debt in 2009 and 2010, whose expansion, according to the European Central Bank, averaged ca. 25% in the wealthier countries. One symptomatic example was Ireland, where state debt rose from 40% in 2007 - well below the Maastricht Treaty limits -to more than 80% in 2010 under the cumulative effect of a fall in Irish GDP, the government’s energetic recovery measures and its unconditional support for the country’s bloated banking sector.

It is true that state debt – even when it reaches unreasonable levels - does not necessarily culminate in a country defaulting, contrary to what Adam Smith predicted quite inaccurately in ‘Weath of the Nations’ (1776) when he wrote that, "The enormous public debt oppressing us today will probably ruin all great nations of Europe in the long run". Indeed, a very frequent error of analogy consists of trying to compare a regime whose existence is, in principle, unlimited and which also benefits from the monopoly of legal violence to create additional taxes as needs be, with the situation of private individuals who are obliged to reimburse any debt capital and interest according to a fixed calendar while remaining subject to the dual risk of mortality and uncertain future income. At the same time, recent academic studies have also demonstrated that beyond a threshold of 90% of GDP, state debt is likely to become totally uncontrollable.

There are a limited number of options for cutting debt, and certainly no more than five. Defaulting (or repudiation, the more radical variant that Lenin implemented in 1917 and Mao in 1949); drastic cuts in spending, with edifying examples in 2009 including authoritarian reductions in civil servants’ wages in Ireland (-7%), Hungary (-8%) and Lithuania (-15%); inflation, which is almost impossible given the European Central Bank’s impregnation by a German culture deeply rooted in the Maastricht Treaty; higher taxes; or strong growth.

This diagnosis is particularly applicable in France, global recordholder in terms of the duration of deficits (uninterrupted since 1974) and whose current annual deficit, equivalent to 8% of GDP, is half due to causes that the country’s Cour des Comptes account supervisory board considers structural in nature.

Towards the euthanasia of tax niches

In 2010, tax systems in the developed world were inspired by three schools of fiscal thinking, each corresponding to a different vision of modern societies: the neoliberal (free market) approach; the social approach; and the moral approach. Note that the boundaries between each of these categories is not nearly as straightforward as portrayed in this segmentation. In reality, developed countries tend to combine all three ideal-types, each in its own idiosyncratic proportions. Thus, the neoliberal approach that dominates in the United States or Great Britain emphasizes the economic efficiency of taxation, in line with Adam Smith and David Ricardo’s fiscal conceptions. The social approach, which applies in the social-democratic countries and France, seeks to strengthen tax yields while achieving a form of social justice based on progressive taxation and less pressures on lower income categories. Lastly, the moral approach views tax as a political instrument encouraging virtuous citizenship (best symbolised in France by corporate research or energy-saving tax credits).

Regardless of the fiscal policies that French lawmakers adopt over the next decade, analysis of parliamentary debate has clearly uncovered significant convergence translating a remarkable consensus in the country's political class and uniting lawmakers from Migaud to Mehaignerie in the battle against tax niches (fiscal spending). This crusade is facilitated by the extraordinary difficulty that economists face in assessing the true costs of such niches, due to the fact that many of the operations in question actually derive from their corresponding tax advantages. At the same time, even if tax niches’ destiny seems sealed, questions remain about the modalities of their euthanasia. In reality, there are two ways of killing them off. The first consists of an overall income ceiling, which in 2009 involved limiting most investment-related niches to €25,000 or 10% of a person’s total income. Much like Edgar Allan Poe’s famous short story, this ceiling is scheduled to shrink a bit every year (having already fallen to €20,000 and 8% in 2010). The second kind of euthanasia consists of chipping away at each niche, for instance by 5% a year. First evoked in summer 2009, this latter idea has yet to be implemented but the die seems cast.

All in all, asset managers owe it to their customers to anticipate these inevitable fiscal changes and implement wealth strategies adapted to the future rules of the game even as they stave off the most damaging effects of tax legislators’ inexhaustible inventiveness.

Expertises of Éric PICHET

Researcher, Professor of Economics and Finance, Postgraduate Programme Director, Author, Independent Board Member. Discover Éric PICHET’s world.

Expertises