The Tax Delusion

09/09/2011 5 Comments

Have you ever met a climate change denier? I wonder why they don’t believe in global warming. Using some fairly basic maths you can calculate the Earth’s surface temperature assuming no greenhouse effect exists – it’s about minus 18°C. The reason we’re not in a permanent ice age is because of the greenhouse effect.

“Rubbish!”  you say, “the greenhouse effect is something new, we didn’t have it before and it wasn’t that cold!”

The greenhouse effect is actually nothing new – it’s been around as long as carbon dioxide, water vapour and other greenhouse gases have existed in our atmosphere. The problem now is that our activities are increasing the concentration of these gases. Basic physics states that this should increase the Earth’s surface temperature and lo and behold that’s exactly what we observe. Of course there are many factors that affect our climate at any one time and while we cannot be 100% sure how much the greenhouse effect will affect the surface temperature in any one given year, we can be sure of these two facts, which are absolutely indisputable:

a) We are increasing the concentration of greenhouse gases in the atmosphere

b) Greenhouse gases increase the surface temperature of the planet

When the temperature starts going up in line with this it is surprising that lots of people choose to put their heads in the sand and deny what theory and evidence shows is very clearly happening. The reason I think, that this denial-phenonmenon exists, is simply that it is much more convenient for people to live in denial than it is for them to accept reality.

Accepting the true scale of the problem means significantly changing our lifestyles and a lot of people don’t want to do that. Pretending that climate-change skepticism has any basis outside cloud-cuckoo land allows people to continue doing what they’re doing and avoiding this massive inconvenience.

This blog isn’t about climate change though.

Have you ever met a supply-sider? Supply-siders have a lot in common with climate change deniers. I should explain what I mean by a supply-sider. It’s about tax though, so grab a coffee before you continue.

Cutting income tax has a positive effect on economic growth because people have more incentive to work and have more disposable income to spend. The problem though is that tax cuts need to be financed by cutting public spending and that has a negative effect on economic growth and a negative effect on people’s quality of life. As an alternative to cutting spending, we could borrow to cover short-term tax cuts but we can’t make permanent tax cuts and still have a functioning NHS, education system, armed forces etc. etc.

That much is, again, basic maths and uncontroversial. Unless you are a supply-sider. Supply-siders believe that the effects of tax cuts is so ridiculously large that they more than pay for themselves – that cutting taxes actually increases government revenue and everyone becomes better off because of it.

Nowhere are supply-siders more prominent and militant than in America. When Bill Clinton took office he took over a large budget deficit. He responded to this by introducing tax rises on the middle-classes and wealthy. Supply-siders went mad – claiming that this would starve the economy and usher in financial disaster! In fact what happened was that the economy grew, unemployment went down and the deficit turned into a surplus.

Enter George W. Bush. As a supply-sider, Bush brought in an era of tax cuts and the richer you were, the more you benefitted. This, he assured everyone would make a massive boost to the economy. The surplus quickly turned back into a massive deficit.

Of course these are just two examples (albeit good ones) and there were many other things going on which would have contributed to these two outcomes. Importantly though, supply-siders said that Clinton’s policy to raise taxes on rich people to pay off the deficit would spectacularly backfire and they said Bush’s policy to cut taxes on rich people would boost the economy. In both cases they were 100% wrong.

Like, climate-change deniers, supply-siders ignore logic and evidence simply because the reality is inconvenient. Supply-siders organise huge campaigns to tell voters that their taxes are harming the economy.  They tell people that if they just paid less tax to the government and kept more money for themselves, we’d all be better off. This is voodoo economics. This is one of the ultimate examples of bad marketing. This is to economics what homeopathy is to medicine.

So we can see that while cutting taxes stimulates economic growth, it does not pay for itself. Cutting taxes will cost money and if it is the rich receiving the benefit, it is everyone else who is receiving the cost of it.

It was therefore, with sadness that I read this week’s story about 20 economists writing to the FT to campaign for a lowering of the top tax rate, stating that it was harming the economy.

I do agree we need something to stimulate the economy. As I’ve discussed before on here – we won’t get rid of the deficit without economic growth and there is precious little of it at the moment. I do though have a big problem with attempting to do this through a tax cut on the 320,000 richest people in the country. Don’t misunderstand me – I am not so much of a liberal that I want to advocate the punishment of rich people, I simply think that if you are in the top 320,000 richest people in the country you should not be at the front of the queue when it comes to government handouts.

The supply-siders’ excuse is that by giving rich people even more money we will boost the economy and it will filter down to the poor people.

So which of these boosts the economy more?

a) Giving 10 rich people £1,000,000 each

b) Giving a million poor people £10 each

The letter to the FT offered nothing more than vague anecdote to say why we should go for a). 24% of income tax, it said, is paid by the richest 1%. This could be because taxes are grossly unfair. It isn’t though.

The income gap between rich and poor has been rising for a long time and is now bigger than it has ever been. When a small number of people earn lots of the income, a small number of people pay lots of the income tax. On its own, that figure of 24% paid by 1% tells us nothing useful at all. (I wrote more about this here.)

I reread the letter a few times and couldn’t really understand how 20 economists (a few of them with senior academic positions) could so strongly advocate such a tax cut and only provide a weak argument of vague anecdote to back it up.

To say the least it was a wish-washy argument: “Some rich people might all move somewhere else with a lower tax rate.” Well they might indeed – we all understand incentives. I would have thought though – no I would absolutely have expected that 20 economists arguing for tax cuts for rich people, between them could have come up with something concrete to show why, in the circumstances, this is a good policy. The US has (and has had for a long time) a far lower top income tax rate compared with the large economies in Europe and they’re doing worse than we are. I haven’t see a huge number of UK companies abandoning ship and moving to the US.

Supply-siders argue that when taxes on top-earners are raised that top-earners find ways to avoid and evade the taxes. That’s also true, but it isn’t necessarily a reason to sort it out through a policy of:

“Damn those rich people, they’re so wiley! We’ll have to recoup that money from the less-wiley poor people!”

If our tax rules are this easily side-stepped by rich people then we should look at the tax rules and make them tighter. We should not be saying that poor people should be picking up the bill because we have loop-holes in our tax law.

A very important point that the letter ignored though is what people do with the extra money they receive through tax cuts. If we go with option a) and give 10 rich people £1,000,000 they might spend a bit of it but most likely a lot will go into their savings – they already have plenty of money to finance their lifestyles.

If we go with option b) and give 1,000,000 poor people £10 each they will spend it. When people are really struggling to get by on what they earn they don’t open a savings account.

This is very important because the key reason that tax cuts help to stimulate an economy is because people have more money to spend and in spending that money they stimulate the economy. If we make a tax cut where the extra money goes straight into people’s bank accounts then no economic growth is realised. These are two very basic and indisputable economic rules:

  • Rich people save a greater proportion of their income than poor people
  • Spending money stimulates the economy
It is therefore absolutely the case that option b) would lead to more of the realised tax benefits being pumped back into the economy. Wouldn’t it be a good idea to have at least mentioned this in the letter? Maybe shown how they could be so sure that the effect of the disappearing, tax avoiding rich people outweighed this effect?

Anyway, as it transpired, the 20 economists’ letter to the FT had been organised by a PR company. I’ve no idea why a PR company decided to set out to find 20 economists to sign their letter but something fishy is definitely going on.

Labour’s alternative is to make a temporary cut in VAT. This might work quite well as an economic boost – everything is cheaper for a year, buy it now! It isn’t a perfect way of targeting the poorest – VAT has a reasonably equal effect on everyone. The Lib Dems (remember them?) are said to favour raising the threshold below which no income tax is paid to £10,000. I like that one the best.

Let’s be clear, though – none of these ideas is going to suddenly pay for itself. Despite the claims of the supply-siders, all tax reduction policies would increase the deficit (or mean additional, unplanned spending cuts.) While increasing the already massive deficit is not ideal, I would be in favour of doing so if it kick-started some growth and simultaneously helped out the poorest people who are struggling the most.

If, when you started off reading this blog post you were an advocate of tax cuts for the rich and are now considering your position then this post has done its job.

If, when you started off reading this blog post you were an advocate of tax cuts for the rich and are not now considering your position then don’t worry, you’re not on your own – George W. Bush is on your side too.

RedEaredRabbit

Filed under 10 Posts You Should Read, Economics Tagged with , , ,

Beating Up The Rich

08/01/2011 3 Comments

In amongst the knob gags and poo jokes, someone occasionally writes something serious on Twitter. The other day someone wrote this:

The top 10% of earners pay more than 50% of all income tax. When can we stop beating up on the rich?

It got retweeted and found its way into my timeline. I did try to start a debate with the originator but they didn’t seem to want to take part. Twitter is a fairly clumsy medium for doing so in any case.

I hope I am not doing the originator a disservice but I think the case being made was one I have heard on several occasions – that because such a large proportion of tax is coming from a relatively small proportion of the population they must be more than paying their way and it would be unfair to ask them for even more.

The point I wanted to make was that this statistic on its own doesn’t really tell us enough to know whether we should stop beating up the rich or not.

(I think we are talking about a metaphorical beating up here. I want to make it explicitly clear that I do not condone the beating up of rich people irrespective of the income tax rate for high earners. Except perhaps Duncan Bannatyne and even then no more than a wedgie and a titty twister.)

So why does this statistic not tell us enough on its own?

Reason #1

Let’s look at two fictional economies:

Thatcherland

The country of Thatcherland has 10 residents. Nine of them earn £10,000 per year. One earns £10,000,000 per year.
Income tax is a flat 30% irrespective of salary.

=> In Thatcherland the richest 10% of earners pay 99% of the total income tax.

Getoffmyland

The country of Getoffmyland is populated by 10 farmers. Nine of them earn £10,000 per year. One earns £30,000 per year.
In Getoffmyland, income tax on salaries up to £20,000 pay income tax at 10%. For anything over £20,000 income tax is 40%.

=> In Getoffmyland, the top 10% of earners pay 40% of the total income tax.

If we simply assume that a higher proportion of income tax paid by the rich is equivalent to fairness then Thatcherland comes out as a brilliantly fair economy! Look, that lovely rich person is paying almost all the income tax. The other 90% of residents only have to find 1% between them!

Of course, it isn’t fair though because we just neglected to take into account the income gap between the rich and the poor: If the income is unevenly distributed in the first place then it should not be a big surprise to anyone that the income tax is too.

Reason #2

The statistic tells us only about income tax and we can’t make a valid judgment without taking into account all the other taxes we have to pay. e.g.

  • In Getoffmyland there is another tax which farmers have to pay based on the size of their farmhouse. The bigger it is the more they have to pay.
  • In Thatcherland, this tax has been replaced with a poll tax where all residents pay the same.

Even if the income tax were fair in Thatcherland we would be fairly rash to declare the whole tax system fair without taking the poll tax into account.

Let’s forget about our fictional economies and move to a real one. The UK government is currently in the process of implementing policies to reduce the national deficit. At the highest level they have two fiscal measures they can adjust to do this:

  • Government spending
  • Taxes

It seems to me they are a lot keener on adjusting the former than they are the latter and I do have a big concern about this. In August the IFS published an analysis of the government’s emergency budget and found that contrary to George Osborne’s claims the policies were not progressive. i.e. they proportionally penalised the poor more than the rich. (You can read the post I wrote about that here.)

This shouldn’t be a big surprise. If you hugely reduce the budget of local councils then libraries close, public transport services reduce etc and those services benefit the poor more than the rich who buy their own books and have their own cars. Additionally there have been much publicised cuts to both housing benefit and tax credits and despite what the Daily Mail says, people who claim benefits are not all millionaire hoodwinkers.

This week also saw the introduction of the rise in VAT to 20%. A lot of debate went around as to whether this tax rise was progressive or regressive which in itself says a lot. I’m not really a fan of raising VAT because at best it’s a clumsy way of targeting revenue and the fact that people can’t even agree on whether it affects the poor or the rich the most underlines this. How can we be so sure this is good for the economy when everyone disagrees what the effects are? It’s even more concerning when we consider that a higher VAT rate also leads to lower high street spending which is the opposite of what the economy needs at the moment.

Strangely though, throughout all of this, no one has seemed to consider for 5 minutes financing any of this through a rise in income tax on the wealthy (metaphorically beating them up) and I really don’t for the life of me understand why.

Prior to the downturn the UK economy had enjoyed 15 years of sustained growth and a great many people benefited because of this. Now the economy is in a bad way, why should we not consider going back to those who have benefited the most and ask them to contribute some more to help get it back on track? Especially when the alternative, favoured by the current government, is asking the poor to foot the bill.

I must though, be fair to the government and highlight a progressive policy they are implementing – the freezing of the television license fee. It is just a shame that David Cameron had to get in bed with Rupert Murdoch to come up with one.

Leaving the rich untouched and taking it all from the poor just increases the income gap, pushing us still further towards the economy in Thatcherland.

And as we approach Thatcherland, the richest 10% will pay more and more of the income tax.

And things will be more and more unfair.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , ,

Inheritance tax cuts? Give me a break.

02/05/2010 9 Comments

A recent Ipsos MORI poll showed that the British public still considers the economy to be the most important issue facing the country, and well it might. The Office for National Statistics’ figures showed, as of the end of 2009, that the UK national debt stood at £950.4bn – equivalent to 68.1% of GDP.

Such huge numbers are hard to comprehend so let’s look at this another way. The UK population currently stands around 61.4m so the debt per person is about £15,500. To pay off our national debt this is the amount of money we need, on average, to recoup per person through spending cuts and tax rises. Note per person, not per taxpayer – if you live in a family of five, your family’s share of the national debt is about £77,500. Sorry, if you just spat your tea all over your keyboard.

Seeing the figures presented like this brings home the scale of the problem facing the next government and one would therefore expect some serious proposals on how such a crucial issue would be addressed. A recent study from the IFS, however, concluded that no party had identified anything like the amount of spending cuts that would be required. The Conservatives had identified 17.7%, Labour 13.1% and the Liberal Democrats 25.9%.

For a moment, imagine a large, struggling, multinational corporation is interviewing for a new CFO. There are three candidates. The company is seriously in debt and as part of the interview process the candidates are asked to show how they would go about tackling it. The answer from all three is essentially, “Use fewer paperclips for a start and I’ll tell you the rest after you give me the job”. This wouldn’t work for a business and it is frustrating that we are forced to accept it for the national economy.

Given our huge debt and the fact that no party has proposed what to do about it, it is abundantly clear that any tax cuts or spending increases would need to be considered with the utmost care. This is why I have been continually baffled throughout the campaign, as to why the Conservative party propose raising the inheritance tax threshold for couples from £700,000 to £2,000,000.

To make it clear, a couple who’s estate is valued at less than £700,000 (that’s the vast majority of us) will have no benefit from this tax cut at all – we’d have paid no inheritance tax anyway. Couples who’s estate is valued between £700,000 and £2,000,000 will receive part of the benefit and couples who’s estate is valued at more than £2,000,000 will receive the full benefit. With debt as it is, tax cuts will be few and far between. If you really want to do one, is this really the section of the population that needs it most?

Last Thursday during the third and final party leaders’ debate, Gordon Brown made a rather labored (sorry) attempt to pin Cameron down on this point. His response was:

“Now, let me answer this question directly about inheritance tax. I believe in this country that if you work hard and you save money and you put aside money and you try and pay down your mortgage on a family home, you shouldn’t have to sell that or give it to the taxman when you die. You should be able to pass it on to your children. It’s the most natural human instinct of all, and I’m afraid these other two parties simply don’t understand that.”

To me, this misses some important points. Firstly if you truly believe this then inheritance tax should surely be abolished completely – Cameron isn’t advocating removal of the tax altogether, just changing the threshold.

Secondly the threshold under current government proposals is already very high – no couple leaving behind an estate of less than £700,000 pays a penny. This tax is not hitting the average person on the street – only those lucky enough to have a large inheritance coming to them anyway.

Which brings me on to my next point. Virtually all taxes have positive and negative effects on the economy. National Insurance for example, whilst raising significant revenue, makes it more expensive for employers to employ their staff. The more expensive it is to employ someone the less incentive an employer has for doing it and it therefore leads to lower employment in the economy. You may think this makes it terrible and we should abolish it. Fine, but then you need to explain where the £90bn it raises should come from instead. The fantastic thing about inheritance tax is that the negative effects are really very small. I am yet to meet someone who faced financial hardship, lost their job or had their house repossessed because they had to pay tax on an inheritance of a million pounds.

Inheritance tax isn’t an ‘optional add-on’; an ‘either/or’ that can just be removed with no other impact anywhere else. As I have already mentioned, we are deeply in debt and any tax cut has to be financed from somewhere else. This means, if you don’t pay tax on your estate after you die, you have to pay it by other means when you’re alive. Wouldn’t you rather enjoy lower taxes now, in the knowledge that should you be lucky enough to have become rich later in life, you can pay it from the wealth you leave behind? I would.

All of this leads me to wonder about what possible motives the Conservatives can have for this tax cut. The Daily Mirror would have us believe that it is all a conspiracy to make David Cameron and George Osborne richer. I fear the truth is much simpler and far more worrying – Cameron and Osborne just don’t understand economics.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , ,

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