The Tax Delusion

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

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About RedEaredRabbit
My name is RedEaredRabbit, King of Kings. Look on my works ye Mighty and despair.

5 Responses to The Tax Delusion

  1. madtante says:

    Excellent. A layman’s explanation anybody should understand yet won’t. I get the eejits (that were, my peers–but for perspective) following what they’re told because that’s what they want. “Tell me I’m going to Hell. Awesome! Take more of my money and tell me you’ll give it back to me when the time is right cos you know best. Awesome!”

    The part I don’t get are the otherwise informed people who can look at facts and figures and still believe the way that always fails is going to work this time — and the way that worked was Bad. Even worse are the people who make say 200k-400kUSD (125-250kGBP) who are being taxed at a higher rate than those “above them.” I get them kvetching for lowering taxes (cos they’re actually paying) but I don’t get why they’re not pointing a finger upwards. “Hang on. What about THEM?”

    I suppose it’s hope springing eternal and they think by parroting the bully, the bully will eventually let them in “his circle.” They’re wrong. Those people aren’t bullies. They don’t understand what it’s like to get up at 3:30AM and come home from the 2nd job at 8:30PM–for under 20kUSD a year–with dodge “health care” that you pay 1/4 of your earnings for and then can’t afford to use. Of course they’ve no clue about the “upper-middle” class, either. The owner of a company I may or may not work for (not joking too much there–not sure if I’ll last the year) isn’t the top 1%–you’d think he’d stop voting for people who keep making sure he pays but they don’t.

  2. George Shilling says:

    What really annoys me is the BBC running the story about this letter – as their main headline, despite it’s arguments having no basis in fact or reality. Something fishy there.

  3. Debs says:

    Yup, exactly – Sweden’s first move when their economy was looking shaky was to increase benefits because they knew the poorest would spend them. And they were one of the first countries in Europe to come out of recession.

    Only thing missing with the rich save/poor spend argument is a mention of investment. If the rich were investing in, say, thousands of small businesses and providing start-up capital for social enterprises then you could argue that they are better off being left with more cash in the bank. (I’d disagree because I think a small number of unelected, unaccountable rich people are even worse at making good decisions about money than not-very-accountable democratic institutions, but it’s a point of view.) the thing is though, that’s not what rich people’s money goes into – mostly it now gets invested in the fortunes of other rich people’s money, flooding into asset bubbles like subprime housing or commodities like wheat and rice, where the trick is to make good guesses about where everyone else is going to invest (and when to jump ship and make a profit) not find a genuinely valuable product to invest in. This not only results in people being denied basic goods like food and housing, but makes the excessive wealth of a handful of rich people dangerous for the economy as a whole – they actively destroy wealth rather than creating it. Taxing big companies and rich individuals heavily and enforcing that tax is essential if we’re going to stop the wild swings of boom and bust within commodity markets that routinely leave people without access to the basic essentials for life.

  4. My experience of the example, “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” comes from working in architectural practice.
    People say to me, ‘Well you’ll be fine, the rich will always be rich and they will always want bigger, better houses.’
    My simple understanding of it is this. When only the rich have money, they might employ an architect to design them a house. The building work might be put out to tender, and the contract taken on by a particular company. Those builders, electricians etc. then have a job for the time it takes to build that house (going all the way down the line to the manufacture of materials, haulage…).
    The architect doesn’t need a secretary, any architectural assistants or draughtsmen.
    However, if many people require many small building jobs, then people like me (architectural assistants) get a job. We take on that workload, we earn less than that head architect earned for designing that house, but we earn. As do builders, carpenters, electricians…etc.
    Whilst I understand that construction is not the most basic of consumer needs, my realisation that this is how things have directed my life (I’m not currently employed in my industry) has made me certain that the wealthiest holding on to their wealth is not a way to boost the economy.

  5. Pingback: How Not to Organise a Referendum « Musings of a Red Eared Rabbit

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