Creative destruction

The traditional distinction between the 'left wing' and 'right wing' approaches to failing businesses is that the lefties like to prop them up with subsidies (paid for by taxes on the more successful parts) and the right-wingers prefer to allow them to fail, i.e. newer, better businesses will step in to take their place, a process which they refer to rather cruelly as 'creative destruction'.

It seems to me that the 'right wing' approach, however hard-hearted in the short term must be the correct approach in the medium or long term (and short term measures tend to end up as long term ...); it also seems reasonable that the rents on business premises should be set 'by the market' (be that upwards or downwards).

Let's first consider the position in the absence of any taxes whatsoever, and let's look at a business which rents its premises - the rent it is paying is probably much the same as the rents that other businesses in the area are paying. Landlords will charge the highest rent that they can get away with, so if a business is making less profit than what a new business trading from that location could make, the market rent will squeeze out the marginal business and a new business will take its place. The right-wingers are happy with this model, and in the absence of taxes, so am I.

But of course, once we accept the fact that the government has to raise some money by taxation, most right-wingers abandon their principles and scurry back into one-sided economics and protectionism.

If you can accept that the worst taxes of all are those that relate to output, production and employment, i.e. VAT, income/corporation tax and National Insurance (because they of necessity depress output, production and employment), we have to scrabble round for a tax that broadly relates to 'ability to pay' (unless you are a fan of Poll Taxes) but which does not discourage the efforts of entrepreneurs, investors and workers. VAT (for non UK readers, it's a Sales Tax) and its predecessors have been sold to the gullible electorate as 'a tax on consumption', which is A Big Fat Lie of course - it is a tax on the turnover, i.e. the output, of about half the economy (applied more or less at random to some things but not others, thus leading to further distortions and misallocation).

We know for a fact that the total occupation costs of a business is a function of its profits (the occupation costs, rents plus Business Rates - for non-UK readers, this is a flat tax on the rental values of business premises, i.e. a property value tax-, mop up all 'super-profits' above and beyond a normal return on capital or labour invested), that is the upper limit - if occupation costs rise above that level, all businesses would close down (by definition). Seeing as business premises are in fixed supply, and an increase in Business Rates CAN NOT increase total occupation costs (in all but the very short term), Business Rates merely depress the rents that landlords can collect (an increase in one leads to a reduction in the other). Conceptually, reforming Business Rates so that it is a tax on the location value alone would better, but in the short term it doesn't make any difference.

Now, seeing as the surplus rents that a landlord can charge over and above a fair return on capital invested in bricks and mortar is equal to the 'super-profits' that active businesses generate from being in a favourable location, that source of income seems fair game for taxation to me; however high the tax, the location is still there; the location rent is a form of privatised taxation anyway, where the landlord is the tax collector - and it does not put a tenant business out of business.

"Hmmm." respond the right-wingers, "There may be something in that ... but what about businesses that own their own premises? If the profits they are making are less than the Business Rates, then they go out of business! So you're wrong!" (see e.g. John Redwood's reply to my comment here).

Well, that's the whole point about 'creative destruction', isn't it? If I rent business premises and run a business rather badly, I am forced out of business if a more profitable one is bidding for premises in the area. If they build Crossrail or something, business rents will go up - businesses which can make better use of it will outbid and replace businesses that don't - 'creative destruction' and 'efficient use of assets' in a nutshell.

So why should people who run a business from their own premises be immune from this? If owners of business premises who choose to run an unprofitable business thereon, surely it's a good idea to introduce them to the concept of implied or notional costs?

The simple fact is, if somebody can't even generate enough profit to cover the Business Rates (let alone what a full market rent would be), then they'd be better off shutting down and renting out the premises to the highest bidder: the owner of the premises is better off for less effort (hooray!); a new business, which hopefully provides goods and services more efficiently or creates more employment, finds premises more easily (hooray!) and the government gets its extra tax revenue without depressing the economy, which it can use to reduce more damaging taxes or reduce government borrowing (hooray!).

What's not to like?