Friday, 1 October 2010

Custard Pie

Cross posted at Nourishing Obscurity.

OK, let's go back to the drawing board and try to agree a few principles for the best, or at least the least-bad, kind of tax. Such a tax would encourage – or at least not discourage – effort and enterprise and investment in income producing assets, and it would prevent both poverty and privilege from becoming entrenched. If the tax fails these tests, it can be discarded.

1. It would be a tax on 'consumption' rather than on 'income'. That rules out
a) Income tax and corporation tax, obviously,
b) National Insurance, which is a super-tax on employment income at worst and a compulsory savings scheme at best.
c) Value Added Tax, which is a tax on production, and not a tax on 'consumption' in any meaningful sense.
So we have to look for something which has value to people, but which is not actually 'produced' by any identifiable individual private enterprise.

2. We can also rule out 'transaction taxes' like capital gains tax or stamp duty, as these discourage efficient allocation of resources and you can avoid these by simply hanging on to something you would otherwise sell. Import duties are a barrier to free trade and make us all poorer, and again, VAT is just like a colossal import duty that treats every place of business as a foreign territory.

3. We can rule out taxes on 'wealth' generally (such as Inheritance Tax) because they are usually disguised income tax, as they are a small percent charge on a value that is directly proportional to the income generated (like shares or bank deposits); they discourage saving; and there is an enormous amount of hassle with valuations, possibility for evasion or taking assets abroad.

4. We have to bear in mind 'ability to pay' so it has to be something from which e.g. pensioners can be exempted; and it would relate to something that is reasonably well correlated with income (a ‘normal’ good) and/or it must relate to a 'luxury' rather than a 'necessity', which can be achieved by introducing a 'personal allowance' or individual credits to offset against the liability so that no household is taxed on 'necessities'. The tax would be broad based and nigh universal, so that everybody (unless exempted for political reasons) pays at least something.

5. Remember that there is an advantage to taxing scarce resources or those whose quantity is fixed, because price rationing is the best form of rationing (so increasing the cost to the user encourages efficient allocation of resources). Although as a general rule 'if you tax something you get less of it', if something is in fixed supply, that is not a worry.

6. User charges are better than taxes, i.e. where the payment is in return for specific benefits received, and even better, if the payment compensates other people on whom the state places restrictions on the taxpayer’s behalf. Where our economic system demands that the state protect certain quasi-monopolies or local monopolies (or even infinitely small shares in a larger monopoly), it is fair game to levy taxes on it.

7. The tax would be simple to assess and collect with clear penalties for non-payment; and would be impossible to evade so that the dishonest cannot steal a march on the honest, so it must relate to something that does not need to be separately declared each year and something, which cannot be taken abroad or hidden from the taxman.

8. Assuming we want to replace most existing ‘bad’ taxes (see 1, 2 and 3 above, I’ll exclude fuel, tobacco and alcohol duties from this debate) it must be possible for this single tax to raise similar amounts in revenue, but there would have to be as few winners and losers as possible from the transition, and it would have to be simple for the ‘losers’ to rearrange their affairs to bring their liability down to something they can afford.

9. The tax would be collected with monthly payments and not deducted from wages [unless the taxpayer finds that to be convenient and it's not too much hassle for employers] or embedded in the price of goods, so that people know exactly how much they are paying. Politicians find it harder to increase in-your-face taxes than stealth taxes, so people would also have reasonable certainty as to how much they will pay in future. By the same token, future revenues would be stable and predictable and ‘recession proof’. It would be even better if the tax itself helped to iron out or dampen booms and busts in the economic cycle, which are largely caused by credit bubbles.

10. The tax would have no dead weight costs (i.e. would not have a Laffer Curve or discourage effort and enterprise) and would not discourage investment in the UK economy. It would also ‘go with the grain of the markets’ and prevent privatised tax collection.

11. The tax would not force people to contribute to the cost of government activities that add no value; it would encourage the government to focus spending on things that add value; and there would be automatic compensation for people who lose out as the result of those government decisions that benefit the majority but harm a minority.

12. The tax would have been tried and tested and shown to work – not just in the UK throughout its long history but also in other countries, now and in the past. Finally, just to go on the safe side, let’s check what the small government free market libertarians from Adam Smith and David Ricardo - not to mention Edmund Burke, JS Mill, Tom Paine, Winston Churchill in his younger days - all the way up to Milton Friedman said.

I have worked as tax advisor for twenty years and have been thinking about this long and hard for five years. I think that there is a tax which ‘ticks all these boxes’, but before we argue about what that tax might or might not be, I’d like to know – are these the right principles? Have I missed something important?


DBC Reed said...

Not sure that the criterion that the tax should be freestanding and not deducted from wages is a good idea. If say LVT(to take something completely at random!)were deducted along with income tax it might prove less visible and irritating and there would be a built-in impetus to reduce the combined total by having the LVT component gradually replace the income tax-take in the manner of the Recipracating Tax Mechanism devised here a while ago.
Also a lot of tax discussion is based in an idealised 1950's where workers lived in council houses and went to work in factories.There is now a vast "lost generation" of white van men who try to live off inflationary property values
by overcharging for home improvements and repairs who never go near a factory ,have wilfully misstated their earnings to get a mortgage and avoid paying tax by working cash in hand.

Bill Quango MP said...

I think that there is a tax which ‘ticks all these boxes’, but before we argue about what that tax might or might not be..

He he he...

Mark Wadsworth said...

DBC, as a matter of adminsitrative convenience, if we were to agree that LVT ticks all those boxes, people would be able to choose whether the bank simply adds it to the mortgage repayments; whether a household's CBI entitlement can be deducted from it to save 'churn'; whether people can ask for it to be deducted from payroll (hassle for employers, not good); to pay it weekly, monthly or quarterly; in cash at the Post Office or by Direct Debit. That's a separate topic.

BQ, go on, any suggestions? Whereby 'no taxes at all' is an option, but you then have to consider whether this just leads to a corresponding increase in private tax collection.

Hollando said...

Yep, agreed.

Out of interest, are there any studies relating to the emergent behaviours caused by LVT?

Bankers/Footballers living in hotels?
Caravans/Trailer Parks becoming more popular?
Slums left standing to suppress the land value of an area?
Corruption at the valuation office?
Planning permission only granted to value-added assets? (tough luck sewage farms)

Not all bad though:
Businesses moving into low LVT areas?
Regions able to compete on rates?

Mark Wadsworth said...

H, one example that springs to mind is James Wilson's comment here, see my reply below.

As to 'slums left standing' and 'corruption at the planning office', I have an example which I will post later on.

neil craig said...

I suspect I can see where you are going ;-)

Arguably (I would argue it) taxes on things which are bad for us in quantities we can easily afford, but couldn't afford back when we were cave men do provide a useful signal. Thus taxes on alcohol, tobacco & other drugs can gave a positive effect beyond (or despite) filling the Exchequer.

Taxes on wavebands or street parking also help in the rationing of "commons" goods.

A wealth tax need not be, indeed should not be, a concealed income tax. It should be a tax that discriminates against those with large assets which they do not use well. The problem with wealth taxes is that wealth can be moved or hidden which makes LVT a particularly practical sort of wealth tax.

Mark Wadsworth said...

NC, yes of course, those particular duties, parking meters, radio spectrum auctions etc all tick the same boxes, I'm comfortable with those.

Derek said...

I would add to the principles that its collection should require little or no effort on the part of the taxpayer or the government and that in particular it should not require the unpaid recording and collation of hundreds or thousands of transactions or valuations per person per annum.

Mark Wadsworth said...

D, I thought I covered that in point 7, but you get the general idea.

James Higham said...

Difficult reading all this in two places at once. :)