Thursday, 12 February 2009

Legal and economic incidence of a tax

It is actually nigh impossible arguing the finer points of economics in the 'blogosphere (but good fun trying).

It must be perfectly clear to anybody who stops to think about it that government bailouts cannot work, as they increase the tax burden on the profitable parts of the economy and transfer the proceeds to the loss making parts; or that minimum wages merely serve to condemn those whose earnings potential falls shy of that arbitrary threshold to unemployment; or that statutory maternity rights merely make it more difficult for young women to find good jobs etc. So much to the lefties, but this is a centre-right 'blog so there's not much point in me arguing this here (it's more fun over at LabourHome, obviously).

So let me turn to the faux libertarians, who also believe that they can suspend the basic laws of economics in justifying their own prejudices. Devil's Kitchen highlighted this, approvingly, as his Comment Of The Day in a debate on the respective impact on the productive economy of Sales Taxes (or VAT) and Land Value Tax (or Business Rates, Council Tax etc):
I find it odd that the laws of economics magically change depending on the product being sold.

For instance, if my product is leased land, apparently LVT is a super duper tax that cannot be passed on by me, as the market decides what the rent is, and I have to absorb this additional cost and put up with it. Hurrah, we've bashed the evil landlord. Hurrah!*

However, if my product is a leased car, apparently VAT is an evil, authoritarian tax that is instantly passed onto the consumer, increasing car rents, causing plague, famine, and making landlords even more evil than before. Booooo. Evil landlords. Boooo*.

Strange that, eh?

* Georgist porn added for amusement value.

Paul Lockett, Richard Allen and I went to great lengths to explain that the laws do not change; but that the laws apply differently depending on the relative price-elasticities of supply and demand, to little avail of course, but hey.

Luckily, Wiki has a nice short article on Tax Incidence to which I can refer you, which says exactly what any serious economist says. It covers the two extremes of

a) inelastic supply/elastic demand (which applies mainly* to property related taxes - the taxes being borne by the property owner, hence making it a largely voluntary tax - nobody is forced to own property - that does not impact on economic activity), and

b) elastic supply/inelastic demand (which relates mainly to alcohol, tobacco and fuel duties, making it also largely a voluntary tax - more importantly, these taxes raise a shedload of revenue under the guise of 'discouraging harmful behaviour' without actually affecting people's behaviour very much at all).

Wiki covers the intermediate case - elastic supply/elastic demand - i.e. most other goods and services, which are (in the EU at least) all subject to VAT with a diagram here. Such taxes do increase the cost to the consumer to some extent (which appears to be politically palatable, Heaven knows why) but more importantly - and far more damagingly - they also reduce the price received by the producer and the quantity produced, thus they have the most damaging effect on the economy, employment and returns on investment.

This has nothing to do with politics at all, it is borne out by observation and commonsense.

The question is, seeing as most people in the UK are both workers/investors and home-owners, why are they so willing to cut off their noses to spite their faces? £1 tax raised from property values costs them £1 (possibly slightly less, different topic), but every £1 raised from the productive economy costs them £1 and reduces the size of the economy - their main source of income - by a further 50 pence or £1.

Answers on a postcard, as ever.

* Land Value Tax applies mainly to non-agricultural land values, as land with planning permission is in fixed supply, but exactly the same logic applies to any 'asset' or 'right' which derives its value - or which generates super-profits for the incumbent - primarily because of naturally or artificially imposed restrictions on 'supply', such as 3G licences, pub licences, airport landing slots, taxi drivers' permits in London, oil and gas fields in the North Sea etc.


neil craig said...

The laws of supply & demand don't work for land as they do for cars. If the price goes up the amount of it doesn't increase.

Except in Holland or if building L5space colonies.

Lola said...

It's all very well being right and understanding all this, but 'the public' won't get it, at least not easily. And all sorts of charlatan politcos will have a field day with lies and spin....unless we are very lucky indeed and someone gets into power who has the intelligence, knowledge, political skills, energy and time to implement the tax changes required to drive forward growth and wealth creation. And I haven't even got round to metioning to antics of that other group of fascists, the ecomentalists.

You know I'm with you on all this, but really, sometimes I do despair...

PS Osborne G does not inspire such confidence.

Anonymous said...

Error..Error..Does Not Compute..Does Not Compute....

This has nothing to do with politics at all, it is borne out by observation and commonsense.


Land Value Tax applies mainly to non-agricultural land values, as land with planning permission is in fixed supply

...and on the 3rd day, the lord maketh planning permission, and it was good...


Now, as I said on that thread... I am a libertarian, not a thatcherite, or a free marketeer, or whatever. And the moral or political consequences of giving the state complete control, via planning/zoning and tax, of who may live where is unacceptable in my book.

Mark Wadsworth said...

HH, for sure, as the example of 'flatland' areas in most of the USA, where there are next to no planning restrictions, towns just expanded outwards over the last decade - there was no big rise in house prices. The USA property price boom was on East and West coasts where there are stricter planning restrictions - and where prices are now crashing.

So allowing people to build new homes and offices around existing towns (or wherever else they think it's appropriate) helps people at the margin. That's libertarian orthodoxy and all perfectly correct. We're agreed there. People in these areas wouldn't pay much in LVT either, obviously.

But land values in town centres, round train stations, where there's a nice view etc will always be much higher than at the margin. It is these much more valuable areas that are by definition restricted in supply, where the landowner makes windfall gains through no effort of his own. So by taxing those values, you do not depress productive economic activity - simply owning land is not an activity.