BRIEF GUIDE TO SOUND TAXATION POLICIES
1 – Low rates of tax will generally raise more money than higher rates
This principle is illustrated by the Laffer Curve, which starts from the general observation that tax rates of both 0% and 100% will yield zero revenue. The skill of a judicious Exchequer is to ascertain and impose tax at a rate that gives the greatest yield.
The Laffer principle may seem obvious, but it is rarely observed in practice. Whenever it has it been applied it has been successful. For example, when President Reagan reduced corporate and income tax rates in 1981 the result was higher growth, productivity, employment and output. The “tax base” grew, bringing more businesses and individuals into the tax net, giving exponential wealth expansion and tax revenues. This was not a “one-off” – it is a principle that cannot be gainsaid. It happened here under Thatcher and Lawson in the ‘80s.
It is also the reason why those countries with a “flat tax” policy, using a relatively low rate, succeed in increasing the overall tax haul.
Why is it not applied by every government? The main reason is the popular notion that the rich should pay more tax. This blunt notion causes governments to adopt popular rather than rational policies.
The Laffer principle works in reverse too. High tax rates that discriminate against the most successful entrepreneurs, often inspired by populist left-wing gut-thinking, cause a shrinkage of the tax base together with a rising tax requirement for welfare etc. The result is a spiral of decline and an inevitable economic crisis – excessive government borrowing, high inflation and high unemployment.
2 – The earnings of employed people are not a legitimate target for taxation
Income tax (and NI) extracted from wages through the PAYE system is, by its nature, severely counter-productive.
Like VAT (see my covering e-mail), there is a general failure to distinguish the mechanics of the tax’s calculation from its incidence (who actually bears it). Tax under PAYE is calculated by reference to a purely notional figure called “gross pay”, which no employed person in history has ever seen, let alone touched or spent. The employee’s real income is of course the net pay; and the amount of tax which has been “deducted” is always the employer’s liability, to be remitted by the employer to HMRC in full, every month. As with VAT, the employers are the de facto tax-collectors. In this case they are also the tax-payers!
[This unwarranted imposition is made even more complicated by the coding system. This forces employers to take account of a host of reliefs, on an individual employee basis, that have nothing to do with the employment itself. How much simpler it would be if a single rate of tax were to be used, leaving present deductions such as dependent relative relief (et al) to be separately claimed, outside the scope of the tax system. Many wage-departments would become wholly unnecessary.]
The most obvious reason why this category of tax is counter-productive is its disincentive impact on productive effort. (Why else would so many employees prefer to be taxed under Schedule D?) The work I did in the ‘80s on the design and implementation of tax-free schemes in industry amply illustrated the point: payment of wages without deduction (ie gross) generates a productivity boost that more than makes up for the extra tax that the employer has to bear. I remember visiting Nicholas Ridley at the Treasury and persuading him to requisition the production of “grossing-up” tax tables to make it simpler for employers to calculate the “tax on tax”: after all, the gross amount actually paid to employees is deemed, under the present system, to represent the net equivalent of a higher “gross” figure!
[The full story of these cases is readily available to all interested parties.]
3 – Every attempt to tax wages sets in motion a “shifting” process whereby the tax finishes up as a corporate impost anyway.
This phenomenon was clearly set out 220 years ago in Adam Smith’s illustration of an employee earning £100. If the state imposes a tax of 20%, his pay must rise by 25% in order to re-instate the employee’s former purchasing power (£100). He must now be paid £125 so that the 20% tax leaves him with disposable earnings of £100. In practice there may be a time-lag over which purchasing power (or the basic standard of living) is restored, but national statistics always show a ratio between real (net) pay and GDP that tends toward a constant. The effect is always inflationary as the costs, no matter how notional, feature in the revised price structure.
4 – You cannot “tax” the earnings of those who are paid out of taxes
The application of the the entire PAYE rigmarole to employees in the public sector is a nonsensical charade whereby tax on the imaginary figure of “gross” pay of public sector employees is “taken” by HMRC, and given straight back to HMRC in its capacity as collector.
We know from the above arguments that taxing people’s wages finishes up in effect as a corporate tax when the ramifications are laid bare, but the notion of applying this process to the earnings of those who are paid out of taxes lends it a still more farcical twist. It enters into price structures throughout the community and thereby fuels inflation and distorts all public sector costings.
5 – Regeneration starts at the “margin”
The corporate liability for so-called PAYE deductions is grossly iniquitous in its incidence since it takes no account of the “taxable capacity” of the employing businesses. The latter is an economic differential based on type of business /industry and location. Although bank clerks and miners may have comparable earnings, the added value per head which their respective industries are capable of generating (ie the respective taxable capacity of each) differs enormously. The present system, basically a glorified payroll tax, completely ignores the question of employers’ ability to bear tax. It is no wonder that subsidies are needed at one end to keep marginal businesses alive, while huge windfall gains arise at the other.
Taxes based on employees’ earnings will therefore impinge most heavily on marginal businesses, manifesting in unemployment, derelict sites and demoralized communities, as these businesses flicker in and out of viability at the whim of any rise in local or central tax imposts. The result is the appearance of “enterprise zones” with tax privileges that are necessitated by taxes on the margin in the first place.
[We had a graphic illustration of this principle some years ago when British Steel’s marginal status was completely ignored: its “losses” of £1 million per day were exactly balanced by the income tax deducted from employees’ earnings! This of course necessitated a huge (and totally unnecessary) debt burden with high interest rates, effectively crippling the industry’s future – and all having to be passed on down the chain in inflated prices.]
6 – Tax on corporate added value
Such a tax would satisfy most of the criteria which should now apply.
Taxable capacity is a corporate, not an individual, concept. The employed individual has no taxable capacity. However, the present system of shifting the PAYE burden on to corporate shoulders is indiscriminate in that it takes no account of taxable capacity, as measured by corporate added value.
Added value is not the same as profit – a concept that virtually defies definition, let alone computation, although perennially expanding tomes of statutes and law reports attempt this, giving a field day for avoidance specialists.
Added value equates to turnover minus those costs which form part of their suppliers’ turnover. It is easy to calculate and cannot be fudged. It is therefore an ideal basis for levying taxes. However, to reflect the fact that the payment of wages is a distribution of added value rather than a cost of production, and to avoid penalising labour-intensive businesses, the amount on which tax should be levied is added value after payment of wages.
A standard, or flat, rate could then be applied.
Since the resulting tax would replace employees’ income tax, NI (a grotesque fudge if ever there was one), and corporate tax, the effect would be raise output; make work more attractive than unemployment; and reduce dependency of individuals and businesses on the state. We could safely anticipate a steady fall in taxation as a proportion of GDP, together with a corresponding increase in taxation as an amount.
Note on classical sources
“Wealth of Nations” by Adam Smith includes his famous “Canons of Taxation”, such as ease of determination, cost-effectiveness of collection, proportionality to ability to pay, and so on.
“The Principles of Political Economy and Taxation” by David Ricardo addresses the distribution side of the economic equation, and provides the most comprehensive and compelling case for a tax on the economic rent. He shows that attempts to tax the other factors of production, wages and profits, are always ultimately unsuccessful, and will in any case shift the tax back to where it belongs, the economic rent of land, albeit via a circuitous, inefficient, costly and inflationary route.
In this paper I have avoided reference to land or rent because of the emotive undertones that cause readers immediately to switch off! I have instead referred to the more acceptable concept of added value, notwithstanding the fact that AV is an accurate reflector of economic rent. The most productive sites, after all, are thus advantaged only because of their location, and by definition they generate the highest added value – not necessarily as an amount, but AV per employee, or AV per square metre occupied.
Countries which have embraced taxation of site values have always benefited: Denmark, Canada, New South Wales in Australia, South Africa, Hong Kong and many others. To be fully effective, the tax is on the value of unimproved land only (in many instances exempting domestic housing altogether). It therefore leaves buildings completely out of the equation. Just take a look at the Sydney seafront to see the full effect of such a tax as a source of infrastructure funding.
The fear of politicians to talk about land or rent tax is suprising – it has, for example, a very long provenance as one of the Liberal Party’s main pillars for reform of the tax system. Regrettably, this appears to have died with Jo Grimond; my conversations with him showed a sharp intellectual grasp of the principles.