Tackling Taxes for Economic Prosperity


In a recent essay published on this blog1, the present author highlighted the need for a libertarian strategy to be firmly and uncompromisingly radical, rooted in challenging the inherent injustice of the state as the ultimate destroyer of liberty. This is in contrast to gradualist or, we might say, deliberately half-hearted approaches, which are forced to accept the state’s basic injustices (such as its taxes, regulations, and monopoly over law, order and defence) and replace any radical principle with some kind of utilitarianism.

While it is wonderful that liberty brings with it heightened economic progress in the form of material increases in the standard of living, libertarians recognise that these ends do not justify the means. For example, if it could be demonstrated that murdering red heads would add a few percentage points to GDP we would still regard such acts as evil; the ability of everyone else to buy a few more pairs of shoes would do nothing to change this fact. Therefore, while leaps and bounds in the standard of living certainly add moral weight to the case for a free society they fail to add moral decisiveness.

Interestingly, however, it seems as though wedding oneself to a fundamental principle allows one to examine the economic effects of liberalisation more pertinently and that even on their own terms, gradualists, neo-liberals and utilitarians fail to make proposals which would bring the highest economic benefits. In other words, libertarians such as ourselves, who are derided for being too “utopian”, “principled” and “unrealistic”, seem to have a better grasp of the primary utilitarian case for liberty than do their more pragmatic brethren. We will elaborate on this observation here by examining the problem of taxation.

Taxation and Economic Progress

Pretty much every free market proponent agrees, at least in some way, that taxation is a drag on economic progress. The Adam Smith Institute (ASI), for example, has the following to say:

Outside of impossible or improbable lump-sum taxation systems like taxes based on height, innate ability, or simply existence, and a small range of Pigovian taxes on externalities, there are no taxes which do not cause deadweight losses. That is, there are no real world taxes which simply move money around, without reducing economic activity at the same time. Once we’ve collected the revenue of well-designed congestion charges, fuel taxes, alcohol and smoking levies, and carbon taxes, we are always going to have to reduce economic welfare when we tax (even if we increase welfare overall by spending that money well).2

In spite of the caveats, as well as the reference to “well-designed” taxes and the absurd proposition that the state could ever spend tax loot “well” (let alone “increase welfare” by doing so), the basic point is clear: you cannot impose a tax without impeding economic progress. Taxes will make us poorer than we would be if taxes were not there at all. One would expect, therefore, the intellectual cadre of the ASI to wheel out its heavy guns in order to demolish any strongholds in the fortress of taxation. And yet in resolving what they admit to be a scourge on the economy, the policies of the ASI are remarkably bloodless, consisting only of the following key objectives:

  1. Take the poorest workers out of tax altogether by pegging the personal allowance and National Insurance threshold to the National Minimum Wage rate.
  2. Merge income tax and both employee and employer National Insurance contributions into a single system rate to boost transparency.
  3. Abolish all taxes on capital and transactions, such as corporation tax, capital gains tax and stamp duty.
  4. Broaden the VAT base and consider replacing income tax with a progressive consumption tax, so savings are not taxed.
  5. Reform business rates and council tax into a pure Land Value Tax on unimproved land values so that capital investment is not taxed.

Regarding point 1, it is always great to relieve people of their tax burden – but surely granting this to only the least productive people who comprise a minority of the workforce is unlikely to make much of a difference? Point 2 just adds existing taxes together which, although it may dissolve the imposition of double taxation on the same income, does not, by itself, eliminate anything. Point 3 is great, the best of the programme. Point 4, part of which wants to explicitly increase the tax burden, is terrible, and the idea behind a “progressive consumption tax” is based on a fallacy that we shall expose below. Finally, regarding point 5, space precludes us from elaborating on the passionate debate over the Land Value Tax but suffice it to say here that, as will become clear, this kind of fiddling that simply replaces one tax with another is beside the point for a serious tax reduction programme.

So out of these five tax proposals of the UK’s leading free market think tank only one merits any kind of wholehearted support, another is dreadful and should be scrapped, while the rest are neither here nor there.

Let us explore what is wrong with the ASI’s programme from its own point of view of aiming to boost economic prosperity. From this analysis let us propose instead a strategy that will really tackle the tax problem in a realistic and practical manner by focussing on just three key aims.

“Revenue Neutrality” and Government Spending

The first of these aims is to junk the apparent obsession with “revenue neutrality” which seems to blight a number of tax reform proposals, even from free marketers.

The ASI does not hide its priorities when it implies that it wants to preserve the state’s existing “£700bn” annual tax revenue; in other words, the ASI is trying to have its cake and eat it by finding efficiencies within the tax system to boost economic progress while simultaneously keeping the state’s coffers well stashed with looted cash. It seems as though the ASI would be at home in the company of the seventeenth century French Finance Minister Jean-Baptiste Colbert, who said that “the art of taxation consists in so plucking the goose as to obtain the largest number of feathers with the least possible amount of hissing”.

Unfortunately, however, these “efficiencies” are likely to be uncertain and nuanced at best; at worst they will not materialise at all. This is something that we shall see more clearly later; suffice it say here that the biggest depressing effect on prosperity is always going to be how much of the productive output of the economy that the state tries to grab for itself. The bigger the slice of the pie that the state gobbles up then the more will productive enterprises be deprived of valuable resources and the less motivation productive people will muster to bake more of the pie in the first place.

To put it crudely the principle of “revenue neutrality” will serve to castrate any free market programme for tax reform – it simply won’t have any balls. All it will do in its neutered state is tread softly, as if on egg shells, tinkering with little subtractions here or little additions there, while any wholesale changes resort to little more than moving a tax around and calling it a different name.

Although libertarians do not wish the state to be made better off (or, at least, left unaffected) as the result of any tax reform, we might as well point out that the principle of revenue neutrality makes a misfired shot at such a target anyway. Almost every debate concerning tax focuses only on the nominal monetary amounts that are going here or there, while failing to acknowledge that being wealthier does not mean having more pounds in your pocket – it means being able to buy more with every pound.

For instance, being a billionaire would be useless if the price of a single loaf of bread was a billion pounds. On the other hand, if you had £1,000 with which you could buy accommodation, food and clothing for an entire year then you would be much better off. Consequently, it is pointless for anyone who is concerned about the state’s ability to spend as a result of tax reform to whine about how “if we cut taxes there will be less money for the NHS! Schools will close! X, Y and Z programme won’t be afforded!” etc. etc. The focus instead should be on ensuring that more wealth is created so that a smaller proportion (or a smaller nominal amount) of tax revenue will be able to buy more. In other words, one can eat more heartily by taking a small portion of a large pie than by taking a large portion of a small pie. And the only way to make this pie bigger through the tax system is to cut taxes.3

So even if pro-free market fellow travellers are not going to make the same anti-statist commitments as libertarians, the very least they could do is make the effort to understand the full implications of what the “free market”, the very thing they claim to love so much, will achieve. Any effective, pro-free market tax programme must abandon the principle of revenue neutrality and must be committed to reducing the tax haul of the state. The programme should be explicitly for tax reduction rather than just tax reform.

In this vein, it must also be emphasised that the economic benefits of cutting taxation are realised only to the extent that government spending is concomitantly reduced. To reiterate, economic progress can only occur if the state’s share of the pie is diminished – for it is this aspect that makes resources more readily available to private citizens and entities to purchase and invest as they see fit.

Unfortunately, it is not the case that cutting taxes will lead to an automatic reduction in government spending. This is owing to the prevalence also of government borrowing and monetary inflation, both of which may be regarded as pseudo-taxes that serve to fund the government outside of its ability to raise actual taxes.

If tax cuts are simply countered by monetary inflation in order to maintain government spending then it is obvious that whatever gains people make from keeping more of their pay packets will simply be offset by higher prices. If, on the other hand, the government resorts to borrowing then, apart from the fact that this borrowing will, eventually, have to be paid for with tax revenue anyway, the more immediate problem is that it competes with private entities for the source of investment funds – resources that would have gone into productive investment are instead diverted towards government consumption. There is, therefore, no benefit to economic progress.

Thus, any endeavour to cut taxes must address the problem of spending as well – indeed, cutting both taxes and spending should be seen as a unified programme. Unfortunately, remarkably few proposals to cut taxes in order to achieve economic progress acknowledge the fact that there is no point in cutting taxes if spending remains the same (or is even increased).

While the focus of this essay is on actual taxation, we should acknowledge that, from a strategic point of view, cutting spending is likely to be the hardest aim to achieve. Cutting taxes at least has the political advantage of the government being able to tell people that they can keep more of their own money; cutting spending, on the other hand, is another story. The UK government’s so-called “austerity” programme, for instance, involved cutting a bare fraction of government expenditure while major drains on public funds – such as the NHS – were protected. Yet, somehow, this programme has managed to have a significant political impact.

Taxes on Wealth vs. Taxes on Income

The second aim concerns the precise type of taxes which should be tackled as a priority.

All taxes, regardless of what they are called, are a confiscation either of resources or, more commonly today, of the purchasing power over resources (i.e. the money which can buy them). Consequently, in order for there to be a tax, there has to be a produced product that can be taken. In spite of the plethora of different taxes that exist, all of them draw on at least one of only two possible sources of this produced product: first, the product that has been produced at some point in the past, i.e. the existing stock of societal wealth; or, second, the product that is produced today, i.e. income.

Within wealth taxes are all kinds of property taxes (including, in the UK, council tax and business rates), land taxes, death taxes, stamp duty on the transfer of assets, or any other tax which is assessed according to the value of some existing stock of wealth. Within the category of income taxes are earnings (payroll) taxes, sales taxes, VAT, customs and excise taxes (including “sin taxes” on alcohol and tobacco), capital gains taxes, dividend taxes, and corporation taxes – in other words any tax which is calculated according to the value of the product produced through the existing stock of wealth, rather than on the existing stock of wealth itself.

Although the different taxes within each of these two categories will cause their own distortions and perverted incentives, from the point of view of economic prosperity they are not, all else being equal, nearly as important as the difference between the two categories themselves.

There is a tendency for all tax reform programmes to focus on income taxes as opposed to wealth taxes. The reason for this, presumably, is because the very vast majority of government revenue is raised from taxes on income rather than taxes on wealth. For instance, in the UK death duties (euphemistically named the “Inheritance Tax”) raise only 0.7% annually, with all types of stamp duty raising only about 2.5%.4 These small sums cause wealth taxes to be overlooked. This may well be a mistake because the economic effects of taxing wealth are disproportionate to the actual revenue raised.

If a tax is levied on income, i.e. the product produced today, it is possible for the state to leech off the population while maintaining the integrity of the economy’s productive apparatus. Thus, in spite of the tax, it remains possible to produce an equal income tomorrow, and the next day, and so on into the future.

For example, let us say that a productive asset is able to produce an annual product (“income”) that is 20% of its value and that no additions are made to the capital stock.5 Let us say also that the state levies a tax of 10% on this income. If this was so, it would be still be possible for the same income to be produced the following year and for every year after that, thus maintaining the standard of living:

Wealth1

The state would, quite obviously, never tax all of the income as any incentive to produce would be completely destroyed; furthermore, growth of and additions to this productive apparatus will be retarded. However, at least from a mathematical perspective, such a tax has the ability to be imposed at any level without destroying the economy’s basic wealth producing capacity and, for the most part, prosperity, together with increases in that prosperity (by diverting some of the income to saving and investment) can continue, albeit at a reduced rate.

If, on the other hand, the state decides to develop an obsession with “soaking the rich” or combating “greed” by replacing6 the 10% tax on income with a 10% tax on wealth – i.e. on the product produced yesterday – the results are now markedly different:

Wealth2

Here, the imposition of a wealth tax has resulted in the active consumption of the productive apparatus of the economy (“capital consumption”), the effect of which has been to cause a dramatic reduction of that capital’s income generating ability. Indeed, the tax, in this instance, has caused annual income to more than halve within a decade. Wealth taxes therefore destroy the economy’s capacity to generate continuing prosperity and cause retrogression to earlier levels of impoverishment and destitution.

One might point out, of course, that in the real world all else tends not to be equal and, because of these dramatic effects, wealth taxes are usually levied at a much smaller rate than income taxes; or, if they are levied at a relatively high rate, then they are imposed infrequently (such as the “Inheritance Tax”).

Unfortunately, this only adds to their insidious nature. In the first place, wealth taxes are more marketable to the general public than income taxes – they can be sold easily as a tax on “the rich”, and the low headline figures or the rarity of their levy serves to camouflage the full extent of their destruction.

The biggest problem, however, is that such destruction is characterised more by the wealth that does not come into existence rather than the active taking of wealth that is already there.

With income taxes there is arguably a greater visibility over what is being taken – every month the state is dipping into your pay packet and you only have to turn on the news to see what else that money it is being spent (or wasted) on. Although such taxes will affect the height of production and the incentive to work it is easy to characterise income taxes by the tangible loss that is incurred – something that you held in your own hands has been confiscated from you and somebody else is now spending it.

This is not always so with wealth taxes. Because they have the potential to blight the entirety of the stock of wealth – an enormous sum – they have, purely by virtue of their existence, a huge depressing effect on the very thing that is responsible for the lion’s share of economic progress – the creation, movement and deployment of capital.

For instance, a stamp duty or some other tax that takes effect on the transfer of assets will not visibly happen very often and you can avoid it easily by not selling what you have. But if transfers of assets are penalised then it will result, all else being equal, in fewer such transfers and, thus, the inefficient allocation of capital. Capital will then be concentrated in the hands of people who are less able to direct it to its most productive uses. The blackest cloud in this regard is the campaign to implement the so-called “Robin Hood Tax” – a tax on the transactions of a wide array of asset classes such as stocks, bonds, commodities, currencies, derivatives and so on, which would blight the efficient allocation of this wealth.

A lump sum tax such as death duties also will happen very rarely; yet it has a massive impact on the incentive to build up inheritances, which are the very reason for continuing economic progress generation after generation.7

And if wealth taxes are levied frequently then even a small one of, say, just 2% annually would cause an asset to lose half of its productive power within a generation. This difference has to be made up by diverting more of the income to maintain the integrity of the capital stock. While this represents only a small proportion of the value of the capital, it could amount to an enormous percentage of the income. In our example above, where an asset worth 100 units yields an annual income of 20% (20 units), if the government levied a 2% (2 units) wealth tax on this asset then 10% of the income (2 units/20 units) would be required to plug the hole left by the wealth tax. In other words, a full 10% of the income has to be diverted just to get the economy to stand still.

This situation would be bad enough as stated in the example. In the real world, however, very few assets can produce, consistently, an annual return as high as 20% and so the proportion of the income that must be diverted to maintaining the asset is even greater; and, moreover, numerous types of income tax are already sucking the blood out of the income so the wealth tax simply becomes yet another burden lumped on top of these and destroying further the incentive to produce.

Of course, in a given year when the taxed asset earns a sufficient income then the tax is just paid out of income directly to the state; a portion of the asset isn’t literally disinvested, sold, and then reinstated out of the income. However, if the wealth tax is imposed at a rate which exceeds the rate of income then a portion of the capital must, quite literally, be disinvested and sold to pay for the tax without any funds to replenish this loss. Thus, true capital consumption sets in and the path towards economic retrogression is trodden. At least, with income taxes, if there is no income then there is no tax and the state just leaves you alone. But a wealth tax may be is imposed regardless of whether capital assets have been successfully productive. And obviously any kind of holding or hoarding of assets – perhaps to deploy them at a more opportune moment in the future – is also penalised. The tax seeks to confiscate wealth purely because it is there. Consequently, another effect of imposing a wealth tax is capital flight.8

Therefore, all forms of wealth tax are a terrible burden on economic progress and are likely to be much more so than income taxes. For the avoidance of misunderstanding this should not, of course, be taken to mean that income taxes are unimportant. They still exert a heavy drag on prosperity, and very high rates of income tax – such as those that the UK imposed during the so-called “post-war consensus” – may render them the most urgent problem, especially as the decimation of productivity would itself lead to capital consumption. There are also some income taxes which have similar effects to wealth taxes, such as taxes on realised capital gains (i.e. payable only when an asset is sold) and on dividends, both of which act as a disincentive upon the transfer of accumulated assets. Ultimately, it is up for the individual confronted by a particular situation to judge his priorities when the ceteris are not paribus. Moreover, income taxes can be more problematic from a strictly libertarian point of view when you consider the bureaucratic inroads the state needs to make into one’s financial affairs in order to ensure compliance.

Nevertheless, for purely economic reasons, and assuming relatively “normal” rates of income tax, there is a strong case for suggesting that the first priority in reducing the tax burden is to get rid of and/or prevent the introduction of wealth taxes ahead of income taxes. And yet the only kind of wealth tax that the ASI programme wants to abolish completely is stamp duty (although, as we just noted, we should also commend the proposed abolition of capital gains taxes).

The False Promise of Taxes on Consumption

Within these two groups – wealth taxes and income taxes – the individual names of all of the different taxes refer not to fundamentally different types of tax; rather, they denote either the specific kind of good to be burdened (i.e. property, alcoholic beverages, etc.) or the particular event that triggers the tax liability. For example, within the category of taxes on income, an income/payroll tax taxes the income at the point it is earned; a VAT or sales tax, on the other hand, taxes the income at the point it is spent.

Changing the precise moment when a tax is levied ultimately does nothing to ameliorate the effects of the tax – it simply means that you might be able to hang on to your money for a little bit longer before having to give it up. Neither also does changing the triggering event have any effect upon who, ultimately, pays for the tax. All taxes must be paid for out of production and so the burden of any tax always falls upon producers.9

This fact is the basic reason why the rationale behind point 4 of the ASI’s tax programme – that is, the canard that it is somehow “better”, from an economic point of view, to tax consumption rather than earnings and the returns on savings/investment (i.e. production) – is ridiculous. In other words, the ASI hopes to steer people’s behaviour away from consuming and towards increasing production simply by moving a tax around rather than by eliminating it.10

Space precludes us from undertaking a detailed examination of arguments in favour of the consumption tax here – such a study will be published on this blog by the author as a separate essay in due course. The basic point that needs to be grasped for now is that shifting a tax around does little or nothing to relieve its burden upon economic progress and so such endeavours should be ignored.

The Rate of Taxes

Having tackled revenue neutrality and government spending as well as denoting the primary importance of the difference between wealth taxes and income taxes (and having exposed the pointlessness of shifting taxes around), the third major aspect of tax that really matters from the perspective of increasing economic prosperity is the rate at which taxes are imposed. Quite simply, that a tax of 40% is better than a tax of 50%; that a tax of 30% is better than a tax of 40%; 20% is better than 30%, and so on. In the words of Jean-Baptiste Say, “the best scheme of public finance is to spend as little as possible; and the best tax is always the lightest.”11

We need not spend too long justifying this as the basic reason for it should be obvious – in whatever form it ends up being paid, the higher the taxes that people have to bear the heavier will be the drag upon their incentive to produce.

When it comes to choosing precisely which taxes should be reduced, all else being equal the highest taxes should be targeted first. Given the progressive nature of the UK tax system this is going to mean, in practice, that the taxes of “the rich” are cut ahead of the taxes of “the poor”. While this may prove to be a tough sell, there are sound economic and strategic reasons for taking this approach.

First, reducing the tax penalty of the most productive persons will have the greatest economic effect. These are the people who create the most wealth – so much so that the top 50% of earners pay 90% of total income tax revenue in the UK (with 25% of the total coming from the top 1%).12 Targeting the tax payments of these people will not only rob the state of a significant fill to its coffers, but stimulating the incentives of the most productive will be more worthwhile than targeting those who can only produce enough to account for the remaining 10% of all tax receipts.

Second, targeting the taxes of the lowest tax payers first could have the perverse effect of increasing taxes overall. The reason for this is that if the majority of the tax burden falls on a minority of citizens and/or if there is a significant proportion of the citizenry that pays no tax whatsoever, then it creates the situation where a major voting block has little or no interest in the height of taxes at all. Consequently, politicians seeking election can bribe these voters with goodies that they know can be paid for by lumping extra taxes onto the minority of highest earners. As counterintuitive as it may sound to libertarian ears, if we have to put up with taxes then it might be better, in the long run, if everybody has to pay at least some tax solely to keep their minds focussed on the issue. Perhaps the most sensible approach would be a) to work towards achieving tax reductions for the most productive as a priority while b) should a reduction to the least productive happen to be offered it should not be refused.

Furthermore, there are a variety of other approaches which should be followed and championed:

  • Increasing the number and scope of tax credits and deductions13;
  • The extension and augmentation of tax-free wrappers to saving and investment vehicles;
  • Preventing the closure of any so-called tax “loopholes”;
  • As a corollary, preventing the crack down on any so-called “tax avoidance” schemes and legalising any trade or investment structure which may be entered solely for the purpose of avoiding tax;
  • Prioritising the reduction of specific taxes which are uniquely and absurdly high, such as Fuel Duty;
  • Removing cases of “double” taxation, where two or more separate taxes allow the state to leech off the same stream of productivity and serve to camouflage the true tax penalty. Within this category would be corporation taxes and taxes on dividends, which are both taxes on corporate profits; income taxes and VAT, which are both taxes on the same income; and we might also include “National Insurance” which is an additional tax on specifically earned income. Although the abolition of National Insurance is included in the ASI’s programme it does not, unfortunately, feature for the reason advocated here.

Tackling the rate of existing taxes is a far more important endeavour than trying to change the system of tax gradations – e.g. flat taxes, progressive taxes, regressive taxes, etc. – which often seems to be the focus of tax reform proposals. There are several reasons for this.

First, the type of gradation itself says nothing about the rates of tax that are imposed. For instance a progressive system with a top rate of 20% will be better than a flat tax at a rate of 30%, whereas, conversely, a flat tax at a rate of 20% would be better than a progressive tax with a starting rate of 30%. The outcome of a lower tax burden is therefore not guaranteed solely by the type of tax system.

Second, arguments for and against a certain tax gradation are usually based on concerns of “fairness” and/or take their aim at tackling other supposedly pressing concerns such as “wealth distribution”. Consequently, one’s efforts are shifted from achieving tax reduction in order to boost economic progress onto having to deal with the use of tax as a vehicle for achieving so-called “social justice”.

Finally if the aim is to lower taxes then it’s probably more straightforward to just try and reduce the taxes that already exist rather than take the circuitous route of rewriting the tax code anew and seeking reductions on top of it. Indeed, this is one of the major problems with any proposal to switch to a tax on consumption – any beneficial effect could be achieved far more easily by reducing the tax burdens that already exist.

The only possible residual economic argument in favour of supporting any particular mode of taxation is if it could be demonstrated that the different requirements for compliance may result in a lower overall taking to the state. For example, any tax which requires the taxpayer to actively submit his payment to the revenue – such as a head (poll) tax – would almost certainly result in less revenue being collected successfully compared to a method which relies on an automatic deduction, such as a withholding tax on payrolls. Unfortunately, however, while non-compliance is a boon to libertarians it will probably prove difficult to advance as a mainstream argument in favour of a particular measure.

As a corollary of this free marketers should not be particularly concerned with making taxes simpler or “more transparent” – such as point 2 of the ASI’s programme attempts to do. Although we noted that the proposed abolition of National Insurance is commendable, the reason for this was that it removes a case of double taxation. Whether one should seek to make taxes simpler for the sake of it, however, is another matter. One could suggest that doing so would serve to clarify and thus provide a degree of certainty over one’s tax affairs which will boost economic progress. Moreover, it could provide some visibility over precisely how much the state is leeching from us. On the other hand, it could be argued that a complex tax code provides a greater opportunity for loopholes and avoidance schemes to be exploited, weighing down the resources of the revenue bureaucracy as they have to expend extra effort in working out what people owe. Most likely the argument is too nuanced to give decisive support either way. Consequently, it is probably not worth including as a major plank of a truly effective attempt to reduce the burden of taxes and so indifference to the issue of complexity is probably the best stance.

Conclusion

What we can see from all of this is that a radical programme for tackling the economic burden of taxes can be achieved by focussing on three key aspects:

  • Revenue neutrality must be abandoned and government spending must be reduced;
  • Tackling all forms of wealth tax ahead of all forms of income tax;
  • Getting all existing rates of tax lower, regardless of what form they take.

None of this means that some of the more intricate differences between types of taxes should be ignored – they will all have their own perverting and distorting effects. But, for any programme that really wants to take a wrecking ball to the tax problem, the three priorities outlined here should form the lynchpin.

Finally, when it comes to the ASI, it would do far better if it based its detailed tax plan on the kind of broad rhetoric which underpins its commentary on “Tax Freedom Day” – the day in the year when the average Briton stops working to provide income to the state and starts earning for himself.14 Indeed, back in the 1980s an ASI recommendation to cut the top rate of tax from 60% to 40% was implemented successfully.15 It would truly be a victory for economic prosperity if those kinds of achievement were to recur.

Notes

1Duncan Whitmore, Is Libertarianism Utopian? https://misesuk.org/2018/07/02/is-libertarianism-utopian.

2https://www.adamsmith.org/policy

3For the avoidance of doubt, this is not a restatement of the “Laffer Curve” principle which seeks only to point out the existence of a tax rate somewhere between 0% and 100% which will maximise the nominal amount that the state can raise in taxes. Instead, we are suggesting here that, all else being equal, cutting taxes will eventually allow more real goods and services to be purchased with tax revenue regardless of whether tax rates are set at the point which gives the state the highest nominal revenue.

4https://www.ifs.org.uk/bns/bn09.pdf

5Except for repairs, which are deducted prior to calculation of the income.

6Of course, in the real world, a new tax rarely replaces another but is simply piled on top of the existing tax burden, making the situation even worse.

7For an excellent, if technical discussion, see Barry Bracewell-Milnes, Euthanasia for Death Duties – Putting Inheritance Tax out of its Misery, IEA Research Monograph 54 (2002).

8Although houses and residential property are durable consumer goods rather than capital goods, some of the effects described in this section can be appreciated by anyone who has to suffer the payment of a) council tax and b) UK inheritance tax when the primary asset in the estate is one’s residential property.

Council tax is calculated according to the value of the property, but, for practical purposes, it ends up being paid out of one’s income and represents a far larger proportion of the latter than the former. Consequently there are fewer funds available for and a disincentive towards improving and investing in residential property, and so the quality of such property will decline.

In the case of inheritance taxes, in spite of “generous” allowances to reduce the incidence of people having to sell their family home in order to meet tax bills, it may be the case that, once all allowances and exemptions are exhausted, the only way to pay an inheritance tax bill is to sell the inherited property if one does not otherwise have sufficient income to cover the charge. This problem first hit the aristocratic owners of landed estates and stately homes in the early twentieth century as their dwindling agricultural incomes failed to produce sufficient income to pay death duties. Thus, estates which had been in the same families for generations ended up being sold.

9This does not mean to say, however, that different types of tax within each category are not underpinned by different philosophical assumptions and priorities. National Insurance, for example, is levied entirely on productive work in order to fund state benefits and so is motivated by the principle of “from each according to his means to each according to his needs”.  “Sin taxes” such as duties on alcohol and cigarettes, on the other hand, are at least partly premised on the notion that certain activities should be discouraged.

10We might as well point out that, regardless of the effectiveness of a tax on consumption, it is no business of the ASI whether a person prefers to consume today instead of saving/investing. Ultimately, economic prosperity means servicing people’s needs as they actually are, not trying to change them to something else. If a person would rather consume today but, instead, chooses not to because the government would penalise that decision, then, from that person’s point of view, he has suffered a loss as a result of being denied his most preferred option. No doubt, however, this understanding is too “Austrian” for the ASI. Cf. Murray N Rothbard, Man Economy & State with Power and Market, Scholars’ Edition (2009), pp. 1170-71.

11Jean Baptiste-Say, A Treatise on Political Economy, 4th Edition, p. 449.

12https://en.wikipedia.org/wiki/Taxation_in_the_United_Kingdom.

13It is important here to denote the difference between a tax credit and a tax subsidy. Benefiting from the former means that one gets to keep more of one’s own income out of the claws of the taxman; the latter, however, means that one is paid tax that has been looted from somebody else. Consequently, tax deductions should be championed whereas tax subsidies should be resisted.

14https://www.adamsmith.org/news/tax-freedom-day-2018.

15https://en.wikipedia.org/wiki/Adam_Smith_Institute#Tax_reform

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2 comments

  • A very good and penetrating article – I particularly liked the section on wealth taxes. I do however disagree with you on a number of points.

    1. If it was the case that the only intervention by the government was taxation, then it would follow that the highest earners are genuinely the greatest producers and they are those most harmed by the State however this is not so clear in the current situation. e.g Legal restrictions to entry in a market could make incumbents incomes far higher than they would otherwise thereby making them appear more productive than they are. Whilst it would take a lot of empirical research it would seem it is the middle class which is harmed most by the State. The poor receive welfare and the rich legal restrictions on entry plus some direct corporate welfare.
    2. Tax simplification can be a means to tax reduction. If you were to subsume all taxation into a single tax (e.g. income, VAT or sales) it is highly likely you could sack many bureaucrats. Further, especially with VAT or sales added at the till at the point of sale, would definitely increase tax consciousness and would make everyone pay tax (obviously State employees still wouldn’t but you get the idea). Whilst I can see benefit of tax loopholes diverts more resources away from genuine production to accountants who just attempt to find tax loopholes. A simpler system which collects the same tax revenue but is simpler wastes fewer resources in collection and also avoidance.

    From my calculations you could fund current government spending (I know you dislike this but I think if the intention is a future reduction of tax and government spending, then as a transitional method it is fine) with a single 40% VAT on all products – with the abolition of all other taxes. This would also be good for a privacy as the State would not need to know your personal finances.

    • Duncan Whitmore

      Thank you for your appreciation and for your thoughtful comments. In response to the latter:

      Re. taxes on the highest income earners: while everything you say is almost certainly true, it is not the case that targeting the highest rates of tax would “benefit” only the super rich (a point which, admittedly, was not made clear in the essay). In England and Wales the higher rate of income tax, for instance, begins at the modest, “middle class” income of £45,001. Moreover all rates of tax, high or otherwise, have not only a “seen” effect on those currently paying the tax but an “unseen” effect on those below the tax band who are discouraged from seeking promotions and better employment/entrepreneurial opportunities etc.

      It is, however, worth emphasising that the simplest benefit from tackling the highest rates first, regardless of how “deserving” the taxed individuals may be, is that it takes the biggest axe to the portion of private income that the state can grab for itself – funds that would allow the state to confiscate directly a larger proportion of resources and direct them towards the kind of interferences that you mention.

      Re. your point that “tax simplification can be a means to tax reduction”: this possibility was not disputed. The point being made in the essay is that the arguments either for or against simplification as an aim in its own right are too tenuous and nuanced in order for that aim to be a priority. I myself tend towards thinking that the more the state has to bleed in order to extract every penny the better, and that tax accountants are not a waste if the amount spent on them is less than the amount of revenue they keep out of state coffers (nor would they be perceived as a waste to those people who get to keep more of their money as a result of employing them). But this is not a view that is worth creating divisions over and I certainly wouldn’t let it stand in the way of a programme whose explicit aim was to cut taxes yet happened to make the tax code simpler as an incidental effect.

      Indeed, the theme of the essay is not so much about what is “right” and “wrong” or whether such and such a scheme would have this or that effect. Rather, it is more about highlighting priorities – which measures would have the greatest beneficial effect upon economic progress for the least amount of effort.

      As was stated in the essay, a full critique of the proposal to replace income taxes with a consumption tax will be posted in due course (it was originally intended to be a part this essay but it just grew too long). This may answer some of the points you have made specifically in that regard.

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