Wednesday, August 17, 2011

Why A Billionaire pleads for higher taxes

In most Western countries, the rich are taxed less than the poor.

This is even though most Western politicians demand that the rich should pay more tax than the poor, both in absolute terms and also in relative terms.

Yet the fact is that these same politicians then enact policies that precisely fail to bring this about. They enact more and more detailed tax codes in order to "close loopholes" and to promote some specific social or political benefit, and with every regulation that they put into place they increase the burden on the the low and middle income earners, but not necessarily on the high income earners. Indeed some, rather self-serving, rightist politicians deliberately reduce tax rates on the rich "in order to promote incentives", as though becoming wealthy was not incentive enough.

As your economics text book will tell you, there are essentially three components to creating wealth in the modern capitalist world: Land, Capital and Labour. Of these, the the first two are insufficiently taxed- indeed Land is often not taxed at all- while the third is taxed way too much. Employees pay a huge percentage of the gains from their labour directly in income tax or indirectly in consumption taxes, to the point that- as Warren Buffet noted this week - where the very wealthy are now paying the lowest percentages of tax, since they derive a high proportion of their income from "investment" or "carried interest".

I am something of a realist when it comes to tax. No one wants to pay if they don't have to, but the rich, well advised and geographically more flexible, are far better able than the rest of us to avoid onerous taxes. Indeed, although their nominal tax rates are set higher, as Warren Buffett shows, they often end up paying far less as a percentage than the majority on middle or low incomes. So, to my mind simply getting the rich to pay then same as the rest of us would already be an achievement, and ought to significantly improve the level of tax receipts.

The first observation to make is: the simpler the tax code, the more difficult it is to avoid tax. Instead of setting multiple levels of different tax rates (remember the higher rates are more avoided anyway), I believe that we should set a simple 20-25% flat tax rate. Initially progressives recoil from this, finding it repugnant that those on say €100,000 per year should pay the same as €25,000 per year. This, they argue is morally and economically wrong.

I have two answers to this mistaken analysis, firstly keep in mind that the rich currently pay less tax as a percentage than the poor; secondly, if the tax free allowance was set at- say- €12,000 then the individual earning €25,000 is paying tax on €12,000, i.e. half their income, while the individual earning €100,000 is paying tax on 88% of their income. Set the tax free allowance higher, and the tax becomes highly progressive. The point is that it is progressive, not because the richer are supposed to pay a higher rate, but because the poorer are increasingly opted out of tax altogether. The simplicity of this regime eliminates the need for the vastly complicated and hugely expensive system of tax credits which are supposed to help the poor, but in reality do little to improve social conditions and often remove an incentive to work. The key is to set the tax free allowance sufficiently high.

If the taxation of income could be simplified and made genuinely progressive, that already helps the poorer, whose position, vis-a-vis the richer in the West has been eroding for at least the past three decades.

The second improvement, to my mind, should be to tax capital in a simpler way. It seems to me- and to Warren Buffet too- that income derived from the investment of money is not truly different from income derived from the investment of time (i.e. labour). The distributed return of capital invested is income, and should be taxed in exactly the same way as income derived from labour is already. Some argue that this might reduce capital invested and thus damage the economy, but the fact is that capital is already taxed, and no matter what the tax rate, investment capital is little affected: far more significant is the general condition of the economy, both global and local. Since no one - except some of the more extreme supporters of the so-called Tea Party in the US- seriously proposes to end the taxation of capital altogether, I submit that a simpler tax regime might promote new investment, simply by eliminating distortions: retained earnings: not taxed, distributed profits: taxed as income.

Then, finally, there is the highly vexed issue of Land. For many, a Land tax has a rather quaint air, yet even today in the UK, the possession of large holdings of land defines wealth far more accurately than capital does. Huge holdings of land in the UK are not subject to tax, and yet large incomes are derived from them. This is where so much special pleading has distorted the British economy significantly. Less than 10% of the landmass of the country is built up and only 1.3% is devoted to housing. Yet this represents well over 90% of the tax take from property. Substantially all of the remaining 90% of the surface of the UK is subject to nothing more than peppercorn taxes. If it is agreed that capital and labour should be taxed, then why is land totally exempt? It is not an accident that the biggest opponents of a land tax and some of the most vocal supporters of the green movement are large landowners. Behind the cant they offer up, the fact is that their "stewardship of the countryside" is nothing more than giant special pleading. Huge subsidies are offered to agri-businesses, and as a result much of the countryside is disfigured by mono-crops and industrial tillage. A green agenda could be far more effectively delivered through a flexible tax regime than any other policy framework.

As a significant benefit, a land tax shows that we are actually serious about protecting the countryside, and promoting a sustainable housing policy. The current, horribly distorted land policy means cramming in more housing on already densely populated areas, while village communities are becoming ever less attractive as institutions such as pubs, shops and schools become uneconomic. A land tax makes a policy of flexible and sustainable development far easier.

So there you have it, a fairness agenda in tax is not about higher nominal rates of tax for the rich, it is about ensuring that it is simply easier and fairer for the richer to pay than to avoid. By attempting to promote "progressive taxation", we have in fact promoted a highly unfair (and very expensive) regressive taxation. With a clear tax code, then the idea of attempting to opt out of taxes becomes socially far less acceptable- since most people will understand that it is not about opting out of higher taxes, but opting out of tax completely. Of course people like Phillip Green can already do that, but with a simple flat tax on capital and income, he would find it far more difficult and far less socially acceptable than he does today.

In the end I slightly admire the -in my view- public spirited way that Warren Buffet has pointed out the outrageous unfairness of the current system. In Britain, it is time for the Liberal Democrats to stop grandstanding on tax rates and get serious about promoting a truly radical, truly fair tax agenda. A Flat tax/Land tax agenda can promote this.

Are their working examples already out there?

Absolutely: Welcome to Estonia!

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