Monday, December 1, 2008

Taxes, Taxes and More Taxes


Note: If you are new to this blog, I would not recommend this post as a starting point, as the necessity of the proposed reform makes more sense in the context of broader economic problems. There are some links to the left which offer an introduction to some of the key themes of this blog, and you may want to read these first.

As promised, my post on taxation reform. The purpose of this post is not to discuss rates of taxation, but rather to discuss how we are taxed. As you will see, my argument is that the current system is wasteful and distorts behaviour. Somewhere along the line, it seems that governments forgot what taxation is for, which is to raise revenue to fund their operations.

It is a bit of a dry subject (even though taxation methods have inspired revolutions!), and this is perhaps reflected in my post. Please accept my apologies for this, but I hope that it is nevertheless worthwhile.

The Business of Taxation

Before writing this post, I took a look at the online yellow pages and typed in the word 'tax' to see what would be returned. Having followed some links I found these business services for taxation; tax returns, tax planning, corporation tax, tax advice, tax mitigation, inheritance tax planning, capital gains tax, income tax returns, VAT, self-assessment (offering a service for tax self-assessment is an oxymoron, I think), payroll tax, tax consultancy, tax investigation and tax savings. There were many more...and huge numbers of results.

Having looked at the business services for taxation, I thought I would look on an online job site (Monster UK), and found 673 jobs under the word 'tax' and 307 for VAT. You can compare the number of tax jobs with the 2,300 for 'manufacturing'. In this search, for every two manufacturing vacancies approximately one vacancy for administering taxation was found. It seems that there is something distinctly unbalanced in the jobs market.

Job titles for the tax job search were; Tax Manager, Tax Senior, Manager Indirect Tax, International Tax Planning Manager, Manager Indirect Tax, Head of European Tax Structuring, Technical Tax Manager and so forth. The few jobs that listed salaries had very high salaries. For VAT they were VAT Senior, VAT Manager, VAT Consultant, VAT Assistant and so forth.

To give a sense of scale in the public sector, there are 95,000 employees at HM Revenue Customs and Excise (HMRCE). The cost of administration of HM Revenue Customs and Excise is £4,499,000,000. To these numbers, we need to add the massive army of individuals involved in local taxation....or, for example, the cost of the army of workers in vehicle taxation. In the private sector, the numbers are more difficult. For example, The Chartered Institute of Taxation lists nearly 15,000 members, but the Institute of Indirect Taxation does not list member numbers, and these are just the tip of the iceberg of tax related professionals. If you look at the numbers of vacancies, and the membership of the institutes, you will get the picture....There are a lot of people who work in the private sector taxation 'industry'. Aside from the tax specialists, many accountants will have training and some expertise in taxation, and will help their company/clients in management of taxation. All of these individuals will be devoting their time, and directing their training, towards the management of tax.

In other words, the combination of the private and public sector employment in the business of taxation, and the amount of money spent on training in, collecting, avoiding, managing, and complying with taxation is substantial. However, what the numbers do not account for is the fact that many of the individuals who work in taxation will be, by necessity, individuals who are well educated. As such the value of the loss of these individuals from other activities will be disproportionate to the actual numbers. The reason why they need to be well educated is detailed next.

Complexity of the System

I downloaded a summary of all the receipts from different taxes from HMRCE with the rather silly hope of listing all the different categories of tax, but there were just too many to list. Have a look here and you can download an Excel file, or you can find some examples of the types of taxation in the 2007 UK Government Budget Report here. Take the time to look through it, and you will see that there are more different taxes than first is apparent. On top of this, there is local taxation.

Essentially, all of this amounts to a complex tax system, with this just one example of the many complaints about the resultant complexity (from Acountancy Age):
'Chas Roy-Chowdhury, ACCA head of taxation, said the Treasury’s explanatory notes for the finance bill alone ran into 1,148 pages, but the actual Bill was 113 sections long and about 440 pages in total.'
Another article here details the growth in complexity of the tax system:
Tax compliance doesn’t get any easier. According to figures compiled by the World Bank, the number of pages of tax law in the UK has more than doubled in the last ten years from 3,700 to 8,300. So it’s not surprising that most finance directors complain about the amount of resource they have to devote to the work.
Quite simply, the system of taxation is frighteningly complex. There are huge numbers of taxes, all with their own rules, their own systems of inspections, and an army of individuals working in the industry of complying with the rules.

Cost of the Complexity

I have found some figures for VAT compliance costs, compiled in 1998 (figures taken from here). The cost as a percentage of turnover is; for a business with a total turnover of between £20,000 and £50,000 = 2%, £half a million to 1 million = 0.5%, and larger businesses 0.2%. The overall cost was just over 1% of business turnover.

If we take the costs of administering payroll taxation, we find similar problems:
'We have found compliance costs to be a significant factor in business costs.
Moreover they are a cost which increase with scale, but are subject to significant
economies of scale. Apart from the number of employees, the econometric
analysis also suggests compliance costs are directly proportional to (i) ‘disturbance
variables’ such as labour market flows, (ii) ‘complexity variables’ as proxied by
the average wage and the number of casual workers and (iii) the ‘frequency’ of the
payroll as measured by the number of workers paid on a weekly, as opposed to,
e.g., a monthly basis.' (1)
I wanted to find a simple number to give a sense of the cost of managing payroll taxation, and found this from a commercial concern (which therefore may be considered a bit of a dubious number, but does not look too different from some of the academic studies that I have looked at):
'Research shows that it costs the average UK business £350 per year per person to administer their own in-house payroll.'
I am not going to labour the point with any more examples. The point is very simple. All of these individual forms of taxation, the volume of taxes and allowances, and the difficulty of understanding and complying with the tax system is quite simply horrendous and expensive. I would love to find a figure for how many individuals are either directly or indirectly involved in the management, planning, collection, mesurement, prosecution of all of these taxes, and what the total cost might be. However, whilst no such figures exist (that I can find), it is very clear that the whole business of dealing with taxation is an 'industry' in its own right.

What is Tax For?

I say an industry but, of course, all of this 'industry' does not produce one single thing of any value. All it is doing is shifting around the value that is created by others. Every single person employed within the tax industry is not working in a productive role in the economy (excepting those who are working to help UK companies avoiding taxes in other countries), and there are armies of people involved in this work. For the lucky few who have taxation experts, it is possible to avoid paying too much tax, but for the majority, the system is quite simply too complex to think about.

Perhaps the most disturbing part of the whole system is the reason why it is so complex. On the one hand part of the complexity is the use of stealth taxes in place of open taxation for personal taxation, and on the other hand it is complexity to change the behaviour of both businesses and individuals. I am not going to go over all of the uses of stealth taxes, because there are plenty of others that have undertaken this task. Somewhere, somehow, the government forgot what the purpose of taxation actually is.

Complexity in Practice

What I will do, is take a couple of simple examples of overly complex taxes that most people will be familiar with. Let's take the example of car taxes. Why are there two different kinds of taxes on the use of cars? On the one hand there is the variable tax on CO2 emissions, and on the other hand there is the tax on petrol. Assuming that the aim is to reduce emissions, surely the latter tax is a good proxy for emissions. Why have two forms of tax collection? The answer that will be given is that former ensures compliance with other laws, such as MOT (fitness of the car for use, for those not familiar with the UK) compliance. However, at what cost in administration? According to the accounts for 2007-8 of the Driver and Vehicle Licensing Agency, the cost of operations was £541,818,000,000. I have looked at their published accounts, and the cost of administration of the vehicle tax is not separated from other costs. However, it is a major part of their activity, so will be a substantial proportion of that total.

Another example is the variable duty between different kinds of alcoholic drinks. Someone somewhere has decided it is better to provide incentives for people to drink one kind of alcoholic drink over another. Why? At what cost in additional complexity? By way of explanation a report will be produced saying that x type of alcohol is less harmful than y.

The same goes for businesses, with capital allowances (13 categories and endless sub-categories), and all kinds of other incentives for businesses to do what the government believes is the 'right thing', such as R&D credits (100% allowance) and so forth. What we have here is the government saying that it knows better than a company how that company should allocate resources. Why? Are the government more knowledgeable about how to run Unilever, than Unilever are? The government seems to believe that it 'needs' to provide incentives. Surely a company knows when it needs to make an investment.

A good example is R&D. The first point to make is that the total amount of tax paid in corporation tax is going to be the same, as any losses made due to taxes not being paid through R&D investments will just be extracted from elsewhere. This means that a company that is not spending so much on R&D subsidises a company that is spending on R&D. The result is that the post-tax profit at the company not investing in R&D are reduced in order to fund the R&D in another company. Why? Why is it that one company is subsidising the R&D of another company?

To make the point clearer, think of it this way, in a simplified form. The government wants 100 units of corporation tax per year and there are a total of 100 identical sized companies paying corporation tax. On average, therefore, each company must pay an average of one unit of corporation tax. Amongst all of these companies, 20 of the companies do a lot of R&D so that they then each get an allowance of half a unit of tax back, making a total of 10 units lost from the 100. What then happens is that every other company must now pay 1.1 units of tax instead. In other words, some companies are subsidising the R&D of other companies.

But R&D is a good thing, right? That is what everyone says......for example, the government says in the 2007 Budget Report:
'Supporting science and innovation which is central to success in the international economy, as global restructuring focuses developed economies toward knowledge-based and high value-added sectors'
Let's examine one of the companies in this example that is not spending heavily on R&D. Let's imagine that they would like to make a sales drive to expand into new markets in Europe. They want to spend considerable amounts of money on developing their brand throughout Europe. The trouble is that they need to keep profits at a certain level to keep shareholders happy. As they are now paying an addition 0.1 units of tax, they are more constrained in their ability to invest in their expansion into Europe. In particular, the reduced amount of profit makes raising the money for the expansion more difficult, as their returns are lower than the companies spending heavily on R&D. The companies spending on R&D get tax relief, but the spending on brand building does not qualify. Even though the expansion into Europe would make them a more successful company, the tax system does not see it that way.

In this example, spending money on R&D (whether a good or bad investment) is considered a better business investment than building an international brand. The fact that both routes might equally create growth, and bring wealth to the UK, does not figure in government thinking. The fact that branding can add significant value to a product (the aim of the government R&D tax allowance is to develop high added value) is irrelevant. Instead of expanding into Europe, the company is instead directed into spending on R&D, which may not be the best approach for the success of their business. The expansion into Europe may the better use of their resource to achieve long term growth and profit, but the government knows better.

In all of this, the single unifying theme is that the government knows better. As such, they know better than you or I as to whether we should drink a pint of beer, or a shot of whisky. They know better whether a business should invest in building a brand or invest in R&D. They have lots of policy advice that says so....

The Total Tax Required is the Same, Whatever the Source...

I have tried to put forward an argument that covers several points:
  1. There are huge numbers of highly educated individuals working in both the private and public sectors to manage the system of taxation, and these individuals are a major loss from productive activity
  2. The costs of administering taxation are quite startlingly large, even if there are (apparently) no figures for the total economy wide costs.
  3. Each tax has its own justification, and can be justified in its own right, but when taken collectively, they create huge complexity and cost.
  4. Many of the taxes are either taxes to avoid telling people how much tax they actually pay, or are taxes aimed at influencing behaviour. In the case of influencing behaviour, they can be based upon appealing but false assumptions, as in the case of R&D tax relief.
At present, the government raises their revenues from a huge range of taxes but their aim each year is to achieve a predetermined budget for all government revenue. This revenue (unfortunately in combination with borrowing) provides the income for operations and activities of government. The source of that revenue is irrelevant to achieving the operational objectives of government in the provision of services such as health care, law and order and so forth.

What I would like to do is to return to the example of the 100 units of taxation, and extend this idea somewhat. Instead of 100 units of taxation being collected from corporation tax, we will now say that the government needs to collect a grand total of all taxation of 100 units (If you want to see an actual breakdown of taxes and where taxes come from, see here for the budget report).

The question that then arises is how to efficiently gather the total of 100 units of tax at minimum cost to both the public and private sector. The solution to this is relatively straightforward and leads to two methods of taxation; single flat taxation and hypothecated taxes.

A hypothecated tax is one in which the revenue from a tax is dedicated to the activity from which the tax is raised. For example, in the US, petrol (gasoline) taxation is used for the provision of transport infrastructure, and is not put into a general fund. These kind of taxes make sense where the government is providing a service which has variable and discretionary usage, such as using the road system. In the case of a tax on petrol, the greater the usage of the infrastructure, the more tax that is paid by the user (I would suggest road pricing as an alternative, but this has civil liberty implications).

The other proposed method of taxation is a single flat taxation. This is where there is only one source of taxation for all non-hypothecated tax, and that where there is only one rate of taxation. This means that there are no allowances, no variable bands and so forth.

At this stage, a flood of objections will be pouring forth in your thinking, so I will ask you to bear with me, whilst I (hopefully) answer all of your objections.

Objection 1: The rich should be taxed more

The idea of taxing the rich more is often called 'progressive' taxation. Before discussing this, it is worth noting that the expression 'progressive' is actually a slogan, not a description. To be against progressive taxation implies that an individual is 'regressive', and nobody wants to be called regressive.

At this stage, I would like to abandon these terms progressive and regressive, as they have technical meanings but also have connotive implications. What I would rather do is focus on outcomes to individuals. The first point is that in introducing a single flat tax, sales tax disappears. Sales tax has a disproportionate effect on those with lower to middle incomes. Another example (amongst many) is air passenger duty. As a flat fee, this has a disproportionate impact on the income of the lower paid when, for example, they want to go away on holiday.

Another good example is rates, in which the value of a property determines the level of tax paid. However, the value of the property and the income of an individual are not always correlated, and the proportion of the income of a wealthy individual/family paid will often be lower than income tax rates. Quite simply, it is an irrational method of taxation that is actually very difficult to justify. For example, one family may forego holidays, and other luxuries, preferring to spend their income on a better house. Why should those people be taxed more than people who choose to live in a lower value property, but spend their income on holidays and luxury goods?

The second point is that flat taxes also allow for an individual tax free income allowance. For example, at present the allowance for each individual is £6,035. Raising or lowering this rate can have a very significant effect on the low paid, but has less and less impact for people higher up the income scale.

Objection 2: What of Corporation Tax - Companies Must be Taxed, Mustn't they?

I have yet to see a convincing argument for why corporations should be subjected to a general taxation on their profits. I would agree that there are certain hypothecated taxes to which they should be liable, such as disposal of rubbish and waste, but why should the profits of companies be taxed?

The first problem with taxing companies is that it creates huge complexity and leads to activity dedicated to ways of making businesses tax efficient (avoiding tax). These activities and incentives create distortion in the behaviour of business. If we remember that there are only so many units of taxation to be collected, trying to manage and calculate tax is an example of huge and unnecessary complication. We have come to see this complex system as perfectly normal, and to even suggest otherwise appears a little shocking.

If we think about it, corporation tax simply does not make any sense at all. If we think of a large public company, when it makes a profit, it is the shareholders that benefit. This is typically pension funds, life insurance and so forth, who act as proxy shareholders for individuals. As soon as that profit is transferred to any of the shareholders, that profit becomes income for those individuals. The simplest way to tax the corporate profits is at the point that the profit translates into income for individuals. At its most simple, the profit of a company only becomes meaningful for taxation when it is translated into profit for individuals (i.e. as a simplistic illustration, when the profit is moved from a corporate bank account into an individual's bank account or pocket). A company might make monstrous profits, but an individual only becomes rich at the point that those profits are transferred into income for that person as an individual.

A company is not a person, so there can be no 'social injustice' in big company profits. For those who argue about social injustice in big company profits, they are confusing the idea of individual income and company profit. The only time that income disparities between individuals arise is when company profits are transferred to an individual. It really is that simple.

So what would be the effect of removing corporation tax entirely. The first point is that it would make employment of individuals more expensive. This is because the tax burden shifts onto income tax, such that the compensation necessary to offer a person a living wage must rise. The actual amount of total tax taken by the government has remained the same, but has been displaced from corporate tax to income tax. At this stage, it might be argued that this will lead to unemployment. However, in making individuals more expensive, the focus of companies will be on ensuring the high productivity of individuals that they do hire.

With no corporation tax, there is a combination of a goal to focus on generation of profits, and a goal of achieving high productivity due to the cost of individual employees. This is essentially the most basic definition of the fundamentals of business success, and the basis for business growth. Whilst there are many other factors that make business successful, these are two very basic elements. In removing incentives based upon taxation, the company can focus on what business is supposed to focus on, which is the efficient management of the business. As well as allowing business to refocus on what they should be doing, the saving of resources in not having to manage tax will be quite substantial, as is evident from the earlier points in the post.

It is worth mentioning that there are some people who seem to believe that a business that makes large profits, and is highly successful, is somehow a bad thing. However, the entire wealth of a country depends upon successful businesses, and in particular businesses which export goods or services. In allowing business to focus on what matters the businesses will prosper and grow, and will in the medium to long term lead to greater employment and higher wages. Employment and wealth can only be the product of successful business....not of anything finances everything directly or indirectly, as it is the only activity that (legitimately) creates wealth. Even when an artist creates a masterpiece, this is business - the artist has created a product with massive added value. When a nurse in an NHS hospital treats you, the root source of her pay, and the hospital is business activity. When your child goes to a state school, if you trace back the source of the money financing the education, it is business that has financed everything. A successful business sector is the source of all wealth.

If corporation tax is removed, it should be remembered that the total fixed amount of taxation has not changed. It has just moved. If you doubt the effectiveness of no corporation, look at the success of export processing zones that have been set up in developing economies. I am really not sure why anyone has ever thought taxing business was a good idea in the first place. It seems that the idea of taxing business is built in part upon the idea that 'they always have been' and that big profits in business is just intrinsically bad. I have never seen any sensible justification for why profit in business is bad, or why they should be taxed (excepting hypothecated taxes).

Objection 3: What about taxing alcohol and cigarettes? Surely that is a good thing?

This is an interesting point. We can all agree that excessive use of these drugs causes illness, and costs to the health service, as well as negative social effects, such as drunken bad behaviour.

To deal with the first problem, which is negative health effects, if we were to follow this line of thought to a logical conclusion, why stop at alcohol and cigarettes? For example, horse riding is a shockingly dangerous activity. What about base jumping, with even more horrendous outcomes. Why not tax these? Within the taxation of cigarettes and alcahol, there is a hidden moral agenda. There are many activities which are potentially injurious to health, but nobody suggests that these should be subject to taxation. No doubt, some readers will be spluttering into their coffee at this point. However, I would ask you why it is that the damage done to an individual, with possible knock on negative effects for their family, from a horse riding accident might be different from a person who smokes and later becomes sick from their habit?

In the case of alcohol, unlike horse riding, there are other effects, such as drunken and disorderly behaviour. However, this is not a matter of taxation, but of enforcing the law. If the law can not manage this problem, then there is a problem with law, not with the system of taxation. In other words, identify where the real problem lies, and deal with that problem. At its most basic, why should a responsible drinker have to pay high taxes to ameliorate the actions of an irresponsible drinker. None of us like the state of our city centres on a Saturday night, and many of us accept the endless climb in taxation as it is supposed to stop the problem. It is evidently not stopping the problem as, even while taxes have soared, the problem has become ever worse. The problem can only really be managed through the law and effective policing, and this is where the problem resides. In other words, taxation is being used to make up for the failures of other areas of policy.

The fundamental question here is, what is taxation for. It is for raising the necessary operating revenues of government or is it a tool of law and order? It is this confusion over what tax is for that creates the complexity. The tax system has been turned into a system to control behaviour, which should not be the function of taxation.

Flat Tax in Practice

To date, no country that I am aware of has yet implemented a flat tax as radical as that which I am proposing. However, many countries have made moves in this direction. A review of flat taxes by the Economist, which can be found here, finds that there is considerable debate about how effective flatter taxes actually have been:
'Two main reasons have been advanced in favour of the flat tax: that it strengthens revenue collection, and that it encourages investment—domestic but particularly foreign—through a simplification of tax rules. Although east-central Europe has in recent years enjoyed strong economic growth, boosted in part by copious inflows of foreign direct investment (FDI), it is difficult to quantify empirically the impact of tax reforms—including the introduction of a flat tax rate. Some studies suggest that the increased compliance, tax revenue and labour supply that proponents of the flat tax cite as its main advantages have either been absent, or have been as much the product of other reforms (such as stronger tax code enforcement).'
The problem here is that it is difficult to isolate the influence of flat taxes from other policies, and therefore it is impossible to quantify the benefits. As the Economist quite rightly points out, there are enthusiasts for flat tax, and I might quote some of them here. However, to do so would be to present evidence that can never be conclusive, as there is always the possibility that someone can argue that other policy has been responsible for the benefits.

It is for this reason that I have started this post as I have done. When it is possible to find one tax management employment advertisement for every two manufacturing job advertisements, it becomes apparent that something is wrong. When we view the high salaries of tax professionals, we know that there is considerable talent being misdirected into areas of activity that are not productive. When we see the costs and complexity of implementing and managing the taxation system, we have to ask about how much this must hinder the activities of businesses.

Above all else, there is a simple principle. Taxation is supposed to be about raising revenue for government to finance government activities. At its most basic, the government needs to raise x units of taxation to fund that activity. The taxation might come from any number of sources, but the obligation of the government should surely be to make the raising of those taxation units as simple and as transparent as possible. The use of the taxation system to alter the behaviour of individuals, and the use of 'stealth taxes', exceeds the basic purpose of taxation, and just creates endless complexity and cost, as well as removing transparency.

A flat income tax, and hypothecated tax, offers a simple and fair means of taxation. For those that argue that the poor should pay less tax, tax free allowances are a simple and fair solution. For those who argue that the tax system should be used to influence behaviour, the examples I have given show that the approach is inconsistent and also unfair. Why should I pay more for a pint of beer because some idiots behave badly when they are drunk? I do not behave badly, so why should I pay for their behaviour. Why should a person be taxed for their pleasure in smoking, when other activities carry huge risk, but they are not taxed as such? Why should my company subsidise the R&D of another company? Why should I pay more tax because I choose to spend my income on a better house, rather than going on holiday every year?

It is when we ask these questions that it becomes apparent that the tax system has become unfair and inconsistent. Not only is it unfair, but it leads to a massive burden on society. All of the money and activity devoted to the monstrous taxation system could be redirected into productive activity and, instead of being a drain on wealth, could be utilised in the generation of wealth.

As with my posting on energy, I do not expect this post to be well received by some readers. It is a radical solution that goes against many assumptions. However, I would argue that we have become fixated on the current method of taxation as a matter of habit. In some cases that habit is combined with moralistic overtones, such as taxing smoking. In these cases, the use of arguments about health become a fig-leaf for the moralistic sub-agenda, or to avoid facing policy failure in other areas.

The principles that underlie this post are very clear; taxation should be simple, efficient, consistent and transparent. I would challenge anyone to suggest that the current system meets these objectives.

(1) Hudson, J & Godwin, M 2000, 'The compliance costs of collecting direct tax in the UK: An analysis of PAYE and National Insurance', Journal of Public Economics, vol. 77, no. 1, pp. 29-44.

(2) Griffith, R & Klemm, A 2004, 'What has been the Tax Competition Experience OF THE Last 20 Years?' Institute for Fiscal Studies and University College London.

Note 1: I will freely confess that I do not know the full complexity of the operations of the current tax system. As such, I hope that I have not made any errors in detail, but I would hope that the principles of my argument will nevertheless stand. As I have pointed out, the complexity of the system is such that only those trained in taxation can fully understand the system of taxation, in particular corporate taxation. I therefore welcome corrections from those who have been so trained. However, try not to be too hostile, as I am aware that my solution would not be helpful to those of you who have made such efforts to learn the system. For those of you who have been trained in taxation, although it would undo the utility of all of the hard work undergone in the study of taxation, would you not rather prefer to be doing something more constructive? More productive? This is not a criticism of your work and hard studies, but rather that your talents and abilities are being wasted. If you can learn and manage the tax system, you clearly have great potential, and could use your talents in far better ways.

Note 2: There has been some discussion of the IMF in the comments on the last post that I wrote. Jiri points out that an IMF bailout of the UK would come with strings attached, and Lord Sidcup correctly questions whether the IMF finance cupboard will be bare. The basic problem is the question of who can finance the IMF, when the traditional finance providers have their own problems, so that the IMF can finance bailouts. Again, Lord Sidcup is correct when he suggests that the winners are those who had their crisis sooner than later!

Note 3: An anonymous poster has described me as 'scary'. I hope that it is my analysis that is scary, rather than me. My intention is not to scare, but to offer the best analysis of the situation that I can. Whether that analysis is right or wrong, only time will tell. My aim is to offer an alternative to the 'quick fix' solutions of government which are self-deluding and will cause long term damage. My aim in the posts on reform is to offer possible solutions to the many problems in the economies of the West, and I actually believe that, if we do reform, we may go through pain now, but will eventually return to wealth. I am not sure that my solutions would succeed, but hope that they would, at the very least, offer better long term solutions than those of the 'quick fixes'. I am sure that others might have better ideas, and welcome any contributions that can be offered. Steve Tierney sums it up in a comment on my last post:
'That's exactly what we need to do. Live lean, work hard, and what spare revenue we do have must go into Industry and Agriculture (the 'big two' in my opinion.) A government that concentrated on those would be very unpopular, because times are going to be hard indeed, but in the long run they would be vindicated.'
The key point here is that we have to pay the price for our errors, face up to them, and seek to avoid continuing on the same paths that created the problems.

Note 4: Paul provided a link to an article in which the pay differentials between the Japanese auto workers is highlighted as follows:
The Republicans left the closed-door meetings after the UAW union refused to cut wages next year to bring them into line with their Japanese counterparts. UAW's current contract with the car makers expires in 2011.
What we have here is the refusal of the union to face reality. It seems they would rather see their employers bankrupted, rather than accept that they need to reduce pay.

Paul also offered a defence of the printing of money. I had hoped that my post illustrated that it is not possible to magic money into existance. The idea that the government can literally create something from nothing has to be illogical. It is, quite literally, an impossibility. In this case, the printing of money is only possible at the cost of destroying the value of each unit of money. There is no more value created, just a redistribution of value, such that the value is spread more widely accross a greater number of units. It is the appearance of creation, not actual creation. It makes no difference in the real world, excepting that people lose confidence in the value of money, as the value of each unit of money reduces. In so doing, it destroys incentives to save or invest. It encourages capital flight to places where the value is retained. I have discussed this before, so will not labour the point here again, but as soon as governments print money, they are on a very dangerous road indeed.

Another commentator, Jonny, has kindly offered a link to an article, which is expressing the risks inherent in money printing. It is a very good article, in that expresses very clearly that, one way or another, the printing of money will eventually lead to massive inflation. I also rather like the way the author identifies money printing as a form of taxation, which fits neatly with this post. If you think about it, money printing is a form of taxation. The government is taking the value of the currency you hold, and transferring it into the currency that they are printing. That is a form of taxation. They are transferring your wealth into the newly printed currency (thank you for an excellent link, Jonny).

Note 5: DZ asks the following:
'Just thinking that Argentina did default on their international loans a few years ago... has there been any studies to see how well they have recovered from it?

Could this be the model that western countries can follow?'
The answer to this question can be found in an article in the Economist here. I am a subscriber of the Economist, so am able to see all of the articles. I do not know whether this article is publicly available, but a good summary of the position is in this quote:
'While Argentina’s diversified export markets buffer it somewhat from the US recession, it has proven one of the most vulnerable countries in the region to the international financial crisis. Its exports to the EU are falling and commodity prices have plummeted, yet it has no access to international credit to help it fill the shortfall (this is due to ongoing problems related to its debt default of 2001—at US$95bn the largest sovereign default in history). Argentina’s several years of rapid economic growth were largely the result of an export bonanza and historically high prices for soybeans, but the price of this product is currently at about USD$300 per ton, half of what it was in June 2008. And, having been locked out of international credit markets, will have difficulty meeting payments on its US$28bn in debt, which comes due over the next three years.'
Interestingly, one of the positives of restriction to credit is that governments are unable to borrow (obviously). I am against all government borrowing, full stop. In the case of Argentina, the underlying problems in the economy become apparent when the credit taps are turned off. If Argentina could borrow more, then the government could hide the problems in the economy. In the case of countries like the UK, government borrowing is just such a hiding of the underlying problems. It may make a government popular in the short term but.....the price will be paid later.

The only reason I do not want the UK to default is that continuing credit is needed to whilst the country transitions in face of new economic reality. It is why I suggested a five year period in which to return to surplus. It is not that I believe borrowing is good, but rather that it will ease the shock and, more importantly, it will take time to trim all of the fat (blubber) from government spending.


  1. This was very, very interesting - here in Hungary this system may well be adopted in some form and this is the best, most thorough explanation of the flat taxation system I have read.

    After reading articles by Dr. Michael Hudson, I'm minded that the problem that the UK and other economies face with taxing the wealthy is not the rate at which their income is taxed, but the fact they increasingly arrange their affairs in order to have no taxable income at all.

    In view of this, how do you view such tax avoidance by individuals and the use of "tax havens"?

  2. Very interesting and well thought out. One thing, you mentioned tax free allowances - they would add massive complication and cost to a flat tax. I would propose that negative taxation would cover any free allowances, make the system simple and possibly finish up adding to the amount of tax collected.

  3. Mark

    As a devotee of free markets, what is your opinion of business monopolies? Possibly by a fluke, rather than by providing a good service, a company can gain a one-off advantage over its rivals, but from then on use financial muscle to shut down the competition. In the end I would guess that this suppresses potential prosperity.

    I don't know the details of how businesses are taxed, but I wonder if part of the justification is to help keep the playing field flat for weaker companies. Again, if this were the case it might be an example of using taxation for a purpose other than which it is ostensibly intended, but at least it would be an automatic mechanism and not arbitrary and subjective, unlike relying on a commission to pick on companies because they think they may have seen some uncompetitive practice.

  4. (I think I meant "anti-competitive practices" not "uncompetitive")

  5. Mark

    Not unrelated to my previous comment, here's a quote from someone writing about the Great Depression.

    "As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth — not of existing wealth, but of wealth as it is currently produced — to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”

    Eccles, Marriner S. 1951. Beckoning Frontiers: Public and Personal Recollections (New York: Alfred A. Knopf): p. 76

    It sounds quite plausible. One interpretation of it would be that the 'trickle down effect' is a myth; there's only so many plasma televisions and cars that a man can use. The billionaire then spends his money on 'investments' which suck even more money out of the pockets of the little people until the system collapses.

    I think there is something in this. As with financially powerful companies, rich individuals cannot help but become richer, but not necessarily by doing anything productive. They distort the economy, in the end perhaps threatening its actual existence.

    Perhaps one of the ideas behind progressive taxation is to self-limit this effect which, in turn, may result in more prosperity for all.

    Do you think there is anything in this? If so, but you didn't want to use the taxation system to correct it, what other mechanism could be used?

  6. Given that 'National Insurance' is really income tax in disguise our existing income tax regime can hardly be described as 'progressive' anyway in the usual understanding of the term.

    The common focus on marginal rates of income tax rather than effective rates conceals how flat rate income tax combined with a larger tax free allowance would genuinely result in the rich paying a higher rate of tax. Suppose, for the sake of argument, a universal tax-free allowance of £15,000 and a flat tax rate of 60%. Someone earning £15,000 pays no tax, someone earning £20,000 pays 15% tax, someone earning £30,000 pays 30% tax, someone earning £100,000 pays 51% tax, etc.

    A sufficiently high allowance would (a) save administrative costs by collecting tax from far fewer people, and (b)remove the need for many benefits & (hopefully) the absurd bureaucratic nightmare of tax credits. No sane society would means-test all parents earning up to around double the national average in order to pay them a tax credit, but the UK does!

    You question the justification for corporation tax. It seems reasonable to me that businesses should be taxed to compensate wider society for having to bear the costs of their externalities.

    You appear sympathetic to hypothecation. I think this a bad idea: administering it would require new rules of ever increasing complexity and a vast bureaucracy to run it.

  7. This is great Mark.

    Two comments. First briefly, you suggest that helping a UK company avoid foreign tax is useful to 'the economy' - it's only useful to the UK part of the economy, it seems to me to be a drain on the world economy.

    Secondly, I mentioned this a while ago but I dont think you picked up on it, is the idea of replacing all benefits and unemployment insurance and state pensions with a 'citizen income' which would be administered through the new streamlined tax system. So instead of a 2 tier scheme as Chas suggests (personal allownace / flat tax) you have a 3 tier scheme. So for example every person recieves an annual lump sum from the state of say £5,000. On top of that they have a personal allowance of £10,000; and on top of that they pay a flat tax of 60%. These are completely made up numbers - I have never seen any sane analysis as to whether this is an economically viable alternative to the current benefits system, and what effects it would have on incentives for unemployed / ill people to take on work. I also think it could allow for massive scaling back if not abolition of government grants to e.g. artists, business startups, etc. as all these individuals would be at liberty to do their own unwaged work and not starve. Does this make sense or am I havering?

  8. Who bears the burden of progressive taxation? For example, if we consider the employees at a supermarket, they and their payroll taxes are a cost to every consumer buying at the supermarket. That must be the case since the company's only source of revenue is its customers. Thus, the total company payroll tax bill is a percentage cost of every sales price on average.

    Therefore, who is considered to pay income taxes? It surely cannot be the individual employees through their payroll deductions as we can see that they are essentially collecting tax from consumers and passing it on directly to government, without it even touching their own pockets. The great delusion is that by this taxation strategy employees think that they are paying tax, but those employment taxes are translated into equivalent sales taxes and so are all taxes involved in the chain of production down to the consumer.

    No, the real taxpayers are ultimately and entirely the retail consumers.
    And, the real equivalent sales tax is the same for everyone rich or poor. That is the extent of progressive taxation on incomes. Some might see it more as political.

    It is almost self evident that any scheme of taxation on producers can be financed only by their paying retail customers at the end of the supply chain and it will always be in proportion to individual customer spending. Therefore, we are already subject to taxation of our consumption, but it is imposed by the back door in a hugely complex, expensive, intrusive and convoluted manner that misleads voters as to the true cost of government that is contained in every pound we spend. I would suggest that the obvious next step is to convert to an explicit consumption tax regime with a single flat percentage rate, abolishing all other taxes. Current net personal income would be declared true income in employment contracts henceforth. Then, the massive income tax industry could be put to more constructive use and entrepreneurs would flourish.

  9. Hi

    Just wanted to say I thought this was a fantastic article- simple yet effective :)

    Well done was a great read!


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