Dr. Peter Bowman is Science Coordinator on the University Preparatory Certificate at University College London (UCL) and tutors economics at the School of Economic Science, London, UK
When I read Anthony Werner’s recent guest Blog “Can taxation be fair?”* it reminded me of a quotation I had read recently from JR McCulloch, first professor of political economy at UCL where I work. This is what he had to say about income tax:
‘The tax would fall with its full weight upon men of integrity, while the millionaire of “easy virtue” would well nigh escape it altogether. It would, in fact, be a tax on honesty, and a bounty on perjury and fraud; and, if carried to any considerable height—to such a height as to render it a prominent source of income—it would undoubtedly generate the most barefaced prostitution of principle, and would do much to obliterate that nice sense of honour which is the very foundation of national probity and virtue.’
This rings very true today as, in these times of austerity, the issue of tax avoidance and evasion has come to the fore. At one level the deliberate avoidance or evasion of tax is a gross injustice and is particularly malevolent in these straitened times. But McCulloch’s quote raises a different point which I wish to pursue and that is the question of how effective, how just, in simple terms how “good” are the taxes that honest citizens are expected to pay. If we as a society demand that everyone should pay their fare share of tax should we not also demand that the taxes we have to pay are “good” taxes? What do I mean by “good” taxes? Classical economics gives four criteria – (1) they should be fair, so no-one gains an unfair advantage, (2) they should be certain so it is clear how much everyone should pay, (3) they should be easy and cheap to collect and (4) they should fall as lightly as possible on production so they do not inhibit growth. For simplicity I will call taxes which fulfill these criteria “good” and ones that do not “bad.”
Clearly to McCulloch income tax was a bad tax. He had the foresight to recognize that although it sounded good in theory in practice it would not fulfill criterion (2) in ways that were corrosive and corrupting. But it is also bad in another way. It is a huge disincentive to productive economic activity. Income tax drives a wedge between what an employer has to pay to get someone to work for him and what that employee receives in return. The effect of this is that the tax has a considerable impact on labour productivity and also on the level of unemployment. Economists measure the efficiency of a tax in terms of the GDP foregone for each pound of tax collected. Empirical studies have shown income tax is one of the least effective taxes. This foregone GDP is called deadweight loss. It places a huge burden on the productive economy and acts as a brake in growth and employment. One problem is that we have got so used to this we have stopped noticing it.Let us contrast this with the example of a “good tax”. The one I would like to give from the UK is the auctioning of the electromagnetic spectrum for 3G in 2000 which raised £22.5 billion for the government. You may argue that this was not really a tax. I would agree and add that if all conventional taxes are effectively arbitrary levies imposed on the population like a form of legalized theft then maybe they are all bad. Hence good taxes would turn out not to be like taxes in the normal sense but are innovative forms of public revenue. The electromagnetic spectrum is a free gift of nature. In the absence of government regulation it could have simply been appropriated by a telecommunications company, put to their use, and the benefits would all have fallen to their owners. Behind the auction was the idea that here was something that was part of the common good – the commons if you like - and if someone wanted exclusive use of it then they had to pay the rest of us for the privilege. Since the time of Locke and Hume it has been assumed that the purpose of government is to uphold private property but here it was acting in a different way – overseeing the commons and ensuring everyone benefited from their use. Note how the revenue was easy to collect and could not be avoided. Also it had no detrimental effect on production. Instead all shared what would have otherwise been a windfall to the private sector.
The main “commons” of any state is its territory but there are few examples of a state recognizing this and using its territory as an asset to derive public revenue. Usually the opposite is true and governments in their ignorance oversee the handover of this main asset to private individuals and institutions and are then forced to impose “bad” taxes on their citizens who, instead of expecting to pay something in return for what they have taken, rather demand their property be protected and expect other services to be provided as well. The taxes are almost always insufficient to meet their needs leading to the state being drawn into debt.
Hong Kong in its early days as a British colony provides an example of how a state using its territory as a source of public revenue. Because the land was taken on a short-term basis from China it could not be sold on. Instead it was leased, typically for 99 years, by a combination of an upfront payment and an annual rental payment. As time went on the arrangement was subverted and the annual rental payments declined considerably but nevertheless the scheme had shown how a territory may gain a significant proportion of its revenue in this way.
Smith and Ricardo expounded the principles of taxation two hundred years ago. The key principle they used was that of economic rent. This is a surplus, not a cost of production. It is an effect of the price of a good and not the cause. Taxing rents does not affect the cost of production. There is no deadweight loss.
In these straitened times recognizing the differences between good and bad taxes offers governments a way out of the dilemma they now face of needing to stimulate growth but not being able to afford to borrow to do this. Shifting from bad taxes such as income tax to good taxes such as the collection of the economic rent of land would remove the inefficiencies due to the deadweight loss and stimulate growth without reducing the total tax take. There would also be reduced scope for avoidance and evasion. In addition they would help to restore the growing imbalance between rich and poor.
A recent study by the OECD provided empirical evidence of this when a study of taxation in OECD countries showed that a tax shift from income tax to taxes on immovable property (the best proxy available for the economic rent of land) of just 1% could, in the long-term, increase GDP by up to 1%. It makes you wonder what effect a 10% or even a 50% shift would have.
*Anthony Werner, “Can taxation be fair?”
http://gcgi.info/kamrans-blog/200-my-guest-blogger-anthony-werner-can-taxation-be-fair
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