Sound Tax Policies

Economic Perspectives 37

Emile Woolf, Going Postal

The government of a totalitarian state doesn’t have to worry about a tax system because the nation’s entire output is already in its hands. This is a mirror image of what happens in a democracy, where government decides how much to take from its citizens; under a totalitarian regime, by contrast, the state decides how much to give them to enable them to live and, hopefully, keep them content.

However, every state, whatever its political colour, should subject itself to the discipline of keeping its spending plans within the limit of its resources. If it spends more than it has raised in taxes, and what it has in reserves, it must borrow the shortfall (assuming it can find a lender) or resort to the monetary printing press.

Even that is not a viable solution because fake money loses its purchasing power and, ultimately, becomes worthless. Current news from Venezuela is that street beggars don’t even bother to pick up money that lies like litter in the streets, no matter how many zeroes are denominated.

Readers will know from my previous essay that most existing methods of raising taxes are indiscriminate, politically interventionist, and grossly inefficient. It’s a huge compliment to this country’s productive capacity that it is able to survive the destructive effects of its tax-raising regime.

Is there a better way?

Adam Smith’s canons of tax policy have stood the test of time. They tell us that a tax charge must fall within the capacity of the taxpayer to bear it; its amount must be certain and not arbitrary; its cost of collection should be the minimum required and involve no waste; and its yield should be sufficient to meet the needs for which it was levied – again, no waste.

We must also remember that low rates of tax will generally yield more revenue than high rates. The so-called “Laffer Curve” is based on the observation that tax rates of both 0% and 100% will yield zero revenue. The skill of a judicious Chancellor is to identify the rate that produces the greatest yield. Indeed, latest figures show that the most recent tax cuts in the UK have already resulted in a significant rise in tax revenues.

Last week’s essay demonstrated that “income tax”, levied through the pay-as-you-earn system, is a corporate liability, effectively a payroll tax or, unvarnished, a tax that penalizes businesses for employing people.

Almost 250 years ago Adam Smith illustrated the madness of such a tax with the example of an employee earning £100. If the state imposes a tax of 20%, the employee’s pay must rise by 25% in order to reinstate the employee’s real income. The additional cost is borne by the employer: the “gross pay” must now be £125 so that the deduction of 20% tax leaves disposable earnings of £100. Indeed, national statistics always show that, whatever the tax rate, the ratio between real (net) pay and GDP tends toward a constant percentage.

It’s the business that bears the tax!

The idea that the employer is a mere tax collector on behalf of government is therefore sheer nonsense. The reality – that payroll taxes are borne by the employer – takes no account of the fact that marginal businesses have limited taxable capacity. As an example, some years ago British Steel reported trading losses of £1 million per day, an amount that was exactly balanced by the tax “deducted” from its employees’ “gross” earnings and paid to the revenue authorities.

British Steel, as an enterprise, clearly had no taxable capacity at that point in time. Although its accounting losses shielded it from having to pay corporation tax, it suffered a vast tax penalty for the sin of being a major employer!

Several businesses I know took the brave step of paying employees their full gross pay without deduction, and the result in each case was a highly motivated workforce and a leap in productivity that exceeded the additional tax. [I actually visited Nicholas Ridley at the Treasury and persuaded him to provide them with “grossing up” tables to help them work out the tax! Interested readers can find two of such examples on my website.]

But wait for it! The most ludicrous charade of all is enacted whenever the earnings of those paid out of taxes are “taxed”. Applying the PAYE rigmarole to the earnings of civil servants, council employees, NHS employees, Inland Revenue staff, and the thousands of other central and local government employees, all paid out of taxes, takes on an especially farcical twist!

Almost anything would be better than what we have now. What the Treasury is able to raise in direct taxation is clearly insufficient, so it taxes everything else, seen and unseen – property transactions, cars, fuel, energy, insurance premiums, travel, everything you buy, professional services, marriage, death, you name it – they are all taxed, one way or another!

But to avoid the traps into which our tax regime has descended, it is essential that we, as humans, exercise our powers of reason!

Next week I shall post some recommendations.

© Emile Woolf September 2018 (website)

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