There has been a fair bit of controversy recently over the government’s decision to cut the top rate of tax in the latest budget. Those earning over £150,000 will now pay 45p for every pound they earn rather than 50p.
The politics of giving a tax cut to the top 1% of earners at a time of austerity is pretty stark, but the chancellor believes it will actually bring in more money. At 50p, rich people have the added incentive to avoid tax, so a 45p tax might bring in more revenue. This phenomenon has been described in the Laffer curve, which suggests there is an optimum level of taxation. If you raise taxes too much, people will stop paying. Push it too far and tax avoidance becomes a kind of national pastime, a situation Italy has found itself in and is desperately trying to remedy.
Whatever you think of the chancellor, taxation is hard to get right. It’s important that tax is fair – but then people have different ideas of what is fair. Asking the rich to pay more looks fair to those on lower incomes, and profoundly unfair to those having to surrender 50% of their income.
But perhaps we need to think more creatively about tax, and ask some bigger questions about whether income tax is a good idea in the first place.
We need governments and the safeguards they provide, and that means taxation in one form or another. (If you’re one of these libertarians who thinks we don’t need government at all, I suggest moving to Somalia). There are lots of ways to raise taxes, from customs and excise to corporations taxes. Among Britain’s rich history of taxation are such exotic levies as a window tax, which prompted many people to board up their windows. There have been hearth, hat and salt taxes. Perhaps most bizarrely, Henry VIII taxed beards, and so did Russia’s Peter the Great.
Income tax is relatively new. It has cropped up at various points in history, but in Britain it was a way of paying for the Napoleonic wars. It was supposed to be temporary, but it stuck around, despite several attempts to remove it. Officially, it’s still a temporary tax and it has to be renewed in law every year. At the start, it was a fairly modest levy, with a standard rate of 6%. That was blown away by the First World War. By 1918 most people were paying 30% of their income. In the Second World War it got worse, the standard rate rising to 50%.
Once established, income tax was too useful to shift. Where customs used to be the biggest tax revenue source, income tax has grown and grown and now accounts for 30% of the British government’s revenues. It would be hard to do without it now. But that still doesn’t make it a good idea.
A fundamental problem to bear in mind is that every tax has consequences. If you tax hearths, people will brick them up and shiver, as Charles II discovered. If you tax beards, they will shave. Tax can be used to shape behaviour – which is just what Peter the Great had in mind with his beard tax. He wanted Russia to modernise and fall in line with the rest of clean-shaven Europe. We do the same thing when we put high taxes on cigarettes, or low ones on electric cars. Tax can be a way of encouraging things we want more of, and discouraging those behaviours society wants less of. Income tax, under that philosophy, is all wrong. It is a tax on productive work, when actually that’s something we want more of and should be looking to encourage.
So what if we scrapped it? The New Economics Foundation recommends just that in its report The Great Transition, or at least scrapping it for most people. We could replace income tax with a number of other measures, such as a more local services tax, as part of a broader localization agenda. Consumption taxes make much more sense than income taxes, since it is consumption rather than wealth per se that drives resource depletion. If most of our taxes were paid through consumption, those who lived a more sustainable lifestyle would pay less. Tax rates could be applied by ecological impact, so that locally produced or environmentally benign goods were cheaper than energy-intensive, high-carbon goods and services.
To help reduce inequality, income tax could still be levied on above average wages, and redistribution could also be achieved by taxing other forms of wealth – assets and property. Ultimately, you’d be looking to create “a shift from taxing ‘goods’ such as work, to taxing environmental and social ‘bads’ such as pollution, consumption and short-term speculation” as nef puts it.
Needless to say, those would be big changes and would need to be part of a bigger strategy. But it would be nice to see some fresh thinking on taxation.
The Earthbound Report 
Jeremy, you have said – ‘redistribution could also be achieved by taxing other forms of wealth – assets and property’. We moved from Surrey to Wales to retire to a smaller house by a river and a bit of land (managed by us for wildlife hence, the environment, hence GOOD), hence its value is relatively higher than the surrounding village properties but the same as our ex-Surrey property (we gave up convenience for country). It is likely that we have the lowest income in the village but we pay the highest council tax. If you want to see property taxed this would seemingly add to the injustice already upon us and similarly placed people. What would you do about this, since the government does not care?
There are lots of ways of applying a tax on land. It could be a land use tax, so that productive land isn’t wasted, and so developers can’t acquire prime land and sit on it (a problem we have in Luton, where we have vast amounts of brownfield land, but it is all owned by developers waiting for better economic times. Since there’s a housing shortage, the council is trying to push through new developments on parks and greens instead. It should never be easier to build on a park than a disused factory site)
The ‘mansion tax’ has been much discussed already this year, a tax on larger properties. I think a tax on second homes would be a good idea, or on houses standing empty. It would encourage people to get houses back into circulation, addressing the housing shortage without having to build more.
Another way to address your specific problem would be to set council tax rates by the size of the house rather than the value.
Jeremy, what are your thoughts on a land value tax? An idea with a long history, but little actual implementation.
I’m attracted to the kind of Pigovian taxes you (and nef) mention, but they do have a downside, namely, a perverse incentive is set up for the government to ensure that the socially negative activities that generate the tax are never quite eliminated (or even substantially reduced). This is particularly the case once they become a significant source of government revenue. For instance, in NSW, the government has become quite dependent upon revenue from the gambling industry (esp pokies), and this has even seen substantial *increases* in gambling since the taxes were introduced since the government says it wants to reduce problem gambling, but actually receives a fair slice of its income from that source.
That’s true, and Britain is strangely bound to the fuel duty, which rakes in over £25 billion a year. I think it works as long as you have a long-term view in mind and plan for the decline.
And a land value tax is a good candidate for taxing wealth, given the huge inequalities in land distribution in Britain.
“Tax can be a way of encouraging things we want more of, and discouraging those behaviours society wants less of.”
This is actually why car users have to pay Motor vehicle excise duty, known as ‘road tax’ by most people in the UK.
The idea of taxing consumption is a good one, but then you’d have to make it legal to live with less consumption: for example, at the moment it’s very hard to build a low-energy house: it’s not expensive, and it’s not complicated, but the rules practically force people to buy expensive, industrially made houses. Likewise with cars. It’s quite right to tax car use highly because of the damage it causes, but then we need to make an alternative for people who can’t or don’t want to pay the tax, which the UK has failed miserably in. German is slightly better but not brilliant. The trouble is that as soon as consumption is taxed, governments have a motivation to increase it either by encouraging it or by effectively forcing people to consume.
There is a problem in the long term with any strategy that involves trying to reduce something through taxation – you’re essentially eroding that revenue stream every year. The key is to balance those taxes with stable revenue streams, and to bank your windfalls for the future – as Norway has done with its North Sea oil revenues. Britain didn’t do that, and spent its revenues on government services instead.
I also think there’s also a case for a certain amount of state-run enterprise – they don’t have to be lumbering subsidised state institutions. Singapore has shown that you can have competitive profit-making companies that return their profits to the government rather than investors – and if your government services are profit making, that means lower taxes.