Thursday, 17 January 2013

D. Local taxation and the only fair tax is...

Here are another two myths and three nonsensical statements which are trotted out all too regularly:
• MYTH: I pay for local services out of my Council Tax (skip to article)
• MYTH: The UK collects more tax from land than any other OECD country (skip to article)

Having debunked these, let's look at the practicalities and merits or demerits of the other taxes mentioned (preamble):
• The only fair tax is a Poll Tax

 (skip to article)
• The only fair tax is Sales Tax/VAT; Tax consumption, not production

! (skip to article)
• The only fair tax is income tax

 (skip to article)

Just for fun, let's round things off with...
FOOTNOTE: The only fair tax is... Land Value Tax (skip to article).
FOOTNOTE: Will LVT be a national tax or a local tax? (skip to article)
BONUS: We have to have VAT because the EU says so (skip to article).

1. MYTH: "I pay for local services out of my Council Tax."

We can dismiss this one straight away, because whatever the logic of it (and it has no relevance to the merits or demerits of LVT), it is simply a downright lie.

We know for a fact that Council Tax currently raises £28 billion a year (before deducting Council Tax benefit), which is only about five per cent of all tax receipts. To be able to make such a statement, you would then have to say what you mean by "local services".

The last time I looked, apart from defence, paying debt interest and maintaining embassies and consulates abroad (and ignoring corporatist subsidies, theft and waste), everything the government does is "local". It spends about £150 billion a year on the NHS and the state school system alone. There's plenty of other stuff on top of that which is clearly "local" (road maintenance, police, law and order, refuse collection, street lighting, social workers etc) which brings the bill to £200 million.

Suffice to say, Council Tax covers barely one-seventh of the cost of such "local services".

And you could just as well argue that welfare and pensions spending are local services, because they are paid to people who all live somewhere, and wherever they live is "local", and every bit of land benefits from the fact that we have these non-local services (defence, paying debt interest), in which case Council Tax only covers a twentieth of the cost of "local services".

2. MYTH "The UK already collects more tax from property than any other OECD country"

The smart arses love this claim. What the OECD actually say is: "Between 1965 and 2010, the share of taxes on immovable property, net wealth plus property and legal transactions fell from 8 to 5 per cent of total tax revenues. In relative terms, property taxes are important, that is, they have a share exceeding 10 per cent of total tax revenue in four countries; Canada, [South] Korea, the United Kingdom and the United States."

Japan (thanks to General Douglas MacArthur) and Australia are not far behind on the OECD's table 22, and Hong Kong would be miles ahead if it were on it. So countries which we normally (rightly or wrongly) think of as free-market rather than social-democratic seem to collect a higher share of their taxes from taxes on property, which is most reassuring.

The smart arses then usually go on to imply that this must be the natural upper limit; that no more than a tenth of tax revenues can come from land value tax, which is quite simply not true.

The OECD takes a very wide view of what constitutes a tax on property. Out of the £70 billion-odd in such taxes collected in the UK, how much is actually an annual tax on the rental value of land?

Business Rates, £28 billion, yes, is pretty close to LVT.
Stamp Duty Land Tax is a tax on certain transactions in land and buildings, it might be vaguely land-related but it ain't LVT.
Other taxes such as Inheritance Tax, capital gains tax and Stamp Duty on share sales, are general taxes which apply to lots of other things than land. Not LVT.
Council Tax, £25 billion, is basically a per-home Poll Tax, which varies depending on what a home was (or would have been, had it existed) worth in 1991. In 1991, house prices were much flatter around the UK and values were closer to the "bricks and mortar" value, so you could say that it's a Room Tax of about £300 for each room in a home, if you have more than nine rooms, the rest are tax-free.

So actual quasi-LVT (Business Rates) is more like only five per cent of UK taxes collected.

The amount of quasi-LVT collected in the USA and Canada is much higher in the UK; the bulk of their property taxes are annual taxes pro rata to the value of each home, with no upper limit in most states (some apartments on Manhattan cost over $100,000 a year); and their Stamp Duty Land Tax equivalents are much lower.
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The bulk of the cost for all these services is paid out of national taxes on output, employment, income and profits. Council Tax is to all intents a national tax and Business Rates is a national tax, as all revenues are pooled nationally and then redistributed from the centre (I think there are separate pools for England, Scotland, Wales and Northern Ireland). So let's compare like with like and compare the merits of national taxes.

People's stated preferences is usually based on whatever system they think will mean that they pay less than now and somebody they don't like will pay more.

So people with high incomes like the idea of a Poll Tax; people with low incomes like the idea of income tax; people who [think that they] own lots of land hate LVT (and the majority do not own much land, but disappointingly, do not support LVT); and the economically illiterate like the idea of Sales Tax (or Value Added Tax or Turnover Tax or however it is described, the economic impact is always the same), because they imagine that it is somehow a voluntary tax paid by consumers which does not affect producers.

And if you want to be an idiot, stick the word "local" in front of your favourite tax.

So let's look at how we would raise £200 billion using LVT, a Poll Tax, Income Tax or Sales Tax/VAT. Rather conveniently, £200 billion is the approximate cash outlay on the entire pensions and welfare system to give you a feel for the numbers. Let's look at the actual numbers involved at individual or household level and judge these taxes on the following criteria:
- ability to pay
- willingness to pay
- evasion and collection costs
- compliance costs
- deadweight costs
- impact on social cohesion

3. "The only fair tax is a Poll Tax

"

To collect £200 billion, the Poll Tax would have to be £4,000 per UK resident adult (pensioners and working age alike) per year.

A Poll Tax is also the diametric opposite of the welfare system, old age pensions or a personal allowance, so it would be nonsensical to have both, administratively, it would be simpler to scrap all out-of-work benefits and reduce the basic state pension to £20/week and the pensions credit level to £60/week, and scrap the tax free personal allowance, so employees would pay PAYE on every penny of their earnings.

That means less cash redistribution via the government, which you might think is a good thing, but it also means more indirect redistribution upwards from the working population to land owners; and it means that a higher share of residual government spending would be on stuff which they want to do and not on stuff which benefits the population in general.

How does £4,000 Poll Tax score on our six criteria?
- ability to pay. Bad for people at the lower end (including all Poor Widows, whether in Mansions or council flats), good for higher earners.
- willingness to pay. N/a
- evasion and collection costs. Huge
- compliance costs. Low/good. For those who are willing and able to pay it, it's just a question of setting up a Direct Debit.
- deadweight costs. Doesn't discourage work and possibly encourage it, so quite good (except for those who turn to crime = bad)
- impact on social cohesion. Absolutely terrible. Having a police state would be pretty much a pre-requisite.

So we can rule out a Poll Tax.

4. "The only fair tax is Sales Tax/VAT; Tax consumption, not production

!"

VAT at 20% currently raises £100 billion a year, so raising another £200 billion from it would require a VAT rate of more than 60%, which is yet another reason why this is nonsense.

VAT is not a harmless tax on "consumption", it is a tax on the gross profits of productive businesses, so land or finance-based businesses are largely zero-rated or exempt, surprise, surprise. The tax might well be voluntary from the point of view of the customer, but the tax is borne - economically and legally - by the supplier, from his point of view it is much like income/corporation tax. If enough customers walk away, then businesses go bankrupt.

If you look at changes in prices of VAT-able and VAT-exempt goods and services before and after a change in the VAT rate; or if you look at supermarkets' gross margins before and after a change in the VAT rate, you will observe that two-thirds of the VAT is borne/absorbed by the supplier (which feeds all the way back up the chain to the manufacturer), so it's just a tax on gross profits (or profits plus wages). The recent halving of VAT on restaurants in Sweden gives the same result. The clue is in the name: Value Added Tax.

Sales taxes are also the administratively most fiddly taxes once you get down to the detail and they create the highest barriers to entry or growth.

We would observe exactly the same effect with any other tax based on sales or turnover, with or without a credit for input tax. So if we are going to be honest at least, let us call for higher income taxes on all industries, including those which are currently VAT-exempt.

How does a 60% VAT score on our five criteria?
- ability to pay. Fine for consumers but the burden is all on the producer.
- willingness to pay. Ditto.
- evasion and collection costs. Huge, at least ten per cent of VAT is evaded, avoided or not collected.
- compliance costs. Huge.
- deadweight costs. Enormous.
- impact on social cohesion. The resulting unemployment is very bad indeed, even though people would not be able to identify the cause.

So we can rule out VAT.

The slogan "Tax consumption not production!" is meaningless gibberish spouted by economic idiots across the political spectrum. One man's production is another man's consumption. It's two ways of measuring the value of goods and services being exchanged for mutual benefit. The only consumption which you can safely tax without discouraging production is a tax on the consumption of land rents, i.e. LVT. And LVT certainly is not a tax on "production" is it? "Production" of what, pray tell?

5. "The only fair tax is income tax"

That all leaves income tax as the only serious challenger to LVT.

Here's where the Home-Owner-Ists borrow from the Socialist lexicon "From each according to his ability to each according to his needs". Fair enough, but why does this not cut both ways: yes, the pensioners need to be looked after (by younger workers) and younger worker needs somewhere to live. Why is it seen as normal that the younger worker to pay twice: once "according to his ability" (via income tax) and again "according to his needs" (via rents or mortgage payments? Or to cut out the middleman, why not collect national wealth (primarily land rents) instead of collecting private wealth (via income tax) and distribute the proceeds according to "need"?

A flat income tax is the second least-bad tax, per Milton Friedman (guess what he said the least-bad tax was?), and everything proposed here assumes a flat rate of income tax of 20% in place of all current taxes on output (VAT), wages (PAYE and NIC), profits (income tax or corporation tax). This would raise approx. £280 billion, so to raise an additional £200 billion would require a rate of 45% (taking Laffer effects into account).

Admittedly, this would be slightly less-bad than the current system where there are several different layers of income tax, applied more or less at random, i.e.
i. Means testing of benefits (people lose up to 100p for every 100p they earn)
ii. National Insurance (which is 25.8% for normal employees, a lower rate for contracted out employees, 9% for the self-employed with exemptions for investment income and rental income)
iii. Income tax at 20%, 40% and 50%/45% (with higher effective rates where certain thresholds are crossed)
iv. Student loan repayments (at various percentages up to 9%)
v. Corporation tax at 21% - 24%
vi. Higher rate tax on dividends of 32.5% and 42.5%/37.5%.
vii. VAT payable by most businesses at 20%, others are zero-rated or exempt and there are reduced rates and also the flat-rate scheme for smaller businesses.

These rates can't simply be added together, because each tax takes a slice of a smaller amount of the original gross income, but the overall average marginal rate is somewhere between 50% and 55% (depending on how you weight them) with a huge range between negative and over one hundred per cent.

- ability to pay. Scores well, obviously.
- willingness to pay. People pay grudgingly. You get nothing directly in return for your income tax.
- evasion and collection costs. Fairly high, but not as bad as Poll Tax or VAT.
- compliance costs. High (but not as bad as VAT).
- deadweight costs. High (but not as bad as VAT).
- impact on social cohesion. Poor. High earners don't like paying it, and welfare and pensions claimants don't seem to appreciate it.

7. "The only fair tax is... Land Value Tax"

Bearing all that in mind, is collecting £200 billion (before rebates) in LVT as outlined here (approx. 90% of current site-only rental values, or about 3% of 2012 selling prices) really so terrible? Apart from all the other advantages of LVT, assuming it is matched with a system of rebates, personal allowances, Citizen's Dividend (or whatever you want to call it) the median household would quite simply not pay any net tax (or receive any net benefits), as the rebates it receives would match the LVT it is due to pay; the two amounts can be netted off at source to a small net payment in either direction. LVT would more or less fund the entire welfare and pensions system.

Net payers would be those who are willing and able to pay it in exchange for living in the most desirable homes in the most desirable areas. And the net beneficiaries would be those who currently live off welfare (whether that is working age welfare or old age pensions) provided of course they are prepared to live in the low-tax areas or in very small homes in more desirable, higher-tax areas.

How does the Land Value Tax outlined here score on our six criteria?

- ability to pay. Poor in short term, but this can be largely alleviated with the deferment/roll-up option for pensioners; very good in medium or long term.
- willingness to pay. Probably grudgingly at first. But with income tax, the payer gets nothing in return; with LVT, at least the payer gets to live in nice house at a lower cost than otherwise. Once people grasp that however much LVT they are paying, they and their children are saving twice as much in other taxes and mortgage payments or rent, we will get used to it.
- evasion and collection costs. Evasion is nigh impossible. Collection rates and collection costs for annual land taxes are very good (i.e. high and low respectively).
- compliance costs. Negligible. Appeals will be fairly straightforward questions of fact and like-for-like comparisons.
- deadweight costs. Negligible or even negative - LVT stimulates the economy.
- impact on social cohesion. Low/good. Households in homes up to the median rental value simply won't pay any, it will be covered by personal allowances. And when lower income people see posh houses, they won't think "Those rich bastards!", they'll think what decent chaps the occupants must be for voluntarily paying all that tax to pay for everybody/everything else .

To recap:
- LVT has the advantages of income tax (it relates to ability to pay in the medium or long term, and more importantly relates to willingness to pay) without the disadvantages (easier to assess and collect, no compliance costs and no disincentive to earn more).
- LVT has the advantages of a Poll Tax (it is easy to assess, low compliance costs, doesn't discourage work and enterprise) without the disadvantages (high collection costs, high levels of evasion, ability to pay and damaging effect on social cohesion).
- LVT has the advantages of a "tax on consumption" like VAT (LVT is a tax on consumption of land services) without the disadvantages (it taxes consumption without taxing production so no deadweight costs; easy to assess and collect; and it is the opposite of a stealth tax).

Does that make it the perfect tax politically? No, the politically perfect tax is one that you think somebody else is paying. So what? That's a question of de-brainwashing people.

8. FOOTNOTE: "Will LVT be a national tax or a local tax?"

The answer is "both". It will be set at a national rate but collected and spent locally.

The whole topic of local government finance is currently nigh impenetrable. It is a mixture of a small amount of locally collected national taxes (Council Tax and from 2013 onwards, a small proportion of Business Rates) and hundreds of different adjustments to and fro to say how much money each council, local NHS, local education authorities etc get from central government out of national taxes. And of course there are different layers of local government: town and parish councils, local boroughs, county councils, unitary authorities and regions such as Scotland, Wales and Northern Ireland.

So here's a simple example of how it could work, if we just consider one level (local boroughs and unitary authorities), of which there are about three hundred...

a) Officially, only about one-quarter of total government spending is "local", i.e. arouns £170 billion a year. But you could easily classify two-thirds of UK government expenditure (£450 billion) as "local", i.e. anything that can reasonably said to be spent in a particular area. So in the wider sense, this includes an NHS hospital, a state school or university, roads, the local police, refuse collection, Housing Associations and of course pension and welfare payments to people in an area. Truly "national" stuff is defence, immigration control, foreign embassies and consulates, debt interest and so on.

b) This means that in an average council area, total government spending through whatever channels (NHS, Dept of Education, Ministry of Transport, DWP, police, whatever) is £1,500 million a year (200,000 residents x £7,500 per person). Currently, the average council collects about £100 million in Council Tax and the other £1,400 million is block grants or spending paid directly by Whitehall departments.

c) The Domestic and Business Rates proposed here would raise £240 billion a year, so on average, each council will be collecting, or at least empowered to collect, £700 million a year. So they will be able to keep every penny of this and will also receive an average 'top up' of £800 million from 'somewhere else'.

d) There is only one area which would almost finance itself out of LVT, which is Greater London (GL).

Using round figures, the population of GL is 7 million, which means a total budget of £52 billion. The average site premium of GL homes is about £20,000. Assuming 2.5 people per household/home, that means 2.3 million homes, so LVT receipts from domestic would be £46 billion, to which we can add another 15% for Business Rates = £53 billion.

Clearly, there will be transfers from the highest value areas in central and west London to lower value areas in south and east London, but these need not be direct transfers, we can simply fund more London-wide expenditure (rail and road networks) from the surplus generated by the highest value areas.

e) The same principle applies at county level. The surplus from the few non-London councils which collect more than £1,500 million year can be deal with by redistributing them to lower value areas in the same local county.

f) So a council which can collect £1,000 million can keep every penny of it and gets grants of £500 million, i.e. block grant (plus spending on "local" services paid directly by Whitehall) and grants from higher value areas in the same county (to the extent there are any). A council which can collect exactly £1,500 million can keep every penny of it, but has to pay for all "local" spending itself and gets nothing in grants. A council which can collect £3 billion a year (i.e. Westminster) is allowed to keep half of it and the other half goes into the wider local pot (GLA or local county).

g) If some councils decide, for political or ideological reasons, to collect less than what they are entitled to collect and cut back on "local" spending accordingly, well, that is their decision. And clearly, the block grants would have to be re-assessed regularly and tapered gently so that local councils are incentivised to improve their areas as best they can, because they can keep any increase in rates receipts in the medium term. No system is ever going to be perfect but you could hardly make it worse than it already is.

9. BONUS "We have to have VAT because the EU says so"

a) That's quite true, making the reasonable assumption that the UK remains a Member State for the foreseeable future (although we can change the headline rate). But the EU does not dictate corporation tax, income tax or National Insurance rates; those are entirely self-inflicted. And VAT is so damaging because it taxes gross profits ("value added") and is thus in addition to those other taxes.

b) VAT (currently at 20%, i.e. 20/120 of turnover) pushes up the overall marginal tax rate for an average earner working for a fully VAT-able business to just over 50% (i.e. for every £1 a customer spends, the employee receives 49.8p). The overall rate for an average worker in a VAT-exempt or zero-rated business is just over 40% (the employee receives 59.8p). For a given value of output (turnover), the net income of the employee in the VAT-able business is 83% as much as the net income of the employee in a non-VAT-able business.

c) The proposal made here is to have a flat tax of 20% on earned income/profits/return on capital employed, so if we have to continue with VAT of 15%, we can achieve an overall rate of 20% by taxing wages/salaries and profits at a lower rate (for example, applying 9% Employer's NIC to their wages but exempting them from PAYE income tax and Employees' NIC).

d) Yes, there are plenty of businesses who sell a mixture of VAT-able and zero-rated goods (like supermarkets or manufacturers who export part of their output) and some businesses make a mix of VAT-able and VAT-exempt supplies (who in turn can only make partial reclaims of input VAT). There are various semi-statutory foul compromises available to such businesses, but basically, they just agree an overall average VAT rate and wing it from there.

Under a flat tax scheme, such businesses just agree an average VAT rate and deduct that from the nominal 20% to arrive at the rate to be paid on wages/salaries and profits. So if the business ends up paying an average VAT rate of 10% of turnover, the Employer's NIC would be 9% as above and gross wages would be subject to flat PAYE of 3%.

e) Again, the maths of this is circular, but broadly speaking, the overall rate will come out at about 20%.

6 comments:

  1. What's wrong with corporation tax? Isn't this a tax on profits, which means it wont have the negative effects of VAT in terms of hitting marginal firms the hardest?

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  2. Anon, for sure, corp tax is the second least bad tax on business, being a flat 20% or so, but it only raises £40 billion a year (compared to the worst taxes VAT and NIC which are £100 billion each) but I consider flat income tax and flat corporation tax to be much the same thing (like in Hong Kong).

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  3. Thanks for your reply. Presumably if corporation tax were raised, say to 40 or 50%, it wouldn't end up raising much more revenue, due to Laffer effect? Someone the other day suggested to me that it (or 'profits taxation' generally) would be just as good as, if not better than, LVT in terms of its lack of distortion affects on production. But above a certain level it would presumably be a massive disincentive for businesses to make profits at all, so wouldn't ever raise much more than it already does?

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  4. Anon, make up your own mind about what the revenue-maximising tax rate is for Laffer purposes, maybe it is 50% and that would raise twice as much as now, that is not the point.

    The point is that a tax rate of 50% reduces the size of the economy by between 10% and 15%. That is an absolute loss to everybody and of benefit to nobody.

    LVT simply has no deadweight costs, there is no disincentive to making profits and every incentive for using as land as efficiently as possible, it all reaches its own equilibrium. So whoever said that to you was talking complete and utter rubbish.

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  5. Could we not just leave the EU so we can get rid of VAT?

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  6. No need to leave the EU. We just need to man up and refuse to comply with the more stupid things (like VAT) and either they accept it and we stay in (good) or they chuck as out (also good).

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