The third horseman of the economic apocalypse

In the last two blogs, I have considered the options of printing more money and borrowing more money as means of generating new funds for public expenditure. Neither should be rejected out of hand. Each can sometimes play a short-term role in loosening the purse-strings, but neither appears to offer a sustainable way of creating new revenue for the government in the long term. What, then, about the third option – taxation?  

Few issues divide the two main parties more than taxation. Often the distinction has been blurred: political circumstances have forced Conservative governments to tax more than they would have chosen, and Labour governments to tax less, so the underlying differences in attitude have been disguised. For a while, under Tony Blair, Labour appeared to share the Conservative approach to taxation. Now, the gap between the two parties has widened again and is apparent to all.

Conservatives traditionally believe in low taxation, and not (or not only) out of meanness, as their critics would say. They believe that letting both businesses and individuals keep as much as possible of what they earn is the surest way to have a healthy, growing economy, which will then produce higher tax revenues to fund better public services. Labour believes that growth can be stimulated by higher taxation, at both the corporate and personal levels, as long as the proceeds are partially reinvested in public infrastructure projects as well as being used to improve public services.

These attitudes may both have started as rational beliefs among the adherents of each party, but they have long since become articles of faith: mantras to be repeated at all times and in all circumstances, no matter what contrary evidence is produced.

On the face of it, there is evidence, from many countries and over many years, that raising taxes substantially can actually reduce tax receipts, and that lowering them can increase receipts. It is time that Labour acknowledged this possibility and its implications. However, asserting that lower taxes will always increase revenues is an equally untenable creed. The reductio ad absurdum of that argument would be that the highest level of revenue would be achieved with a tax rate of 0%.

There must be an optimum level of taxation at which revenues will be maximised. It will, of course, vary from country to country, from year from year, and from one type of tax to another. It will only be notional. It is most unlikely ever to be at the very high or very low end of the tax range.

Recognising that such an optimum exists, if only in theory, might be a useful way for the political parties – and the economists, journalists and think tanks that buttress their prejudices – to wean themselves off their respective ideologies. It would certainly be useful if the non-partisan media could be more active in educating us about this issue and explaining the sensitivities of tax levels in layman’s language.

However, any discussion of tax levels is irrelevant if the tax is not collected. And here, as in earlier blogs, I must ask a question to which no one appears to know the answer. If all the companies and corporations that operate in the UK, and all the individuals that work for them, were to pay the amount of UK tax they should pay, how much extra revenue would the Treasury receive? For all I know, it could be quite a small amount – relative to the scale of government expenditure – with no great bearing on the funding of public services. Or it could be a vast amount. I have no idea.

This issue rankles hugely with many people and is exacerbated by the absence of answers. It goes to the heart of whether our society is considered fair or unfair; it goes to the heart of Labour’s performance at the last election; and it may yet go to the heart of the politics of the next decade. Persuading Google to cough up a few million more is no answer. It is time for politicians to lay the issue – and the problems in resolving it – squarely in front of people.

Times have changed. Once, a tax could be raised by 10% and one could be reasonably certain that the revenue would rise by something close to 10%. No longer. As everyone knows, wealthy companies and individuals can change at will where (and if) they pay their taxes. All governments now battle constantly to raise meaningful levels of tax from international corporations and from individuals who can choose where to be domiciled for tax purposes.

Worse than that, attitudes have changed. Few of the very wealthy seem to have a sense of social responsibility. They no longer consider it part of their bargain with society to share some of their wealth. All tax evasion is fair game and, if a government says it isn’t, a battery of lawyers and accountants will enter the fray and are usually victorious.

In these circumstances, tax can reliably be collected only from those firmly within one tax jurisdiction. It can be collected via corporation tax from smaller, national companies, which will reduce their international competitiveness. It can be collected via PAYE, which bears heavily on low- and middle-income earners. It can be collected via VAT, which bears disproportionately on poorer families.

The Cabinet Minister Chris Grayling claimed earlier this year that “the amount of tax paid by the wealthiest in our society has risen and risen in the last few years” – a claim repeated in various forms by many on the right. This would appear to be another misleading statistic: true only if we accept his definitions of “tax” and “wealthiest”, which many would not, and even then not on the scale that the remark implies.

It is altogether more relevant to say that the highest-earning 10% of people in Britain pay about 34% of their income in taxes of all kinds, and have done for many years, whereas the lowest-earning 10% pay about 47% of their income in taxes. This would seem to give a truer picture of where the UK tax burden falls, not as amounts of money, but in terms of impact on individual lives.

It is clear that the notion of a ‘progressive tax system’ – one in which the better off pay a greater share of their income in tax than the less well off – has not only been abandoned, but reversed. The edifice that created universal material progress during the early decades of democracy has crumbled.

So it must surely be the case that, if tax is to play a significant part in revitalising public services, it will need to be through the increased taxation of the better off – all the more so since, ideally, we should be looking to reduce the tax burden on the less well off.

Which brings the argument back to the issue where it always seems to founder: how, in today’s world, do governments make the rich pay more tax?