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Monday, December 12, 2016

Incentives matter in all tax policy

A tax policy proposal crossed our desks this week purportedly offering a way out of our nationís large deficit. Itís in a presentation by Conveyancing Direct ; we rather hope few have been duped into the impression that it makes any practical sense or tackles the central issue that Scotland faces with its finances.

It promotes the age old chestnut of a Land Tax Ė an idea that has been around for centuries which lauds the notion that land offers both a very wide tax base and one which cannot be hidden from the taxman. This tax is offered as a way to ďreverse the austerity agendaĒ and ďa fair way to fund all public servicesĒ.

Pink elephants can look quite pretty; but this proposal contains a number of ugly and major flaws in that it ignores four fundamental principles about tax. This week, as Mr Mackay offers up his first budget for parliamentary scrutiny, it is worth us reiterating those.

The first is an economic principle; that tax rates matter. This Land Tax proposal appears to suggest that extracting an additional £10billion from land values, even while reducing taxes elsewhere, will have zero effect. This is an error, while land cannot be moved about, its value as revenue earning wealth can be adjusted. In that respect, any land tax has to follow the immutable tax rule that unless rates are kept extremely low, those owning land will adjust its uses - and not necessarily in the way the tax designers expect.

The second, and linked, principle is about behaviour. Adjustments by individuals will inevitably apply in different ways across the wide tax base and uses of land. Much of the wilderness lands of America, controlled by the Bureau of Land Management, are gradually deteriorating due to regulatory intrusions (implicit land taxes curtailing the use of land without property), the Bronx in New York City is famous for its almost total destruction in the 1970ís due to rent controls (implicit land taxes on the use of land with property on it), Southern English houses are now being built with bedrooms without room for cupboards and garages into which modern cars do not fit (implicit land taxes through planning induced space shortages).

Land and property taxes, indeed all wealth taxes are extremely powerful in their effects because they do not tax income we already have at the margin Ė they take the core individual wealth that makes us feel secure, and the wealth of suppliers who take risks because of that wealth. A serious distortion of domestic property markets across the UK is well underway with labour mobility declining rapidly and a new generation forced to rent from a stalling buy-to-rent sector Ė high property taxes have done that.

These dynamic effects multiply through the reactions of individual owners and, when summed, create a key, wider principle that the total tax burden on any economy matters. Itís not enough to claim that tax reductions elsewhere might bolster incentives in other ways; they will, but the overall distortive effects of additional burdens, especially in land and property wealth, will be detrimental to economic activity. Mr Mackay please note.

The higher our nation's total tax burden is, the slower change and growth take place. There is now a lot of academic work suggesting that any intrusion by the state above 25 percent reduces wealth accumulation at an accelerating pace. Scotland, with a state intrusion around 50 percent performs well below its potential. Adding to this will always make things worse. Mr MacKay, again, please note.

The fourth principle is one of political economy; that the distribution of tax impositions is driven not by logic, but by choices made through political motives. The Land Tax proposal offers a good insight into this process. Lauded as being a genuinely equitable tax, its authors have realised that it cannot be imposed at equal rates to everyone. Rates are therefore adjusted; with marginal land, woodland, arable land, town and urban land seeing progressively higher rates of burden. As such, it reduces itself to absurdity to become little more than an additional localised council tax or business rate based on property land value. Would such de-centralisation ever be acceptable to the central planners of Holyrood who are there precisely so that they control re-distributions of centrally collected tax revenue in support of their centrist plans? All tax revenues entice political action on rates to favour whomever politicians decide are worthy. Localised land tax controlled by a polity composed of local shopkeepers would, through time, no doubt push the burden to urban retail chains and country landowners, a polity composed of urbanites might choose the middle class homeowners and, again, the long-suffering (usually marginal) large land owners about whose lifestyles they know nothing except their own prejudices.

There is, as so often, deep within this proposal, the perception that the poor are poor because the rich are rich, and that the rich are happily ensconced in their castles supping port and counting their gold. The first idea is just plain wrong, the second ignores the huge overheads that stewards of land, flora, fauna, and historic buildings carry in a constant battle to keep cash flow positive. Today, these struggling estates are usually companies rather than families; taxing them merely taxes their workers and customers. Thatís a great way to empty the countryside.

It is a stated aim of the Scottish Government to impose taxation equitably, but letís hope that Mr Mackay is not duped into believing that claims for taxes that apply widely to all means that they will be applied equally to all through time. There are always winners and losers, and it is the politicians' job to make sure their voters are winners and other parties' voters are losers. Taxation is by definition a coercive act by the state for as long as we are free to own earth and earn our own income.

Which leads to the real rub in all this; the issue is not taxation Ė itís spending. The proposal for a Land Tax (indeed all taxes) starts from the wrong place. Scotlandís deficit is not something that needs solving through a higher tax burden, it needs resolving through finding out how to spend less and then introduce a lower tax burden which will balance the books over the longer term.

Until the Scottish Government comes forward with a clear set of policy proposals to live within its means, and lays out a clear path into the future that identifies what Scots can expect in tax rates and the burden of distribution, our nation will struggle with lower growth rates, lower investment and a high rate of talent export.

In this environment, Scots will endlessly be treated to the unedifying spectacle of endless political wrangling over how to find more tax revenues and empty aspirations about where to spend them when the reality is that there is no more money that can be extracted from Scots taxpayers. That devalues our nationís capability, literally and metaphorically.

POSTED BY EBEN WILSON - DIRECTOR, TAXPAYERSCOTLAND 

 





'Government is the great fiction through which everybody endeavours to live at the expense of everybody else.'
Frederic Bastiat