We need to talk about income tax

A flat rate tax would reduce the share of income tax paid by higher income groups and increase the share of tax paid by lower income groups. The red and blue bars would be the same height for each income group under a flat rate tax system.

Overview

The focus of this post is on income tax, the moral objection to it, and a possible replacement to it. It starts with a brief overview of how income and income tax are both distributed in the UK. This is summarised in the graph.

The figures used for the graph have been derived from an HMRC study  to estimate the disincentive effects of the current top income tax rate  of 50%. http://www.hmrc.gov.uk/budget2012/excheq-income-tax-2042.pdf  (Thanks to Frances Coppola for the link).

Although the assembled figures may not be precise they are not misleading. The graph gives an accurate impression of how income and income taxes are shared across the different income groups.

Key points shown by the graph

  • One per cent of  individuals receive income in excess of £150 k per year. This group receives 14% of all incomes and pays 29% of all income tax. This group pays the 50% top rate income tax.
  • At the other end of the income scale 47% of individuals receive incomes of less than £10 k per year. This group receives 16% of all income and pays 9% of all income tax. Many individuals in this group will not pay income tax and those that do will not pay more than 18% of their income.
  • The graph confirms UK income tax to be broadly progressive. That is, the proportion of  income surrendered through income tax increases as income rises.
  • The ratio of the top income percentile to the bottom income percentile is roughly 40. This means that on average someone in the top income group receive £40 for every £1 received by someone in the lowest income group. This is a rough estimate only and is not cited as a precise figure – it is merely intended as an indicative measure of income inequality in the UK.
  • A similar calculation for income tax paid yields £150 for the top percentile against every £1 paid by the bottom percentile. Again, this is a rough estimate and is intended to be no more than indicative.

Objection to income tax

Libertarian thought , at least as formulated by Nozick,  http://www.iep.utm.edu/nozick/#SH2a (hat tip to Chris Dillow for the link) seeks to persuade us that income tax is akin to theft or forced labour. Although Nozick’s thesis is persuasive to many, it is also incomplete because it offers no solution to poverty or extreme inequality. His thesis holds that there is just one virtue, that of self-ownership (self-determination). Many people will hold that other values, such as charity and compassion, are of equal importance and that Nozick seeks no balance between these sometimes competing values.

Abolition of income tax

It is probably uncontroversial to say that abolition of income tax without replacement would severely damage living standards for lower income households. Public services depend on taxation and so income tax abolition would damage the welfare state upon which vulnerable people depend unless a suitable replacement was found.

Hoarding

Abolishing income tax might well cause high income groups to hoard the additional money arising from the tax savings. High income groups  spend a smaller proportion of their incomes on goods and services than lower income groups do.This is significant because spending on goods and services keeps money in circulation and people in employment. Hoarding money, in contrast,  takes money out of circulation and subtracts from the commonwealth. Hoarded money is either sent abroad or comes back into circulation through someone being granted a bank loan. Hoarding thus obliges people to incur debt instead of earning their way to pay for their monthly outgoings.

High income tax rates go some way to addressing the propensity of high income groups  to hoard because the government spends taxes on public services that employ people and on benefits. A high rate of income tax levied on high incomes, which is then injected into the economy through government spending programmes, keeps money in circulation which otherwise would have been hoarded. Low income groups, who often benefit the most from public spending, are less likely to go into debt if the tax and benefit systems assist then to finance their monthly outgoings.

Replacing income tax

A replacement tax, which  might overcome Nocick’s objection to income tax, may be a Land Valuation Tax (LVT). Introducing a LVT  to replace income tax may also eliminate the alleged disincentive effects that  high income tax rates may have on investors and job creating entrepreneurs. A Land Valuation Tax will need to address the issue  of hoarding and be able to raise enough to replace income tax if it is to be an effective and fair replacement to income tax.

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5 comments

  1. Great to have another writer on the important issue of tax.

    A couple of points:
    On Nozick: A Nozickean could respond that Nozick isn’t interested in virtues – they are up to individuals. And people can be as charitable as they like with their property without interference from a Nozickean state. The state, however, should not take that which people have a right to. Which is why it is better to attack his notion of self-ownership rights head-on.

    On LVT: LVT has the advantage of not causing economic distortion. However, if it is applied without any compensation, then land owners will immediately lose the value of their land (since they would now have a large liability corresponding to its value), meanwhile the wealthy without land will not lose anything. This means 1) It is like a wealth tax, which are unattractive as it does not seem to be a problem for people to choose to save rather than spend. 2) It is not obviously progressive, since many wealthy people will own other non-land-based assets (patents, government bonds etc.).
    Also, you can tax the profits from land (and other things as well) with a capital-gains tax (or comprehensive income tax), and so you do not need to have a land tax in order to tax those who would gain from owning land.

    • Hi Doug

      Thanks for your feedback.

      In a Nozickean state, would the government have a moral right to impose indirect taxes, such as VAT or stamp duties? These taxes do not “steal” labour time, which appears to be why Noxick objects on moral grounds to (labour?) tax. In other words, there is no “forced labour” with indirect taxes and so this type of taxation is morally legitimate in a Nozickean state, it seems to me.

      With regard to Land Valuation Tax, I confess to not knowing an awful lot about it. I am puzzled by some of things you say in relation to it though. I don’t see why landowners should be compensated following its introduction. First of all, the land tax releases land owners from income tax so arguably the compensation is built into the switch of tax base. Secondly, the landowner would be able to recover the land tax through rent charged to tenants. If the land is owner occupied then the land’s value value in use would be unaffected by the tax. It is likely to affect the land’s exchange value though. Only when the landowner comes to sell the land may its price be lower than its historical purchase price as a consequence of the land tax. But that’s the market. It’s not the role of the state to guarantee asset holders capital gains.

      Wealthy people without land will stay pay land tax, albeit indirectly, through rent which the landlord should set so as to recover the land tax. Ultimately, land tax is thought to fall on the land owner because the tax will depress the exchange value of the land (be detrimental to a capital gain on resale).

      I suppose my real concern about LVT is that it may not address the hoarding issue. However, trades in other assets such as bonds and patents and other financial assets, could be brought under an ad valorem stamp duty / or transactions tax regime so that hoarding by wealthy buyers is taxed. This would not violate Norzick’s principle of self-ownership since these assets do not acquire their value through the buyer’s labour time.

      There are roughly 242,000 square kilo-meters in the UK. A tax rate of £1 on 1 square meter will yield £242 billion (I may need to check this rough calculation) but this is a nice figure to be thinking about, if it is anywhere near close.

      Kindest

      The Uxbridge Graduate

  2. Hi,

    Yes, sorry my criticism of LVT was very brief.

    I would assume that landholders wouldn’t be compensated for the loss of sale value on their property, though Victorian proponents such as John Stuart Mill thought they should be compensated. Which then costs as much as you get in from the tax (at least until there is some kind of economic growth). Some landowners will be able to afford the tax by using rental income, but then they will not get the rent that was factored in to their calculations when buying it initially. Others would have planned to live on their land, and they will have to find additional money to pay the tax. This is therefore very serious for the first generation of land-owners (hence the compensation proposed by the likes of Mill). These people have their land-based investments/life plans interrupted, while those who happened to invest in bonds or shares (except in land-owning companies like British Land or Land Securities) or their own education would not pay the tax. It is therefore (in the first generation at least) a wealth tax that falls on some much more than others. Its not the job of the state to guarantee capital gains, but in this case the rule-change is simply going to make a large group of people worse off. It is an easy way to raise money I guess, but not a very principled way (unless you believe in left-libertarianism – Hillel Steiner and Mike Otsuka are prominent left-libertarians).

    I’m against wealth taxes in general because I don’t see why someone’s choice to invest their income rather than spend it straight away should create more of a tax liability than someone else who has the same income but chooses to spend it. Progressive taxation should be about taxing the economically fortunate at a higher rate and the economically less fortunate at a lower rate. An income tax that–we might say–taxes income from work at a lower rate than income from investments would achieve this.

    Regarding hoarding – aren’t the hoarders likely to be investing their money? The worry is perhaps that they are going to invest it abroad, or hide their investments by using tax havens so nobody knows to tax it. But in general if people want to save their wealth I don’t see that this is a major problem. I would have thought that a progressive tax system would do a pretty good at sorting out the effective demand issues you mention by redirecting income to low-earners who are more likely to spend.

    As for the Nozick thought, I would guess a Nozickean would be against all forms of tax (consumption (VAT, sales), wealth (land)). These would also stop people making free transactions with others, which would violate their rights. Nozick did admit the need for some tax to fund national defence and contract-enforcement, but suggested this should be a poll-tax type thing. (He later went back on these late-60s early 70s beliefs by the way I believe).

    I could send you my tax proposal if you are interested.

    Best,
    Doug

  3. Hi Doug

    Thanks again.

    The savings in income tax should pay for the new land tax levy.

    Perhaps the answer is to exempt earned income and to tax savings and unearned income when it exceeds a tax free allowance. That will penalise hoarding whilst meeting Noziack’s objection to income tax .

    With regard to Noziack his objections to tax specifically refer to labour time being stolen. Taking his objection at face value I don’t see how taxing unearned income and consumption can be objected to on the grounds of forced labour. I know Libertarians say all tax is theft but that way lays madness. Is taxing consumption or the land a person is occupying stealing labour time? Perhaps it is, I don’t know. What individuals do with the fruits of their labour is their business but, at the same time, it is legitimate for a government to impose a tax on behaviour that is detrimental to the commonwealth. Kant is not the only moral philosopher. Did not Jeremy Bentham advocate the greatest good for the greatest number? A balance between Kantian and Utilitarian philosophies needs to be struck, in my view. Noziack seems to rely solely on Kant when he talks of self-ownership.

    I would be very interested to see your tax proposals. Do you have my email address so you can email them to me? If you don’t let me know and I will forward it to you.

    Best

    The Uxbridge Graduate

  4. Pingback: Shouldn’t the rich contribute more? – Hoong-Wai in the UK


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