Monday, July 30, 2012

Land Tax: Plucking the Goose

The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” Jean-Baptiste Colbert


·      Moving from income, council and business taxes to a land-value tax (LVT) would be revenue neutral whilst raising efficiency and equity.
·      In taxing economic rent rather than effort and investment, LVT would boost growth and curtail speculative housing bubbles.
·      LVT would reduce tax avoidance and foster a more productive use of capital.
·      LVT would ameliorate material inequality both within and between generations.

Given its long and illustrious list of proponents, including Adam Smith, John Stuart Mill, Henry George and Winston Churchill, one may ask how it is we are still without a land value tax (LVT). The reason is Britain’s equally long and enduring tradition of entitlement. In the wreckage of the crisis, with the economy in a listless state of inertia and widespread indignation at the inequities all around, now may be a golden opportunity for change.  

The analysis of any tax must address three concerns: that of efficiency, equity and revenue. The LVT is interesting because its advocates are both on the free-market right and egalitarian left, with their concerns for efficiency and equity respectively. The LVT breaks the usual trade-off between the two and so brings together these opposing factions.

A land-value tax is an annual levy on the on the unimproved value of land. This value is derived from its scarcity and the supply of local amenities, rather than the productive capacity or quality of what is on top. The LVT therefore taxes economic rent, rather than effort or investment. As the supply of land is perfectly inelastic (it does not vary with its price), the efficiency loss of its taxation is zero. Whereas most taxes such as income or council tax distort economic decisions, pushing resources away from their most efficient application, a LVT is non-distortionary, as it is payable independent of the land’s use. Geared rent-seeking, or speculative purchases of property, which drives up its price by virtue of restricted supply and local public services and infrastructure, has created house price bubbles. These serve only the interests of those speculators, and the costs of financial instability and unaffordable housing are borne by the rest.

A LVT would allow those who create the value of land to realise some of the return and would enable revenue-neutral reductions in other taxes, encouraging labour supply, innovation and investment in human capital. This is a view recently taken by the OECD, who also point out that “as real estate and land are highly visible and immobile these taxes are more difficult to evade, and the immovable nature of the tax base may be particularly appealing at a time when the bases of other taxes become increasingly internationally mobile.”[1]

Inequality of wealth is far more severe than inequality of income. The top 1% of earners get 8% of total income, whilst the top 1% most wealthy have 23% of the country’s wealth. Income tax avoidance is rife at the top of the distribution and according to the ONS the poorest fifth of households pay 5% of their household income in council tax, the middle fifth 3% and the richest fifth less than 2%.
There is also an inequality of living space between generations. Young families with the most need for space are precluded from the property market by prohibitively high house prices, as the elderly hang on to their largest and only growing investment. Britons hold a disproportionate amount of their wealth in residential property (74%, compared with 54% in the US[2]) and the problem of intergenerational inequality was massively exacerbated through the great moderation years of 1995-2007, when house prices increased by around 180%. These investments are not capital accumulating but rent seeking.

As for revenue, it is estimated that levied at a rate of 0.5% the LVT has the potential to raise around £30bn pa, enough to abolish council tax and give a tax cut to those living in cheaper properties.[3] In Australia a LVT raises 4.5% of their tax revenues.

The difficulty comes in separating the value of a crop for example, and the value of the parcel of land the crop grows on. As data and technology have advanced it has become easier to make these calculations and indeed insurance companies do so all the time. A complete substitution of LVT for our present tax system would be politically and practically untenable, but a shift in that direction would serve to increase efficiency and equality, without damaging revenues.

[2] Sierminska et al (2006)

Tuesday, July 10, 2012

The Tobin Tax Anathema

Europe's lurch left will amplify calls for a tax on financial transactions. Its populous is
hungry for redistribution, stability and social justice. Francois Hollande believes a socalled
Tobin tax will bring stability and raise revenues to fund infrastructure. A
commitment to include such a measure in any EU budgetary renegotiation helped
him win the presidency. In Britain the tax has received the theological backing of the
Archbishop of St Andrews, and a recent poll by Oxfam finds 51% of the public
support the idea. Though the aim is laudable the approach is flawed.

In 1971 President Nixon divorced the dollar from gold, thereby ending the Bretton
Woods system. The ensuing instability in currency values caused by the ‘Nixon
Shock’ led James Tobin, professor at Princeton and student of Keynes, to call for a
tax on currency transactions, to throw ‘sand in the wheels’ as he put it. These days
the term ‘Tobin Tax’ is used as a catchall for financial transactions taxes.

Its enduring appeal comes from a ‘double dividend’ argument. Proponents say that a
‘small’ tax on every financial transaction would bring stability and raise revenues.
There is however an inherent contradiction in this argument as the objectives require
opposing behavioural responses. To raise revenue you want low responsiveness and
to create stability you want high. Responsiveness, or elasticity, depends on the rate
at which the tax is levied. Presently the European Commission is proposing rate of
0.1%, which it hopes will raise €37bn annually in revenues. The literature suggests
this rate errs on the elastic side, implying a large behavioural response. Distortions of
this kind have huge effects on the ‘general equilibrium’, beyond their intended
sphere. Ernst and Young estimate the tax will lead to a net fall in the EU’s revenues
of €116bn. This concern goes to the heart of the theoretic results of taxation
economics. The seminal Diamond-Mirrlees 1971 paper strongly advocates no such
tax on ‘intermediate’ goods, as these propagate through the economic complex,
causing many unintended effects.

What’s more, the evidence suggests the particular behavioural response in this case,
far from calming the markets and edifying those hotheaded speculators, will actually
increase volatility. The Institute of Development Studies finds ‘…the balance of
evidence would seem to suggest that there is a positive relationship between
transaction costs and volatility.’ This of course makes intuitive sense. If the banks put
a charge on ATM withdrawals you would expect people to take out more money less
often. Restraining the ability of traders to follow changes in fundamentals will lead to
jolts in prices and foster uncertainty.

The second issue concerns incidence. The popular discourse on tax invariably
ignores the economic wisdom that he whom a tax is levied on is not necessarily he
who pays. Tax shifting is where the burden of tax is pushed back or forward to other
related parties and again depends on relative elasticities. In most instances this
means employees and consumers end up footing the bill. Two such parties likely to
suffer from this tax are pensioners and emigrants who remit money back to their
home countries.

Tobin described his tax as an ‘anathema to Central bankers’. It is also an anathema
to reason and evidence, which its well-intending sponsors must not ignore.

Saturday, July 7, 2012

Economics etc

Malign economics, or more properly its malign political abuse is the cause of the economic and social problems in the United Kingdom today. Banking crises, civil unrest and tax avoidance are all symptoms of a far deeper problem: the centralisation of power and negation of personal responsibility.

Following the publications of Alfred Marshall’s Principles of Economics in 1890 and later Paul Samuelson’s Economics 1948, neoclassical ideas have dominated the discipline of economics. Elegantly embedding mathematics and Euclidian geometry in the study of political economy, neoclassical economists created a ‘science’ of scarcity. Consumers, producers and the government are pitted against one another, each performing nimble calculus under conditions of perfect information, perfect competition, rationality and unbounded self-interest. The models divorce the economic from the social and step over the contextual issues which weighed so heavily on the scholars of classical political economy such as Smith, Marx and Mill.

The illness

Ignoring social institutions and regarding individuals as mere sumps for utility is a useful abstraction and has given us many valuable insights. As Mill wrote, ‘the first object in every practical discussion should be to know what perfection is’. But its application in public policy has been disastrous. It has led to centralised control, arbitrary performance targets, obscure tax schedules and welfare dependency. Economics focuses on the margin and so too has public policy.

For example there are currently 5.4m people in receipt of an out-of-work benefit.[1]Welfare represents 15% of an ever-growing public expenditure outlay; more than is spent on education and just less than is spent on health care.[2]This in itself is just unfortunate. What is ruinous is that there is no link between social insurance payouts and contributions, no ‘conditionality’. Benefits are seen by many recipients as simply a lifestyle choice, a right, rather than a safety net (as in Beveridge’s original conception). A sacrifice principle approach to welfare has bestowed a right without responsibility, and last August’s riots were a reaction to the (perceived) withdrawal of this ‘right’. What’s more, there are feedback effects into other spheres of policy. For example, work by economist Ronald Cummings[3] has shown that where individuals perceive paying tax as a fair fiscal exchange they are less likely to avoid/evade. Moral hazard permeates the entire economic complex if individuals are relieved of responsibility for their actions. The state spends nearly 50% of gdp and as long as central government is deeply enmeshed in the provision of local services this proportion will continue to grow.

The cure
Competition is not a state of affairs but a process of discovery. Price rarely reflects marginal cost and profit is not exploitation but the signal which drives resources to their best use. Information is disseminated and no single agency ever has access to all of it. Those most proximate and most affected are able to make better decisions than those removed and distant. These are the insights of Austrian economics. From the insights of behavioural economics we know people are highly susceptible to cognitive bias and myopia and so are unlikely to act in the ‘perfect’ way the textbooks purport. Together with the work of economists such as Amartya Sen and Martha Nussbaum they call for a capabilities approach to policy. Services should be provided locally and people should be allowed to compete free from the coercion of technocrats. Above all growth must be allowed to happen organically, without the short-termist, inevitably unstable inducements of government.

[1] (February 2010) The Poverty Site
[3] Cummings et al (2007), Tax morale affects tax compliance: Evidence from surveys and an artefactual field experiment.