SOUND TAX POLICIES
The government of a totalitarian state doesn't have to worry about a
tax system because the nation's entire output is already in its hands
This is a mirror image of what happens in a democracy, where
government decides how much to take from its citizens; under a
totalitarian regime, by contrast, the state decides how much to give
them to enable them to live and, hopefully, keep them content
However, every state, whatever its political colour, should subject
itself to the discipline of keeping its spending plans within the limit of
its resources. If it spends more than it has raised in taxes, and what it
has in reserves, it must borrow the shortfall (assuming it can find a
lender) or resort to the monetary printing press.
Even that is not a viable solution because fake money loses its
purchasing power and, ultimately, becomes worthless. Current news
from Venezuela is that street beggars don't even bother to pick up
money that lies like litter in the streets, no matter how many zeroes
are denominated
Readers will know from my previous essay that most existing
methods of raising taxes are indiscriminate, politically
interventionist, and grossly inefficient. It's a huge compliment to this
country's productive capacity that it is able to survive the destructive
effects of its tax-raising regime.
Is there a better way?
Adam Smith's canons of tax policy have stood the test of time. They
tell us that a tax charge must fall within the capacity of the taxpayer
to bear it; its amount must be certain and not arbitrary; its cost of
collection should be the minimum required and involve no waste;
and its yield should be sufficient to meet the needs for which it was
levied - again, no waste.
We must also remember that low rates of tax will generally yield
more revenue than high rates. The so-called "Laffer Curve" is based
on the observation that tax rates of both 0% and 100% will yield zero
revenue. The skill of a judicious Chancellor is to identify the rate that
produces the greatest yield
Last week's essay demonstrated that "income tax" , levied through the
pay-as-you-earn system, is a corporate liability, effectively a payroll
tax or, unvarnished, a tax that penalizes businesses for employing
a
people
Almost 250 years ago Adam Smith illustrated the madness of such a
tax with the example of an employee earning £100. If the state
imposes a tax of 20%, the employee's pay must rise by 25% in order
to reinstate the employee's real income. The additional cost is borne
by the employer: the "gross pay" must now be £125 so that the
deduction of 20% tax leaves disposable earnings of £100. Indeed,
national statistics always show that, whatever the tax rate, the ratio
between real (net) pay and GDP tends toward a constant percentage.
It's the business that bears the tax!
The idea that the employer is a mere tax collector on behalf of
government is therefore sheer nonsense. The reality - that payroll
taxes are borne by the employer - takes no account of the fact that
marginal businesses have limited taxable capacity. As an example,
some years ago British Steel reported trading losses of £1 million per
day, an amount that was exactly balanced by the tax "deducted" from
its employees' "gross" earnings and paid to the revenue authorities.
British Steel, as an enterprise, clearly had no taxable capacity at that
point in time. Although its accounting losses shielded it from having
to pay corporation tax, it suffered a vast tax penalty for the sin of
being a major employer!
Several businesses I know took the brave step of paying employees
their full gross pay without deduction, and the result in each case was
a highly motivated workforce and a leap in productivity that
exceeded the additional tax. [I actually visited Nicholas Ridley at the
Treasury and persuaded him to provide them with "grossing up" tables
to help them work out the tax! Interested readers can find two of such
examples on my website.]
But wait for it! The most ludicrous charade of all is enacted whenever
the earnings of those paid out of taxes are "taxed". Applying the PAYE
rigmarole to the earnings of civil servants, council employees, NHS
employees, Inland Revenue staff, and the thousands of other central
and local government employees, all paid out oftaxes, takes on an
especially farcical twist!
Almost anything would be better than what we have now. What the
Treasury is able to raise in direct taxation is clearly insufficient, so it
taxes everything else, seen and unseen - property transactions, cars,
fuel, energy, insurance premiums, travel, everything you buy,
professional services, marriage, death, you name it - they are all
taxed, one way or another!
But to avoid the traps into which our tax regime has descended, it is
essential that we, as humans, exercise our powers of reason!
Next week I shall post my recommendations.