Why more taxes on the rich may be a dead end

The debate about inequality has reignited the discussion on taxes. The picture emerging from any analysis of tax revenues is a stark one indeed. Essentially there are two disparities that stand out. The first is the widening gap between the taxes paid by small and medium sized enterprises and those paid by multi-national companies. Figures for the US illustrate this point well. The effective tax rate multinational companies in the US paid on their profits has been 24 percent in 2015 (The Economist, 9th July 2016), yet the official tax rate stands at 39 percent. This means that small enterprises which do not have the advantages of being able to move their profits into low tax havens or to use tax loopholes to shield their profits from tax are effectively paying a higher rate on their profits than the largest top 50 firms.

The second area which contributes to a sense of injustice in tax matters is personal income tax. This debate has been galvanised by the revelations about the superrich hiding their assets in tax havens through tax avoidance or tax evasion, depriving governments of legitimate tax income. So far, the UK government has tried to tackle the disparities in the tax system by taking people at the bottom of the income scale out of tax altogether, raising the income tax allowance.

Whilst reducing the tax burden of the poorest is welcome there are signs that the increasing income and wealth gap creates some limits on what can be achieved through tax policy on its own. The danger is that lowering the reliance of the government's income tax base on tax payers at the bottom of the scale whilst increasing its reliance on top tax payers creates unacceptable volatility in tax revenues in the long term. Take the example of California. On paper, income tax policy in the sunshine state is one of the most radical in the West. The rate of income tax stands at 13.5 percent (on top of federal levy of 39.6 percent). That makes income tax levels in California one of the highest in the Western world, something to be celebrated in the books of campaigners for equality.

However, it also means that about 45 percent of all income tax revenues are now coming from a very small number of superrich people who happen to have their tax base in California. The top 1 percent of tax payers pay almost half of all income tax in the state. Since other taxes are subject to strict regulation and cannot be changed easily, California's lawmakers have little room for manoeuvre when things go belly up. If only a few of the top 1 percent of tax payers decide to leave the state, this creates a considerable gap in the government's coffers rippling through to education and welfare policies with a vengeance.

High dependence levels on very few tax payers, whilst welcome in terms of creating more equitable levels of income, thus looks like a poor mechanism to create stable and effective government revenue streams, which in turn are essential for public services and infrastructure investment. Narrowing the tax base may therefore increase volatility at the expense of tax revenue certainty which is so important for long term strategies to tackle inequality. It seems the debate on how to best address inequality needs a few more ideas.

Are we bothered by inequality?

One of the central electoral campaign themes of the Labour Party is inequality. Economic and social inequality has certainly figured prominently in the public debate over the last couple of years, spurred by discussions about bankers' salaries and bonuses for CEOs. The Miliband camp argue that attitudes of British people have fundamentally shifted from the Blairite cavalier approach ('Not bothered about the filthy rich') to significant levels of concerns about wage inequality. But is this true?

In the journal Political Insight, a team of authors published a summary of the research on British political culture. Their study investigated whether political culture fosters specific social attitudes over the long run. Whilst their results reveal some interesting correlations between longitudinal shifts in attitudes and potential changes in political culture, some findings from the British Social Attitudes Survey can also be read with Miliband's claim about shifting views on economic inequality in mind. The figure below shows the responses stratified by age of respondents and year of survey to the question: 'Thinking of income levels generally in the UK today, would you say the gap between those with high incomes and those with low incomes is (1) too large; (2) about right; or (3) too small?'

Is the gap between the rich and poor too large (high values agree) Britain 1983–2012, by age

From:The British Social Attitudes Survey, 1983–2012.

The diagram clearly shows that there has been widespread concern about income inequality across all age groups in the 1990s, then largely petering out during the Blair years. Interestingly, looking at the years 2010 and later, there is no reversal in the aggregated responses to the high levels of concern under Thatcher and Major. The survey results appear to indicate that, with the exception of the age group between 55 and 70, concern with income inequality remains low. Moreover, the younger generation registers the lowest levels of concern with the issue of income inequality compared to all other age groups, a finding that contrasts sharply with the anecdotal (ostensibly wrong) evidence of young people on barricades (and in occupy camps) in the UK protesting against income inequality.

This has also implications for the campaign of the Miliband camp. If income inequality does not appear to be a major concern of people in Britain, it is unlikely to be a major motivating factor to vote either.

Thomas Piketty and the discourse of envy

Thomas Piketty's 600+ page book on Capital has caused some jitters in the US and UK. Some right wing commentators have roundly condemned the work as a product of unmitigated socialist ideology (which might just be a badge of honour in Piketty's home country France). Yet, nothing could be further from the truth. The book is in fact adopting a measured and balanced tone throughout and cultivates a sense of intellectual fairness that serves the ongoing discussions about equality well.

It is also well written and easily accessible which makes it, if not exactly bed time reading, a welcome contribution to a wider debate on the effects of capital accumulation in the developed world (Pickety is unashamedly focussing on the 'First World', mainly for reasons of data sources, and consequently there is very little about China, India, or even Central European countries in Piketty's volume).

It is of course easy to find flaws in a monumental piece stretching over more than 600 pages but Pickety insulates himself well to criticism by pursuing a tightly controlled theme and rarely straying from the main path. The data he has marshalled are impressive and the argument flows coherently and plausibly.

Yet, after a detailed exposition of capital in all its manifestations (real estate, financial and industrial assets), Piketty then embarks on a more daring path, entering the territory of economic prediction and tax proposals. His suggestion of a world wide capital tax has been widely debated and criticised so I wont go into detail on this, except, in fairness, point out that he repeatedly reiterates the hypothetical and idealistic character of his own proposal.

A more relevant criticism appears to lie in the way in which he discusses the purposes of taxation in general. At times, he seems to suggest that the reason taxation is levied is to give tax authorities (and researchers) a better data set. To my mind, this is like putting the cart before the horse. Taxation should have a purpose beyond simply generating knowledge for bureaucrats in tax authorities or, incidentally, academics.

Once his political instincts come to the fore, he identifies another additional purpose of taxation: to reduce capital differentials amongst the populations. This, of course, is the expected culmination of his treatise on the history of capital: to reduce inequalities. Yet, Piketty cant quite bring himself to look for a consistent justification why taxation should be the prime mechanism to bring about equality. To do this, he would have to enter the domain of political philosophy yet, he struggles to engage in this debate. It may be because the language of politics is less determined by the grammar of economic development than by political legitimacy, an aspect of political morality that sits oddly in any economic treatise. In an aside, he lets his guard down and writes:

'Even a person of the most refined taste and elegance cannot easily spend 500 million euros in a year.' (p525)

The implication is that if somebody cannot plausibly make use of what she owns, she should not keep it. It is this curious inversion of property rights that puts him on a par with the illiberal sections of radical socialism. Incursions into people's right to life, liberty and property (as Locke referred to them) requires careful justification. Simply stating that somebody couldn't plausibly have any use for their property moves Piketty dangerously close to the illiberal discourse of envy. This does a disservice to an otherwise insightful and impressive historico-economic study.

The benefits of coalition government

As a German I have always been quite comfortable with coalition government, unlike most people in this country. Indignation about broken electoral promises never resonated with me, given that the main  benefit of coalition government seems to be a need for compromise that often weeds out the nuttier promises made in the heat of the electoral battle.

As the present coalition government edges to its final days in the UK, the 'play fights', as Andrew Rawnsley from The Observer calls them, increase. They are in essence the separation rituals of two partners that need to differentiate themselves from each other whilst at the same time trying to celebrate what they achieved.

Whatever its accomplishments, there is one advantage of coalition government that is rarely discussed. It's the fact that both partners are in a learning experience, coming into direct contact with other opinions and views on how to run the economy (and the country) without having the privilege to reject other perspectives out of hand. In other words, coalition government has a disciplining effect on all partners, forcing them to listen and to learn.

One area which demonstrates this increased capacity to learn under the conditions of a coalition government is taxation. In 2010, the Conservatives were steadfast against increasing the personal tax allowance whilst Lib Dems made it one of their most prominent electoral pledges. Two years into the coalition government and Chancellor George Osborne publicly commented that he wished this had been a Tory pledge all along. The Tory support for the increase of the personal tax allowance became so strong that Lib Dems felt miffed about it and kept pointing out to anybody who wanted to hear it that this was originally their idea.

There may be some disadvantages about lifting more than 5 million people out of tax altogether, mainly relating to the fact that modern societies are based on the contributory principle, for which taxation is the main conduit. But overall, there is now only one party that does not support a further increase in the personal tax allowance, the Labour Party. How Labour politicians square this with their avowed ambition to do good for the lowest paid is beyond me, but it seems that the two coalition partners have got it. Sometimes it may be a good thing if you are forced to share power.