The truth about taxes

Election time comes round and a deal of heat is generated discussing a subject about which few, if any, politicians have any understanding.  To deliver a coherent economic policy requires we need to understand what the purpose and effects of taxes are.  Traditionally economists divide taxation under two headings:  a) direct taxes b) indirect taxes.  If only it were really that simple!

Income tax is regarded as a direct tax and then there is National Insurance.  Half of National Insurance is paid by employers.  They pass that on when they price their products and so it becomes, in effect, an indirect tax.  Then again; employees pass on the cost of their income tax to their employers, or at least they try to.  Once again this ends up as a component of the employer’s price and so it becomes someone else’s indirect tax.

A principle of taxation has been that it is unfair to levy a tax where there is no income to support payment.  Business Rates, however, are levied before a business can even attempt to collect any income.  This punitive form of taxation can be blamed for the failure of many small to medium sized businesses and probably for the emigration of many larger enterprises.  Its sister tax, Council Tax, is equally punitive and unfair.

Let us take Corporation Tax as another example.  This is levied on the profits of companies.  How do we define what is, or is not, profit?  Clever accountants are employed to prove profits are “nothing of the sort”.  The basis of the calculation is financial accounts whereas true profitability can only be ascertained using Cost and Management accounts.  Hence Company accounts have become the most popular form of fiction while any Company ending up with a tax bill, once again, simply adds that to the price of their goods or services.

 Who pays taxes and why?

Guess who really pays.  Yes.  The consumer.  All taxes are paid by the consumer.  Some consumers are able to pass those taxes on again.  The cost may be passed on again and again until finally it hits someone too poor to be able to avoid it.  Despite protestations to the contrary the bill for our services generally lands at the door of the poor.  When politicians and economists talk about “progressive” taxation you know they are lying.  There is no such thing.  Measures can, however, be taken to alleviate the regressive nature of a given tax.

Taxation serves two purposes.  First it raises money to pay for public services at both national and local level.  Then it can be used to distort the relationship between prices, supply and demand.  In fact every tax has that secondary effect and when discussing taxation policy it is essential the implications on behaviour are considered.  If the price of a commodity increases then the demand for that commodity will be reduced unless consumers find they can dispense with some other commodity to enable them to afford the increased price or are able to increase the price for what they deliver (labour).

Laws of economics.

The first law of economics is the Law of Supply and Demand.  Second is, surely, that everything is on shifting sands and absolutely nothing is fixed.  Making changes to an economy is rather like driving a speeding car on snow or ice but without winter tyres.  You know that a gentle touch on the controls will tend to make the vehicle move in a given direction but there is no way to guarantee exactly where it will end up.

 Government taxation policy, in the UK, is dictated by the Treasury.  This archaic department must surely be the one Dickens was emulating when he created his Department of Circumlocution.  By ignoring the secondary effects of its hideous creations it finds itself continually trying to create mechanisms to correct its mistakes and more deplorably to hide the true rate of taxation or to alleviate or correct for the problems its ineptitude has caused.  The rate of taxation is considerably greater than it needs to be because of the cost of managing the complexities this self-cannibalising monster excretes.

 The net effect of our complex tax system:  The trade deficit!

Meanwhile the bulk of taxes are applied only to those creating products and services here.  Imports get off scot free.  We subsidise our imports and we penalise our exports.  No wonder we have never manage to deal with the trade deficit!

 The tax that is subjected to the most virulent attacks is the one that is most visible.  Yet the tax concerned is the way to remedy all the above effects.  It contains mechanisms to enable it to be applied in a way that the poor can be exempted almost entirely from it.  Inexpensive to collect, it is very hard to avoid.  It provides a means of collecting from the rich and multi-national corporations because it is collected at the point of sale. Taxes should, however, be visible.  If they are then people will know the crippling burden they represent and politicians will have nowhere to hide.

 IFS figures and what not to read.

The Institute for Fiscal Studies compile and publish details of Government tax income and spending.  It is an excellent resource but not so good at predictions.  You may be astonished to note that only a quarter of Government income is derived from “Income Tax”.  When added to that other “Income Tax” (National Insurance Employees’ contributions) that takes the figure up to around one third.  All other taxes should be treated as indirect taxes.  The much maligned VAT provides only 16.8% Government income. 

 Now you see it.  Now you don’t!

Visible taxes, then, account for around HALF of Government income.  The remainder is collected by stealth.  An unholy collection of hidden indirect taxes such as Business Rates, Air Passenger Duty, Corporation Tax, Employers’ National Insurance, Betting and Gaming Duties, Climate Change Levy, Alcohol Duties, Fuel Duties, the list goes on and on, are collected by stealth and impact on every price we pay.  This means that, in truth, food is taxed at the rate of around 50%, making that zero rate of VAT quite meaningless and disgustingly deceptive.  If you spend £100 on food then around £33 of that is tax!  Remember, too, that each of these taxes has its own expensive bureaucracy to enable them to be collected.

 A simpler fairer tax system means dealing with this dishonest and disreputable taxation regime which is the product of all the old order parties and the prime mover in creating inequality.  This complexity prevents enterprise and destroys jobs and opportunities.  It is the prime culprit behind our economic decline and reform is the most urgent job facing the United Kingdom.

 How to fix it.

My solution would be to tear up our tax rules in their entirety.  The only taxes should be Income Tax for people on above average incomes and variable VAT.  VAT might be zero rated on essentials but set at punitive rates on luxuries or products that are a health hazard.  It should be applied to interest charged on unsecured lending (with the proviso that the greedy banks would be required to absorb the cost on existing lending).  This taxation would correct for a number of ills that bedevil enterprise in this country.  By replacing the stealth indirect taxes, levied on ingredients, with VAT those taxes would be recoverable when the completed product is sold.  This would mean a substantial effective reduction in energy costs for British manufacturing. 

One final tax might be considered i.e. a “distributed profits tax”.  As an example I would suggest that if a Company can pay a pound in dividends it could perhaps pay a pound in tax.  No complex accounting would be necessary and multi-nationals would be taxed on money taken out of the country since this would be defined as “profits”.

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