There has been a fair bit of controversy recently over the government’s decision to cut the top rate of tax in the latest budget. Those earning over £150,000 will now pay 45p for every pound they earn rather than 50p.
The politics of giving a tax cut to the top 1% of earners at a time of austerity is pretty stark, but the chancellor believes it will actually bring in more money. At 50p, rich people have the added incentive to avoid tax, so a 45p tax might bring in more revenue. This phenomenon has been described in the Laffer curve, which suggests there is an optimum level of taxation. If you raise taxes too much, people will stop paying. Push it too far and tax avoidance becomes a kind of national pastime, a situation Italy has found itself in and is desperately trying to remedy.
Whatever you think of the chancellor, taxation is hard to get right. It’s important that tax is fair – but then people have different ideas of what is fair. Asking the rich to pay more looks fair to those on lower incomes, and profoundly unfair to those having to surrender 50% of their income.
But perhaps we need to think more creatively about tax, and ask some bigger questions about whether income tax is a good idea in the first place.
We need governments and the safeguards they provide, and that means taxation in one form or another. (If you’re one of these libertarians who thinks we don’t need government at all, I suggest moving to Somalia). There are lots of ways to raise taxes, from customs and excise to corporations taxes. Among Britain’s rich history of taxation are such exotic levies as a window tax, which prompted many people to board up their windows. There have been hearth, hat and salt taxes. Perhaps most bizarrely, Henry VIII taxed beards, and so did Russia’s Peter the Great.
Income tax is relatively new. It has cropped up at various points in history, but in Britain it was a way of paying for the Napoleonic wars. It was supposed to be temporary, but it stuck around, despite several attempts to remove it. Officially, it’s still a temporary tax and it has to be renewed in law every year. At the start, it was a fairly modest levy, with a standard rate of 6%. That was blown away by the First World War. By 1918 most people were paying 30% of their income. In the Second World War it got worse, the standard rate rising to 50%.
Once established, income tax was too useful to shift. Where customs used to be the biggest tax revenue source, income tax has grown and grown and now accounts for 30% of the British government’s revenues. It would be hard to do without it now. But that still doesn’t make it a good idea.
A fundamental problem to bear in mind is that every tax has consequences. If you tax hearths, people will brick them up and shiver, as Charles II discovered. If you tax beards, they will shave. Tax can be used to shape behaviour – which is just what Peter the Great had in mind with his beard tax. He wanted Russia to modernise and fall in line with the rest of clean-shaven Europe. We do the same thing when we put high taxes on cigarettes, or low ones on electric cars. Tax can be a way of encouraging things we want more of, and discouraging those behaviours society wants less of. Income tax, under that philosophy, is all wrong. It is a tax on productive work, when actually that’s something we want more of and should be looking to encourage.
So what if we scrapped it? The New Economics Foundation recommends just that in its report The Great Transition, or at least scrapping it for most people. We could replace income tax with a number of other measures, such as a more local services tax, as part of a broader localization agenda. Consumption taxes make much more sense than income taxes, since it is consumption rather than wealth per se that drives resource depletion. If most of our taxes were paid through consumption, those who lived a more sustainable lifestyle would pay less. Tax rates could be applied by ecological impact, so that locally produced or environmentally benign goods were cheaper than energy-intensive, high-carbon goods and services.
To help reduce inequality, income tax could still be levied on above average wages, and redistribution could also be achieved by taxing other forms of wealth – assets and property. Ultimately, you’d be looking to create “a shift from taxing ‘goods’ such as work, to taxing environmental and social ‘bads’ such as pollution, consumption and short-term speculation” as nef puts it.
Needless to say, those would be big changes and would need to be part of a bigger strategy. But it would be nice to see some fresh thinking on taxation.