Learning to love tax

The obvious thought about a book called Taxation: A Very Short Introduction is that it can hardly be short enough. Yet, Stephen Smith, a professor of economics at University College London, confounds that cynicism because he has written a very short book on taxation that I wished were longer. Even at its truncated length (152 pages), this is a clever, detailed and entertaining guide to tax policy.

If tax policy sounds dull, then politics itself is dull, because there is no better embodiment of the competing political philosophies that fought the general election than policy on taxation. Who or what to tax and at what rate? There is a lot to be said about these questions which is technical, but before they are technical, but first they are philosophical.

Taxation is a mirror in which political traditions see their own virtues. The left sees it as the state’s method of arranging fairness which is a casualty of capitalist relations. The left’s claim to moral superiority over the right, which is its willingness to correct inequality, is embodied in its policy on tax. The group of people for whom the left thinks itself the representative—the relatively dispossessed—it seeks to help through tax transfers. The right’s opposite instinct, that government is liable to be a poor diviner of individual wishes and an inefficient provider of services, leads it to the view that taxation should be light. The greater good is served if as much personal income can be kept in the household as possible. The beneficiaries of such a view, as a matter of political fact, will be people in the middle and the upper end of the income scale.

Smith’s story is drier and less political than this. He shows instead how the source of tax revenues differ between nations. Countries in mainland Europe, with welfare states that derive from the contributory principles established by Otto von Bismarck, allot a greater weight to forms of social and national insurance than the Anglo-Saxon countries. Some nations, and Britain is a notable example, take a lot of money from consumption taxes on discretionary purchases. The United States, by contrast, has no federal sales taxes at all, although some are levied by individual states.

There are, of course, differences not just in the nature of the imposts levied but also in their scale. The US and Australia tax their citizens comparatively lightly (Smith notes that by 2012, the US had the lowest level of taxation, as a percentage of GDP, of any country in the OECD); the Lutheran countries of northern Europe more heavily. Britain, which seems to desire European levels of public spending and equality with American levels of taxation, lies somewhere between the two extremes.

All such differences embody choices about the nature and scope of the state. Public philosophies are implicit in every decision and this remains true in spite of the force of Smith’s point that the history of taxation is rather haphazard. The tax system we have in Britain today, for example, is not the rational upshot of a single tax commission. It is the accidental accretion of ages.

The most famous story of all in the UK is the introduction and the growth of income tax. On 5th April every year an application has to be filed in parliament to seek a mandate to renew income tax. That is because, when income tax was first levied, in 1798, to raise funds for the Napoleonic Wars, it was, at least in theory, a temporary tax. It still is and the UK government has to pass an annual Finance Act so that the legality of income tax does not lapse.

The story of the growth of taxation is also the story of the growth of the modern state. At the end of the 19th century tax revenue was less than 10 per cent of national income in both the United Kingdom and in France, and less than 7 per cent in the US. Since 1965, the percentage of Gross Domestic Product (GDP) that is taken in taxation has risen, across the Organisation for Economic Cooperation and Development (OECD) countries, from 25 per cent to 34 per cent. Britain, at 35 per cent in 2012, is just above the OECD average, having been substantially above in 1965. In hard cash terms at current price, each person contributed $3,600 in 1965 but stumps up $14,500 now.

The rise in taxation in the second half of the 20th century is part of the process of modernisation and bureaucracy-formation charted by Max Weber. Countries such as Japan that, in 1965, were poorer have seen significant growth in the reach of the state, and hence in the tax burden needed to finance it. There has also been a policy choice in Europe to increase the range of services offered. Indeed, the only OECD nation that has seen a reduction in the percentage of GDP taken in tax between 1965 and 2010 is the US.

It is a familiar tale which Smith tells and illustrates well. His focus is very much descriptive and practical rather than normative and philosophical. He has chapters, and excellent chapters they are too, on the structure of taxation, from whom the money is transferred and to who, the economic impact of taxation and the problems of enforcement and evasion. He has a lot to say about the efficiency and practicality of taxation and he is a very reliable guide to it. He has less to say, because it is not really the question he sets out to answer, either about the purpose of taxation or about the desirability of one of the big stories that, implicitly, he tells.

To take the purpose of taxation first, the best answer is probably that supplied by John Stuart Mill. Taxation is an unfortunate necessity brought upon us by the desire to provide certain goods. Of course, this argument is then freighted with moral argument. As I have said, the social democratic left regards taxation as the means by which an unequal capitalism is made just. One of the reasons Ed Miliband’s prospectus was so unattractive to the nation was that his moralistic relish for higher taxation, in the service of greater equality, was quite clearly not shared by enough people.

The argument about tax therefore connects very directly to the main distinctions between the political traditions. Parties like to pretend to themselves that they are repositories of distinctive values and virtues. That is not really true. The real difference between social democrats and conservatives, between Labour and Tory, is a difference of method. The left has a greater optimism that the state will use public money wisely in the pursuit of the public interest. The right tends to pessimism on this question. As a consequence, it seeks to raise less money in tax.

That leads to the question, which Smith is not especially concerned with, about how to raise that money. Smith’s account shows that the main principle of taxation is simplicity and ease. Any tax which is easy to collect and raises a steady stream of revenue will tend to be popular with the tax authorities, if not necessarily with those paying it. This explains the attraction, to Conservative governments in particular, of Value-Added Tax (VAT). It is easy to increase and collect and, because many purchases are not really voluntary, the money flows in. The second important distinction between the political parties is sociological. Labour stands for the bloc of the industrial working class and the Conservatives for the suburban and rural constituencies. Of course, both parties periodically attempt to break out of their historic homes, but the electoral map of 2015 is remarkably split between city on the Labour side and small town and country on the Conservative side. This is reflected in the differing arguments for who should bear the greater burden of taxation. The Labour party has just spent an unsuccessful election campaign arguing for higher taxes on the wealthy, resisted by their Conservative opponents.

This is itself a familiar story, but the compulsory seizure of money deserves a more principled defence. The British government has to find more than £600bn a year from somewhere and it would be better if it were done on the basis of some agreed principles. Smith’s history shows that taxation has been moving in exactly the wrong direction, towards greater and greater levies on labour and endeavour, with no party setting out the principles on which these were based.

The best principle for taxation can be found in Herbert Asquith’s Budget of 1907. Asquith’s intention was to tax work lightly and to seek instead to locate idle wealth, the sort which, as Mill memorably said, “falls into our mouths while we sleep.” Asquith sought to tax bad things heavier than good things and enterprise lighter than unearned wealth. These principles were then embodied in David Lloyd George’s “People’s Budget” of 1909.

Smith shows us that we never really did follow these principles. Across the OECD countries the big growth between 1965 and 2010 has been in sales taxes which, in 1965, raised 12 per cent of all revenue and now raise 20 per cent. The other big change reflects the demise of tariffs. Excise duties in 1965 were good for almost a quarter of all revenue but raise only a tenth now. The other big change has been the growth in social security taxes, up from 17 to 26 per cent.

We certainly do not follow these principles in Britain. The coalition government between 2010 and 2015, at the instigation of its Liberal Democrat members, did embody the lighter taxation of income by lifting the threshold under which no income tax is paid to £10,000. However, it is still the case that Britain taxes income, which is quite easy to get your hands on, quite hard.

The most conspicuous development in 20th-century taxation was the demise in the idea of contribution, originally embodied in national insurance contributions. The notion that a dedicated contribution was part of the contract between the citizen and the welfare state was central to the panoply of benefits established by Lloyd George. Here again, taxation trails a philosophical divide. An idea of contribution gave way, as the 20th century unfolded, to an idea of need. Labour governments, then followed by their Conservative counterparts, were more concerned with the distribution of income than they were with individual contributions.

Tax on work in this country amounts these days to 44 per cent of the total take. The taxes on business that Jim Callaghan introduced in 1965 are the source of a fifth of tax revenue and consumption taxes a further third, which is considerably more than most other nations. The source of money which has declined during the 20th century is precisely the one most obviously identified in the Asquith and Lloyd George budgets. Britain levies a meagre 5 per cent on land and buildings, the static creators of unearned income that go under the technical name described in Henry Addington’s Act of 1803: Schedule A taxation.

The case for taxing property and land is hard to make politically, though it is a good one. Property is visible and hard to hide. A tax on the domestic home would be hugely unpopular but it might help to flatten out the volatile cycle in house prices. It would yield cash while taxing something that is producing unearned income. There is no real personal merit, no genuine investment skill, in a house price rise caused, in a nation which does not build enough houses, simply by too much money chasing too small a supply. The case for taxing it is clear. The other commodity which accrues unearned wealth, and which sits entirely idle, is land, of which there is a fixed and immovable supply of 60m acres. The ownership of land is subject to windfall gains, which derive largely from public infrastructure that is developed on and around the holding. It should be taxed accordingly. So should the gains that accrue from large-scale construction. The economic rent created by high-speed rail, for example, should be taxed and given to local authorities as an incentive to develop vacant lots.

This is no small measure, either. A tax of 1 per cent on the £5tn of British land would raise £50bn. That would be enough to cut income tax by a third or abolish corporation tax entirely. The objection, of course, is neither technical nor philosophical but political. As Mill once said in a letter to Henry Chapman: “I fully expect to offend and scandalise 10 times as many people as I shall please.” Perhaps there is a compromise. Perhaps it could be a temporary tax, renewable every year, just until it is no longer needed.