Last week I had been thinking of writing a follow up to the email I sent you regarding the HMRC but never got round to doing it.
I then saw something on the Adam Smith blog which was very similar to what I had wanted to say. The point I wanted to make was that the reason that there are so many mistakes made in the calculation of taxes is that the system is just too complex. The shifting flotsam of different tax bands, rebates, subsidies and tax credits that change and gets added to with every passing year creates the kind of uncertainty which requires huge departments of tax accountants and lawyers to sort out. The article in the Adam Smith Blog pointed out recent research which shows that the more complex the tax system, then the greater the extent of tax evasion.
As Gordon Brown increased the tax burden and complexity of the system, more productive work was pushed into the shadow economy as the cost of formality rose.
This goes hand in hand with the Laffer curve which predicts that as tax rates rise, then the marginal rate of increase of taxes collected falls as peoples’ behaviour changes. If the more you work and invest to increase your earnings leads to more taxes then the incentive to work and invest falls. Indeed there comes a point when increasing taxes leads to falls in tax revenues as individuals stop producing or look for ways of avoiding paying taxes altogether.
The other week I was watching on cable a documentary on the Rolling Stones and their famous album ‘Exile on Main Street’. They had just fled Britain to escape the penal tax rates of the time. A couple of years later Dennis Healey said he would ‘squeeze the rich until the pips squeak’. Well squeak they did – all the way to Nice in France. Britain’s 1970’s Chancellors thus gave the French taxman the chance to cash in on one of the most successful albums in rock music history.
But at least the Rolling Stones got around to making their album, even if they did it in France. The real misery however of the Vince Cable type of class envy politics lies not just in the lost tax revenues. Higher taxes also leads to lower economic growth, less goods in the shops, less money to buy services, less innovation and more unemployment. This is always the problem with a modern democracy. A politician can get easy and immediate benefits making populist class-envy statements. David Cameron can splash all over the Sun that he will sock it to the bankers and impose a 50% tax on their bonuses. But the maintenance man and sandwich supplier will never know that the job they would have got now no longer exists because the hedge fund has moved to Switzerland. And how many life saving new medical devices haven’t been produced because the capital gains tax rate made it too costly to invest in the project? Politicians love to talk about increasing taxes on cigarettes and alcohol to reduce their consumption. Hence, the current concern about cheap supermarket booze and its impact on binge drinking and falling pub revenues. However, there never seems to be a connection made between raising the cost of work, savings and investment through taxes and regulations, and the fact that by doing so, you get less work, savings and investment.
A far better system would be a Flat rate tax system. Set the tax rate at 20% for everybody no matter how much they earn. There would be no allowances, tax bands or tax credits. People could calculate their taxes on the back of an envelope because all they would need to do is add up all they have earned in the year, take of 20% and send the cheque off to the tax man. Of course this would lead to mass unemployment amongst tax accountants, lawyers and bureaucrats, but I don’t think many people would feel too sorry for them. In fact the ones this would most impact would be the very rich who would no longer be able to use their expensive tax lawyers to avoid paying tax. If you earn $20,000 a year you pay $4,000 in taxes. If you earn 100 times that amount, you pay 100 times more in taxes. No quibbling, no fudging.
There is a reasonable philosophical argument that it is good that everybody has ‘skin in the game’. If you pay taxes you are more likely to want to vote for responsible politicians rather than just vote for those promising more handouts. However, the reality is that the first $10-12,000 is vital to keep people off the breadline. You need every penny just to pay your basic bills. So I would advocate that the first $10-12,000 should be tax free and then after that 20% on all income.
Anyway, here’s a good video on the Flat tax from Dan Mitchell at the Center for Freedom and Prosperity.