Land Value Taxation, part 2: Why arguments for the LVT don’t work

In a blog earlier this week I explained how changes to the tax regime can create windfalls or immediate costs to owners of the types of property affected by the change. For example, a tax on housing will hit the owners of housing at the time the tax is announced as their asset will immediately drop in value in line with the newly increased tax.

I’m sure those of you who have read my previous post explaining the LVT can all work out where I am going with this. If an LVT is introduced it will reduce the expected income on rented land; more of the rental income than expected will be lost to the tax. Similarly, for people who own and use land their cost for continuing to use the land will immediately rise. Buyers will not be willing to pay as much as they will now expect to pay the tax in order to enjoy the use or investment income from the land. These future owners will not pay anything as the result of the introduction of the tax, nor will the past owners who sold up before the announcement.

For this reason, a big question for supporters of the LVT is whether to compensate owners of land upon the introduction of the tax. This was considered, for example, by J.S. Mill back in his 1848 economics textbook. A pure version of the LVT would provide this compensation in order to ensure that the tax only falls on those who might benefit from increases in the value of land. However, if the government compensates landowners it will suddenly need to find a huge amount of revenue which will only be repaid over a number of years. Government revenues will take a huge hit in the short and medium term and the LVT will not bring in any substantial revenue for many years. This leaves the government to rely on loans and other taxes in the short term.

This also means that all the increases in land values that occurred up to the introduction of the tax are not taxed by the pure LVT. To make matters worse, if land values don’t increase after this point, then it will take ever longer to repay the debts taken on. Supporters of LVT tend to assume land will always increase in value, but this is much more likely if there is an overall increase in productivity and population (or that the increase in one over-rides the drop in the other).

The “pure” version of LVT would therefore raise much less revenue than the “impure” version, which can be considered a wealth tax. I have argued in a previous post that wealth taxes are generally regrettable, though they might be acceptable in some cases. However, the impure LVT is even more troubling than other forms of wealth tax. This is because it is a discriminatory wealth tax. I refer to it as such because the tax only falls on those who hold a particular kind of wealth, namely land.

Consider a group of imaginary people to see the problem. Take four economically fortunate individuals who have various forms of investments, and two less economically fortunate individuals who have scrimped and saved in order to purchase some land. Anna, Bernie, Celine and Daryl all receive a significant inheritance (in an unjust society where inheritances are entirely untaxed), while Enid and Fred are diligent savers investing for their impending retirement. Anna and Bernie inherit a large amount of land while Celine and Daryl inherit money. Bernie sells his land to Fred and invests in other things, while Daryl decides to purchase land with his inheritance. Enid, meanwhile, invests in the stock market. Then the government suddenly announced an impure LVT.

Anna, Daryl and Fred face an immediate loss in the value of their investment. Meanwhile Bernie, Celine and Enid are entirely unaffected. This imposes a wealth tax on those who are unlucky enough to have chosen to invest in a particular kind of investment. Some of those taxed were economically fortunate, but Fred was not. Furthermore, some of the most fortunate people are unaffected, even if their good fortune arrived in the shape of gifted land. The introduction of the impure LVT is like a game of musical chairs, whereby those left holding the land at the time in question lose out.

One argument that I have seen in favour of a land tax is that land should not have been privately owned in the first place—it has been stolen from the community and those who benefit from this theft can have no complaint if their investment loses value. The problem with this argument is that Bertie gained from the supposedly unjust theft of land—his family were landowners for centuries—but he did not pay any of the tax. Bernie sold his land to poor old Fred. Fred did not gain from the land; he merely lost his retirement investment. Meanwhile Bernie got away with a land-based fortune intact. I don’t agree with the idea that landowners are in a morally more questionable position than others (though it is true that most of the landowners in England and Scotland in the past centuries got it through very questionable means).

If we wish to tax the previously undertaxed wealth of the economically fortunate a more comprehensive wealth tax would be much more principled than an LVT. The pure LVT will raise very limited revenue and fail to tax those who benefitted from land and economic fortune in the past if it is pure. Furthermore, the impure LVT should be rejected as a very blunt and discriminatory wealth tax that will also fail to fall consistently on those who have benefitted from either land or good economic fortune.

This only leaves the argument for the LVT that in the longer term it will tax those who benefit from the increased prosperity of the whole community. This occurs because the increased wealth in the community will translate to more valuable land. However, if this is the basis for taxing land then a comprehensive acquired income tax of the kind I propose in chapter four of my forthcoming book, Rethinking Taxation, is much a better option. This would take into account the profits that people make on any investment. It would therefore fall on all those who gain from increased prosperity, not just on the landowners who benefit from it.

On Land Value Tax (LVT), Part 1.

The longstanding tax proposal for LVT was reasonably popular in the late 1800s and still has some advocates today. I will explain the LVT, explain its advantages and disadvantages. In the following blog I will provide a further argument against it, referring to a couple of my previous blogs, to show that LVT is in fact a very limited and partial form of wealth tax.

The idea behind the LVT is fairly simple; tax the rental value of the land that people own. There are many variants of the proposal, but the most sensible approach is to focus on the value that the land would have if it were sold without any development on it, and then the owner would be charged a proportion of this value each year. This requires the land to be valued regularly.

LVT-type proposals were generally advocated by classical economists such as Adam Smith, David Ricardo and JS Mill, who saw land as a separate category. Popular political thinkers such as Thomas Paine and Henry George argued for the proposal, but obviously ran up against landed interests. These thinkers perhaps realised that landowners got money for their land without having to do anything, and realised that taxing the land would not produce any economic disincentives—landowners would need to use the land productively but now to pay the tax instead of to enrich themselves.

Classical economists saw land as a separate economic category with its own economic nature. However, the marginal revolution in economic thinking did away with this categorisation. According to post-classical (including of course neo-classical) economists economic decisions are (or perhaps should be?) based on the marginal benefits of one economic use when compared to others. The upshot was that land was treated just the same as any other economic resource (or input, or “factor of production”).

The case for treating land any differently disappears if we point out that there is nothing particularly special about land as an economic factor. Economic theories that can fully explain economic decisions about land without creating an additional category are going to be more attractive than those which depend on extra categories. One defence of LVT is to insist that classical economics is uniquely correct, and this is the recourse of the commentator on this blog “Physiocrat” who has commented on several of my previous posts. It is an interesting project to consider what has been lost in the shift from classical to marginal economics, but I do not think that the treatment of land as a special economic category is one of the losses.

I have said repeatedly that taxation is a normative issue and this is where the real action lies. I have argued that taxes should be judged on their incidence with regard to the economically fortunate/unfortunate and their likely economic effects, and LVT does fairly well on this count. However, it taxes only those fortunate people who have a prior investment in land, as I will explain further in the following post. Taxing people who have good economic fortune in a more systematic manner through the imposition of a tax on comprehensive income, particularly on windfall income, would be much more appropriate. LVT fails to tax the recipients of gifts, inheritances, and returns to scarce talents. Fortunate people who have investments in government or corporate bonds will be relatively unaffected by the switch to LVT.

However, there is a political philosophy which supports the imposition of LVT on normative grounds; Left libertarianism. This view has been defended by political philosophers such as Hilel Steiner (see An Essay on Rights) and Mike Otsuka (Libertarianism without Inequality). The idea is that people own themselves, and therefore the products of their labour (so far so libertarian). However, people cannot come to own land, since this is for the benefit of the whole community. Therefore, when people take ownership of land they owe the community rent from taking temporary ownership of this communal resource.

This position is a perfectly philosophically valid, but I’m not convinced that such strong self-ownership rights exist, nor that it is that important to enforce them in such a stringent way. The division between the treatment of the self and the treatment of land seems arbitrary to me in this instance. Of course, we have reasons to limit what can be done to persons in ways that do not apply to land, but taxing people on the returns to their labour does not trouble me that people are being violated in any way. Slightly less strong rights of ownership seem to provide all the personal freedom that people need.

I’m not convinced by the economic arguments or philosophical ones for LVT, and I will add a further important point about the introduction of an LVT in my next post.

Tax incidence and legislation change

In a previous blog I set out my approach to taxation. What matters is the incidence of taxation and where possible this should fall on the most economically fortunate members of society. In this blog I wish to emphasise an important point about how changes to tax rules create windfalls for, or costs to, taxpayers. This means that the incidence of the tax system may not fall on the intended groups in the aftermath of such changes.

This point was emphasised in an address given over one hundred years ago by the economist Edwin Seligman. Much of this address is aimed at attacking the somewhat silly views of taxation from what he calls the perspective of the individual: taxation according to the benefit principle or ability to pay principle. Despite his warnings these views have remained popular with tax lawyers and economists through to this day. (Murphy and Nagel in The Myth of Ownership have in this century done a good job of attacking these views of taxation and we can but hope that writers on taxation will take notice at some point). Seligman wants to focus on the place of taxation within society as a whole, which is a much more satisfactory perspective. The tax system has to be justified to all, taxpayers and benefit recipients alike, and this needs to be done through a theory of justice. In the course of his address on this subject Seligman makes a very important point about the incidence of taxation, which I will describe here.

Seligman pointed out that we need to take account of the shifting and diffusion and capitalization and absorption of taxation. The rational price of an investment, or factor of production, or whatever, will take account of the expected tax which it will attract. This is the capitalization aspect. So if a new tax is levied on a particular kind of investment (in Seligman’s example a bond), or the rate of an existing tax is increased, then this will be passed on to the capitalized market value of the bond. So the person who is holding the bond when the change takes place will take an immediate hit on the value of the bond. It will be absorbed into the new price. Previous owners of the bond are unaffected, as are future owners. This is because past owners have already sold at the previous capitalization and future owners will buy it at the new capitalization rate.

The idea of shifting is that people will pass on some taxes to others, so that a special tax on housing will fall on housing owners. However, as a result of this people will stop investing in housing until rents or values rise to cover the cost of the tax. In the meantime, the tax will therefore fall primarily on people who build houses and provide goods and services to house builders (or the investors in and workers of these companies). The tax is therefore diffused onto many people instead of the owner of the primary item.

In both cases this leads to the disappearance or vanishing of the tax. The increase in tax is a heavy burden on some existing owners but does not create a permanent burden on such owners. The tax may fall on other, unintended groups and individuals, as well. When creating or increasing taxes, these changes should be borne in mind, since the increase may act as a kind of wealth tax, something I will write about in another blog.

Of course, this point goes the other way. Removing tax or lowering the rate on existing taxes can create windfalls to owners. If someone buys something at a market value where there is an expectation of a certain amount of taxation and the taxation is dropped, the owner immediately has something they can sell for a larger amount. The potential to create windfalls is something to which we all need to be aware.

Governments are therefore going to be constantly lobbied to allow special exemptions and for the dropping of taxes which will create an immediate windfall to whoever happens to own the item at that point in time. In states where corruption is relatively difficult lobbying of this kind will be one of the easiest ways to make a quick windfall. Governments may be enticed to bribe strategically important voter groups (more likely in the UK due its archaic democracy) and political parties may be able to offer corporations and the wealthy artificial windfalls in exchange for campaign donations (more likely in the US due to its ridiculous rules on political party funding).

Failures to collect tax also create windfalls. An example of this is the Vodafone Mannesmann deal, over which Vodafone could have expected to pay several billion pounds in tax. Through questionable accounting (via Switzerland and Luxembourg), Vodafone paid very little tax and for some unknown reason HMRC officials made a deal with Vodafone that enabled them to pay a fraction of the expected amount. This was a pure windfall to Vodafone shareholders and a pure loss to the rest of the UK who would benefit from the government spending (or debt alleviation) that would have followed from the tax revenues. Of course, other corporations will then ask that they can have the same favourable tax treatment. This bizarre decision, described in Richard Brooks’ book the Great Tax Robbery, was an absolute scandal.

Given these temptations, right-thinking citizens must remain vigilant that governments and their agents are not falling prey to the promotion of the interests of the few at the expense of the many. Tax windfalls of this kind will usually benefit people who are among the least deserving of state help. Tax reductions may sometimes be advisable, but they should always be undertaken with the utmost caution.

Market society and market fundamentalism

Continuing the theme of my previous blogs this week I wanted to say something further about market institutions and the tendency towards market fundamentalist (or libertarian) thinking. I have said that the market economy is the only way to secure economic prosperity and freedom. It’s the only economic game in town as it incentivises people to work, save and innovate. Markets also automatically facilitate the exchange of huge amounts of information through constantly shifting prices. However, I have also said that market prices lead some people to an “everyday libertarianism” whereby people think that pre-tax exchanges are in some way just or correct.

It is important that, as Michael Sandel puts it, we do not move from a market economy with useful market institutions to a market society. This is a society in which everything is valued through the lens of market interaction. This is hardly a novel thought; it has been presented in many forms by religious preachers, Marxists (including Marx), and many political philosophers (such as Deborah Satz). However, even though there are big differences between my views and those of these thinkers, the basic shared point needs to be repeated regularly for reasons that are apparent from my previous blogs. This is that market institutions can lead to this everyday libertarianism or market fundamentalism.

Resources should be valued in accordance with their market value when they are exchanged or when taxation is calculated. The market value of items of property will represent the scarcity of their component parts and the cost of putting them together and transporting them. People should have to pay this amount. However, that does not mean that people should only value themselves or the resources they might obtain for what others will pay for them.

It is a real shame when people judge themselves according to the money they make in the labour (or even investment) markets. Markets are competitive and often where one person wins another person loses; we can’t all win. If people judge themselves according to their market earnings then many people will feel inferior not because they are incapable but because they are slightly less capable (or in some cases less fortunate in their social connections or simply not being in the right place at the right time).

If we want to use market values to judge the contribution that we ourselves or other people make to society then market prices are useful up to a point. After all, if someone is performing unpopular and socially valued labour then they usually will be financially rewarded. And if someone is inventing or investing in useful products then they should receive a good return. However, market returns do not always indicate contribution. People can contribute in ways that aren’t rewarded by the market, such as volunteering, performing services in their local community, and caring for relatives or neighbours. Conversely, markets can provide handsome rewards for behaviour that makes little or no contribution; if some captures a monopoly (such as Bill Gates with Microsoft), obtains rent on something they did not pay much—or anything—for, or if they take advantage of a strong bargaining position then they are not really contributing as much as the money indicates. Market outcomes do not tell us much about a person.

Regarding the resources themselves, people will hopefully value these resources for their ability to help them live their life in the way that they wish. The market value simply represents the opportunity cost to other people of those resources. If market fundamentalism takes hold, however, people may come to value resources for their market value alone rather than what they can do for people. If this happens then people engage in unproductive and bizarre behaviour, such as seeking resources to use as status symbols for display to others rather than resources which provide some kind of benefit to their holder. The desire for status is very prominent in the human psyche, but it is a zero sum game in that one person’s plus point is another person’s minus point. This point has also been made by utilitarians such as Richard Layard. It can be even worse than this as the misery of those with status anxiety probably outweighs the happiness benefits that the fortunate obtain (not that I think everything should be evaluated on the basis of the happiness caused, of course).

Of course, being a liberal I’m not going to suggest that someone should be unable to use her resources to attempt to buy a feeling of superiority; that’s entirely up to her. What I am pointing out is that (very positive) market institutions can lead towards (very negative) market fundamentalism and that right-thinking people need to take note of this phenomenon and resist it. I don’t agree with radicals that this unfortunate tendency overrides the benefits of the market economy—there aren’t any better proposals to organise an economy. Nor do I think it is the job of the state to counteract the tendency. Rather, it is the job of all of us to ensure that we are not ensnared by this kind of thinking. We can also challenge others who attempt to impress through the purchase and display of status items; it don’t impress us much.

Libertarian myths

In my previous blogs I have emphasised a libertarian myth; the everyday libertarian myth. This could be alternatively described as the myth of the free market outcome; that people should receive whatever the market would provide them with minimal interference by the state. We could also call this "free market fundamentalism." Rather than simply viewing the market as a a vitally important and useful institution, the fundamentalist thinks that free market outcomes are somehow correct outcomes with some kind of inherent moral value.

A further libertarian myth to expose mutually supports the free market fundamentalism. This is the myth of the economically isolated individual. Political philosophers such as Hobbes and Locke have made much use of isolated individuals in order to consider the legitimacy of the state. Some, such as Nozick, have applied this line of argument to the justification of the distribution of goods as well. However, it is important to emphasise that the distribution of goods has to be justified to all members of society. The focus on the idea of an isolated individual is completely inappropriate in this setting.

People are not isolated; humans are completely dependent on others for the first several years of their lives. Even beyond that point, our sense of ourselves as humans comes from our social interactions with others. A human raised by animals would probably not be recognised as human. There are of course the few historical cases where people have found themselves living somewhere where they are able to survive despite the fact they have no interaction with others. The classic example is the shipwreck victim on an unpopulated island. Such examples are extremely rare but such stories—real or fictional—are very popular. However, even this person takes with them their previous human capital and whatever technologies and equipment they have with them.

We might accept that the individual in the lonely island case is fully entitled to what they find or make, though this raises questions about global justice that I will not consider here. The point I wish to emphasise is that humans are part of a society and the rules of entitlement should be developed with that social interaction in mind, albeit with respect for each individual member of that society. What an individual might be able to get if their society was viewed as many one-person economic islands should have no influence on what an individual should receive in a society.

The myth of the economically isolated individual is regrettable and should not have any influence on anything. Yet it seems to underpin many people’s thinking (particularly in the USA). Political philosophy depends on artificial examples, and I have no problem with using them in arguments. However, while these examples and illustrations and powerful their use is limited to the particular argument they are designed to support. The idea of the economically isolated human has been taken outside its immediate contextual usefulness and used to bolster an otherwise unpalatable free-market ideology.

Should we tax wealth?

The idea of taxing wealth seems to be discussed more often as government revenues drop and austerity begins to bite. Wealth taxes appear to be attractive as a way to provide public funds without causing too much economic damage; it may reduce the quantity of resources available for investment but it does not seem that much investment is being used for innovation anyway. A one-off, entirely unexpected, wealth tax would not cause any major change in economic behaviour (though a lot of discussion about it might). Most of those considering the merits of a wealth tax will think that the wealthy should have been taxed at much higher rates than they have been previously, and so a wealth tax appears attractive on many counts.

The practical case against wealth taxes is that they discourage people from investing. If people expect a wealth tax in the future they may decide simply to spend money earlier (since many wealthy people would probably choose to have something—even if it is relatively pointless—in preference to having nothing for him and more for the government). Wealth taxes cause additional uncertainty and anxiety for investors, and may result in wealthier people taking even greater care to hide their wealth than they already do. The practical arguments for the occasional wealth tax may or may not outweigh the practical arguments against, but normative issues are of course paramount.

My view is that taxes should fall where possible on the more economically fortunate and this may appear to be a good argument for wealth taxation; the wealthy are almost by definition economically fortunate. However, this is far too quick.

Some of those who are economically fortunate may not be wealthy at the time chosen for a one-off wealth tax. The economy is a dynamic thing, full of flows (transfers) as well as stocks (wealth), and many economically fortunate people will spend their large incomes quickly. Conversely, some people who are not particularly economically fortunate will have a strong preference to save, perhaps due their preferences about when they wish to spend or because they are very risk-averse. A wealth tax will fall heavily on savers and less heavily on spenders, and these categories do not necessarily match up with levels of economic fortune.

I therefore tend to oppose wealth taxes. However, I would not rule them out. If there is a crisis which means the state needs quick funds then a wealth tax may be necessary if the alternative is default. I would also suggest that they can be justified where the past economic regime has been unjust and there are costs in switching to a just regime; it seems acceptable that those who were benefiting from the past injustice should provide the revenue required for the change. Finally, very low wealth taxes can be used as a backstop where it is not possible to tax income. The idea, proposed by Deborah Schenk is to set the tax rate as a proportion of the expected return to investment. So if a 20% desired investor tax-rate were not possible and investment returns of 2% a year are expected then a wealth tax of 0.4% would provide a rough proxy.

I have presented some acceptable forms of justifications for wealth tax, but in general I am against them. People have legitimate expectations regarding their property and the state should be enabling people to make and carry out plans. It does not matter if those plans involve spending or saving. A wealth tax interferes with the plans that savers have made, making their lives harder not easier. Equally importantly, it does not reliably fall on the economically fortunate. 

Is tax a burden?

In my last post I discussed the libertarian political philosophy in relatively abstract terms. I will consider the issue from another perspective by asking the question is tax a burden? When judging whether taxation is just we should focus on the overall taxation system rather than any particular tax, and indeed the place that taxation plays in society. So the proper question is: In what ways does the tax system burden people, and are these burdens justifiable?

In one sense the tax system creates a burden. This is the burden of complying with the rules of taxation. We might call this the administrative burden; people have to know the rules of taxation and provide whatever information and payments are needed to be compliant with the laws and rules. This is a burden of time and effort in the small scale, and it should be minimised where possible by the withholding of tax revenues from taxpayers. However, the burden imposed is fully justified on a larger scale if the tax system as a whole is imposed in a legitimate manner by a legitimate state. If the tax rules are legitimate then people have a duty to comply with them and the state is justified in enforcing compliance. Since this administration is a duty on citizens it is not really a burden in any morally troubling sense.

A second sense of the burden of taxation might be the idea that handing money over to the authorities is a burden. However, this is even less clearly a burden than the administrative burden. Paying money to the tax authorities is not a burden on anyone since the tax bill is merely a sign that the taxpayer has not paid the correct amount of money to the tax authorities. This may be because it is necessary for the taxpayer to receive the money and then pay it to the authority where the authority is unable to arrange for the revenue to be withheld at source.

A more sophisticated argument for the burden of taxation is that if someone were taxed less they could either a) work less or b) have more resources to live their life. It is of course a greater burden on people to live their life with fewer resources. However, this comparison is irrelevant unless people have a right to those resources in the first place. Of course, we can imagine numerous different sets of rules and laws surrounding taxation and state benefits which would ease the burdens on one group and increase them on another. Everyone could therefore complain that they are burdened compared to some regime or other. The proper question is whether the regime is legitimate (and ideally it would be fully just).

The important point to emphasise is that the “loss” of money to the taxpayer is in fact not a loss at all. The payment does not take away anything that was the person’s to begin with, since people are only entitled to their post-tax (net) income anyway. Most people appreciate this point when they reflect on it. However, “everyday libertarianism” mentioned in my previous blog can creep into people’s thoughts on taxation. This makes it appear that taxation is a burden when it is not.

What matters is that the overall system of taxation and assistance payments by the state are legitimate. If the system is not legitimate then we can say that taxation payments are a burden. The points I have made above also explain why retroactive taxes—where rules are changed to create taxes on past income—are generally considered unjust. These are burdensome since the taxpayer can legitimately treat the money they have received as post-tax income to use as they please. Retroactive taxes cross a moral line between the legitimate seizure by the state of what does not belong to the citizen and the seizure by the state of what does belong to the citizen. These cases aside, however, citizens are in no way burdened by paying taxes.

Libertarianism

Libertarianism is broadly the view that things should be left to the free markets, and that the state should do nothing over and above facilitating the market and property rights. According to this view, the correct distribution of resources is that which is produced by a minimally interfered with market. There are two broad arguments for this, a consequentialist one and a rights-based one.

The consequentialist argument for libertarianism is associated primarily with F.A. von Hayek and Milton Friedman. These authors sometimes make some important points about states can sometimes fail in their attempts to improve things because they do not take proper account of the role of the market. I hope to come back to this useful insight in later blogs (and the insight is included in my earlier post about the purpose of taxation) but the basic thought is that these attempts to improve things can be self-defeating.

Consequentialist libertarians take this point further and create a principle or maxim that state actions always have negative consequences overall. This takes the sensible insight far too far, unless it is assumed that the free market outcome is somehow optimal. There is no reason to think that this will be the case, and it would be necessary to argue for this as a theory of distributive justice. Another form of argument for libertarianism does this, the rights-based (or deontological) argument.

The most sophisticated and best known rights-based argument for libertarianism was presented by Nozick in his book Anarchy, State and Utopia. This is an impressive book, but has been thoroughly criticised by philosophers such as G.A. Cohen, Allan Gibbard, Thomas Nagel and Samuel Freeman. I will not rehearse these criticisms here. However, I will mention an important book on taxation which touches on libertarianism.

An important theme in Nagel and Murphy’s book The Myth of Ownership is that people seem to operate with something the authors call everyday libertarianism. This is the unfortunate tendency that people have to assume that the state takes their pre-tax (or gross) income. In fact, this is an illusion. Taxation by a legitimate state is not in fact a reduction in anyone’s income from this pre-tax income. The framing effect produced by the market transaction for labour can encourage people to think of pre-tax income as theirs but this is just an illusion. The state sets the rules for the market and this includes taxation. People are only entitled to their post-tax income and so the pre-tax income that they would have received if there were no taxation has no moral importance regarding the distribution of resources. It is neither here nor there when it comes to what people should get from society, what matters is that the rules—including rules about taxation—are fair.

Libertarianism and Utilitarianism

In my previous blog I mentioned that many people view taxation through the lens of either libertarianism, utilitarianism, or a mixture of the two. I thought it would be a good idea to write up some of my thoughts on these approaches. I’ve got a lot to say about libertarianism so I’ll do that over the course of several separate blogs.

Regarding utilitarianism, I will just make the brief point that Rawls’ well-known insights against utilitarianism from his Theory of Justice are still powerful. When applied to the distribution of goods in society (distributive justice), utilitarianism requires these goods to be distributed in the way that maximises overall happiness. But it does not matter who gets the happiness.

Rawls correctly diagnosed that this approach therefore ignores the fact that, even if we accept that all that matters is overall happiness (which is patently false anyway), people are separate from one another. It matters what resources each person has to live their life.

An improvement on utilitarianism is therefore prioritarianism, an idea presented by Derek Parfit. This still holds that the total utility matters, but allows that people who have less should receive priority in the receipt of goods even if this results in a lower overall maximum. (In fact, this is similar to the way that many economists appear to refer to Rawls’ view even though Rawls explicitly talks about the distribution of primary goods such as income and wealth rather than utility.)

While I accept prioritarianism is preferable to a classical utilitarian approach to distributive justice I still don’t find it the best approach. Prioritarianism shares with utilitarianism the problem that it takes human beings to be receptacles of utility rather than individuals who might have other concerns.

What is the purpose of taxation?

In order to determine what taxes should—and should not—be levied we need to know what the purpose of taxation is. A simple answer is that taxation is to raise revenues for the government. However, while this is true, it is an inadequate answer. In my PhD thesis and in a section of my forthcoming book, Rethinking taxation, I provide a fuller answer to this question, which I will summarise here.

The primary aim of taxation is to secure distributive justice. Taxation has a crucial role to play in ensuring that the main institutions society are constituted in a way that is fair to all members. Some aspects of the state are important for all, such as having a stable and prosperous society (political system, criminal justice system, regulation of markets, provision of public goods etc.). A certain amount of taxation revenue is therefore needed to provide the fundamental responsibilities of the state and its government, but the state will need more than this baseline amount.

A market capitalist society is the only one that can reliably provide stability, prosperity, and a degree of personal freedom. However, markets do not distribute in a way that is fair to all. Some people do very well as they have rare and valuable talents, while others find it difficult to find work at all. Some people are fortunate with their investments while others have bad luck due to unforeseeable circumstances. Markets tend to reinforce this process, making it easy to turn good economic fortune into further economic fortune. Some people get in a position whereby they own the property that earns easy rents.

The taxation system overall should do something in response to these forms of economic fortune. This is achieved by taxing the more economically fortunate (or the things from which the more economically fortunate will gain an income) at a higher rate and subsidising or supporting the less economically fortunate in so far as this is possible. 

This is complicated by the fact that taxes have economic effects, which can undermine redistribution. If tax policies undermine economic prosperity then pretty much everyone loses out. The incidence of taxes and the economic effects of the tax system therefore have to be carefully considered. Even if we deny that economic efficiency is itself the primary aim of taxation,[1] economic analysis is still very important.

Taxes are needed to provide revenue to the state. These enable the state to function, but also provide funds for redistributive purposes. Unfortunately, it is not always easy to anticipate the consequences of taxation, and therefore consideration of the economic consequences of policies are of paramount importance.

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[1] A common approach to taxation by economists in recent years is to assume that taxation should produce minimal economic distortion. For example, see the Mirrlees Review. However, there is no value to the free-market outcome that means its outcome should be preserved for its own sake. The strange hybrid between libertarianism (against state intervention) and utilitarianism is highly regrettable: both are discredited approaches to distributive justice.