Money breeds money: Not just common sense

I described in my previous post that the rich tend to get richer while the poor find it very hard to amass any serious amount of wealth. I mentioned several of the processes that are likely to drive this tendency.

Sometimes things that appear to be common sense don't turn out to be true once they have been properly studied: the sun doesn't go round the earth but the earth rotates as it goes around the sun.

However, an economist, Thomas Piketty, appears to have gone to great pains (600 pages!) to provide the evidence for the trends I mentioned in my last post. The fruits of this work is the book Capital in the twentieth century, and his explanations of it and the reviews I have read make me want to read it.

I tend to agree with Piketty's conclusion that this tendency towards concentration of wealth, along with any other fact about capitalism, does not create the need to have a total revolution. Such anti-capitalist conclusions are clearly too hasty; you would need something better to replace capitalism with. But it does remind us of the need for constant efforts at redistribution to check the undesirable tendencies of free markets.

This provides a further argument against libertarianism. Libertarians support free-market outcomes for at least one of several reasons, but as well as attacking those (wrong-headed) reasons we can also point out that their proposals will have poor consequences. Hugely unequal societies in which a larger and larger share of resources are held by a smaller and smaller minority is not many people's idea of a utopia (bizzarro's such as Ayn Rand excepted).

Furthermore, if such a (dis?)utopia came about it may even be worse for those who are very well off, if Wilkinson and Pickett are to be believed. These authors show that more unequal societies are less successful and happy than more equal societies.

My tax proposals are aimed to providing the most redistribution possible commensurate with good economic performance. This is done by taxing those who get unearned income at much higher rates while encouraging economically useful activities, transfers and exchanges.

Why the rich get richer, and what this means for the tax system

There have been lots of articles in the papers over the past week resulting from the recent Oxfam report into the richest poorest members of society. It seems that the richest five families in the UK have as much wealth as the poorest 20% put together. That is five families against nearly 13 million people. This is unsurprising in that the richest are the richest and have a hell of a lot while the poorest are the poorest and have little or nothing.

However, the scale of the difference does not indicate that some people are saving while others are spending. Richard Seymour’s piece highlights how this difference is largely a result of the adage that “money follows money,” “money begets money” or “money makes money.” These can be understood to mean that people who have money find it easy to make more money, or alternatively that the children of the rich end up rich themselves. Both of these are usually true unless there is a highly redistributive or economically restrictive regime.

There are obvious reasons why the rich can easily get richer while the poor will find it very difficult to get richer. The wealthy can give their spare money to financial institutions, or just sit on their property and watch it increase in value. The poor have to use most if not all their resources on the basic costs of living, leaving little left over for investment. Wealthier people, by contrast have the same amount of time available to them to work and earn in that way, while earning money on invested capital. Meanwhile, any money they earn can be invested rather than used for necessaries. Furthermore, poorer people may need to take jobs with few prospects as they need money quickly while richer people can take a longer view and more easily develop a career.

Of course, you may get rich people who are very bad with their money and blow it all. Occasionally someone from a less wealthy background will build a business or obtain a very highly paid career. But these are anomalies, and the processes described above will tend to lead to greater and greater concentration of wealth over time unless checked. Which leads on (did you guess?) to taxation.

If we are looking at what to tax, there are very clear arguments to tax the returns to capital in preference to taxes on the income and consumption of the less-well-off. Certainly revenues above the change in the value of money should be taxed on a progressive basis. This is not punitive—people should be able to invest and earn something from this after tax. The punitive approach would discourage investment and that would be very bad for the economy. But it still makes sense to be taxing returns to capital at high rates in order to reduce taxes on those with low incomes.

Unfortunately things seem to be going in the opposite direction in many ways, as I will discuss in my following blog. 

Happy times!

A few happy things to report.

The first is that my brother married Emily on Saturday and it was a wonderful day. For the first time I have a sister!

The second is that my paper "Realising International Justice" is available as an advance viewing. In the paper I argue that the requirements of background justice require the global taxation of international citizens, but that this does not require the creation of a global state or for all states to impose the same tax rates. Instead, I suggest that the employment of a counter-incentive would achieve the desired ends. I also explain my counter-incentive proposal in a book chapter published last year and in chapter eight my forthcoming book, Rethinking Taxation.

If you work at a university you might want to ask your librarians to subscribe if they do not already receive the Moral and Political Philosophy journal as part of a package. It should develop into an important journal in the field, and mine is the second paper it has made available.

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.