Wednesday, 29 August 2012

Nick Clegg's 'Tax The Rich' Fallacy

Nothing makes my job easier than when a political party leader I find to be a pompous, incompetent twit brings up a contentious issue and gets it completely wrong.  That’s what Nick Clegg has done today with his ‘Wealth Tax’ nonsense.  Clegg wants to indulge in a bit of quick-fix tax accumulation by going after the rich to ease the current fiscal crisis.  Big mistake!

Assuming the way to boost the economy is exactly as he suggests (it isn’t, but that’s another day’s blogging for yours truly), it is still quite literally impossible to raise revenue by the method of taxation Clegg suggests.  Nick Clegg imagines a very wealthy Mr Pomsonby-Smythe type of chap whom he can help offload some of his millions to stimulate the economy.  It’s quite disconcerting that minds like that have any power in our nation.  Here’s what Nick Clegg misses.  When the Government relieves Mr Pomsonby-Smythe of a chunk of his fortune, a bunch of 1s and 0s get transferred across a few bank computers.  So far nothing about the economy has significantly changed.  The only really significant consequence of taking money from Mr Pomsonby-Smythe and giving it to the Government is that the Government will use it to consume more goods and services.  But if the Government is going to consume more goods and services, then somebody else must consume fewer.

Who might that be? Well it depends on what the Government spends the money on. The first thing that probably will happen is that when Mr Pomsonby-Smythe withdraws his chunk of money from the bank to make his tax payment to the Treasury, the bank makes fewer loans, interest rates rise, and then someone cancels a holiday, or postpones the purchase of a car or caravan, or abandons a business that was getting off the ground.  They are the people who bear the burden of the tax – those who rely on the banks for capital investment.  The tax on Mr Pomsonby-Smythe (who, by the way, most likely consumes no more or fewer resources because of this action) is really a tax in disguise at the borrowers or spenders’ end of the market.

What Nick Clegg is doing is confusing green pieces of paper with real resources. He thinks the Government can somehow acquire real resources just by taking Mr Pomsonby-Smythe’s money.  That doesn’t mean that taxing the rich cannot work – it just means you cannot do it the Clegg-way. What you have to do is do it in a way that encourages (or induces) the rich to consume less or produce more. Taxing Mr Pomsonby-Smythe doesn’t generate any more money for the economy, it merely reduces somebody else’s consumption stream.  I’m sure Mr Clegg has no idea whose consumption stream it will reduce, so he cannot say whether the policy is a net gain on resources or a net loss (if it benefits people richer than Mr Pomsonby-Smythe it will even increase wealth inequality by a bit, although that’s somewhat trivial)

If you transfer n amount from Mr Pomsonby-Smythe to the Treasury Mr Clegg would call it Government revenue.  But it’s important to understand that only one of two things can happen as a consequence. Either a) the Government spends no more than before, in which case nothing of any significance has changed; Or b) the Government decides that because it has more “revenue” it can increase its spending, in which case someone else’s consumption stream will shrink.  That someone else is not Mr Pomsonby-Smythe, because while Mr Pomsonby-Smythe has accumulated his wealth without any intention of ever spending any of this money he has effectively reduced the money supply (what he does spend only hikes up prices).  As a consequence of Mr Pomsonby-Smythe acquiring wealth and hoarding it, everybody else’s pounds have become slightly more valuable, as everybody else can now consume the goods and services that Mr Pomsonby-Smythe has decided not to consume.  If the Government takes the chunk of money from Mr Pomsonby-Smythe and spends it, then the effect is the same as if the Government had printed an additional n equivalent of that chunk and not taxed Mr Pomsonby-Smythe.  Everybody else’s money supply is worth a bit less and everybody else can consume a bit less, as the Government consumes more.

What should be interesting to the Government is not where the money comes from; it’s where the goods and services come from. The Government uses the money either to claim more goods, or to reduce other people’s else’s taxes, allowing someone else to claim more goods. So the question is all about where the goods came from, not the 1s and 0s that make up green pieces of paper.  To focus on the money transfer as Nick Clegg is doing is to miss all the important economics.  Clegg thinks that taxing the money that Mr Pomsonby-Smythe spends on cars and luxury living (or maybe just sitting in the bank drawing interest) then goes to pay for defense spending or hospitals or machinery or something of perceived worth by the Lib Dems. But defense equipment and hospitals and machinery are not made of money, they are made of bricks and steel and glass and plastic and concrete, etc.

If there are idle resources that can be employed at no extra social cost (which seems to be the Lib Dem thing), then you don’t have to tax Mr Pomsonby-Smythe to employ them. The act of taxing Mr Pomsonby-Smythe creates no additional resources above and beyond what is already available.

That was the economics – but only the economics – I haven’t even talked about fairness.  Is it fair to tax the rich more than the poor?  Most people think yes.  I don’t disagree, because it seems necessary that wealthier people bear an extra part of the burden.  But I don’t think it’s an assumption that can just be established as a sine qua non.  Think about this; Jack and Jill are brother and sister – both have the same opportunities and almost identical backgrounds – but Jack plays it safe, leaves school after mucking around, gets himself a factory job and shows no aspiration for climbing the greasy pole.  Jill on the other hand studies hard, goes to university, and ends up as a successful career woman.  20 years later Jill is paying a much higher rate of tax than Jack – she has fallen foul of a system that fosters inequality.  Jill chose to make the most of her talents – Jack chose to muck around and not make the most of his.  Yet with those same opportunities people think they can cry foul on Jack’s behalf at the expense of Jill.  They are probably right in their methodology – but the assumption of entitlement ought not to be made purely on difference of outcome.

There is one other thing to consider; most people don’t realise this but while Mr Pomsonby-Smythe’s money is being kept out of the part of the economy that Clegg wants it in (the goods and services part) the average Jack in this country should be pleased.  This is because the common argument, that extracting some of the rich people’s wealth and putting it back into the economy will make us all better off is almost entirely wrong.  Just the opposite is true – you see, in actual fact,  the mega rich people who hoard their wealth in stocks, bonds and international currency actually make us all financially better off by doing this, not worse off.  I think it is because most people don’t grasp this that they are forever having lustful paroxysms about economic stimulus systems that state they will put more money in our banks and lighten the load of the mega rich. It’s nonsense!

Hang on, I hear you object, if the mega rich man gave some of his wealth to feed the homeless, then that’s good for the economy, because the more the rich man spends the more the hungry have to eat.  You would only now believe that if you hadn’t ingested my point about where value is to be found (i.e. not in green pieces of paper).  Here’s what you are overlooking – the food that feeds the homeless people doesn’t just come out of thin air – it has to affect the economy somewhere.  If he feeds the homeless then the cost of that food is impacted in the rest of the economy – either others eat less or others pay more for other food (the same would be true of all goods and services).  So I’m not saying it is not moral to feed the homeless, or even for the rich to bear a heavier burden – I am simply saying that the argument about spreading the wealth in the economy is mathematically wrong.

When the Government spends well, the world gains – if it is foreign aid then mostly poorer people benefit from water and food (and the British people’s money supply is worth more, not less – a point that those who are opposed to foreign aid always miss), if it is on health the sick benefit, if it is on road maintenance the drivers benefit, and so forth.  But if it is spent poorly, on wars (some wars are injudicious), on profligate enterprises like consultants fees and think-tanks (which are often a waste of money), on injudicious ecological strategies, or on shoddy investments, then everyone suffers, because they usually think they could have spent the money more wisely (and mostly they probably could).

However, they need not necessarily suffer financially.  Poor Government spending can still lead to an overall job growth, because when people’s resources hit a significant loss, borrowing increases, which hikes up interest rates, which dissuades people from holding onto money (remember one other golden rule – money is not an interest-bearing asset), which has the corollary effect of increasing spending, which drives up prices, which either leads to business expansion (creating more jobs), or a concomitant rise in employees’ wages commensurate with the employers’ profit increase, which means workers have more to spend, and so on.

Either way, the Government quite naturally spends its money wisely and poorly – but its control of the overall market is so minimal it is virtually negligible – so there’s no real reason to hope they get more of it at the expense of Mr Pomsonby-Smythe.