Tuesday, 8 September 2015

Let's Talk About Tax: How Taxing The Rich Can Be Good For The Rich

One reason it is good not to over-tax people is because tax is part of competition, just like goods, services and labour - and competition is the main driver of economic growth. Our tax in the UK is relatively low because we are a nation that's relatively competitive in the global market. That's why our economy (particularly London-Oxford-Cambridge and other parts of the south east) is thriving more than anywhere else in Europe, and why lots of foreign investment is generating lots more economic growth here than in the rest of Europe. Contrary to popular opinion, when we earn money it is not the case that the money belongs to the government and the government lets us keep some of it. The money belongs to us, and although many of us willingly pay tax, the system ensures it is taken off us with the threat of imprisonment for non-compliance.

Despite empirical evidence that low top rate taxes are best for growth, we hear a lot of people on the left asserting that reducing the top rate of tax is tantamount to "Giving hand-outs to the rich while neglecting the poor". That is silly. Such people have forgotten the above maxim - that getting to keep more of what you earn is not a hand-out. If a mugger forces you to hand over your wallet and mobile phone but lets you keep your watch, you're not going to take kindly to a policeman who tells you that in not taking your watch too the mugger was giving you a hand-out.

In terms of what they get out of the deal, the richest people in the UK have every right to argue that they pay too much tax, particularly when considering how relatively little they get for those taxes in return. The richest 5% may own 40% of the wealth but they pay a whopping 48% of total tax. That means by definition they are paying for a lot of public service units that they don't use. Those units confer a State-guaranteed wealth on every citizen that nearly half of which is paid for by the rich. In contrast the bottom 50% of taxpayers pay just 5% of total tax.

I argued in this blog post that there should be no automatic assumption that the rich should pay more tax, but by the end of the blog post I conceded that it's a good thing that they do, largely because rich households have a lot more of their income that is not spent on basic necessities, and thus have more to spare in a way that the poor do not. As well as it being a good thing for those that have plenty to give a helping hand to those that have little, there are also other obvious benefits too - namely that big taxes for the rich enable the government to spend some of the money on things that benefit the citizens of that country - more government spending on scientific research, better roads, better defense, better food standard research, better foreign policy, and so forth.

But there is another less obvious reason why taxing the rich can be good for the rich - one that you may not have considered before. Rich people spend money on luxuries and on status-mongering - and these things are not ultimately helpful to them. At the high end of spending, the law of diminishing marginal utility kicks in, in a big way. The law of diminishing marginal utility basically means that satisfaction from something declines with every additional unit. So for example, if you ate five of your favourite chocolate bars on the trot the fifth would be less pleasurable than the fourth, which would be less pleasurable than the third.

Translating that to rich people: the pleasure gained from getting your first £50,000 Nissan Skyline is greater than the pleasure of upgrading from a £50,000 Nissan Skyline to a £60,000 Nissan Skyline. The general point being that the gains when one goes from very high spending to very very high spending give diminishing returns. On the other hand, if all those £10,000s went towards building a play area in the local park, or towards better roads, or towards supporting a charity that works in global development, or towards more police officers on the beat, then these are benefits that would be more strongly felt in society. In other words, for society the net gain of having a few more police officers in your area is likely to trump the net gain of a few people upgrading from a £50,000 Nissan Skyline to a £60,000 Nissan Skyline.

While we should respect people's desire to spend their money how they want (within reason, and within the law), taxing the rich does them a favour in that it often spends the money on their behalf better than they would, where better equals better for society. Rich people have been known to spend anywhere between £50,000 to £10 million on things like a bottle of champagne; a child's birthday party, a handbag, a wristwatch, a dressing gown, and so on. All this type of spending is done primarily for the purpose of vanity and status mongering - trying to stand out from or emulate their peers. The term for this is often referred to as "Keeping up with the Joneses". The trouble is, when Rich Tom's peers spend more, so does he, which ends up conferring the same social distinction on him for a lot more money. In other words, a man who stands out from his peers by buying a £5000 watch compared with his peers' £1000 watches stands out to exactly the same magnitude as a man who buys a £500,000 watch compared with his peers' £100,000 watch. Status mongering is one of the big causes of obscene prices, and given that insecurity is the primary driving force behind status mongering, it really is quite futile in the long run.

You’re probably familiar with the well known stadium metaphor, in which one-by-one people stand up to get a better view, culminating in all standing up, with no one having any advantage over when they were all seated. That’s what happens in status mongering. Rich people buy more luxurious things in order to attain status, but once others follow suit the comparative advantage dwindles, causing them to increase their luxurious spending further in a rinse and repeat cycle. A poor husband shows he loves his wife with a box of Milk Tray and a £10 bunch of flowers. A multi-millionaire shows he loves his wife with a Prada handbag and a necklace from Hatton Garden**. But it doesn't mean the love shown by the rich person is greater just because the consumption costs are higher.

A tax we really should desire
Personally I don't much care for the kind of people who are so detached from ordinary people's reality, and so focused on status, that they would pay hundreds of thousands of pounds for items like clothes, ornaments and fireplaces. I'm all for the government taxing the heck out of a billionaire's purchase of a fleet of yachts. I would like to see luxury spending taxed highly under progressive income-consumption tax system.

Under a properly progressive income-consumption tax system, taxpayers could pay according to earnings, savings and consumption (maybe high price consumption). Consumption tax could be correlated with savings and earnings, and start low and rise according to expenditure. So for example, everyone pays the same tax on a bar of chocolate but not on a Nissan Skyline or a fleet of yachts.

I would like to see consumption tax according to ostentation (an ostentation tax), where the purchase of a Gucci handbag comes with a high rate of tax. So if you're the sort of smug individual who wants to pay, and can afford to pay, £1000 for a bottle of champagne, or £5000 for a handbag, or £40,000 for a set of 10 dinner plates, you are the sort of person who should be giving a lot back to society (for your own good as well as for the good of society). This is the best redistributive system of tax I can think of - ostentation tax - taxing luxury spending. It would be the closest thing to creating money for the poor out of thin air (although it's not quite thin air), while not punishing the consumption habits of people lower down the economic ladder. If heavy savings are taxed, and luxury spending is taxed, then spending patterns should change to bring more income to lower earners in smaller businesses too.

** This sentiment was beautifully summarised by the economist Richard Layard like this: “In a poor country, a man proves to his wife that he loves her by giving her a rose, but in a rich country, he must give a dozen roses."