Flat Tax Is Almost Certainly The More Progressive Tax

I have sympathy with arguments for flat tax rates and for progressive tax rates, but I think the best arguments against progressive tax rates are the declining marginal utility of government spending, and the associated poor allocation of resources. Progressive taxation feeds on the desire to tax individuals more responsibility, where those that have more, put more back into society. Just as we’d ask a man in a desert with ten thousand water bottles to give more water to thirsty people than a man with five. 

The idea being, if a proportionate sum of money has far less marginal value to super rich George, and more to others where it can do more societal good, then there is a reasonable call for George to wish to be able to contribute to wider societal needs. It’s not difficult to demonstrate a utility function with declining marginal utility for which the utility of the higher parts of someone’s income provides less utility, and taxation provides higher overall utility. But only up to a point. When you have a case, as you do in the UK, where declining marginal utility of government spending comes into play, and additional taxation leads to misallocation, waste, bureaucratic overhead, and spending on things that most citizens do not want, any theoretical gains from redistribution are eroded by poor execution in practice. 

So while the logarithmic utility function captures this idea of diminishing marginal utility - that the more you earn, the less each extra pound matters in terms of increasing utility – a tax system that tries to ensure that, after taxes, the marginal utility is more equal for everyone, is likely to be better under a flat tax system if the private allocation of resources has much more utility for the poorest than the public allocation.

The Foolish 'Windfall Tax' Idea

 

Of course, everyone with even a sketchy understanding of economics knows already that the ‘windfall tax’ is a bad idea. But for those who don’t yet know it, here are a couple of pointers. There are three main things we can do in an economy to make the world a better place; the first is waste fewer resources, which means consuming as optimally and efficiently as possible (which also includes allocating those resources in line with the information signals generated by prices in accordance with supply and demand curves). The second is work harder to provide more goods and services that people want and need, at better prices, using resources most efficiently. The third is to keep increasing our knowledge and our technological capacity so that the things we want and need become cheaper, easier and quicker than they were for previous generations. Whether in times of prosperity, in a pandemic, in a war, or whenever, there is nothing better that we can do for humans in an economy than those three things.

Perhaps now you can start to see why capital taxes like this (which includes tax on capital gains, interest, shareholder dividends and corporation income), dressed up as the ‘windfall tax’, are inimical to the threefold progress of the above. If you tax capital, you disincentivise saving and increase consumption, and if you tax capital, you disincentivise investment and innovation. If you increase consumption artificially, you decrease efficiency in point 1; and if you disincentivise investment and innovation, you tax (in the long run) labour, growth and innovation, which decreases the efficiency in points 2 and 3. 

Taxing capital disincentivises capital accumulation, and therefore negatively affects investment, production and labour. But it’s worse than that, because in the current tax systems money is taxed multiple times, which produces even greater inefficiencies and retardation of economic development. Taxing your earnings and then your capital amounts to double taxation, because capital gains are the fruits from the income that has already been taxed once. Taxing both income and capital is like fining a pedestrian for being drunk and then fining him again half an hour later for having too much alcohol in his bloodstream. Finally, taxing capital is also a deferred tax on labour, because capital is earned by past labour that has already been taxed at the point of earnings, and is therefore the deferred benefits of past labour. Tax the capital that is the present reward for past labour and you’re double taxing the original labour.

The upshot of all this is that a windfall tax is a terrible idea thought up by people who don’t understand economics, for the persuasion of people who are impoverished by listening to those people who don’t understand economics. 

 

Is The Government Stupid Or Does It Just Think We Are?

Aaargh….I've just noticed this latest brainwave from our dear leaders:

Policy headline: From April 2020, the government will introduce a new 2% tax on the revenues of search engines, social media platforms and online marketplaces which derive value from UK users.

Policy objective: The application of the current corporate tax rules to businesses operating in the digital economy has led to a misalignment between the place where profits are taxed and the place where value is created.

There's no question this is a bad policy, because any taxes on corporations are a bad idea. But it's what the government says next that really beggars belief:

Impact on individuals, households and families: This measure has no direct impact on individuals as it only affects businesses.

It's this kind of combination of ignorance and slipperiness that politicians really should be held accountable for - because of course this measure is going to have a direct impact on individuals, as it will be individuals who pick up the bill in the form of the higher prices, when the digital companies merely pass on the cost of this tax to their customers. Tut tut!!

Bill Gates Gets This One Entirely Wrong

On New Year’s Eve, multi-billionaire Bill Gates called for raising taxes even higher on rich people like himself in order to reduce inequality. Here’s how he thinks it should be done:

“Although I’m not an expert on the tax code, I think America should shift more of the tax burden onto capital, including by raising the capital gains tax, probably to the same level as taxes on labour.”

There are three big problems with his idea.

Firstly, it's a bad idea because taxing capital disincentivises capital accumulation, and therefore negatively affects investment, production and labour. But it’s worse than that, because in the current tax systems money is taxed multiple times, which produces even greater inefficiencies and retardations of economic development. Taxing your earnings and then your capital amounts to double taxation, because capital gains are the fruits from the income that has already been taxed once. Taxing both income and capital is like fining a pedestrian for being drunk and then fining him again half an hour later for having too much alcohol in his bloodstream. Moreover, what Gates seems to have missed is that taxing capital is also a deferred tax on labour, because capital is earned by past labour that has already been taxed at the point of earnings, and is therefore the deferred benefits of past labour. Tax the capital that is the present reward for past labour and you’re double taxing the original labour.

Secondly, Bill Gates' proposal misunderstands something fundamental about who really pays for the capital taxes. Here's why poorer people are hurt most by taxing rich people's capital. If a rich man has £1 million pounds and puts it in a suitcase in his loft, the rest of the world is richer by £1 million pounds because that's £1 million pounds' worth of resources that aren't being consumed. In economics, people are negatively affected not by other people's hoarding of money, but by other people's spending or use of resources. This is because people aren’t rich by having money - they are rich because of what that money buys (goods, free time, holidays, etc). When Jack earns a bank note and doesn't spend it, the rest of the world is one bank note richer, because Jack produced one bank note's worth of goods and didn't consume them. By not using fuel, there is more for everyone else; by not having a big mansion there is more bricks and mortar for everyone else; by not buying a yacht there are more raw materials for those who might wish to build a shed or a new porch.

I said that in hoarding his bank notes and not spending them on resources, Jack leaves more for everyone else. How are those extra resources shared around? Well it depends on how the savings are made. If Jack puts £1 million pounds worth of banknotes in his loft and never touches them, then everyone else is better off by £1 million pounds, which they'll find by having the prices of goods driven down. If Jack takes his £1 million pounds out of the loft and puts it in his bank he will bid down interest rates to the tune that others will be able to afford £1 million pounds worth of goods or services. Conversely if he buys £1 million pounds worth of timber he will bid up the price of timber for everyone else, and reduce the supply too. 

The moral of this story is that when money is spent by Jack we all become poorer not richer. Every banana or laptop or car Jack buys there will be one less banana, laptop or car, and the prices of those goods will rise. When Jack buys a banana, the rest of the world will be able to buy one less banana.

If we translate that to billionaire Jack, and raid his savings for tax gains, here's what you'll find. Jack's money is just paper and ink - it doesn't produce a new council HS2 office. What produces a new council HS2 office is bricks, concrete, steel, wood and glass. If you tax him £1 million pounds, you don't get the HS2 council office, because Jack doesn't have any bricks, concrete, steel, wood and glass. So those resources will come from somewhere else, which means there'll be fewer restaurants, cinemas, car parks and roads. When the government taxes Jack £1 million pounds for the HS2 office, the price of bricks, concrete, steel, wood and glass gets bid up, and the gymnasium or bowling alley never gets built because the cost is slightly too expensive.

Let me spell that out again, because so few people seem to realise this. If you tax Jack £1 million pounds but Jack's consumption remains unaffected, then the consumption costs will land on those it does affect, and that will probably be on Jill who can no longer acquire a mortgage or Dick who can no longer afford to fund his idea for a small business. This does not mean that there are never good ways for governments to spend money - just that the popular idea of taxing rich people at no cost to poorer people is an idea built on a fundamental misunderstanding about who pays the costs of taxation.

Now let's take it further, and consider how all money is spent (by both poor and rich people). What people forget most is that the state doesn't provide anything - only people provide things, through their work, their skills and their ideas (doctors, nurses, teachers, HR consultants, etc). The state can only claim to provide at an abstracted, filtering level what people actually provide at the ground level in hospitals, schools, and so forth. If workers cannot provide something, the state cannot provide it either. The only thing the state can do that workers cannot do on their own is take money from people and spend it on their behalf. Because of the free-rider problem, sometimes this works (as in defence and rule of law), but often it just causes inefficiencies.

Consider a country with no central government providing any services at all apart from defence, rule of law, welfare, roads and some light regulations. In this country pretty much every pound you spend goes exactly where you’d choose to spend it, and ditto everyone else. Let’s call it model 1. Now consider our current UK model (let’s call it model 2), and ask yourself how closely the current state spends its money roughly similar to how its citizens would spend it if left to their own desires. In a Gini coefficient type of measurement, where 1 equals the state spends our money 100% exactly as we’d spend it ourselves, and 0 equals the state spends our money 0% exactly as we’d spend it ourselves, what would the true figure be? Would it be 0.75, where the state spends our money about three quarters as well as we’d spend it ourselves? Or would it be 0.50 perhaps, where they spend it half as well? Or perhaps even 0.25?

What we do know is that it’s impossible in model 2 for the state to spend our money exactly as well as we’d spend it, but we also know that there will be some things on which the state spends our money roughly as we’d spend it. To get a rough idea of what you think the true figure might be, imagine you are a self-employed person who refuses to pay any tax in the next financial year. Instead of paying the tax, you spend the money however you want: on some education for your daughter, you contribute a little towards defence and to the police force, you help support the local youth club, you do a grocery shop and donate it to a food bank, you buy a few more things you otherwise couldn’t afford, and you save a little in a private pension fund and a health care fund. Because of this, you get hounded by the government for not paying your taxes, and eventually arrested, sent to court, fined, re-arrested, sent to court again, and eventually to prison. Your crime was spending the money you earned on whatever you wanted to spend it on for the good of you, your family, your city and your country.

Now consider what you spent the rest of your money on – the money the government was going to let you keep anyway. You were going to buy a Laptop, but you decided on a tablet; you were going to buy a summer house but instead you bought a family holiday to the Lake District; you were going to buy a cheeseboard but instead you bought a DVD; you were going to give a donation to Cancer Research but instead you gave it to WaterAid. At no point would you get any threatening letters, have to appear in court, or get sent to prison - your consumption habits were freely chosen and with a multitude of choices at your disposal, with suppliers competing for your custom. I hope you can see from that illustration how markedly different model 1 is from model 2.

Thirdly, not only is Bill Gates’ desire to target wealth that has already been taxed at the point of labour a regressive one, it directly contradicts the environmentalist work he champions elsewhere. Here’s why. There are only three things the present earthly inhabitants can do to make the world a better place for our descendants. We can consume less, leaving more resources for them to consume; we can work harder to create future value in the form of goods and services that they will inherit and build upon; and we can innovate by advancing our technological capabilities and standard of living that they will inherit and build upon. Increasing capital taxes reduces the incentive to save, increases the incentive to consume, and diminishes the incentive to work and innovate, which has a triple whammy negative effect on the three things that will do most good for future generations.

Why We Should Be Wary Of Carbon Tax

Being 6ft 7, I don’t have much leg room on planes. This was even more apparent on my night flight back from America in 2017, when the passenger in front of me wanted to recline his chair into a sleeping position, and I had to apologetically advise that this would not be possible as my leg room was already at full capacity. Most people would agree that having this discomfort imposed on me would be unfair to me, and that the passenger in front of me should save my discomfort, or else compensate me for it. This is what is known in economics as a ‘negative externality’ - costs imposed on somebody else that circumvents market signals without due compensation for the costs.

Pollution is another ‘negative externality’ in society - and one that many people want to see drastically reduced. To know if we should reduce pollution, we would need to know what the right amount of pollution is - and that is a complex analysis that we oversimplify at our peril. Consider a factory that emits sulfer oxides in the air. Obviously sulfer oxide emissions affect the pollution levels, but that's not the same as saying that they are bad. Technically, breathing pollutes the environment, but no one sensible suggests we should stop breathing. If a factory is turning a profit, it is creating value in society (because consumers prefer spending on the products to keeping their money), so the right question to ask is whether the pollution the factory emits has costs that outweigh the benefits of the consumer surplus the factory affords to society in total production (not to mention the jobs it creates too) or whether the benefits of the factory outweigh the cost of the pollution.

How can we tell which it is? Here's how; if the negative spillover effects of the pollution are less than the cost of preventing it, the pollution produces more gains than losses. If the negative spillover effects of the pollution are more than the cost of preventing it, the pollution probably should be penalised. The point so many people are missing is that sometimes pollution confers net gains on society (actually, my instinct is it usually does).

Returning to my night flight, here's an essential part of the story that is usually missed: it wasn’t just the case that the passenger in front of me was imposing a cost on me if he reclined, I too was imposing a cost on him by being 6ft 7 and sitting right behind him. This is what is meant by the notion that negative externalities are symmetrical. The passenger in front of me was inconvenienced by my height, just as I was inconvenienced by his desire to recline. And apart from a highly subjective recourse to Kamm’s Principle of Permissible Harm, which is the notion that one may endorse some forms of harm occurring but only if such harm is an effect or an aspect of the greater good itself, there isn’t really a sound way outside of market signals to established whose inconvenience should take precedence over the other’s. Naturally, the price system goes a long way towards solving these problems in advance - for example, by making more desirable things like seats with more leg room more expensive to match their increased demand. As my ticket had already been purchased, the way I rectified the problem was by asking if I could be moved to a seat with more leg room and no passengers in front of me - and the stewardess was happy to acquiesce, making all parties happy with the arrangement.

What I'm conveying here is the Coase theorem*, which basically says, we should never assume that the policy should be "Stop Fred from harming Bob" or "Stop Bob from harming Fred" - we need to work out whether we should allow Bob to harm Fred or Fred to harm Bob. Until we know more details, an abstract argument for preferring Bob over Fred is equally rational for preferring Fred over Bob - the devil is in the detail. Coase doesn't gainsay the value of carbon (Pigouvian) taxes per se, but he does teach us that we need to base the decision on evidence not on logic alone. Should we tax a polluter? Maybe, maybe not. Pollution causes harm to others, but so does taxation. The proper cost-benefit analysis is to consider the cost of failing to tax an emission (more pollution), against the cost of taxing an emission (the stuff we forgo because of the tax), and try to ascertain which is the bigger net cost.

To ensure a balanced enquiry, if I was steelmanning here, and trying to find the best argument for carbon taxes, this 5 point argument is about as good a case as I can make:

1) The main defining problem of climate change is that we are all part of the problem as well as part of the solution. We all rely on vehicles that clog up the road for others, pollute the air, and put the price of fuel up. We also use our central heating, wash our clothes and buy things that came from widespread transportation. Many of us even use aircraft to fly abroad, and run businesses that emit lots of carbon. The upshot is, we all contribute to greenhouse gas emissions, so what's needed is a collective effort to change things.

2) This kind of activity has indirect consequences for people who live near rainforests, people in hot countries, and it may well even have consequences for people who haven't been born yet. Even though both the problem and the solution is a shared one, it is difficult to get everyone to co-operate in shared solutions, which is where the state comes in.

3) The state imposes price increases on our transactions in the shape of carbon taxes, which incentivises us to be self-interested in being more responsible with our environmental activities. One problem I have with carbon tax is that due to lots of asymmetry of information the setting of a carbon tax rate is almost entirely arbitrary. Still, despite this, carbon tax might do some good for the following reason. People change their bad consumption behaviour to accord with differing incentives like price changes. So for example, a tax on carbon dioxide emissions of £50 or £60 a tonne would affect our consumption habits in relation to products and services associated with carbon dioxide emissions.

4) If this tax enabled the government to reduce taxes in other areas, then the carbon tax would help us change our habits and at the same time bring about selection pressure in the market for us to be more mindful of the environment. This is part of a general law of economics – when prices go up or down, people change their buying habits. If the price of red grapes goes up by 40% and green grapes stay the same, people will buy more green grapes and fewer red grapes. If the price of emitting carbon goes up, people will lower their CO2 emissions, which will place selection pressure on consumers and on eco-unfriendly businesses. This means that as carbon/pollution taxes endure, people will look for more ways to be greener, making us as humans more mindful of our environment.

5) The conclusion is that green taxes will do some good to bring about a phasing out of environmentally unfriendly activities.

Are they strong enough arguments to justify carbon taxes? My instincts tell me no - so let's explore those instincts more fully. The problem with carbon taxes in the present day is that if carbon taxes won't really do any overall good, they are probably a waste of time altogether. This may not seem obvious at first, but it should soon be fairly obvious when elucidated. In life, partial efforts are often good, particularly if the results are not impeded by others' non-involvement. Giving to charity is a case in point. If 30% of UK folk donate to Save The Children, then poor children still benefit because despite 70% not giving to that charity (some may be giving elsewhere) what they do collect still helps. Similarly if 90% of the country picks up litter then their efforts are not wasted simply because the other 10% did not. In the cases of charitable donations and litter picking, every little bit helps - and despite being simple on the surface, this is measured with rigorous economics (basically, if the Pareto efficiency or Kaldor-Hicks efficiencies are such that negative externalities are immeasurable or inconsequential to the positives then every little really does help).

But when it comes to reducing your own carbon footprint, things are different - because every little bit does not necessarily help - not in net terms. There are two reasons why this is the case: Firstly, reducing your own emissions is a solitary effort that probably has no real impact at the global level. Even if 50% of the UK's citizens made a concerted effort to reduce their carbon footprint, it would still be a drop in the ocean compared with the triune considerations of a) overall global consumption, b) the extent to which climates change outside of human involvement, and c) the comparative advancements of future generations.

And secondly, your reduced consumption will be offset by increased consumption elsewhere. As a hypothetical social experiment, suppose half the UK population were randomly drawn in a lottery and made to reduce their carbon footprint by 20%, with the other half free to carry on as normal. Here's what probably would happen. The reduction in consumption by half the people would reduce aggregate demand for ecologically unfriendly goods, which would see a drop in their price, which would increase consumption for others. What the 50% will actually be doing is helping out the other 50% in buying cheaper fossil fuels. Obviously that's too simplistic because there are global factors to consider, but they do not affect the truth of the statement that reduced consumption for some will mean increased consumption for others. If you can't get your head around it, imagine what would happen to the price of high heeled shoes if half the high-heeled shoe wearing women in the country stopped wearing them and reverted to flat shoes instead - the other half of the demographic would buy more pairs because they'd be getting them a lot cheaper.

Moreover, because politicians can only bring about the imposition of green taxes on their own citizens, not those of other countries (the EU aside), the same problem will apply at a global level - reduced consumption for some countries will mean increased consumption for those other counties that will be beneficiaries of cheaper fossil fuels. The cost incurred by those carbon-reducing countries will thus have a limited payoff in terms of overall global reduction. So it is literally the case that unless the vast majority of the world’s population are singing from the same ecological hymn sheet, environmental progress in some areas will be cancelled out by environmental regress in other areas.

In actual fact, the dialectic between 'If it makes no overall difference then small interventions will be too costly' plays out exactly this way with what’s called a 'cap and trade' policy, where a government issues annual permits that allow companies to emit the amount of carbon dioxide the cap allows. Companies are taxed if they exceed the permit’s level of emissions, and if they reduce their emissions they can trade unused permits to other companies. The rationale being that as the government lowers the number of permits each year, those permits become more expensive, incentivising companies over the years to invest in clean technology.

Alas, whoever devised this scheme isn’t very far-reaching when it comes to economics. Firstly, like every other state-fixed regulation, the government is bound to get the limit wrong, as it has no clue how much carbon businesses should emit. If their cap is too high it will do little good, and will probably even create an anchoring effect that artificially raises emissions. If the cap is too low it will destroy businesses and artificially raise energy prices to the detriment of the industry and consumers. Secondly, it can disadvantage small businesses who can’t afford to buy a permit, and stifle competition too. Thirdly, (for complex reasons we won’t elaborate on in this blog post) it is easier to calculate carbon tax based on per tonne emissions than it is calculating the optimum number of cap and trade permits.

Here's something else a lot of people get wrong about carbon tax - it is frequently assumed to be a method of reducing pollution, but that's not quite right. Even if there are conditions under which a carbon tax is not as bad as a cap and trade policy, a carbon tax is not a means of reducing emissions down to a nominal figure; it is supposed to be a tool for maximising utility. That is, carbon taxes help us incorporate negative externalities into the price system of a free market whereby polluters carry the costs of their negative externalities, but also whereby the price reaches equilibrium as the costs of pollution are measured accurately against the benefits. That way, those negative externalities are compensated for by the fact that they increase utility to a level greater than their costs. For example, a timber factory and a roadside diner on the outskirts of a city add some pollution to the environment, but they make up for those negative externalities by providing goods and services that people want.

Where they could be a benefit is when carbon taxes intervene in the price system to ensure that future costs of transactions are thought to be worth paying for present benefits. The rate of carbon tax is roughly commensurate with the future cost of pollution, incorporated into the price system to justify the benefits now – it should technically be a tax that attempts to ascertain the benefits of pollution, not the costs. Carbon taxes are far from simply being about lowering emissions, although they will likely change future behaviour as businesses innovate to be greener with improved technology.

Two other big problems with carbon taxes

The first problem is the way carbon taxes are used by politicians to make the state bigger at our expense and for their own gain. Here we can elicit a popular term coined by Bruce Yandle called Bootleggers and Baptists, which is about regulations that provide self-interested benefits for both the regulators and for those thought to be victims of the regulations. It is based on the notion that Baptists support Sunday closing hours, but so do Bootleggers, because if local bars and off-licenses are closed, Bootleggers gain too. Here's how it works. Sunday closing hours benefit both Bootleggers and Baptists, while at the same time purporting to serve the public interests - and the green regulations are of a similar nature, as well as being very short-sighted and hugely damaging. Climate change alarmists naturally support heavy green regulations - because it furthers their own agenda, and enables them to cream off crony capitalist subsidies - but so do some of the biggest polluters too because some of the regulations help shut out competition, which a crony capitalist misallocation of resources.

The second problem is that carbon tax does not really punish polluting companies very much; it tends to punish consumers, who are usually the poorest people in society. When a company is taxed - whether it is carbon tax, corporation tax, or labour tax (the minimum wage) - the cost of that tax cannot be borne by a company, because a company is made up of individuals, and only individuals can bear the cost of taxes. When companies are taxed, the cost either has to be borne by shareholders (with lower dividends), or employees (with decreased wages), or by customers (with increased prices of goods or services). Like with corporation tax and tax on labour, the cost of carbon taxes are primarily borne by customers or employees to avoid being borne by shareholders, because a company will always do its best to pass additional tax costs on to employees or consumers. If the cost of taxes ultimately falls on individuals in the form of higher prices of consumption and lower wages (or in some cases increased unemployment) then a carbon tax policy that tries to hurt corporations who pollute is simply a tax policy that harms the people who are most struggling to get by. You may still support carbon taxes on the basis that consumers are contributing to high-pollution goods and services, and that they are paying their fair share - but it’s a bad argument for saying that carbon taxes make companies greener, because what they mostly do is make poor people poorer.

The right amount of carbon tax is this and only this: it is a tax that imposes prohibitive costs on low-utility activities while still allowing for high-utility activities. The trouble is, due to the complexity and inability to see into the future with any degree of rigour, the level of utility is hard to distil, leaving us only with ambiguous probability. The probability estimate is roughly this; if activity A has significant emissions and few offsetting benefits to make it a low-utility activity then carbon taxes on it could be encouraged. If not, carbon taxes should be discouraged. If activity B has significant emission but enough offsetting benefits to make it a high-utility activity then carbon taxes on it should be discouraged. Where the future costs outweigh the present benefits we should make the activity price prohibitive. Where the present benefits outweigh future costs we should make the activity price conducive. If under a system of high or maximum utility we can't go on to produce an alternative to our carbon taxing system then we know we are doing the best and most practical things; if we can go on to produce a better, higher utility alternative, all the better.

Let me give you a simple illustration to show this: take cars. Either the future technology will or won't turn our car industry from a high emissions petrol/diesel generated industry to a low emissions electric/solar powered industry. All the evidence thus far suggests that it will (there are electric car prototypes in place, even as we speak). Give it a few decades and there'll probably be very few if any petrol or diesel driven cars. So, then, using our utility measurement above, the right kinds of car will be produced in the future if it's efficient to do so - and this will happen irrespective of whether the state influences the market or not. It's true that carbon taxes swing the incentive towards more environmentally friendly industries, but as I've shown, that doesn't mean it's a good thing. Taxes on foreign charity may well swing more donations towards the British Heart Foundation, but that doesn't mean this swing is a good thing either.

Here's an example of how not to undertake this analysis. In October 2018, many MPs wanted to ban all of the standard petrol or diesel driven cars by 2040 and allow only vanishingly low emission vehicles on the roads (presumably electric and solar vehicles). A simple understanding of the cost-benefit analysis above would show that such a ban is irresponsible and unnecessary. Here's why. If the present benefits of petrol or diesel driven cars outweigh future costs, we should carry on supporting them, and taxes imposed upon them are more harmful than good. If on the other hand future costs of petrol or diesel driven cars outweigh present benefits then taxes imposed upon them are still more good than harmful. Translated in terms of what the future will hold, what we are saying is: if future technology brings about electric or solar vehicles with greater utility than petrol or diesel vehicles then we'll see a natural switch driven by voluntary market choices, rendering the ban entirely unnecessary. But equally, if future technology brings about electric or solar vehicles with less utility than petrol or diesel ones then we won't see a natural switch driven by voluntary market choices, which means that banning such vehicles (or even heavily taxing them) will make us all much worse off. Either way, a ban is a foolish thing to impose.

Closing thought

The upshot of all this is that when the state intervenes to mitigate the extent to which humans pollute, the intervention will only be beneficial if it outweighs the costs of intervention - and my instinct is, it usually does not. With carbon tax, politicians are trying to prevent future damage by minimising present benefits. But if present and future benefits of pollution outweigh present and future costs - and it seems pretty certain that they do (by a long way) - we should carry on enjoying them, and taxes and regulations imposed upon industrial activity are more harmful than good. This is what is meant by maximising utility - net benefits outweigh net costs. Greens believe that things like carbon taxes maximise utility. Sceptics like myself believe that carbon taxes impede utility - and I have never had a reason to change my mind.  

The scientific and technological capabilities we have acquired in the past few hundred years will almost certainly make a better job of tackling externalities than carbon taxes, especially if humans are given the freedom to cooperate in problem-solving. Our science, technology and market activity are already making huge differences, and they are the progression trinity that will ultimately bring about the future changes needed. The entire nexus of the global economy is a physical system which is all the time tending towards the principle of maximum efficiency. Although carbon taxes bring in revenue for politicians short-term (for a few decades maybe), the long-term indicators are that the market left to run by itself will naturally make us greener anyway. The reason being: businesses are already looking for the most efficient means of supplying customers using as little energy as possible, because in a highly competitive market it is in their interest to do so to remain profitable. The goal to reduce energy output has already come in various ways: replacement of human energy for machines, replacement of metal-based technology for higher intensity resources or carbon-cased materials, replacement of paper for digital devices, and so forth – and these are improvements in production that naturally improve business’s cost-effectiveness.

The transition from the paper revolution to the digital one required lots of burning of fossil fuels, equivalent to energy being driven into the system from outside, but all the time that external energy is helping the global economy tend towards a path to least resistance very similar to how thermodynamics operates in the natural world. As the old saying goes, you can't make an omelette without breaking a few eggs - and the eggs we've cracked since the Industrial Revolution, while not without some externalities, have done more to improve global standards of living than anything else in human history. Carbon taxes may lead to fewer emissions, but with carbon taxes, energy prices rise, resources are misallocated, innovation is impeded (including innovation that actually helps solve climate change), and many of the world's poorest people suffer as a consequence.

My instinct is that because prices have been changed to account for the increased emissions, the only investment that is needed is investment that is more economically viable than the current prices. The imminent effect of those price changes will tell us the best course of action. If, for example, our ability to augment our solar capacity enables that venture to be price competitive against our current carbon industries then consumers will respond to it. If it doesn't, they won't (that point alone illustrates how state interference will probably impede the process). The costs (present and future) of staying with our current carbon trends have already been factored into the increased prices of our externalities. We don't need to throw much taxpayers' money at it at all - because people's preferences for economic viability will drive this, as already happens in virtually every other market process. Consequently, compared with how the market engenders continually increased efficiency, I'm pretty sure that carbon taxes probably will turn out to have had only a much more negligible effect on lower energy output and more efficient use of resources than the free market, because the market is driven by efficiency far more than politicians with political interest. If there is a race to make us greener, politicians are more like the tortoise and the market is more like the hare.

 

 

* Externalities are based on incentives, as was most famously written about by English economist Arthur Cecil Pigou with his standard textbook examples of nineteenth century trains that threw off sparks that frequently ignited the crops on neighbouring farms, and of rabbits that would frequently eat the neighbouring lettuce farmers’ goods. Quite naturally, or so Pigou (and just about everyone else) thought, the railroad owners and farmers with rabbits had to feel the effects of their actions, so recompense was owed to the farmers with the ignited crops and the diminished lettuce supplies. But things aren’t quite so straightforward, because outside of economic expertise, most negative externalities are only narrowly considered from one person’s perspective and not the other. It’s here we need to elicit the Coase theorem – which was conceived by Nobel Prize winner Ronald Coase in 1960. The idea behind the Coase theorem is that negative externalities are not usually asymmetrically one-sided, they are symmetrical. This is what Ronald Coase theorised:

 

"Where there are complete competitive markets with no transactions costs, an efficient set of inputs and outputs to and from production-optimal distribution will be selected, regardless of how property rights are divided."

 

In other words, the Coase theorem asserts that when rights are involved, parties naturally gravitate towards the most efficient and mutually beneficial outcome, with no prior blame or discrimination being automatically assumed. This dramatically changes the situations above, because Coase was smart enough to enquire as to why the railroad owners and farmers with rabbits were the ones causing inconvenience – why not the farmers with the ignited crops and the diminished lettuce supplies? If your trains set fire to my crops, then you have imposed a cost on me, but at the same time I have imposed a cost on you by having my crops near your railroad (which may be in the optimal location for transporting commuters from A to B). Moreover, I may very well use the train myself. Your rabbits are annoying me by eating my lettuce; but equally my lettuce is annoying you because it is causing your rabbits to eat them, which incurs the cost you are forced to pay me as compensation. Your nearby power plant burns fossil fuels and pollutes the air I breathe, but you shouldn’t bear all the pollution costs because you supply electricity to many of the places whose products I buy.

 

Remember, Coase wasn't looking to play the blame game; he was looking for an efficient set of inputs and outputs, regardless of how property rights are divided. In the case of the railroad and the fires, he was looking for a solution that benefits both, not who should reimburse who. If the farmer plants his crops at an optimal distance from the railtrack, then both may enjoy the most efficient outcome. The town has crops and train journeys, and no one is paying financial restitution or looking for ways to sue. Similarly the rabbit farmer can keep his rabbits in cages or secure ring-fences, the lettuce farmer could grow other things the rabbits won’t eat, or they could split the costs and build an impenetrable fence between their farms. The railroad/crops example showed a new way of looking at the situation; yes, if there were no railroad tracks there would be no crop fires, but equally if there were no crops that were so close to the tracks there would be no crop fires either.

 

 

 

 

 

We Have Progressive Tax, Why Not Progressive Sex & Progressive Exercise?

I'm going to offer a proposition that will startle you at first, but one which you'll probably then go on to see as intriguing. Imagine what the UK would be like if the government treated sex and exercise the same way it treats income tax.

In the UK we have a progressive tax system, which is a tax system whereby the tax rate of a working person increases as the taxable base amount (their salary) increases. So someone earning £100,000 per year will not just pay more than the average earner in absolute tax due to higher earning, relatively they will pay a bigger proportion of their income too.

I've argued before on this Blog that although we shouldn't assume the rich should automatically pay more tax, it is good for society (and that includes good for rich people) that they do, 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.  

But if we consider what progressive taxation is - the rich doing favours for the poor by having more privileges with which to help - we get into knottier territories, because we can begin to ask why we don't go beyond financial favours into areas like sex and exercise. For the purposes of fun, bear with me for a moment, and imagine this; realising that money isn't the only way that the better off can help the worse off, the government decides to introduce two other kinds of 'progressive' measures to accompany progressive tax - progressive sex and progressive exercise.

The government's reasoning is that if it is intrinsically the right thing to do for those better off to give a helping hand through taxation to those born without the ability or background or circumstances (or all three) to climb up the ladder, they can make additional laws to help out further in areas of sex and exercise too.

The progressive sex law makes those really good looking people give a helping hand through sexual favours to those born without the looks or the confidence to acquire a sexual partner. And the progressive exercise law makes people with more energy go and do the shopping or mow the lawn for those unfit people in society.

You may say that such proposals would disincentivise unattractive people from sprucing up their appearance and trying to meet partners on merit, and that it would disincentivise people unfit people to get off their bums, get fit and mow their own lawn (and you'd be right), but that equally well applies to financial helping hands too - as welfare inspires many to opt for not-working and instead live a more modest life financially.

At this point in the article your mind is probably racing with thoughts as to why progressive sex based on looks and progressive exercise based on fitness are overwhelmingly less desirable than progressive tax based on income. You've probably already thought, as one example, that mandatory sexual favours would be detrimental to marriages and relationships in a way that mandatory income tax is not. You've also probably already thought that being legally compelled to do things with our bodies is an entirely different intrusion on our lives than being legally compelled to do things with the money we earn.

 

So feel free to relax a bit - although I was only having a bit of fun with the idea of progressive sex and progressive exercise, there is, in fact, a method for ascertaining your differing views on these things. If you consider why it is you support compulsory helping hands in the form of money but not all the other things, you'll find there is a good short-cutting maxim that makes things clearer - it's the philosopher John Rawls' famous veil of ignorance theory of justice, in which ideal moral and ethical systems are implemented through conditions under which "No one knows his place in society, his class position or social status; nor does he know his fortune in the distribution of natural assets and abilities, his intelligence and strength, and the like."

 

So if we pretend that prior to being born we could all partake in a committee meeting to decide upon the fairest and most just society, not knowing where we'd be in that society in terms of environment, background, and natural talents, we'd (try to) pick the most objectively good one, not the most subjectively good.

 

In other words, if we had the luxury of voting on a system before we were born, and we didn't know how well off we would be in the gene pool of talent and in the cultural pool of good and bad backgrounds (where good means high earning potential), we'd all vote for a system to be in place whereby those at the bottom are given a helping hand or a leg up by those at the top.

 

But although we'd probably vote for this in the context of income tax, we wouldn't vote for a system where good looking single people subsidise ugly single people through sexual favours - not least because it would provide an unhelpful incentive for good looking people to be in relationships to avoid this obligation (and as we all know, relationships that are pressure-based and not freely chosen because of love and compatibility are not good.

Perhaps if we'd all been fortunate enough to have a Rawlsian pre-birth committee to decide on the distribution of funds, talents and privileges we'd be able to reach a fair and equitable system. But one thing we'd have to bring to bear is the fact that for every benefit there is likely going to be a cost.

If you give some of my earnings to broke Jack and skint Stephen then their benefit is my cost; whereas if you force sexy Sadie to give sexual favours to ugly Pete and short-on-confidence Dave then you impose a nasty cost on society by creating an exchange of activities above the threshold of what the pre-birth committee would choose. That I think is the best argument we have for picking some kinds of helping hands and not others - some stay within the realms of social-desirability and some don't.

The upshot is that enforced sexual favours are abhorrent, but enforced redistribution of wealth would also be abhorrent were it not for the fact that society benefits overall from it. Don't get me wrong, there are lots of problems with the welfare system - not least the welfare trap and perverse incentives - but there are enough benefits to justify keeping it (even if people don't like it as much as they say they do). Although enforced redistribution of wealth is undesirable in the context of a mugging, burglary or bank robbery, it is desirable in some cases when it is formalised by governmental societal practices (even though politicians do often resemble the mafia.), especially as a safety net makes bold innovation less of a risk, and short-term unemployment welfare benefits gives us time to find a job that best matches our skills and talents to the new position.

 

Leaving aside the bit of fun we had with the progressive sex and progressive exercise propositions, I said a moment ago that if we pretend that prior to being born we could all partake in a committee meeting to decide upon the fairest and most just society, we'd try our hardest to pick the most objectively good one, not the most subjectively good. To see why, suppose just ten people are in this committee meeting.

Translating environment, background, and natural talents into earnings, you learn that one of you is going to take home £750,000 per year, and the other nine are going to take home under £15,000 per year, with two of that nine taking home absolutely nothing (for argument's sake, due to disability and a troubled background). The ten of you get to vote on two systems: system 1 leaves things as they are, and system 2 incorporates redistributive policies that taxes a chunk of the £750,000 and apportions it down the shallow end of the earnings pool. All ten of you are almost certain to vote for system 2, because while you have a 1 in 10 chance of being the high earner, you have a 9 in 10 chance of struggling by on under £15,000 per year, so no individual would be wise to vote for system 1.

Extend that to everyone in society, and regarding your own position you'll see why from behind a veil of ignorance it's rational to desire an objectively fair and just system to ensure those in the deep end of the earning pool help those in the shallow end. Given that if it were possible we would all sign up to be on that committee, there is a reasonable case for arguing that in the absence of such an opportunity the next best alternative is democratically appointing a government that enforces these systems.

Obviously everyone disagrees on what that optimal governmental system looks like, but apart from very extreme libertarians, most of us agree that the system of political representatives is pretty much the next best thing to a Rawls-esque veil of ignorance committee. Obviously a system built entirely on beneficence would be susceptible to misuse and disincentive for the worse off to help themselves up the ladder, but some kind of government controlled system could work well, even if it isn't this one.

What we have at present is a central government that tries (sometimes well, often poorly) to put a simulation of this in place on our behalf by redistributing money gathered from taxation. In a perfect world everyone who has plenty would help everyone who has little - at least to the extent of offering a helping hand related to hardships people suffer that are not of their own making. 

Perhaps the most coherent argument against excessive government intervention in the market economy is Hayek’s ‘local knowledge’ problem - which basically states that no state agent can possibly have sufficient knowledge of a complex aggregation of individual decisions in society, so there are bound to be negative consequences from interfering from on high. Markets are bottom-up, not top-down, and what’s called ‘spontaneous order’ occurs when individuals make their own decisions through local incentives, benefitting the whole as they do so. Politicians do not have the necessary information to make decisions better than the individual agents in the market, so they are bound to do a less good job than leaving it the agents in question. There are few better pieces of wisdom in economics than that one, and we ignore it at our peril.

 
 





Progressive Tax Is Fine When It Applies To Others

A progressive tax system means the rate of an earner's taxation increases as the taxable base amount increases. So someone earning £100,000 per year will not just pay more in tax due to higher earning, they will pay a bigger proportion of their income too. The thing about progressive taxation is that just about everyone prefers it more when it applies to others than if it applied to themselves.

Suppose Jacqui takes up writing fiction in her spare time. She works on her debut novel "50 Shades of Jax", which turns out to be her masterpiece, and earns her a large one-off payment for her efforts. Jacqui spends 2 years on her book, working in her 9-5pm job in the daytime (and paying tax on those earnings too lest we forget) and dedicating her evenings to writing the novel.

If Jacqui's day time labour value is £15 per hour in her 9-5 job, and she spends 800 hours on "50 Shades of Jax" in the evenings, then the cost of her time writing the book is around £12,000 (this is an economic value based on a truism that the cost of an hour spent doing something is roughly proportionate to your earning power in that hour). Thankfully Jacqui gets the rewards for her hard work and skilful writing - she earns a one-off fee of £100,000 from a top publisher (we should actually deduct the £12,000, making it £88,000, as that was the cost of her writing the book - but let's forget that).

So, Jacqui has earned a straight £100,000, and she has big plans for the money. She can pay off some of the mortgage, pay her daughter's fees to send her to university, give some to charity, make a donation to keep open her local community centre, and arguably most importantly she can afford to give up work for a while in order to work on a follow-up book. Her success enables her to fulfil her lifetime ambition of being a paid writer.

The trouble is, she won't get to keep it all, because on current tax rates the government will want to take approximately £36,000 of her £100,000. Generally speaking, there are only two ways that anyone can get your money; either you give it away voluntarily (for example, in the form of a gift, a donation, or spending it on something you want), or it can be taken from you against your will (for example, in the form of an act of theft or extortion).

I've no doubt that Jacqui would rather pay zero tax on that £100,000 if she was let off by the government, so in being forced to pay the tax under the threat of imprisonment the government is engaging in extortion. Under any other circumstance - a big kid in school taking 36% of the little rich kid's pocket money, or being threatened by a couple of muggers for 36% of the money in your wallet - the extraction would be a crime. When a government does the same thing, it is called taxation.

Now it's not quite that straightforward, of course - most people aren't as averse to taxation as they are to being extorted or mugged, because they are able to live in a society in which they and their fellow citizens benefit from some of the taxation obtained. But my guess is that Jacqui will be pretty indignant at actually handing over a whopping £36,000 of her £100,000 after producing something she is very proud of, and working very hard to do so.

And why shouldn't she be indignant? It's true that some of her money will be spent on things of which she'd approve (basic health care in the NHS, education, roads and social services) but equally much of the money will be spent on things of which she probably wouldn't approve (foreign wars, PFIs, agricultural subsidies).

The upshot here is that many people are quite happy to endorse progressive taxation, but in most cases they are bound to be less enamoured with it when it applies to them. Given that we must therefore live in a society in which the majority of people would be indignant if they had to hand over £36,000 of their £100,000 earning (what's more, it's actually more like £60,000 when you account for all the ways they'd be taxed further on what they get to keep), but would be perfectly happy to see others pay that kind of tax, that ought to be a blatant indication that something is fundamentally wrong with the system, and needs changing.

When Tax Is Like Theft & When It Is Not

A friend asked the following question:

"If you don't pay tax you end up in prison. Therefore is tax theft, or is it the price we pay for a civilised society? If it's the price we pay for a civilised society, then it's not one we ever had a say in. Therefore it's a kind of theft, but one we appear to allow to happen to us?"

The best way to answer questions like this, I find, is to reverse the method of questioning somewhat. In asking whether tax is theft, or synonymous with theft, we are actually looking at the properties of something definitely bad and asking whether the other thing shares some or all those properties.  

On top of that, when we consider what is wrong with something, and enquire as to whether the other thing is comparable in terms of wrongness, it is often useful to compare its fundamental principles to other things in society. I will do both those things in this blog post.

The second one first. If at school you deliberately break little Johnny's mum's window, your parents should compensate them. If you break someone's window as an adult, you should compensate them. This has an analogue with some of the negative externality taxes like pollution.

On the other hand, if the local gangster goes round small businesses and obtains money through a protection racket, or if poor Tom takes some of rich Jack's lunch money in the school playground, this doesn't seem so good, even though it is tenuously analogous to how the state treats its citizens.

Apart from in spirit, the local gangster forcing restaurant owners to fund his own lifestyle is not hugely different to how the state forces me through taxation to invest in services I seldom or never use and policies to which I am wholly opposed.

To that end, I'm afraid the properties of taxation do all too often share some of the fundamental properties of theft. If Jack steals Jill's laptop, then Jill is the victim to about the same extent that Jack is a beneficiary. But the wrongness of theft is the moral wrongness that harms society, plus all the other negative spillover effects that I'll come to in a moment.

The wrongness of taxation is that it forces consumers to spend our money on things like establishment pay, layers of bureaucracy, small business subsidies, bailouts and transportation projects that we otherwise would not. To that end, a lot of taxation is a little like theft in terms of the consequences to the consumer, but it more closely resembles a protection racket (but not wholly, as we'll see in a minute).

The other thing that tax and theft have in common is that they both impose value-robbing opportunity costs on society. When Jack designs a mousetrap, or provides a taxi service, or cooks pizzas, he adds value to society. When he steals Jill's laptop, he inflicts all the costs on society that crime imposes, but he also forgoes the opportunity to do something productive.

Taxation has similar opportunity costs. While taxation transfers funds from one place to another, and in a costly way, it doesn't produce very much. There is a small sense in which taxation sustains parts of society (defence, rule of law, and other public goods) that enables others to produce, but there are enormous opportunity costs to taxation that misallocate resources by being out of kilter with supply and demand, and as a consequence rob society of a lot of value.

Taxation and theft also rob society of value by diminishing the number of mutually beneficial transactions that occur, because they both increase the cost of trade, and therefore increase the prices that businesses have to charge. The opportunity costs of taxation and theft are the aggregation of all the forgone opportunities for trade - the mousetraps that don't get made, the taxi rides that never happen, and the pizzas that never get cooked.

Some people struggle with this notion, but it's easy to see its truth by imagining a more extreme example: a country ruled by a greedy dictator who taxes the life out his citizens and allows lawlessness to occur. The costs to the citizens are not just the taxes and the crime - the more acute costs are all the lost productivity and prospective innovations that never materialise because of the taxes and lawlessness.

In summary, then, taxation and theft share many of the same properties - but theft is a bit worse because theft always engenders net costs on society, whereas tax mostly does, but not in every instance.

Every instance where tax goes towards providing something that could, and should, be provided privately, taxation has similar properties to theft. Every instance where tax goes towards providing something, like a public good (defence, rule of law) that is more valuable to society than the cost of the tax gathered, taxation is a lot less like theft - it is more like a compulsory insurance policy that provides societal benefits that would otherwise be more difficult to obtain because of the free rider problem.

Why Graveyard Robbery Will Hurt The People It's Trying To Help

A columnist called Abi Wilkinson suggested in The Guardian yesterday that the government should fund the welfare state with a 100% inheritance tax. It's a nice idea, but like many nice ideas it reeks of confusion regarding the consequences of such a short-sighted brainwave: consequences that would hurt the people the policy intends to help - the poor.

To understand why the policy is a bad idea, it's important to understand the difference between money and resources. A 100% inheritance tax would send a message to anyone with any equity along the lines of "Your loved ones cannot inherit any of your wealth, so you might as well spend all your money before you peg it".

But that's another way of saying "Hey, consume more raw materials while you still have half a chance - oil, steel, timber, etc - and leave fewer resources for others". Encouraging more reckless and less prudent spending to avoid being taxed at 100% on your death means consuming more resources that are then no longer available for others to consume, or are more expensive with which to build factories, and machines, and equipment, and schools and buses. This ultimately hits the poor hardest in terms of the opportunity costs of fewer jobs and more expensive goods and services.

A 100% inheritance tax encourages us to swim against the tide of progression we've enjoyed in the past decades. All the technological advancements, the innovations, the research, and even the increased capacity to help those worst off in society through welfare payments, have come from job creation, which came from using raw materials in an effective way. Part of what made that possible was the availability of resources when people with equity were able to conserve their assets - something they'd be disincentivised from doing under Abi Wilkinson's idea for daylight grave robbery.

You may be tempted to argue that if we allow inheritance then wealthier people may consume less but their heirs will consume more, so the result is pretty much the same. But that's not true - judicious consumption delayed is still better than ostentatious and injudicious consumption in the here and now, as UK citizens get years of forgone raw materials to consume, and additional production from which they will benefit.

A tax that encourages any transactional behaviour that is (at best) sub-optimal and (at worst) tantamount to reckless overconsumption is going to be a bad tax, and one that will hit low earners and jobseekers hardest, as in many cases it will have the knock on effect of increasing prices and decreasing job opportunities.