Imagine a tax system in which the first £10,000 of income is tax-free, the next £40,000 is taxed at 20%, and incomes above £50,000 are taxed at 50%.
Imagine then that the income distribution moves from A to B in my table. B is a poorer society and, by most measures, a more unequal one. Such a move could happen if the financial sector, which has a few mega-incomes, increases in size whilst it imposes a negative externality onto the rest of the economy. Or it could happen because bosses increase the rate of exploitation of workers by engaging in rent-seeking which impoverishes society as a whole.
What happens to tax revenues when we move from A to B?
The answer is that they rise significantly, from 77 to 107. This is despite the fact that B is poorer.
The message here is awkward. Given a reasonable tax system, a government which wants to maximize tax revenue will welcome a rise in inequality - even if that inequality is associated with lower GDP.
This, it is alleged, is what New Labour did. Nick writes:
In the bubble, Labour let the City rip and used the taxes to fund handouts to the poor and social improvements.
And the Spectator's leader says:
Brown's greed for tax was just as pernicious as the bankers' greed for profits. Every bonus paid in the City was split 60/40 with HMRC; it was a joint venture with the banks.
These complaints hint at a genuine trade-off - that, under a progressive tax system, the Left faces a choice between increasing equality and increasing tax and thus public spending.
Now, you might object that this trade-off isn't as acute as I've pretended:
1. "To the extent that higher tax revenues really do help the poor, the social wage rises and so inequality doesn't increase as much as I've painted." But what if the revenues are spent on corporate welfare, or are lost through stagnant public sector productivity?
2. "Given high indirect taxes, the overall tax system is not terribly progressive." True. But I'm not sure this is something the left will welcome.
3. "A clampdown on tax-dodging would allow a leftist government to increase both equality and tax revenue, thus overcoming the trade-off." However, if such activity is as widespread as claimed, it is evidence that the state lacks either the will or ability to eliminate it, which raises another awkward problem.
If there is the sort of trade-off I've described, then Labour has a problem. On the one hand, the case for reducing inequality is very strong - either as a direct goal of policy or as a by-product of putting the financial sector in its rightful place. But on the other hand, doing so would jeopardize tax revenues and thus make it harder to reverse the Tories' squeeze on spending - especially if Labour is committed to fiscal conservatism.