Tax morale and self-fulfilling beliefs

Should people like Richard Murphy be taxed more heavily than the likes of Tim Worstall?

There’s a simple reason to think so. The revenue-maximizing tax rate will depend on, among other things, people’s attitudes to tax.

If you think taxes are state-sanctioned theft used to line the pockets of idiots, tyrants and con-men you'll be likely to try to avoid tax by retiring, emigrating, exploiting legal loopholes, cooking the books or whatever. This means a high tax rate will in fact be expensive; it will lead to a loss of revenue and GDP and to high compliance costs as governments employ lots of tax men to chase down evaders.

If, however, you think, with Oliver Wendell Holmes, that tax is the price we pay for a civilized society, then you‘ll be more willing to pay and so a high tax rate will be feasible.

This means the optimal tax rate depends upon tax morale. The happier people are to pay tax, the higher is the optimal tax rate. A society of Murphys, then, would have a higher optimal tax than a society of Worstalls.

The empirical evidence bears this out. A new paper shows that, controlling for income, “groups with high tax morale systematically face higher average and marginal tax rates.”

Now, I’m not advocating that individuals should be taxed according to their political views; this has obvious drawbacks.

Instead, the point is that the response of tax revenues to tax rates - the shape of the Laffer curve - is not a primitive, fundamental datum. Instead, it depends upon tax morale. A rise in tax morale shifts the Laffer curve right, a fall shifts it left.

For this reason, Tim is not quite right to say that we’ll find out whether the 50p tax rate raises revenues when this year’s self-assessment returns are analyzed. Instead, the revenue response to higher taxes is subject to the Duhem-Quine problem. It tells us about a joint hypothesis - the interaction of tax rates and tax morale - not a single one.

Let’s imagine the numbers were to show that the 50p rate has led to a reduction in tax revenue. The left could reply that this shows not that taxes are too high, but rather that tax morale is too low. Years of neoliberal ideology - and declining trust in government - have increased people’s willingness to dodge taxes, they might say.

Conversely, if it appears that the 50p rate has led to increased revenues, libertarians might say that this just shows that people are still duped by statist ideology into a supine acceptance of high taxes.

In other words, we have a problem of multiple  belief equilibria. If people believe that high tax rates are acceptable then they will be consistent with high revenues. And if they don’t, they won’t.

In other words, ideologies can be self-fulfilling. Anti-statist ideology leads to lower tax morale and so the claim that high taxes are damaging becomes self-fulfilling. And conversely, statist ideology raises tax morale and thus optimal tax rates.

Comments

[Tim Johnson]

I take your point about tax morale, but simply looking at the self assessment forms is not likely to answer the question of whether or not the 50p tax rate raises or does not raise extra revenue. Why? Here are a couple of thoughts for starters:

i) Timing. It takes time to both for individuals to adjust their lifestyles and for companies to react to the changes. Few people make decisions just about tax - it is just one among many factors that they consider. The full impact will take many years to be felt.

ii)the effects are not just felt on the amount of tax individuals paid on the top slice of income over £150,000. They fall elsewhere too. Consider a family with several children. Husband earns £250,000 - they leave - taking their internationally mobile business (and its profits) with them.

What happens to the tax revenues? Well, not only is tax on the husband's "top slice" of income lost, but also all the income tax on his earnings below that. But that is not all. They use that money to hire a nanny who pays income tax and national insurance. They purchase goods and services - on which VAT is paid.

My own view is that we will are likely to find that in year 1 the 50p tax rate raised more in tax revenues than a 40p tax rate would have done on incomes over £150,000. Otherwise income over the £150,000 would in aggregate need to fall by about 20%.

But figuring out the effect will not be a straight forward exercise ....

[George Hallam]

There is a simple solution to this problem.

In U.S. income tax is calculated on a citizen's worldwide income are subject to U.S. income tax regardless of where regardless of where they are living.

U.S. expats are also subject to the same income tax return filing requirements that apply to U.S. citizens or residents living in the United States.

In 1924 the Supreme Court ruled that taxation of the foreign-source income of non-resident citizens is legal.
Of course the obvious way to avoid this tax is to renounce US citizenship.
In recent years several thousand Americans have choose to take this course
However, in comparison to the number of US citizens who live abroad (between 3 to 6 million) they are a tiny minority.

Apart from the risks of difficulties that might arise if they needed to return home, they would not be entirely free from tax obligations.

In 1966 a law was enacted that applied a 10-year tax on U.S.-source income of individuals whose main motive for expatriation was tax avoidance.

In 2008 this was replaced with an exit tax based on the applicant's worldwide income and assets.

[Blissex]

There is the third case where taxes are regarded as a cost to be avoided, and left to be paid by suckers, without any opinion as to whether they are right or wrong; most businesses and business people in most countries seem to have this opinion.

Anyhow your discussion of tax resembles that of fanatical right wingers in one important respect: talking about taxation in standalone, absolute terms.

Taxes instead make only sense when related to spending.

The 40% or 50% UK tax rates are not imposed on "job destroyers" to punish them, but to match spending plans. Alternative tax levels cannot be discussed meaningfully unless spending levels are discussed too, because given some inflation targets, taxation must follow spending.

Also, as "George Hallam" points out implicitly, it is impossible to discuss the legitimacy of taxation without pointing out that paying tax is entirely a voluntary consensual bargain in those countries that allow people to leave them.

In countries which allow exit (no matter whether there are exit fees) taxation is just the membership fee in a group purchase scheme, and every discerning member is free to purchase membership in any other group purchase scheme they can afford, as a bargain of mutual advantage.

[gastro george]

It's worth mentioning means-tested benefits in this context. Reducing the benefits that richer people get from the state reduces their buy-in to the idea of benefits in toto. One reason why the European high-tax model is less controversial is the free childcare, etc. that benefits everybody. The outcome need not be different. Benefits to the rich could just be balanced by higher taxes.

[John77]

The debate by sensible people is not about tax avoidance but about whether the net income it is worth the effort if there is a high tax charge on the gross income. There is a story told of a Scottish laird, when the top rate of income tax was 19s 6d in the £, that he accepted any rents that his tenants came to him to pay but never went round and asked for them. The tax inspector said to him "My Lord, you must collect your rents" to which he replied "Collect them yourself!".
We are now on a 51% tax rate (58% if you're self-employed) but some people would rather have an extra hour in bed than the extra hour's pay net of an hour's pay plus employer's NI contribution for a nanny.
Far more significant than the rate for top earners is that for hard-working low-earners entitled to child tax credits who have an effective marginal rate of over 75% which jumps to over 90% if they also have an older child at university.

[Chris]

The problem with the UK tax system isn't the rates, it's the complexity, which almost certainly encourages legal tax avoidance. And to make our tax system even more ridiculous we have tax credits. We should simplify the system drastically to a handful of fixed-rate taxes. Income tax and NI should be just income tax with a much higher personal allowance (GBP 15,000?) so we can ditch tax credits. Ditch employers' NI and set corporation tax at a low level on profits (10%?) with no claw-back from previous years and no write-down items. Duty, VAT and a land tax complete the picture.

This way nothing is hidden and evasion and avoidance are 'avoided'.

Of course it will never happen because there is so much vested interest in complexity and telling the public the truth.

[Keith]

Chris' tax ideas are worth considering but my impression is that conservative/ Libertarians only use economic arguments in bad faith. Their objection to tax is that they see no reason to promote the welfare of other people. Rather than any bad effects of taxes on economic growth or revenue. The fact that tax payers gain both directly and indirectly from taxation as a result of public services is discounted by right wing leaning people. While negative effects of taxation are exaggerated. I would agree that means testing is problematic in that it denies benefits to middle class people not just the super rich. Means testing Pensions weakens the incentive to pay Tax with a happy face as there is no certain reward for todays sacrifice. charging for social care has the same effect. All the proposals for "reform" seem to require a huge payment potentially from people who need personal care. If the state will not pay everyone a decent pension based on past contributions or help when people are most dependent that makes taxation seem much less justifiable. But all the parties seem useless on this.

[Tom Addison]

I have a friend who runs his own business who was recently asking me how he can avoid tax (despite the fact that I'm an auditor, not a tax advisor), because he doesn't want the government to get their hands on any of this money.

My opinion is that this attitude of his is purely an alpha male thing, a don't-give-a-shit attitude to impress people by showing how ruthless he is and therefore how likely to be successful he is.

I'm sure there are many people who are against tax because of their genuine libertarian beliefs, but for some it's merely an attitude that coincides with their image of being ruthless that'll impress the wags. They probably think global warming is a government conspiracy to get our money as well.

[Blissex]

«They probably think global warming is a government conspiracy to get our money as well.»

I have started to think that is a conspiracy to get people used to consume less fossil energy, not because it leads to global warming (which I guess they think is happening but don't care about), but because they will have to do so as they are running out.