Stumbling and Mumbling

A bad argument for scrapping IHT

Ianayat Bunglawala repeats a really bad argument for abolishing inheritance tax:

In recent years more and more families have begun to get caught up in the inheritance tax net as the rise in house prices has far outstripped the increase in the inheritance tax threshold...The upshot of all this is that inheritance tax is becoming an increasingly immoral tax that is penalising hard working families.

But this is contradictory. Insofar as people are paying inheritance tax because house prices have risen, they are doing so not because they've worked hard, but because they've benefited from favourable monetary conditions and planning restrictions that limit housing supply. Why shouldn't people pay a tax on something they've done nothing to earn?
I agree we should stop penalizing hard working families. But the way to do this is to cut tax on hard work - that is, income tax. And cutting inheritance tax actually prevents this; the £3bn spent on cutting IHT  is £3bn not available to finance cuts in income tax. Now that's immoral; I for one would much rather pay tax when I'm dead that when I'm alive.
This is not to deny that there might (only might) be arguments for scrapping IHT; I'm attracted by Tim's argument that it'll increase heroin abuse by rich kids. And it's theoretically possible - though I know of little empirical evidence - that inheritance tax deters business formation and hard work, as providing for one's children is a major motive for both.
Rising house prices, however, are no argument for scrapping IHT. And the fact that the Redwood report seems to cite this as the only reason to do so (p81) shows just how weak IHT's opponents are.

In defence of tax credits

One of the most damning indictments of New Labour is that it's been rubbish at defending its policies. One example of this is its failure to make the case for the high marginal tax rates faced by those on low wages. In truth, there's a good case for these.
Start from the perspective that there's a case for boosting the incomes of the low-paid. Doing so combines egalitarianism with efficiency.  It's egalitarian, because it compensates people for the bad luck of having low skill. And it's efficient because it gives people an incentive to work rather than stay on the dole. When New Labour came to power, almost one-in-five children were growing up in households where no-one worked. This meant a generation were growing up to think it normal to be out of work. And social norms formed ealy in life can affect lifetime work incentives. Thanks partly to tax credits, the number of such children has fallen.
Now, given that in-work benefits are a good idea, the question is: how fast to withdraw them?  Before 1997, Family Credit was withdrawn quickly, with the result that over a million workers faced marginal deduction rates of over 70% (table 3.4 of this pdf). Tax credits are now withdrawn more slowly over a longer range of income. This means fewer face deduction rates over 70%, but more people face deduction rates of 50-70%, though some still face massive rates; the IFS have got the numbers (pdf).
This has two things to be said for it.
First, it's the counterpart of giving help to the median voter. This has the practical advantage of entrenching support for redistributive policies.
Second, the disincentive effect of higher deduction rates is tiny. This is because many of the low-paid just don't have the skills to earn more anyway. This paper by Mark Stewart shows that "low wage jobs typically do not lead onto better things." They are a stepping stone - but towards unemployment rather than a good job.
And this provides another argument for in-work support. They provide a way of insuring people against unemployment without jeopardizing incentives to stay on the dole, because people can use their temporary in-work incomes to self-insure (ie save) against future unemployment.
So, there's much to be said for the principle of tax credits, if not the administration. The questions are: why has New Labour been so bad at making this case? And what, if anything, is wrong with it?

Taxes, equality & efficiency

Everyone's complaining that private equity bosses pay a lower marginal tax rate than cleaners.
What people don't realize is that this economically efficient.
If a high marginal tax rate deters a minimum wage cleaner from working an extra hour, society only loses £5.35 worth of output - no big deal. But if it deters a top earner from working an extra hour, we can (assuming people are paid their marginal product) lose hundreds of pounds of output.
For this reason, it's a common result in the economics of optimal taxation (summarized non-technically in this pdf) that top marginal tax rates should be low, or even zero.
Globalization makes this even truer, as it makes it easier for top earners to move overseas.
This seems terribly inegalitarian. So what's the solution?
First, remember the difference between marginal and average tax rates. Thanks to working tax credits, cleaners might have negative average tax rates. Top earners don't.
In this sense, New Labour's tax policy isn't absurdly stupid - though, of course, a basic income might be a better way of helping the worse-off.
But there are three other ways of reconciling equality and efficiency.
1. Consumption tax. Your income can be non-domiciled. Your spending can't.
2. Land value taxes. You can take your labour and financial capital overseas, but you can't take your house in Chelsea.
3. Auction off tax permits. Government could tax the rich at a normal marginal rate, but then auction off permits allowing people to pay a special low marginal rate on future income. This would have several merits. It would reconcile equality and efficiency, by combining higher average rates (the fee for the permit) with low marginal rates. It would stimulate incentives, as high earners worked to pay for their permit. And it would probably boost revenues, as a combination of overconfidence and the winner's curse cause people to pay too much for the right to low future tax.
So, it might be possible to tax the rich more without destroying incentives.

Corporate tax and investment

Would a cut in corporation tax boost investment? Intuition says yes. And this report from the Taxpayers' Alliance says the effect could be large. This is because capital is more internationally mobile now, and so a cut in corporate tax would attract investment away from other countries - as Ireland discovered.
This paper (pdf) by Holger Gorg, Hassan Molana and Catia Montagna, however, tells a different story. They estimate that, among OECD countries, there's a positive correlation between corporate tax rates and foreign direct investment - it's higher tax rates, not lower, that are associated with high inward investment.
This, they say, is because high tax rates can be associated with a better educated and healthier workforce, better public transport and social and political stability, all of which attract international companies. They say:

Corporate taxation does not necessarily deter FDI, if it is associated with the provision of public goods than improve the economic environment in which multinationals operate.

This doesn't mean cutting corporate tax is silly. It's just that for such cuts to work, one has to be confident that they won't worsen the social and economic infrastructure that influences investment decisions.

Dividend taxes and investment

Wat Tyler has laid into Ed Balls over the Treasury's 1997 to abolish dividend tax credits. I'd add just one point.
Balls says:

We decided on the basis of civil service advice to go ahead because this was the best thing for the long-term investment of the UK economy.

The idea here is that, by making dividends less attractive, firms would prefer to retain profits instead and invest them.
There's just one problem - this seems not to have happened.
Perhaps the most rigorous public study of the effect of the 1997 tax change is this pdf from the IFS. It says there's "no evidence of any change in investment" as result of the change.

A progressive consumption tax

I say there's no right of inheritance. Tim replies that we shouldn't penalize people who abstain from consumption to give money to their children. These statements can be (partly) reconciled, by a variant upon a progressive consumption tax, as advocated by Laurence Seidman.
Because a PCT taxes consumption, not income, it doesn't penalize people who save to pass wealth onto others. Nor even does it tax inheritances if these are saved.
So far, so Tim.
But a PCT does tax inheritances to the extent that they are consumed, and does so at the highest marginal rate an individual faces. The effective threshold for taxing inheritances is zero, if these are consumed. And houses are a consumption good.
So far, so me.
Bringing me and Tim together is, however, not the only merit of a PCT. There are (at least) three others:
1. It encourages saving and capital formation. In the long-run, it would therefore raise wages by raising the capital-labour ratio and productivity.
2. It would internalize the sort of adverse consumption externalities decried by Robert Frank, and reduce the pressure people feel to keep up with the Joneses.
3. It would be green, as it would deter consumption more than income tax does - though this could easily be supplemented by Pigou taxes upon more polluting goods.
Of course, this is a mere sketch. There are loads of problems with such a tax - it would have to be phased in over years, to avoid hitting current pensioners, for example. But the idea deserves more consideration than it gets.

Brown weakens incentives

I've mentioned before the scandal of high effective tax rates upon the low paid. In today's Budget, Brown has done something about this - he's made them worse.
There are two reasons for this - he's scrapped the 10p starting rate of tax, and he's raised the rate at which tax credits with withdrawn from 37% to 39%.
For a few people, this means withdrawal rates will rise by 12 percentage points - though this is mitigated by a rise in the income you can get whilst getting a full working tax credit.
This means incentives for people to work harder or get better jobs have fallen still further. It also means an even bigger proportion of rises in the minimum wage will be returned to the Treasury.
It also reverses New Labour's 1997 manifesto promise:

Our long-term objective is a lower starting rate of income tax of ten pence in the pound. Reducing the high marginal rates at the bottom end of the earning scale - often 70 or 80 per cent - is not only fair but desirable to encourage employment.

Long-term strategic thinking - ain't it great?

Against tax breaks for marriage

David Cameron asks: "The Prime Minister said today that marriage is a good thing. Well if it is, why not back it [with tax breaks]?"
Three reasons:
1. There are lots of things that are good: cats, cricket, celebrity Dancing on Ice and Cesc Fabregas to name but the Cs.  But we don't back these with tax breaks. Why not? Because there's no clear positive externality to encourage. It's the same with marriage. An average marriage in which kids are brought up averagely well creates no benefits to others; the world is already more than adequately stocked with people.
Sure, bad parenting is a negative externality. But this is  not cured by tax breaks for marriage.
2. Incentives don't necessarily work. The reason we don't give tax breaks to Cesc is that people can't be incentivized to become Cesc. A similar thing's true of marriage. Sure, at the margin tax breaks will encourage cohabiting couples to marry. But do we really want kids to be brought up by the sort of folk who marry for money? That's a different sort of marriage than the ones that happen now.
3. Tax breaks have a deadweight cost. Many go to people who'd do what they're doing anyway. And they increase the complexity of the tax system, which means more civil servants.  These costs must be borne by those who don't get the tax breaks. That's a burden on others.
So, let's be clear. When Cameron calls for tax breaks for marriage, he's not addressing a social problem. He's just trying to bribe median voters.

Something for nothing

Think about all the things that are wrong with our public finances: the increasing complexity of the tax system; our inequitable tax laws; the  "unacceptably high" level of fraud and error in tax credits; the routine over-spending; the rising tax burden; the obscene marginal tax rates on the low-paid; the massive deadweight costs of a tax system that churns income rather than redistributes it.
Given all these offences against decency and reason, what would be your top priority for reform? Tax simplification? Cuts in spending and taxes? A flat tax? Replacement of tax credits with a basic income?
Nope. For over 19,000 Express readers, all this is too intelligent. They think the priority should be the abolition of inheritance tax.
Chris says inheritance tax "steals from the dead."
I think that's a fantastic idea. I'd be happy to be robbed when I'm dead. It's being robbed whilst I'm alive that I object to. The problem with inheritance tax is that there are too many loopholes in it, not that it exists.
Why, then, would anyone prefer to abolish inheritance tax than to cut income tax?
It's because they're greedy parasites. They're looking forward to getting their hands on their parents' houses and they want a tax-free handout.
This is part of the something for nothing culture that's defacing our nation - it's part of the same mindset that gives us gambling fever and the hunger to be a celebrity without having any ability. These people will do anything to get rich - except work.
I'd rather we abolished taxes on City bonuses. At least the recipients of these actually do something for their money.

Damaging the supply-side

Madsen Pirie makes an argument I don't like. He cites David Smith claiming that the UK's structural budget deficit is possibly the worst since 1974 and says:

The problem is that Brown's fiscal policy has damaged the supply side. Excessive and harmful taxes have squandered the golden economy he inherited, in which Britain was less regulated, less taxed, more competitive and more flexible than most of its major competitors (outside the US). This is no longer true.

There is, however, another possible explanation for the UK's large budget deficit. It's simply that falling capital goods prices have allowed firms to replace old equipment cheaply. As a result, corporate saving has recently far exceeded investment. Because private net saving is the counterpart of public dis-saving, this has led to a big public sector deficit; table I of this pdf shows the numbers.
However, it's possible that high profits will lead to rising capital spending in the next few months; there are signs it's starting to do so already. As corporate net saving then falls, so too might public borrowing.
Brown will then crow that people like Madsen were wrong, and that his tax rises haven't damaged the economy.
And this, for me, is the problem. Madsen won't have been wrong. I suspect it just takes longer - many years - for the full damage of taxes upon  incentives to come through. High taxes reduce labour supply not merely (or perhaps even mainly) by causing people to immediately substitute leisure for work, but by changing social norms and institutions; for example, one reason why many French supported a 35-hour week was that they though it futile to work longer and pay more tax.
In  giving the impression that the damage done by high taxes comes through quickly, Madsen is leaving a hostage to fortune, which risks damaging the argument for lower and simpler taxes.