Archive for the ‘income’ Tag

Taxing Sin?

The other day I was talking about tax reform – a favourite subject of mine – with a couple of bright American friends. As he poured himself another large glass of  red wine, one friend said, “It’s obvious – we should start by taxing sin”.

The other agreed, and both were much more content with the soundbite than willing to engage with my arguments in favour of Cashflow Taxation, so – as the red wine was dulling our collective intelligence – I let the matter drop, and the ranting moved on to something else.

Taxing sin, though, is a really rotten basis for a tax policy. It might have its merits as a means of controlling sin, but it’s rubbish for raising revenue – and the worst thing about it is that it’s regressive, leastways if you count the most obvious sins of tobacco and alcohol. There was a doctor the other week suggesting that chocolate should be taxed, because it’s making us all diabetic. Which is nonsense in so many ways. If you were to ask me what I think is responsible for the epidemic of type 2 diabetes, I’d say pop: particularly the practice of feeding children sugary drinks when they are thirsty. Never mind the chocolate, it’s the calories in ‘beena and pop hitting a metabolism that hasn’t yet registered hunger that cause the damage. And it’s not the chocolate but the sugar it contains that’s the trouble. So we should, perhaps, add sugar to the list of sinful items ripe for punitive and deterrent taxation. Jolly good, another way to tax the poor without feeling guilty about it.  An even better wheeze than the National Lottery!

These days, of course, the worst sin of all is being environunfriendly; and before the credit-crunch hit home, all the main parties were talking about “green taxes” as a virtuous, and painful only in the right places, way of raising money.  The same criticisms apply. Green taxes are a good thing if they mean we change our behaviour, but they hit the poorest hardest because poor people tend to spend a larger proportion of their income on fuel. So to stop them being regressive, green taxes have to be accompanied by a complicated programme of countervailing subsidies – such as free home insulation – which will absorb much of the revenue raised.  Consequently, as everyone insulates their home and behaves more greenly virtuously in other ways, the tax take falls.

Since we choose to live in a society which spends thirty or forty percent of its income on universal state-provided goods and services such as education, health and defence, we need to find a lot more money than sin taxes can possibly raise.  By all means, tax sin as part of a sin reduction strategy; but if it works, it’ll be the lack of funds that lead to closing hospitals, not the lack of patients.  Mainstream funding still needs to come from mainstream economic activity.

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Tax and Transparency

Of course, I should be doing my tax return.

Instead, I’m thinking about tax in the abstract.

It’s no secret that our tax system is broken. Broken here, in the UK, and just as badly broken in most other countries of the world. The strongest evidence is that in most countries, despite tax systems that are intended to be progressive,  the rich pay proportionately less tax than the poor.  They manage to do so because tax systems are too complicated, so that at high tax levels (I didn’t say the rich pay less tax than the poor, although, in aggregate, they do, because there are fewer of them, but that they pay proportionately less) it is worth paying a tax professional to reduce one’s tax bill.

The viability of professional tax-reducers is a strong indicator of an over-complex tax system. The more numerous and successful the tax profession in a broadly compliant economy, the more complex the tax system.

So why is tax so complicated? I think the main reason is that we tax the wrong thing. Tax is levied (mainly) on  income, which seems – at first sight –  eminently fair. But what is income? If you get paid a salary, or dividends from savings, it’s easy to see – it’s the big number on your payslip. But if you run any sort of business, you can deduct your business expenses. What’s allowable?  This is the first area of fertile ground for a tax professional.

Now, what about capital gains? So we have to invent a whole new tax to cover capital gains, because capital gains aren’t income.  Depending on whether capital gains tax is more or less than income tax, tax professionals can be called in to classify every receipt into its most favourable category.

Instead, in my opinion, we should be taxing cash flow. Cash flow is clear and easy to define and to measure. There’s no need to distinguish cash realised from disposal of an asset from cash in a paycheque.  For individuals, the only deduction would be cash invested, either as equity in a corporation, or into bonds.  In this radical new world, because it is radical, corporations wouldn’t pay any tax at all: but, instead, would be required to be *totally* transparent.  All money leaving the corporation (whether as salaries, dividends, bond interest, or on the sale of stock) would be taxable.

Two sorts of asset – and two sorts of income

Assets

There are two sorts of asset:

  • assets denominated in money; and
  • assets denominated by title.

A bond, a bank balance, or a pile of cash is an asset denominated in money; a house, or a share in a company, is an asset denominated by title. It is somewhat confusing that shares have a nominal money value, but this is really just a different way of expressing a fraction.  A £1 share of a company with issued capital of £1million is a one-millionth share of the company, entitling whoever owns it to a millionth of the company’s profit and a millionth of the proceeds if it is broken up and sold, after all the other creditors have been paid. But a bond entitles you to the redemption value of the bond, at maturity, and its annual coupon until then: all specified in advance, and denominated in dollars, pounds or whatever.

Assets denominated in money, therefore, are vulnerable to inflation; whereas assets denominated by title increase in value in line with inflation.  Actually, their real value changes with real effects, but their nominal value changes with inflation and the change in their real value.

Income

Closely related, but not the same, is the distinction between the two sorts of income:

  • Unconditional income
  • Conditional income

The interest, or coupon, paid on bonds is unconditional; whereas the dividend paid on a share is conditional. Salaries are unconditional; bonuses are conditional. Annuities are unconditional; profits are conditional.

We usually rely on a mixture of both sorts of asset and income. But the more we can all rely on unconditional income the more flexibly the economy behaves.