Why the poor need tax-cuts for rich people, too

There has been a lot of (welcome) talk recently about the Liberal Democrats’ pledge to cut taxes for low- and middle-income earners. This has been broadly welcomed in the party, though many have only accepted it as long as it is accompanied by a promise that the overall tax-take will remain the same, and that richer people should shoulder more of the tax burden.
This kind of “redistributionist” approach is always very popular, as most people are in the poorer rather than the richer category. It is easy to take from the minority to give to the majority, and there is no minority less sympathetic than the rich.

A counter argument might be that the only fair thing to do (and “fairness is something that the Liberal Democrats claim to take very seriously) would be to cut taxes for everybody if we are cutting them for some. But that kind of fairness - that everybody be treated equally no matter how wealthy they are - generally only cuts one way.

However, economists such as George Reisman make a far more startling claim: that it is tax cuts for rich business people and for corporations that are in the long-term interests of low and middle income wage earners; more so, in fact, than tax cuts aimed directly at the poor themselves.

Reisman’s initial point is a simple one, but one that is too often forgotten: that human society enables one to benefit from other people’s success. “The view of redistributionists…” he explains, “is that the only wealth from which an individual can benefit is his own…” The redistributionists are mistaken, however: “in order to benefit from privately owned means of production, one does not have to be an owner of the means of production… one benefits from other people’s means of production – [not only] every time one buys the products of those means of production [but] also as a seller of labor (sic.).” Capitalists invest in improving the efficiency of production so that they can enhance their profits, but in the process they make the goods we buy cheaper and make our labour more productive, so increasing real wages.

The reason that redistribution looks so attractive is because one tends to think of redistribution in terms of individual sums being transferred from a rich person to a poor person; and there can be little doubt that £1,000 is more valuable to a poor person than a rich person. But it does not follow that £100 billion is worth more in the hands of poor people overall than in the hands of rich people overall.

The problem is that “most people tend to think of themselves as members of the class of wage earners rather than separate individual wages earners, and to think of their interests as indistinguishable from the interests of other wage earners.”

In fact, while it is more in my interests that I have £1,000 than that Richard Branson does, it is no more valuable to me that a poor man in Liverpool has that £1,000 than Mr. Branson. And it is far more likely to serve my interests that a few rich people have £100 billion than huge numbers of poor people, even if £1,000 of that £100 billion ends up in my hands. The reason for this is that poor people spend a greater proportion of their money on consumption, and are more likely to consume than to invest additional sums. As Nick Clegg said in a recent interview with The Times, "give tax cuts to the better off [and] they will just save them. You have to give [tax cuts] to people on lower incomes who will transfer them into consumption on food and fuel.”

This is ceertainly true and is entirely predictable: those on the breadline would be happy for the opportunity to buy new shoes, while those who already own a yacht are free to invest extra money in their business. This is especially true for businesses themselves: business taxes leach away the money that would either be invested in improving productivity or would be paid out in the profits that attract further investment.

There is a point here that Reisman does not fully draw out, but which we can recognise today after a decade of Labour economic mismanagement. Money in the hands of the poor would create greater wealth in the short term, as a result of a consumer boom. But these consumer booms are unsustainable: buying more clothes and electronic goods does not make their production significantly more efficient. Investment makes them more productive, but this requires an investment boom. In fact, during the past decade the consumer boom has been accompanied by a dangerously low and shrinking savings rate: the West has saved almost nothing. Consequently, productivity has not risen as it should have done, which is one reason why real wages for less skilled workers (which are set by their productivity and thus by the investment in them and in the tools that they use) has not risen. Simply taking the money that would be invested in businesses and giving it to others to consume is “eating the seed corn.”

By comparison, “A tax reduction on businessmen and capitalists will promote capital accumulation, far, far more than a tax reduction on the mass of the individual wage earner's fellow wage earners. The average businessman and capitalist will save and invest the taxes he no longer has to pay, in far greater proportion than would the average wage earner, [and the businessman] will be induced to introduce more improvements in products and methods of production, which are also a major cause of capital accumulation…” In addition, “cutting the taxes of businessmen and capitalists [will] significantly … raise the demand for labor and … reduce or eliminate unemployment”. The result of increased innovation will be to enhance “the ability of upstart new firms to grow rapidly and thus to challenge old, established firms.”

Overall, “The effect of this combination is … a continually rising productivity of labor… and thus prices of consumers' goods that are progressively lower relative to the wages of labor, which means progressively rising real wage rates, so that in not too many years the average wage earner is far ahead of where he would have been on the strength of a cut in his own taxes.”

So ironically, it seems that cutting taxes for the labourers makes capitalists rich in the short term, whereas cutting taxes for the capitalists makes labourers rich in the long term.

The reason that Reisman’s argument is so challenging is that it seems to suggest that tax cuts for the poor are not in their own best interests. This isn’t mere sophistry. If productivity does not rise, real wages cannot rise. All “labour” can do is fight with “capital” and “land” for the share of wealth. This seems to be the be-all-and-end-all solution for redistributionists, who argue that the poor can only benefit at the expense of the rich. This would be true in a static economic system. But they forget that economies are (or at least should be) dynamic. The route to prosperity is through economic growth: “The average standard of living would double in a single generation if economic progress at a rate of just 3 percent a year could be achieved. Such economic progress would also mean a halving of the average wage earner's tax burden in the same period of time — if government spending per capita in real terms were held fixed.”

Consequently, the long-term prosperity of the average worker is best served by capitalists who invest for their own benefit. In seeking to further increase their own profits, capitalists invest extra money in improving productivity, which they do by buying new and better plant machinery, "upskilling" their staff and employing new and better business systems. Improvements to productivity in turn push up real wages and so benefit labourers far more than tax cuts on their own wages would. If Government can avoid the urge to “share the proceeds of growth” then wage earners will see their taxes fall anyway – not in absolute terms, but as a proportion of their rising incomes.

If there is a problem in Reisman's plan, it is that in advocating this policy of easing taxes on business and high incomes first, he overlooks the political economy of the 21st Century. No matter how correct he may be about the long term economic effects, it would be impossible to implement such tax cuts in the face of the vast majority of voters who will understandably ask why their taxes are not being cut while those of £billion businesses and rich oligarchs are. What is needed, therefore, is a sort of liberal realism that recognises that lowly paid workers, who form the bulk of the electorate, will want to see some of the short-term gain that their richer peers will enjoy as they wait for the longer term growth-benefits to kick in. One might suggest that a little honey today will keep them sweet until tomorrow’s jam arrives.

Thus if the Liberal Democrats really want to improve living standards for those on low incomes, we need to look not just to redistribution but to cutting the overall level of taxation in the economy. And we must do this by reducing taxes on businesses and among those wealthy enough to invest as well as those who will feel the benefits most in the short term. This is not about larding the rich for their own sake; it is about recognising a fundamental lesson of liberalism – that we all benefit from one another’s success – while also understanding that it is investment, not consumption, that makes future prosperity possible.

Reisman concludes that

Of course, in a further display of their ignorance and blindness, members of the Left will undoubtedly characterize the line of argument I've presented in this article as the "trickle-down theory." There is nothing trickle-down about it. There is only the fact that capital accumulation and economic progress depend on saving and innovation and that these in turn depend on the freedom to make high profits and accumulate great wealth. The only alternative to improvement for all, through economic progress achieved in this way, is the futile attempt of some men to gain at the expense of others by means of looting and plundering. This, the loot-and-plunder theory, is the alternative advocated by the redistributionist critics…. It is time to supplant it with ... sound economic theory….

Corporation Tax and Payroll Tax: the stealthiest taxes of them all

Imagine, if you will, a society made up of two types of citizen: the taxpayers and the voters. Taxpayers cannot vote, and voters do not pay tax. What will the result be? It seems fairly obvious that voters will vote for high taxes to pay for public services from which they will benefit at the expense of the taxpayers. Such a society would quickly fall apart, as the taxpayers agitated for more representation and refused to pay “taxation without representation”

Such a society would seem anathema to us, nowadays. Which is surprising, because we live in such a society. In one respect, devolution has created such a situation: Scottish voters choose representatives that will implement policies – say, free care for the elderly – that will be paid for in part by non-Scottish British taxpayers who have no control over the decision. This is a dangerous situation that is undoubtedly contributing to the loss of faith in the Union among English voters.

However, there is an older and more fundamental form of this: the taxation of companies. Companies do not have a vote, and yet they are taxed on their income, and required to pay additional taxes when employing staff. This seems a rather clear example of “taxation without representation” – it is true that the owners have votes, but they only have as many votes (one each) as non-owners, and consequently are being taxed in a manner additional to that of their non-company-owning fellow voters. If there was a tax on people over 2m in height, we would consider this arbitrary and unfair. A tax on business-ownership is ignored.

To be clear, it is not as if the income that owners derive from their investments is not taxed. Share dividends are subject to income tax at the same rate as salaries. However, when companies turn a profit they have to pay Corporation Tax before paying dividends, which are then subject to Income Tax. This double taxation can only be justified by treating the company as a legal entity distinct from its owners – it is taxed in its own right. But this legal status does not stretch to being permitted to vote.

Socialist economists and policy makers would probably argue that it is only reasonable to tax businesses, as they are the products of capital and that to exempt capital from taxation when the other “factors of production” (land and labour)
are taxed would represent an unfair tax exemption for rich investors (and poor investors, but socialists tend to ignore them!). This is certainly true, and it is not my intention here to suggest that capital should not be taxed. However, there is no justification for taxing it twice: if capital or profits are taxed when earned, they should not be re-taxed when they are paid out. This “double taxation” (distinct from the double taxation that arises when people and capital operate in different jurisdictions) is unfair and ultimately should be ended.

Ironically, those who support business taxes (and here I add in payroll taxes, such as employers’ National Insurance contributions) are actually harming UK consumers more than UK business. After all, the inevitable consequence of business taxes is that they will drive up prices. If tomorrow a Chancellor of the Exchequer announced a 5 per cent rise in corporation taxes, it is not going to result in Tesco generating commensurately less profits next year. The board may take the decision to absorb part of the cost of the additional taxes as a public relations stunt, but ultimately they are going to hand the extra costs down to customers. The same is true of payroll taxes.

The real danger in this is that the tax is therefore invisible. Consumers are aware of the 17.5 per cent VAT they pay on most goods, and most receipts even explicitly state the amount of VAT paid – next time you are looking at you wage slip in despair and your eye flicks enviously over the part that says how much tax you’ve paid, remember also to get those old receipts out of your wallet and factor in the bit at the bottom. This is only (or rather, less than) half the story, however, as the 82.5 per cent of your bill that isn’t VAT includes other business taxes, without which your supplier would be able to (and due to competition would be obliged to) charge lower prices.

Thus Corporation and Payroll Taxes are the ultimate stealth tax: the Chancellor sells them to us on the grounds that they are levied on businesses, and so we are led to believe that they are free money – taken from “someone else”, a faceless organisation with no vote; in fact, they are taken from us every time we open our wallets and purses. Our Income Tax bill confronts us regularly; our VAT bill every time we spend; but taxes on business slip in under the radar, taking money for the state disguised as money for the supplier.

This is ultimately damaging, as visible taxes have more obvious impact and so teach us to exercise more fiscal discipline. If our receipts also told us how much Corporation Tax we were paying, and if we received larger gross salaries but paid higher National Insurance (i.e. the employer contribution was instead factored into our salaries and personal contribution) we would have a more honest view of how much tax we paid. While we were at it, it would be nice if there were a means of quantifying the number of jobs foregone because payroll taxes made marginal employment (i.e. jobs which are only barely going to generate more revenue than they cost – usually the lowest paid jobs) unviable, thus driving up unemployment for the poorest and least skilled. Only then would we have an honest idea of the costs and effects of the policies our leaders are perusing, and for which many of us have voted.