Wednesday, 24 February 2010

Why is Labour afraid of a 'Mansion Tax'?

Is there a causal link between the British obsession with property ownership and the reluctance of our government to tax it? I can only think there must be, because I can't come up with any other reason why a Labour government would have failed to endorse Vince Cable's proposal for a 'Mansion Tax'.

Ever since Vince Cable announced his proposal it seems as though it has been subjected to a barrage of venomous criticism from all sides. Not surprisingly, most of this criticism has emanated from the small sect of people that would have the most to lose from this tax: those that make up the wealthy core vote of the Tory party and their cheerleaders in the right-wing press. Nor is it perhaps surprising that many Lib Dems also appear rather bewildered by it, given that it totally contradicts and undermines their currently stated opposition to that other established property tax: the Council Tax. What I really don't understand, though, is why those on the Left, and particularly most of the Labour Party have not enthusiastically embraced this tax policy. After all, it goes to the heart of what most socialists believe in and are striving for: a fairer and more equal society with a fairer and more even distribution of wealth. It targets extreme wealth, inherited wealth, and the idle rich. Moreover, because it targets fixed assets it is impossible to avoid. People and businesses can move between countries and tax jurisdictions: property can't. Personally, I only have one problem with this tax: it doesn't go far enough.

The tax Vince Cable proposed was originally going to be set at a rate of 0.5% on the excess value of any property above a threshold of £1 million, and was expected to yield over £1bn in revenue. Unfortunately, Vince then appeared to lose his nerve and watered down his proposal by raising the threshold to £2 million. Presumably the Lib Dems were worried that the original proposal might lose them too many votes in their key marginal constituencies in and around London. As a result the tax is now worse than useless. Like Labour's 50% income tax band that I slated in my last post, this proposal doesn't raise sufficient revenue to make it politically worthwhile. It won't fill the fiscal black hole that we are currently staring into, nor will it either help rebalance the property market or contribute anything significant towards promoting greater wealth redistribution and a fairer system of taxation in this country.

Instead of a 0.5% tax above £2m, the tax rate should be set much higher and the threshold set much lower (and closer to the current Inheritance Tax threshold). In short, it should be set at a minimum of 2% on excess property values above £500k. Now that would be truly radical, and it would yield almost £10bn for The Treasury. If the tax were also to be levied on all second homes and buy-to-let properties below £500k, and all commercial land not already covered by business rates (such as speculative land banks etc.), the total could be closer to £20bn. Not only would such a proposal be both radical and progressive, it would also allow the Government to address the problem of the budget deficit without cutting services or raising taxes on income and consumption that could damage the fragile economic recovery.

Of course those that would be hit by this tax would claim it was both unfair and arbitrary. In fact it is neither. The rate at which this tax is set is consistent with existing property taxes. It is, therefore, the absence of this tax that is unfair. To understand why, we need to consider the other main property tax that is levied on the populus: Council Tax. It is the iniquity of this tax that demands the introduction of the Mansion Tax, and also helps determine the rate and threshold that should be imposed.

The average Council Tax in the UK is now nearly £1500, compared to the average property value of about £165k. For most people, this equates to a 0.9% tax on the asset value of the property they live in, irrespective of whether they actually own that property or not. Yet this tax is not levied in proportion to the actual house price, nor even the price back in 1991 when the last valuation took place. In fact, as the graph above illustrates, the relative burden of this tax falls disproportionately on those occupying houses valued in the lower bands (A-E) who would also be expected to have lower incomes and net wealth, while the rich end up paying a much lower rate of tax when measured either as a proportion of their income or their wealth (i.e. property value). This cannot be fair, and goes against all established principles of progressive taxation. It is because of this iniquity that the Mansion Tax is needed.

This then is the rationale behind such a tax. Currently most Council Tax payers (or at least those in bands A-E) are paying approximately 1% of the asset value of their property in tax each year. Yet coincidentally, this equates almost exactly to the amount they would pay in extra income tax (at 20%) from the typical maximum rental income (about 5% of asset value) that they could reasonably be expected to derive from that property. In other words, they are in effect being taxed on the potential income that the equivalent property investment might yield. So, applying the same principle to those living in more expensive properties (bands F-H), who are also likely to be higher rate (i.e. 40%) income tax payers, means that their tax rate should be 40% of the rental value (which in turn is 5% of the asset price), and this then equates to a property tax equal to 2% of the asset value. As for the level at which the threshold for this tax is set, well that should be determined by the point on the graph above at which the tax rate under the current system plateaus off in favour of the rich. This occurs at about band F/G, or 1991 property values of about £160k. Today these properties are valued at about £500k.

There are two main objections that critics of this tax usually try to raise to demonstrate, either its unfairness, or its impracticality.

The first objection is that the tax will prove far too difficult to collect because it is just not possible to value each property accurately enough, or the property values will change with time. If this were true, though, then surely the same problems should apply to the collection of Council Tax and inheritance tax, shouldn't they? So how is it that these taxes appear to work perfectly well? If it is possible to value a property for the purposes of levying Inheritance Tax upon it, then it should be equally possible to value the same property for the purpose of this Mansion Tax. Remember - the Inheritance Tax threshold is currently below the level at which I would propose levying the Mansion Tax. So every property that would be subject to the Mansion tax in the future is already potentially subject to Inheritance Tax now.

The second objection is equally spurious. It is based on a belief that all taxes should be based on the principle of a person's ability to pay. This in itself is a noble and just position to take. Unfortunately, those that seek to oppose wealth taxes like the Mansion Tax presume that one's ability to pay, as they define it, is determined solely by one's income, and not by one's accumulated wealth. Thus they invent the hypothetical case of a little old lady living alone in a vast mansion, with little or no income to support her, other than maybe her paltry widow's pension. This is supposed to highlight the gross unfairness of the tax. With little or no income, how can she pay the tax? An equally valid question though is, with no income how can she maintain the property at all, irrespective of whether it is taxed or not? How will she be able to pay for the roof to be mended, or the electrical wiring replaced, or the boiler repaired?

The fact is that this hypothetical old lady is just that: hypothetical. She doesn't exist because no-one with an ounce of common sense would ever take on the responsibility of the upkeep of such a property without having sufficient excess capital to maintain both the property and their own lifestyle. If though, by some one-in-a-million chance this old lady did exist then there would still be many ways for her to pay. She could sell her home, and downsize, by acquiring a smaller and cheaper property. The capital profit could then be used as income. Alternatively she could re-mortgage and use the capital lump sum to fund her lifestyle.

In effect this argument against this Mansion Tax actually reduces to one in favour of the landed gentry being allowed to live beyond their means. Contrast that with the outcry that would emanate from the same right-wing voters if a group of penniless squatters were to take over a property and expect to live in it tax-free.

The plain fact is that this Mansion Tax is both fair and necessary. With the UK's wealth now estimated to be in the region of £6 trillion, and an astonishing 55% or more of that accounted for by unproductive residential property, it is obvious that we need to rebalance our economy. We need a taxation regime that encourages people to invest in productive assets, not unproductive ones, and the Mansion Tax would do just that if its scope were extended to cover buy-to-let investments and other private property portfolios.

To put it simply, the Mansion Tax is the missing link in our tax system that would do far more to reduce inequalities of wealth than the 50% income tax rate or Inheritance Tax will ever do. It will also raise far more revenue than both these taxes combined, and could even replace them. It is also supported by both Polly Toynbee of The Guardian, and Martin Wolf of The Financial Times.

If we are serious about trying making Britain a more equal and less economically divided society, then the issue of wealth inequality in this country needs to be addressed. With the wealthiest 10% of Britons now owning more of this country's assets than the remaining 90% put together, and with that disparity widening further with each passing year despite the efforts of the current government, something needs to change. Up until now government tax policy has focussed obsessively on revenue raised from income and consumption. Yet, as I pointed out in my previous post, by using higher tax bands for income tax as its preferred method of wealth redistribution, this government actually risks damaging the wider economy by reducing the amount of entrepreneurial activity within the economy. Rather than taxing liquid wealth, the government would be better served by taxing accumulated idle wealth, and by far the largest and least-taxed component of that wealth is property.

Moreover, this tax, unlike many others (such as the recently announced disastrous rise in National Insurance or the abolition of the 10% income tax band) has no electoral downside for Labour. It will have no impact on Labour's core vote, and it will be invisible to swing voters in marginal constituencies, as neither group will be targeted by the tax. Nor does it have the negative economic consequences that recent rises in National Insurance and Income Tax could have, particularly in the midst of a deep recession, by reducing consumption and demand within the economy, and thereby endangering jobs and the speed and scale of the recovery. Instead it targets dead money: money that would otherwise either remain idle and unproductive, or would be used to boost speculative asset prices such as property values; i.e. the same asset prices that caused this very recession in the first place. In fact this tax would target the ill-gotten gains of those that made the most money during the last credit boom, and whose earnings and increase in wealth we now know were both in large part undeserved because they were based on fictitious or inflated profits in the financial sector during the economic boom years.

Sunday, 14 February 2010

Why the 50p tax rate is bad politics and bad economics

The issue of tax has long been a thorny issue for the Labour Party, due in large part to the suspicion that it was the one single issue that cost it both the 1987 and 1992 elections. Hence Tony Blair's pledge before 1997 not to raise income tax in the first term of a Labour government. However, last year Alistair Darling did indeed announce an intention to raise income tax for those earning over £150k by introducing a new 50% tax band for those high earners. The intention of the tax seemed clear: to increase wealth redistribution and to make Britain a fairer and more equal society. There is just one problem with this proposal. Any objective analysis of it suggests that it will probably fail miserably to achieve any of its aims. In short, it is a rubbish policy.

This 50% tax targets a miniscule proportion of the population, it is too easy to avoid, and so it will raise virtually no extra money. In fact by encouraging tax avoidance, it may even reduce the overall tax receipts by also decreasing the number of 40% tax payers in the economy. In addition, the level and threshold at which it is set are so arbitrary that the signals it sends out are entirely negative. To put it simply, if the Government can tax at 50% today, then why not 66% or 90% tomorrow? With no logical reason to doubt that the tax rate could go even higher in the near future such a policy completely destroys any confidence in Labour's future tax plans. Instead it raises the spectre of the bad old days of the 1970's and Dennis Healey's pledge to "tax the rich until their pips squeak." It therefore destroys confidence in the Government without even having the positive compensating effect of raising significant amounts of extra money. So, instead of a win-win scenario, we have a lose-lose one. Brilliant!

If the Government was going to raise the tax rate for high earners, it should at least have done so based on some underlying guiding principle. That principle should be one of equality or fairness. The questions then become, how can we justify such a higher rate of income tax for higher earners, and what should it be?

Historically, government expenditure has tended to hover around 40% of GDP, at least in recent decades. In the light of this one could reasonably argue that anyone who is paying less than 40% of their income in tax is clearly not paying their fair share. At first sight that might appear to encompass the majority of the population who only pay income tax at 20%. However, that argument doesn't account for the additional 11% they pay in National Insurance (soon to increase further), Council Tax (which averages out at another 4%) and the VAT and other consumption taxes that they pay on most other basic costs including transport, food and clothing. So in practice a person on an average income (which is currently about £25k) pays significantly more than 40% of their total income in tax, almost all of which is unavoidable.

As the average Briton is clearly being taxed at a rate that is greater than the overall taxation ratio of 40%, it is therefore only fair that those on higher incomes should also be expected to be taxed at an overall tax rate that is commensurate with the ratio of Government expenditure to GDP as well. However, any additional income that the richest 10% of the population earn in excess of the average household income (currently about £45k) is predominantly disposable income. It is income that is above and beyond that which is required to cover most daily living expenses. Therefore, it seems only reasonable that this should be taxed at the same overall ratio as the national average. That seems to me to be the justifiable rationale behind imposing a higher tax rate for the top earners in society, and perhaps why it has been set at 40% for most of the last few decades. However, there is now a problem. The current recession means that the ratio of Government expenditure to GDP is increasing above 40%, while tax receipts are declining. With public sector net borrowing (PSNB) predicted to exceed £175bn this year, and the bond markets getting increasingly nervous about the scale of our national debt, politicians need to come up with credible policies to tackle this problem. However both the solutions advanced so far have a dark side.

On the one hand is the spectre of tax rises, as exemplified by the recent announcement by Alistair Darling to raise National Insurance contributions, for both individuals and employers. This, though is a tax on both jobs and consumption, both of which could slow any economic recovery. On the other hand the Tories are baying for spending cuts. Yet this also risks prolonging the recession by increasing government spending on benefits even more while reducing government procurement and economic consumption. What is needed is a 'third way' that reduces the deficit without taxing jobs and reducing revenues from consumption. That way is to tax surplus wealth, and one such source is the disposable income of higher earners. I would therefore argue that rather than introducing a new 50% tax rate that benefits no-one, the Government should have raised the existing 40% rate.

My reasoning is this. Given that the ratio of Government expenditure to GDP has now increased to nearly 44% for this financial year (2009-10), and is expected to remain at such a level for the foreseeable future, and tax receipts have plummeted to only 33% of GDP due to the recession, gradually raising the upper tax rate from 40% to 44% would have represented a far better policy than the introduction of a new 50% rate. Not only would it have been fairer, it would have been based on a clear and transparent principle that would have reassured the public that such rates were not arbitrary and vindictive. It would have also raised ten times as much in tax as the 50p rate (£10bn versus £1bn). As such it would have made a significant impact on our underlying budget deficit (currently estimated at about £50bn), while having little or no adverse effect on either levels of employment or consumption (due to it being targeted at the disposable income of the affluent that would normally be invested in assets and savings). It would also be far less prone to the problems of tax avoidance as it is highly unlikely to cause a mass exodus of higher rate tax-payers from the country.

So the essence of this tax policy is this. Rather than having a fixed 40% tax band, or introducing a new 50% band, the current 40% band should 'float' with its level set by the current ratio of government spending to GDP. Under the current financial circumstances we find ourselves in that would mean gradually increasing the rate from 40% to about 44%.

There would of course still be great howls of protest from those with salaries in the top decile of the earnings league who would be the most affected by the raising of this tax level. However, these are to a large extent the very people who enjoyed the largest percentage growth in their earnings during the boom years, earnings that we now know (or at least suspect) were, in a large measure, based on fictitious or inflated profits, particularly in the financial sector. In which case, these were, in large part, salary rises that were unearned.

These are also the people who, more than any other sector of society, invested those earnings in the property bubble that caused the boom and the resulting crash in the first place. So, given that many of them were the largest beneficiaries of the credit boom, and partially responsible for it, isn't it fair that they should also be the ones who should contribute most towards restoring the economic stability of the country? Given that they are also the only ones with the spare cash to do so shows that they also have the means to do so. And if they don't like this policy? Well, they can always vote for a party that will promise to slash public spending in order to keep it below 40% of GDP. But then don't most of them do that already?