Board up your windows, the Budget cometh

Sources in Whitehall are reportedly looking into the re-introduction of the Window Tax 162 years after it was repealed. With the UK government hell-bent on austerity, it has positioned itself as the proverbial ‘canary in the coal mine’, and is in dire need of ways to balance its books. However, the canary died long ago. It seems that other countries have taken note, moving away from austerity to more growth-focused measures, while the UK ploughs ever deeper in to the gas-filled mine. The resurrection of the Window Tax – along with other draconian measures – are back on the table as the UK tries to galvanize its economy and return the fiscal situation to a sustainable path.


The Window Tax was introduced under William III in 1696. At the time, windows were a luxury, and it was likely the number of windows in a property would be in proportion to the size of the property and thus to the wealth of the owner. It was this seen as a progressive tax and a prototype to income tax, introduced 146 years later by William Pitt the Younger. Nevertheless, the tax was unpopular, and avoidable if windows were bricked up, as many were (and one can still see many examples of windows that were bricked up for this reason in London today). Indeed, the term ‘Daylight Robbery’ is thought to have its provenance in this era. The Window Tax lasted 156 years until 1851.

As Brad Pitt in the movie Joe Black would say, the only guarantees are death and taxes. There is nothing new in monarchs and governments finding novel and ridiculous ways to tax their populace to fund their overspending. Likewise the serfs will continue to change their habits to reduce their tax liabilities. Anyone who believes that there is anything substantially different from the proposed Mansion Tax to that of a window tax is likely so deluded that they should be a top parliamentary candidate for the next election.

“I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.” – Winston Churchill.

As the old adage goes, “How do you get rich?”. The answer: “spend less than you earn and invest wisely”.

Unfortunately the UK like most developed countries is taking the other path, spending more than we “earn” in tax revenue and heading towards de facto bankruptcy (although as we know, with the printing presses always at the ready, this would never happen in name).

 

Source: McKinsey

The media is full of talk of the austerity measures being taken to address our growing indebtedness, By now it should be evident – even for a politician – we are not actually cutting spending at all in net terms. We are merely hoping and praying that growth can return to sky high pre-crisis levels to improve the government debt to GDP ratio. As an old colleague used to say, the chance of this happening are “slim to none and slim just left the building”.

We are, in fact, focusing most of our efforts on the taxation side of the government costs-and-revenues ledger; this is the main discussion point of this article.

Politicians and the futility of over taxation

“A liberal is someone who feels a great debt to his fellow man, which debt he proposes to pay off with your money.”- G.Gordon Liddy.

Nick Clegg, Vince Cable and Ed Balls et al, I ask you to please put your coats on and start walking down that long passageway opposite which seems like a million miles long. When you get to the end please take a right turn and walk for another million miles. At the end you will find a door, open it and pass through. You have finally arrived in the REAL world.

In the real world, most people are going about their daily lives trying to provide for their families, paying the mortgage, the gas bill, for the food on the table and a modicum of leisure consumption, made possible by receiving a wage in exchange for services provided. Butcher, baker or candlestick maker you struggle to get that wage. Obviously this line of reasoning falls down somewhat when you possibly include many government workers who not actually having held down a genuine, private sector job, are entirely unversed in the matter of having to deliver on time, to a tight budget, in a competitive market place and have little concept of how razor sharp the boundary is between taxable success and tort-racked failure. (Hat tip to Sean Corrigan at Diapason Commodities.)

For most the wage received is already after income tax and national insurance tax. The paltry remainder is then taxed through any multitude of ways in indirect taxes, on consumption of food, beer, driving or fuel. On the investment income or capital gains of any business you run, you pay tax, and then finally you pay death duties. Take your pick.
• Working: Income tax, national insurance, business rates, corporation tax
• Investing: Capital gains tax, dividend tax, unearned income tax
• Living: Council Tax, stamp duty, landfill tax
• Travelling: Air passenger duty, fuel tax, vehicle tax, toll taxes, customs duty
• Consumption: VAT, betting and gambling, alcohol tax, tobacco tax, insurance premium tax, climate levies
• Dying: Inheritance tax
Paying taxes has never been popular of course but in most countries there is, or at least was, a general consensus that we were paying for the services that the country provided us. Healthcare, a police force, an army, and infrastructure, all come to mind. We don’t need to go further than that to start the discussion.

So most people justifiably feel that they are getting short changed on the deal, paying more and more tax and receiving less and less in return. Some might feel they are getting short changed and subsidizing some of the less efficient areas of the public sector. (They might have a point, see charts below.) No wonder there is a tendency to ‘avoid’ tax.

Source: Centre for Policy Studies

A negative effective tax rate means that you receive more than you pay and the percentage reflects the amount, ie -20% means that you receive 20% more income from the government than you pay in tax. As we can see, the proportion of households with negative effective tax rates has risen steeply in recent years.


Source: Centre for Policy Studies

There used to be a clear divide between legally ‘avoiding’ tax and illegally ‘evading’ tax. This seems to have become blurred and that anyone who tries to avoid paying tax in whatever way stands the risk of being named and shamed by HMRC. (Apparently HMRC, after thoroughly investigating the comedian Jimmy Carr’s legal offshore structure and realising that they were unlikely to be successful in court, leaked it to the media. Most legal tax avoidance schemes like the Employee Benefit Trusts or the Enterprise Zone investments were all given tax-free status in the past for reasons that seemed relevant at the time. If they no longer fit in with the ex post “moral tax code” that is applied today, change the law – but not retrospectively – and move on.

There are two basic concepts in tax collection: the optimal amount an individual can be taxed, and the optimal amount a populace, in aggregate, can be taxed.

The Laffer Curve

The Laffer Curve is a very simple construct that demonstrates the relationship between possible rates of taxation and the resulting levels of government revenue. In basic terms it suggests that no tax revenue will be collected if the tax rate is 0% and 100% (if people could choose whether to work or not) and that theoretically there must be at least one rate where tax revenue would be a non-zero maximum, based on the rational choices of individual tax payers.

The Total Tax Potential

The chart above shows us that the total tax as a percentage of GDP only varies for the most part between 33-38% irrespective of the “low” or “high” tax regime of the current governments. So it is clear, from a macro perspective, that it is difficult to extract more than 38% from the economy even with quite punitive tax rates.

Clearly tax collection is a very slippery customer for the very simple reason that people change their habits with changing tax rates and with the resulting change of residual spending money.

In the following chart, we can see the breakdown of how much tax in the UK is collected in each category. About one third of total government receipts come from income tax, with National Insurance Contributions the second single biggest contributor.

Robin Hood

On the subject of raising tax revenue to reduce the deficit, it is a good time to ask if that is what we really want.

How much are we focusing on a sensible tax policy to generate growth and revenue and how much are we using the tax system for more sinister aims?

In Ayn Rand’s famous novel, “Atlas Shrugged”, (Mr Clegg, please order a copy), the most despised person after the government is Robin Hood. The hero of English folk-lore; how could that be? In the novel, Robin Hood is not thought of as robbing the idle, evil rich to feed the deserving poor. He is robbing the productive wealth and job-providing rich to feed the non-productive government largesse and the non-productive benefit-entitled poor.


“…He [Robin Hood] is held to be the first man who assumed a halo of virtue by practising charity with wealth which he did not own, by giving away goods which he had not produced, by making others pay for the luxury of his pity. He is the man who became the symbol of the idea that need , not achievement, is the source of rights, that we don’t have to produce, only to want, that the earned does not belong to us, but the unearned does….”

Left wing politicians have used the banner “tax the rich more to give to the needy poor” as a vote winner for decades. It has great popularity with the masses – of course the rich should pay more, it stands to reason.

“A government which robs Peter to pay Paul can always depend on the support of Paul” – George Bernard Shaw

But is this really what we want to have, do we really want to tax the rich even more when they are the employers and wealth creators of economic growth?
So a better question might be this:

“Do you think that the rich should be taxed more than the poor?” YES, of, course.

“If that means they can’t expand their businesses and employ you, is it still a resounding YES?”

Let’s return to the Mansion Tax and challenge its Robin Hood-esque proposal. Everyone knows that one should take into account the annual “upkeep” of a property in considering a purchase. Service costs or land maintenance costs – they all go into the equation. A large country house with 3 acres of land may cost substantially less to run than one with 100 acres.

We can view the proposed Mansion Tax as just another upkeep cost and ask what would be the most obvious and realistic assumption if a 1% tax was applied on all property over £2million.

• All property marginally above £2million threshold would no doubt drop below it as has happened with any binary cut off
• All property reasonably above the threshold would have to factor in the new “carrying cost”, assuming people purchase property on affordability whether it be £200k or £3million (even Russian oligarchs can be price sensitive)
• The new tax collected from disposable income would have to be offset against what it would have been spent on otherwise, and the tax collected in somewhere else

Business assets often trade at 10x cash flow. So if you reverse that logic as an asset charge, a 10% drop in property prices is a distinct probability, although unlikely to be linear. If property prices drop 10%, all stamp duty collected on purchases in the future will drop by 10% and as people will have to find the disposable income to pay the 1%, they will have less money to be taxed elsewhere. Go back to the chart on total tax potential, earlier. There is an empirical limit to how much a government can extract taxes from an economy.

A totally unrealistic fairy tale assumption would be:

• It costs virtually nothing to administer and collect this new Mansion Tax.
• All property prices remain at the same levels or rise
• The 1% tax is paid for by the unlimited disposable income that the home owner has
You may laugh, but there are undoubtedly some deluded fools in the government who really believe this. In Blackadder Goes Fourth, the classic BBC comedy, the hapless Baldrick asks what was wrong with the grand plan for averting WW1. Captain Blackadder replies, “Ah the plan, Baldrick . . . . . . . . . . it was total b****cks”.
So let’s admit it, it’s unlikely it will collect much tax, indeed, it could even be a net cost. It is a pure Robin Hood rich-bashing tax in a vain attempt to get more votes.

Benjamin Disraeli, the great 19th century British Prime Minister, once said, “Statesmen think of the next generation, politicians think only of the next election”. I don’t see many statesmen from where I am sitting.

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