The great tax debate

When I first saw the news yesterday that Barack Obama had been elected for a second term, I reflected somewhat sadly at how much less enthusiastic I am about him than I was four years ago. (Then, I stayed up all night to watch the results come in. This time, I had a good eight hours’ sleep.) My initial enthusiasm has been dented by the huge increase in drone-strikes, the failure to close Guantanamo Bay, the Dodd-Frank act, and Obama’s part in the failure to bring the deficit under control. But on balance, I think it is a good thing that Obama has another four years to try to implement his solutions to America’s problems. With all the deadlock of his first term, coming partly from the determination of many Republicans to deny him a second term by automatically opposing his every move, I feel as though he ought to be given a proper chance. It is to be hoped that the upcoming ‘fiscal cliff’ at the end of 2012 will force both sides to make the necessary compromises to narrow the gap between revenue and spending. (Perhaps this is too much to hope for; we’ll see!)

As with all election campaigns since the days of JFK, this one was marred by all kinds of personal attacks with no foundation (see and for two particularly blatant examples). But there was also a frank discussion of some fundamental differences. One was taxation. Both the US and the UK are sharply divided on the issue of tax, and both sides claim the moral high ground. In this article, I want to think about why.

‘We have made very clear that the wealthy must be made to pay their fair share’, wrote Simon Hughes in the Independent, earlier this year. The top rate of tax is certainly a bone of contention between Conservatives and Liberal Democrats in the Coalition government. At the Conservative Party Conference, George Osborne, who recently has become something of a hate figure for the Left, said the following in a speech.

‘Just as we should never balance the budget on the backs of the poor, so it’s an economic delusion to think that we can balance the budget on the wallets of the rich.’

In France, the debate is more extreme. President Hollande is ploughing on with his plan to introduce a 75% top rate of tax, in the teeth of some bitter opposition.

Let’s look at some figures. In the UK, a citizen with an annual salary of £500,000 per year pays about £240,000 in tax and national insurance, or about 48% of their income, whereas a citizen with an annual salary of £33,000 (about the national average) pays about £8,000 in tax and national insurance, or about 24% of their income. Progressive taxation, the system by which higher incomes are taxed at higher rates, is widely accepted throughout the western world. However, it is not universal. In 2001, Russia introduced a ‘flat rate’ of tax: everyone paid 13%, regardless of income. Other countries followed suit, including Serbia, Ukraine, Slovakia, Georgia, Romania, Latvia and Lithuania. Granted, in most cases this was to tackle the problem of tax avoidance, which is a lot harder when there is a flat rate of tax. But an article in the Economist (‘The case for flat taxes’, 14th April 2012) extolled the benefits of a flat tax rate for all countries, and conservatives in the United States looked on, enviously. For just as many on the Left regard progressive taxation as the only ‘fair’ system, many conservatives regard it as unfair, and even immoral. They say that people should be treated equally under the law; and what is more unequal than a tax rate which is twice as high for the rich, as it is for the average man?

To some extent, what we are seeing here is the clash of two rival philosophies of justice: utilitarianism, and classical liberalism.

Utilitarianism can be summed up by the words of its 18th century founder, Jeremy Bentham:

‘The greatest happiness of the greatest number is the foundation of morals and of legislation.’

Put differently, the right thing to do for a government (and a society) is to try to achieve the greatest possible amount of happiness, or well-being, in the society.

Classical liberalism, on the other hand, holds that all people have fundamental rights, which should not be violated, even in order to increase the total amount of happiness in a society. The most important rights include the right to life, the right to liberty, and the right to own property. Closely linked with the right to own property is the right ‘to enjoy the fruits of one’s labours’. Classical liberalism can be traced back to antiquity, but modern liberalism owes much to the 17th century thinker John Locke, who wrote in his ‘Second Treatise on Government’:

‘All mankind… being all equal and independent, no one ought to harm another in his life, health, liberty, or possessions.’

In modern times, classical liberalism has been championed by the political philosopher Robert Nozick, among others. To avoid confusion with the American meaning of liberal (i.e. ‘big government’) and with the US Libertarian party (i.e. ‘small government’!), I will sometimes use the term ‘liberalist’ for an adherent of classical liberalism.

Utilitarianism and classical liberalism can differ sharply on what is the right thing to do in some situations. To see why, imagine that there is terrible disaster that leaves only fifty people alive in the world, one of them a doctor. The doctor and four of the other survivors are healthy, but 45 urgently need organ transplants, without which they will die. Between them, the four healthy survivors have enough organs to save the lives of the other 45, but any organ transplant would mean the death of the donor. None of the four healthy survivors are willing to sacrifice their lives.

The doctor is faced with a dilemma. Does he put the healthy survivors to sleep, and perform the transplants, saving the lives of the other 45, but sacrificing the four healthy survivors? A strict utilitarian would say yes: it is morally justified to kill 4 people in order to save 45. A strict ‘liberalist’ would say no: it should be up to the healthy survivors whether they want to sacrifice their lives to save the others; if they do not want to, they should not be made to.

This is obviously an unlikely situation. But now let’s imagine another situation. Suppose there is an isolated village of farmers. There are two major crops: potatoes and wheat. Potatoes can be sold to a another village at a higher price, but they are also more prone to disease. One year, two-thirds of the farmers decide to grow potatoes, and one third decide to grow wheat. The wheat crop does very well, but the potato crop is hit by a disease, and most of it is lost. The farmers who grew potatoes have just enough of their crop to live on, but none extra to sell. The farmers who grew wheat, on the other hand, have a big surplus, which they sell to a neighbouring village. There is a village meeting, and one of the farmers proposes a motion. He says that the wheat-growing farmers have lots of spare money, and should give some of it to the potato-growing farmers, so that the latter can afford just a few ‘luxuries’ such as decent clothes. The wheat-growing farmers argue that it is their choice whether or not they give their money away. But some think that the wheat-growing farmers should be made to give away some of their money. It comes to a vote. What should be done?

The strict utilitarian would probably argue that money should be taken from the wheat-growing farmers and given to the potato-growing farmers. He would say that the wheat-growing farmers have lots of spare money, and even if each of them loses 10%, their material well-being will not be affected much. On the other hand, if all this money were given to the potato-growing farmers, their material comfort would be greatly improved. In other words, the total amount of happiness would be increased by taking money from one group and giving it to the other. A ‘liberalist’, on the other hand, might well oppose this: the wheat-growing farmers have the right to choose what to do with the fruits of their labours, and no-one should force them to part with their money.

A similar debate is now being played out over tax. What are the common arguments in favour of progressive taxation, and how do they fit in with the utilitarian and liberalist standpoints?

In a modern society, the state provides certain goods and services to all its citizens, paying for them by taxation. Economists call these ‘public goods’. Examples are healthcare, in the UK, and toll-free roads. A supporter of progressive taxation might be tempted to argue that the rich use these public goods and services more than the poor do (they probably do drive more often), and so should pay more in tax. But a ‘rich’ UK citizen on a £500,000 salary currently pays about 30 times more tax than an ‘average’ citizen on a £33,000 salary, and there is no way that the rich citizen uses public goods 30 times more. Indeed, the rich citizen may well use them less: they are less likely to use the NHS (more likely to have private healthcare), and less likely to send their children to state schools. Certainly, progressive taxation cannot be justified on the grounds that the rich use up a greater share of public resources. If we just view taxation as a way of paying for the public services we use, we are likely to end up charging everyone the same amount of tax (e.g. £100 per month) – the very opposite of progressive taxation.

A more commonly used argument in favour of progressive taxation is that the rich owe their wealth partly to their use of public resources. If they have made their money in business, they relied upon roads and communications provided by the government, and funded by taxation; most of their employees were probably educated at state schools. This is certainly true. But everyone owes a certain amount of their income to their use of public resources: a self-employed shopkeeper could not work without literacy and numeracy, and there is a good chance that these were taught at a state school. It cannot be argued that 48% of a rich person’s success came from taxpayer-funded resources, whereas only 24% of an ‘average’ person’s success came from taxpayer-funded resources: while it is hard to calculate exactly, the numbers are probably similar. So if we view taxation as a way of ‘giving back’ the part of our earnings that we owe to society, we are more likely to end up charging everyone a flat rate of tax (e.g. 25%).

Progressive taxation is obviously a form of redistribution of wealth: the state is taking money from the salaries of its richer citizens, and giving it to its poorer citizens. A ‘liberalist’ sees this as violating the ‘right’ of the richer citizens to maintain possession of what they have earned, or to choose how to spend ‘their’ money, and so is likely to oppose progressive taxation.

A utilitarian, on the other hand, may well approve of a certain amount of progressive taxation, as transferring money from rich to poor increases the well-being of the poor far more than it reduces the well-being of the rich. In the language of economics, the ‘marginal utility’ (or benefit) of £50 per month is much greater, if you are on a low income, than if you are on a high income. Even most rich people agree that a certain amount of progressive taxation is necessary for a good society – to ensure that the government has enough revenue to provide a high standard of shared goods and services, to ensure that there is some kind of social safety-net for the poor, and to ensure that there is a high degree of social mobility.

Some advance a further argument for progressive taxation, which does not fall within either the utilitarian or the liberalist ideology. A rich citizen may be able to earn more money than a poor citizen, though both work equally hard, partly due to circumstances beyond their control. For example, the rich citizen may have a greater natural talent in mathematics, music or sport, perhaps due to genetics or due to their early upbringing or education. For some, this would justify taking money from the salary of the rich citizen, and giving it to the poor citizen: it is correcting the ‘unfairness’ of genetics or of early upbringing. A liberalist, however, might well respond that it is no business of the state to try to correct inequalities of genetics or upbringing by redistributing people’s earnings. He might say, ‘My genetic characteristics are inherently ‘mine’; so are the characteristics my upbringing has given to me, and so is the money I am able to earn using these characteristics.’ Most utilitarians would also oppose this idea of ‘correcting inequalities’, on the basis that it prevents everyone, even the most talented, from becoming truly successful and enjoying the fruits of their success; and the hope of this success is an important ingredient in the happiness of a great many people. Also, when a state tries to do this, it leads to huge amount of interference and intrusion in people’s lives, and a great deal of unhappiness. (The Soviet Union is a case in point.)

In the UK, very few people (and no politicians) argue for a flat rate of tax. The debate usually hinges not on ‘whether’, but on ‘how much’ progressive taxation is justified. As well as the liberal argument, there are also utilitarian arguments against very high taxes on the rich. Too much redistribution may trap poorer people into what conservatives call ‘a culture of dependence’, by reducing their incentive to work hard to improve their situation. More importantly, the prospect of higher earnings is a powerful incentive for people to achieve greater success in business, creating more jobs for others: when this incentive is removed by too much redistribution, the economy does not grow, and everyone suffers.

Since freedom is an important ingredient in happiness and well-being, utilitarians must also consider the negative effects of high taxation on the well-being of the rich, which comes from removing much of their financial freedom. More pragmatically, very high tax rates may actually reduce the government’s tax revenue, as it may drive the rich to move abroad, taking jobs (and tax revenue) with them.

Another objection, both utilitarian and liberal: very high tax rates reduce charitable giving, for the simple reason that the rich have less money left over which they can give freely. Many private charities that work with the poor (and also some individuals such as Bill Gates) spend their money in a way which benefits the world a great deal more than most governments. Also, voluntary giving is a good thing in itself: it strengthens bonds between rich and poor, and is more likely to motivate the recipients to improve their situation, than state welfare. (There is often a feeling that voluntary help should be repaid in some way, by making good use of it, and this may not exist with welfare payments, which are somewhat more impersonal.)

My own outlook is, in a sense, utilitarian, but with such a strong emphasis on freedom as an ingredient of well-being, that I agree with the ‘liberalists’ on many issues. Most people’s idea of justice is based on some sort of combination of liberal and utilitarian ideas. I find myself asking: can President Hollande’s proposed 75% top tax rate be justified, by any combination of these ideas? And I find myself answering, ‘no’: it is too great an attack on freedom, on economic incentives, and charitable giving, and risks driving the rich abroad. In my opinion, a 50% top rate of tax is quite enough; if President Hollande and his ministers feel that the rich should pay more, there is nothing to stop them introducing a ‘voluntary component’ of tax, much like charitable giving, except that the money is spent by the government. Doubtless, very few would pay the top ‘voluntary’ rate, but a significant few would (both Bill Gates and Warren Buffett have expressed their willingness to pay more in tax than they currently do), and some would follow their example.

Time alone will tell the effect of the 75% rate upon France, but if it is introduced in the teeth of opposition (and there already is a great deal of opposition: France is not Sweden!), I would predict lower levels of happiness and well-being, as well as lower levels of freedom.

I was saddened when some in the UK, including some close friends and colleagues, expressed support for a 75% top tax rate in the UK, for in my opinion, all the same arguments apply in the UK, as in France. My ultimate hope would be that both the UK and France will eventually turn into societies like Sweden, where the rich are (on the whole) willing to give more than 50% of their earnings (either in tax or as charitable donations), and where there is a strong, well-funded social safety-net, and a strong sense of social responsibility at all levels of society. Then, of course, many of the negative effects of redistribution would disappear. But this society won’t be achieved by introducing a 75% top rate of tax. In my opinion, it can only be achieved by people acting voluntarily, in accordance with their beliefs. A good dose of ‘love your neighbour as yourself’ wouldn’t be amiss!


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