How the SNP Government skews the tax debate

How the SNP Government skews the tax debate

by Eben Wilson
article from Wednesday 15, November, 2017

A NEW PAPER from the Scottish Government is keen for us to debate the future use of our income tax powers.  Our choices in this debate are framed thus: “income tax policy should help maintain and promote the level of public services which people in Scotland expect” and “any tax changes should make the tax system more progressive and reduce inequality”.

This is a highly skewed invitation to indulge in a free lunch from the money tree; “expecting a service” without a price being attached to it ignores responsible fiscal governance and the causal link between more progression and inequality is not a given. 

Two specific ideas in the paper caught my eye and caused me to blink twice.  It will be worrying if they really are views held by our governing state to form the basis of policy.

The first is a reference to Adam Smith’s principles which the Scottish Government purports to use as touchstones. It says “proportionality to the ability to pay in taxation (often referred in the paper as progressivity) is vital”.  This is a bizarre conflation, what Adam Smith actually said is:

"The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state."

Taxation in proportion to revenue isn't progressive taxation, it's proportional taxation – in modern terminology, a flat tax.  Our government wants progressive tax rates; higher marginal burdens on higher marginal earnings.  If we are to have a policy debate, we need to ensure that we discuss this distinction properly. The difference is central to policy choices and outcomes.

The second was the bald statement that “there is no evidence that progressive taxes curtail economic growth” citing an IMF paper.

If this is true, and comes to form the basis of our Scottish Government tax policy, then we could be in for some very big tax rises indeed.  It runs counter to the logic that higher marginal tax rates make people do less and that this in turn curtails economic growth.

The IMF paper itself is in fact less adamant than the truncated statement of the Scottish Government suggests; it isn’t a peer reviewed work, but a summary by IMF staffers of other academic work.  As such, it is very much within the macroeconomic genre typical of the IMF, using broadbrush statisticism to reach conclusions that appear to refute micro-economic rules.  Alarm bells ring when liberal economists read such work.

The paper does indeed suggest that progressive taxes do not curtail growth, in one sentence, but it backs off from this within the same paragraph saying, “empirical evidence on the direct link between tax progressivity and growth is mixed” and cites counter evidence.  To understand this apparent confusion you have to understand the context of the review paper and its evidence base.

The context is that of a world survey of tax policy and its possible effects on inequality, and the evidence base is upwards of one hundred OECD nations with wildly varying economic wealth, welfare arrangements and economic performance.  The sentence comes within a discussion about optimal policies to reduce inequality; and arises in a section discussing why there has been a global reduction in high progressivity in taxes over the past twenty years – policy driven by a consensus among many economists that lowering high marginal rates increases growth.

The authors try to establish the effects on levels of inequality of redistributions from high earners via taxation for public spending. These redistributions are financed through different tax regimes in different countries, with different marginal rates, different attitudes to social welfare and differing impacts on different economies with different rules about parallel corporate income taxation.

Discursive wide-ranging reviews like this are based on constructed averages so extrapolating their conclusions to individual countries is dangerous The technical annexe on which the calculation about progressive taxation and growth is made across a varied minimum of 33 countries and a maximum of 146. It uses varying measures for progressivity and something called “redistributive capacity”. It also contains corrections for initial income distributions, migration of income into capital withdrawals, and population growth.  My greatest concern is that the time period involved in the growth-effect analysis is 1981 – 2016. For the 33 and more countries in the data set this period includes both the recovery of Central European economies from Soviet socialism and the 2008 financial collapse and follow-up recession. 

This is distemper brush econometrics of a most dubious nature.

Any one of these parameters in any one country could adjust the outcome.  The document itself says “large standard errors may result in low power of the regression to reject the null hypothesis that progressivity has no effect on growth”; that is, they admit that their conclusions could be wrong.

There is no doubt to me that the Scottish Government’s paper has used a highly selective view of a paper that is itself a highly specific view of a widely varying real world picture.  Confirmation bias applies. This is not a good foundation for long-term tax policy.

Such an analysis would be better done with figures for Scotland than a distemper brush. As a starting point for that, it would best if the Scottish Government recognised the extensive academic literature that clearly links lower levels of growth to nations with larger public sectors with especial reference to Scandinavian experience. That analysis could be localised to Scottish experience.

In Scotland, with a large public sector, we have specific peculiarities.  Two million Scots do not pay any income tax and 2.2 million pay the basic rate. Only 346,000 adults pay the higher rate, and only 20,000 pay the additional top rate.  Sixty percent of all income tax is paid by those last two cohorts.

Scotland’s existing reality is that we already have high progressivity and our re-distributive capacity is limited.  We have a high and growing self-employed and small business sector so the scope for shifting earned income to capital income is high. We also have a competitive free-trading partnership with a much larger neighbour, so there are risks through tax competition in the medium term. These factors do not bode well for growth in the presence of a high tax regime.

I also hold the view that because of our large public sector, any attempt at further re-distributions from higher earnings could have untoward outcomes for both inequality and growth. The source of this view is that economic power of the middle classes of the public and professional sector who, in Scotland, operate largely in association with each other. Higher income taxes for higher earners would create upward pressure on salaries and fees while lowering private investment and consumption. These public sector and professional earners have the monopoly knowledge power to raise their prices. This creates a house of cards of income flows generated not from physical capital and industrial operative wages, but from a growing overhead of administrative activity that always needs more tax money.  This cycle curtails growth and perpetuates inequality – it potentially increases it. There is evidence from Sweden between 1950 and 1980 that points to this adverse cycle becoming embedded in perpetual low growth.

The Scottish Government paper recognises that there is an “appropriate balance between funding public services through taxation as part of a social contract and leaving individuals to make their own spending decisions”. But any Scot knows that the initial balance point is clear; the Scottish Government’s focus is primarily on what it can spend as controller of this social contract. It wants to “combat austerity” despite being deeply in debt and paying vast quantities of interest while running a high deficit.

Nicola Sturgeon is clear that she wants to maintain what she calls “our cherished public services”.  Some of us would call this vote-buying and would question whether such inefficient, expensive, over-spent and non-improving services deserve any cherishing.

Tax policy designed on this basis for Scotland suggests to me that all taxpayers, including those on standard rate, will in the end have to be tapped for more. This will be justified on the basis of a presumed social contract that exists largely in the minds of factions favouring public spending. Sadly, with respect to likely policy outcomes, this is a case of turkeys voting for their own Christmas.  Voters may well question the cost of feeding them.

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