Friday 14 August 2009

And the OECD says ...

... in the summary to their research on Tax & Economic Growth

Corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxes (1). Recurrent taxes on immovable property appear to have the least impact (2).

A revenue neutral growth-oriented tax reform would, therefore, be to shift part of the revenue base from income taxes to less distortive taxes such as recurrent taxes on immovable property or consumption. The paper breaks new ground by using data on industrial sectors and individual firms to show how re-designing taxation within each of the broad tax categories could in some cases ensure sizeable efficiency gains. For example, reduced rates of corporate tax for small firms do not seem to enhance growth, and high top marginal rates of personal income tax can reduce productivity growth by reducing entrepreneurial activity.

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(1) Unfortunately they make the mistake of lumping in VAT with 'taxes on consumption'. if you go to pages 18 and 19, you'll find this, which certainly applies to VAT:

38. Because they lower the purchasing power of real after-tax wages, consumption taxes may curb labour supply in much the same way as a proportional income tax. Consumption taxes can also reduce labour demand in the short-term if they add to wages and labour cost... Most empirical studies that assess the effect of taxation on employment exclude consumption taxes from the relevant wedge. However, some recent studies that include the consumption tax in the overall labour tax wedge find that a rise in this wedge reduces market work ...

Exactly, the clue is in the name: it's called "Value Added Tax", and what is "value added" if not the same thing as "profits"? So why is it be any better than any other "corporate taxes" (i.e. on profits)?

... and this, which applies to proper consumption taxes:

40. Specific consumption taxes that penalise the production and consumption of “bads” can improve environmental outcomes while generating revenues that can be used to offset other taxes on, for example, labour. Examples are excise duties on petrol and diesel. A similar argument can be made for “bads” that affect consumers’ health, with potential social externalities (e.g. tobacco or alcohol), though the extent of such externalities is controversial...

I'd agree with that as well. The killer point being that demand for these things is price-inelastic, so taxes thereon do not affect behaviour very much, and people just pay more for the same amount of petrol, fags, booze. This makes a mockery of the argument that such taxes discourage driving, smoking or drinking, but hey. As long as the taxes at least cover the external costs, that's the main thing.
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(2) I'd also like to highlight these paragraphs, a bit lengthy, but a good summary nonetheless:

Recurrent taxes on land and buildings have [only] a small adverse effect on economic performance...

47. Recurrent taxes on land and buildings (especially residential buildings) are generally argued to be more efficient than other types of taxes in that their impact on the allocation of resources in the economy is less adverse. This is because these taxes do not affect the decisions of economic agents to supply labour, to invest in human capital, to produce, invest and innovate to the same extent as some other taxes. This conjecture is supported by the new empirical work undertaken in this project (see Section 4).

Another advantage of property taxes is that the tax base is more stable and the tax revenue generated from this tax is therefore more predictable than for revenues obtained from labour and corporate taxes, partly due to less cyclical fluctuation in property values.

Also, as real estate and land are highly visible and immobile these taxes are more difficult to evade, and the immovable nature of the tax base may be particularly appealing at a time when the bases of other taxes become increasingly internationally mobile.

Property taxes also encourage greater accountability on the part of government, particularly where they are used to finance local government. Property taxes, with regular updating of valuation (which, with modern technology, is now feasible), can also increase the progressivity of the tax system (for example, by the exemption of low value properties), provided that special arrangements are made to reduce the liquidity constraints that the tax may imply for the relatively small number of people with low incomes and illiquid assets.

…and they could contribute to the usage of underdeveloped land…

48. The design of property taxes on land and buildings can also be used as an instrument to affect land development and land use patterns. For example, low taxes on vacant property and undeveloped land can encourage the under-utilisation of land which may lead to a reduced supply of land for housing particularly in urban areas. Linking the assessment value to market value may increase incentives for developing land as market prices also reflect the development potential of land.

But, in many OECD countries the assessment values of land lag substantially behind the actual development in land prices generating gaps between taxable land values and current land prices, which are politically difficult to close (e.g. Finland, the United Kingdom).

…while preferential housing tax treatment may distort capital flows...

49. As described in Section 2, owner-occupied housing has a favourable tax treatment relative to other forms of investment in many OECD countries through reduced tax rates or exemption for imputed rental income, mortgage interest payment deductibility and exemptions from capital gains tax. While the favourable treatment of owner occupation is often justified by the specific nature of housing and the positive externalities for society associated with its consumption, they may distort the flow of capital out of other sectors and into housing. They can also reduce labour mobility and thus the efficient allocation of labour.

In these circumstances, raising taxes on immovable property could improve economic efficiency and growth. The distortion between housing and other investments should be removed by taxing them in the same way: taxing the imputed rent and allowing interest deductibility. However, most OECD countries do not tax imputed rent at all, while those that do often under-estimate the rental value. In such circumstances, the denial of mortgage interest relief and the use of property taxes can provide a ‘second best’ approach, though local government control over property taxes makes it difficult in many cases to implement this approach in a co-ordinated fashion.

By contrast, taxes on financial and capital transactions are highly distortionary...

50. It is always less distortionary to tax the income and services provided by assets than the transaction involved in acquiring or disposing of them. This follows from the Diamond and Mirrlees (1971) result that taxes on intermediate transactions are inefficient, in the sense that the same revenue and distributional effect can be obtained at a lower distortionary cost by taxing income (including capital income) or consumption (consumption of housing services).

The lower distortionary effect arises because both transaction taxes and taxes on income/consumption discourage the ownership of the assets, but the transaction taxes have the added distortionary cost of discouraging transactions that would allocate these assets more efficiently. For example, they discourage people from buying and selling houses and so discourage them from moving to areas where their labour is in greater demand.

In fact, the distributional effects of transaction costs are probably also less desirable, as the tax falls more heavily on people who trade more frequently, such as people who need to move frequently for their jobs. Nevertheless, governments have found these taxes attractive for two reasons: they are relatively easy to collect and they compensate for the difficulties of applying VAT to the financial sector.

Capital gains taxes, which are paid only upon realisation, suffer from some of the same shortcomings as taxes on intermediate transactions.

7 comments:

Anonymous said...

A tax on land will result in lower production as businesses cannot reinvest profits to reduce cost of production. If they want to hold on to the land, cash will have to be found to pay the tax before any efficiency increase can be contemplated.Costs will rise Stick to non productive assests like houses. Oh I forgot they will be used to pay nursing home fees and the pension top ups which will be needed!Looks like we are stuck with VAT

CityUnslicker said...

This all makes my head hurt. I don;t think I am bright enough to absorb it. Maybe it would be easier if we had no taxes at all or a flat tax...

Mark Wadsworth said...

Anon, do you have the slightest bit of empirical evidence to support any single one of your contentions? Do you think the OECD just make up this stuff? it is a simple fact that businesses who rent rather than own their premises show a far higher return on capital (which is to some extent 'survivorship bias' aka 'creative destruction', no bad thing in itself).

CU, hurray for flat taxes! One on incomes; one on land values. Job done.

James Higham said...

All right, I've got all that but I keep coming back to VAT. I've never really understood - whose value? You say it's a tax on profits - presumably their profits and we pay the tax on it. Am I close?

Mark Wadsworth said...

JH, VAT is clearly a tax on profits, i.e. 'Value Added'.

If you buy VAT-exempt goods or services for market value of £100, broadly speaking, the total profits earned by every business and employee in the chain will be £100. They pay income or corporation tax on it, everybody knows about that, at least it's honest.

If the rules are changed so that those goods or services are now VAT-able, why would you, the consumer pay more than market value? So you still pay £100*, but the retailer and his suppliers and all their employees and financiers now only have £87 to share out between them. So they are paying it (which includes you as well, somewhere along the line).

The fact that you (the end-consumer) get a till receipt saying "Net £87 plus £13 VAT = £100 total" is meaningless. The till receipt may as well say "Net £82 plus £5 corporation tax plus £13 VAT = £100 total".

* Of course some businesses would go out of business, so supply contracts, so because of scarcity value the price you have to pay goes up, but probably not by the full 15%.

Anonymous said...

So who puts a value on the land and what size of official army is required to deal with rises and falls on the market value and appeals?

Mark Wadsworth said...

Anon, "So who puts a value on the land?"

HM Land Registry's computer can do it, as they know plot sizes, recent selling prices and ownership. All they then have to do is average it out over small geographic areas (postcode sector, council ward, whatever), knock off an arbitrary amount to make it more like land value tax and less like property value tax and Bob's your uncle.

"what size of official army is required to deal with rises and falls on the market value and appeals?"

A couple of dozen to run the spreadsheets at HMLR (which updates automatically for changes in values, as based on recent actual sales) plus six hundred to hear appeals (let's say five for each postcode area, of which there are 124 in the UK). Seeing as I envisage a fairly mechanical/automated valuation system, there's not really much to appeal about except for obvious arithmetical errors.

Seeing as my ideal LVT would replace Council Tax/Council Tax Benefit, Business Rates, Stamp Duty, Inheritance Tax, Capital Gains Tax, TV licence fee, Insurance Premium Tax, Section 106 agreements, roof tax, shared ownership crapola etc etc, I am quite confident that we'd see a significant overall reduction in the number of civil servants.