Tim Montgomerie has been a leading advocate of a move from income to wealth taxes in recent months. In a recent article in The Times he dismissed what he described as fallacies about wealth taxes. It is, indeed, possible that economists who have been beavering away on tax issues for a few hundred years may have succumbed, over all that time, to fallacies which can be dismissed in a sentence. On the other hand, perhaps not…
One of those supposed fallacies is that wealth taxes are double taxes. Tim Montgomerie used the example of VAT to suggest that double taxes are part and parcel of the tax system. In fact, the way in which wealth taxes and VAT work are entirely different.
Free-market economists tend to believe either in a tax on all income (including interest and rents) or in a tax on consumption only. In recent years – wrongly in my view - the Conservative Party have moved towards the consumption tax position, increasing VAT dramatically. What we have, in fact, is not double taxation but a hybrid system. Income is first of all taxed at source and then any of that income that is spent on consumption is taxed again. We have (ignoring higher rates) a 20% income tax plus a 20% consumption tax. We cannot decide whether to tax income or consumption so we do a bit of both!
A wealth tax takes us in the opposite direction and it is a peculiar direction for free-marketeers to take (or, indeed, for Conservatives to take for that matter). A wealth tax would tax income and then tax again only that part of income that was saved. If we want to tax savers more and consumers less, we should change the balance between VAT and income tax, not bring in a separate wealth tax. If we want to penalise savers, we should do it by increasing taxes on the returns to saving and not by taxing the capital itself.
A wealth tax is pernicious because it taxes that wealth year, after year, after year. A small rate on wealth is a huge rate on the returns generated from that wealth. For example, a 1% wealth tax is a 20% tax if the returns on that wealth are 5%. That is in addition, of course, to income tax paid on those returns.
So, to sum up:
- An income tax is a tax on all forms of income, including returns to saving.
- VAT is a tax only on that part of income spent on consumption.
- A wealth tax is a tax only on that part of income that is saved – but it is levied year, after year, after year on the capital and not on the returns.
There are some people who argue that inherited wealth came to people untaxed and undeserved (though who can say which part of our incomes and savings are deserved or not deserved – we did not ‘deserve’ our talents?). However, if you wish to tax this kind of wealth (which I don’t), then the right vehicle is inheritance tax and we have the highest rates in the world, more or less.
But, Tim Montgomerie might be right for all the wrong reasons. He has spotted a problem – a genuine problem – and serious problems often do point to poor policy. However, he has come to reasonable conclusions about some specific policies for entirely the wrong reasons. Tim Montgomerie argued that we should tax wealth by raising council tax on high-value homes. There is a problem with the treatment of property in the tax system. We neither charge VAT on property nor do we charge tax on the owner-occupied use of property (i.e. on the imputed rent). This means that renters (or their landlords) pay tax whereas owner occupiers living in exactly the same house do not. It means that we pay VAT on washing machines but not houses. We pay tax on the returns from saving through all investment vehicles (unless specifically exempted) except the house that we live in. However, most of us pay council tax which is probably quite a good proxy for the amount of tax we should pay on the imputed rent. If a house was worth £0.25m and could be rented for £15,000 a year, the income tax on that would be £3,000 which is somewhat more but not hugely more than the council tax – and given that all savings vehicles have a tax exempt element, this is not a bad outcome.
However, council tax is capped. This means that those with large homes and homes in London get a pretty good deal. Furthermore, non-doms are able to invest in residential property and pay no tax on the imputed rent whereas all other forms of investment in the UK would be subject to UK tax. I would suggest that we deal with this problem by abolishing council tax and charging a tax on the imputed rent from owner-occupied housing, calculated at an arbitrary rate of 5% of its capital value. If the tax were 20% (no higher rates), this would be quite a big increase in tax for many people. There would need to be transition arrangements as it could be a struggle for people on council tax benefit and who live in large houses. However, in the long-term this would provide the money to flatten-out the tax system by reducing higher rates and also it would reduce the cost of housing in the long term.
But, it is important that we get our premises correct. If we do not, we will reach the wrong conclusions. Free marketeers will end up supporting a generalised wealth tax when they should be looking at the specific way in which particular forms of consumption – not wealth – are not taxed in the current system. To repeat – and this is vitally important – a wealth tax is a double tax. It is a tax year, after year, after year on that part of our income that we choose to save. How could anybody who believes in a free economy support such a concept?