The following article by me appears today on the ippr New Era Economics blog, but as it’s as relevant here I cross post it here, in slightly fuller form.

“Tax theory and practice, like so much else in current economic thinking, is narrowly constrained within a restricted set of parameters defined by the assumptions of neo-liberal economics. The Mirrlees Review — subtitled 'Reforming the tax system for the 21st century' — just published by the Institute for Fiscal Studies is an excellent example of this. After undertaking a review of contemporary tax practices around the world it then recommends policies that are entirely in keeping with the prescriptions of the Washington Consensus.

Hence, indirect tax is favoured over direct tax, tax simplification is offered as mere mantra, and corporation tax is only accepted with the very greatest of reluctance as a matter of pragmatism. Capital in general, and savings in particular, is afforded special treatment because, it is assumed, capital is mobile and so must be subject to special tax considerations to allow for the fact that it might otherwise flee at will. The result is not a tax system for the 21st century but one that looks suspiciously like a regime that supports an economy that failed so spectacularly in September 2008.

It is not possible in a short article to fully outline what a better, progressive future tax system should look like, but it is possible to suggest several principles on which it might be based. Tax is assessed for five reasons:

1. Raising revenue
2. Re-pricing goods and services in accordance with social objectives
3. Redistributing income and wealth
4. Raising representation by being the consideration in the social contract between the electorate and the state, as a result of which most people participate in the democratic process
5. Reorganising the economy through fiscal policy.

Neo-liberal thinking attributes most weight to revenue raising, believes that market repricing should be kept to a minimum, and for all practical purposes fails to recognise the other three purposes of taxation. Progressive taxation policy need not accept these neo-liberal assumptions and should instead question whether tax has considerably greater potential than hitherto appreciated in delivering solutions to wider economic problems (other than the need to raise revenue).

This is of particular importance with regard to repricing capital and labour through the taxation system. At present capital is favourably taxed in most taxation systems. Tax rates on corporate profits are low. Significant incentives for saving are provided throughout the UK tax system and capital income is entirely exempt from national insurance charges — providing it with a tax rate differential when employer’s national insurance contributions are taken into account of more than 20 per cent at some income levels.

Consequently, the overall returns to capital have been improving within the economy without their being any real indication that capital is being used to better effect in generating real economic returns. At the same time, returns to labour as a proportion of GDP have been declining and unemployment has been rising. If ever a clearer indication of the need for a revised model of re-pricing through the tax system to meet social objectives were required, this obvious imbalance between capital and labour is it.

A radically new and progressive approach to taxation is therefore, in my view, needed. This has to be based on principle in both strategy and design if it is to work. Those who support the low taxation of capital argue pragmatically that labour is immobile and as a result can be taxed more heavily than capital. But they ignore the fact that the capital returns of individuals who are resident in the UK can be taxed just as heavily as returns to labour if tax is charged on tax residents on a worldwide basis, subject to two conditions applying.

The first is that there needs to be automatic information exchange between countries to ensure that data on the location of capital is easily obtainable. The second is that there must be a robust policy towards those countries that refuse to cooperate. Both requirements now have political momentum behind them and this suggests that there is now good reason for considering reintroduction of a tax long forgotten — the investment income surcharge — which imposes an additional income tax rate (historically 15 per cent) on investment income above a set threshold. This would eliminate the distortion inherent in the tax system against labour and would remove, in very large part, the incentive to recategorise labour income as capital through the use of private limited companies.

In addition, it is time to recognise that the assumption that capital is mobile is just that: an assumption and it is clearly false. Capital can only earn a return, and be employed profitably by productive enterprise, when invested. As Keynesians correctly posit, savings do not necessarily equal investments. Without exception, investments are made where people are employed, customers are located and physical capital is engaged. It is rare that these locations are the same as those where savings are hidden away from the attention of tax authorities.

A progressive taxation policy must recognise this geographical and economic dichotomy, something which to date is has failed to do. Investment needs to be re-priced to encourage the fruitful use of capital within our tax system but no commensurate benefit to encourage saving is required because the two are independent of one another. This has massive implications for tax policy. The incentives for saving need to go. What we need are incentives for capital creation. At present, we have far too few of these.

This last point suggests another essential reform. It is currently financial capital that is incentivised through our taxation system, but that capital is just one of the forms that progressive economists recognise. It is very clear that the UK under-invests in human, social and public sector capital but the current tax system does little, or nothing, to redress these imbalances. The result is an excess supply of savings in proportion to the demand for capital for financial investment in the production process, but a shortage of capital for all other purposes. Unsurprisingly, this excess supply of savings is, in the absence of tax incentives to redirect it, ‘invested’ in activities that are subject to asset booms and busts and entirely unrelated to the generation of real worth in the economy.

The tax system promoted by neo-liberalism is, seen in this light, far from the neutral paragon of virtue that the Mirrlees review suggests it to be. Instead it exacerbates pre-existing weaknesses in the UK economy. Radical taxation reform is therefore needed if the social objectives any progressive economist might suggest desirable are to have chance of being delivered.

Any consideration of the future economy has to put the reform of the tax system at or near the core of its agenda.”