… I wish to use it on the VAT argument. Remember that what Policy Exchange put out on VAT was not something like this:
“Did you know that if income taxes were flat and the world was like the following thought experiment then VAT would not be any different from Income tax?”
Instead, from the FT story, which influences the world’s policy makers, we have:
Policy Exchange … said modelling and academic research showed the idea established in the 1970s and 1980s that VAT was less damaging than income tax was no longer valid. “We found that, contrary to what is widely assumed amongst journalists and politicians, increasing VAT would be more damaging to economic growth than increases in the basic rate of income tax,” the report concluded. … Politicians should consider restructuring taxes by raising the basic rate of income tax and cutting VAT, it said.
It is a claim that their paper proves this particular point, and as such needs to be taken seriously. More seriously, I dare say, than a straightforward thought-experiment that clearly misses out essential features of how the tax system works. The people behind this report are very bright and honourable; they know that they need to treat the world as it is. Empirical data on how consumption taxes affect growth may help ….
I don’t like arguments from Authority, as you may be able to tell. People with 20 years in academia are capable of reaching very different conclusions. Such authority is no vaccine against having badly thought-out views, but merely a great anaesthetic against the stings of criticism that are their best antidote.
But in this case, I find that referring to what the OECD has found in cross-country regressions on tax rates is rather useful. It is not just “politicians and journalists”, as the PX press release misleadingly implies, but serious economists too. And the paper is a recent one, not from the 1970s or 1980s.
Here is the table that justifies their view that:
The results of the analysis suggest that income taxes are generally associated with lower economic growth than taxes on consumption and property … These findings suggest that a revenue-neutral growth-oriented tax reform would be to shift part of the revenue base towards recurrent property and consumption taxes and away from income taxes, especially corporate taxes. There is also evidence of a negative relationship between the progressivity of personal income taxes and growth.
The OECD’s findings are about how things work in practise. Economics as a profession earns its lowest reputation when it is accused of taking a “that’s all very well in practise, but how does it work in theory?” approach. If your theory produces results that are blatantly at odds to the findings, and go against a lot of conventional wisdom, perhaps the right thing to do is question the rather-too-neat theory.
On the question of a more theoretical approach, here is my second argument from Authority: Greg Mankiw, arguably one of the most influential economists around because of his widely read textbooks, and ex-advisor in Bush’s first term. A supply sider – someone who cares for growth more than social justice, I should think:
From a strictly economic standpoint, a VAT is great. It is essentially a flat consumption tax, like the so-called FairTax, but implemented in a way to reduce compliance problems. Because it is collected in stages along the chain of production, rather than all at the retail level, tax evasion is more difficult. If you look at the economic effects, a VAT is similar to the Hall-Rabushka Flat Tax, which many economists love. … My bottom line: If I could replace our current tax system (including the personal income tax, corporate income tax, payroll tax, and estate tax) with a VAT, I would gladly do it.
That is from an anti-tax Republican.
Let me be clear: I am not blindly pro-VAT. I recognise the social injustice, and would and will argue for these to be mitigated should it rise again. But defending it with oversimplified analogies, a blackbox model and mischaracterisations that go against the evidence has not, in my humble view, advanced the argument.
Now back to the Budget ….
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