Saturday, March 13, 2010

Think tanks that can't think.

Oodles of think tanks are churning out articles and papers on the recession and the deficit right now. A think tank called “Reform” has just published a paper entitled: “Reality check: Fixing the UK's tax system".

One of the central claims of this paper is that we should avoid taxes in incomes and employment, and instead, increase indirect taxes (e.g. sales taxes). Reason is that, allegedly, taxes on incomes and employment discourage work and employment. There is a flaw in this argument, as follows.

If the typical employee has to pay £X a year more in direct tax, while tax on the goods that they buy goes DOWN by £X a year, then the typical employee is back where they started! I.e. their real wage per hour’s work is not affected. It is hard to see why this shuffling of tax burden between direct and indirect taxes should OF ITSELF have much of an influence on the incentive to work.

That’s not to say that various changes to the personal or employment tax system cannot influence employment levels: of course they can. For example a flat “per employee” increase in a payroll tax would increase the cost of employing the least skilled. This would probably have much the same effect as raising the minimum wage: raise unemployment.

But that apart, shuffling money between direct and indirect tax does not OF ITSELF influence the incentive to work.

Moreover, even if this shuffling did influence real incomes, the argument is still nonsense because real income per hour worked has no influence on the number of hours people choose to work. For example, real incomes have doubled over the last thirty years, yet people work pretty much the same number of hours per week (actually they work slightly LONGER hours than they used to, according to the last lot of figures I looked at!). And as to international comparisons, real wages in Sweden are double those in Portugal, yet people work much the same number of hours a week in each country!

As distinct from the incentive for employees or potential employees to work, there is the question as to whether a payroll tax reduces the incentive for employers to take on staff. Obviously there is a reduced incentive in the sense that ANY tax on the private sector matched by an equivalent amount of extra public sector spending will shift employees from the private to the public sector. But there is no effect other than this effect.

To illustrate, suppose government raises employers’ contribution to a payroll tax by £X a week and spends the £X on whatever: say road construction. Obviously the £X a week withdraws spending power from the private sector and this is made up for by the increased spending power of the public sector (on roads). Employees will shift from various private sector firms to road building. But there is no affect on aggregate demand or aggregate employment.

If any employer is stupid enough to think that their business has been hit by the tax (over and above the latter “shift to road building” effect) and abandons their business, or contracts it, this will just leave unmet demand, which some other employer can profitably exploit.

Another bit of nonsense in the Reform publication is the following piece of false logic: 1, government spending must be cut to help deal with the deficit, 2, increased efficiency by government would reduce government spending, 3, therefore increased government efficiency would help deal with the deficit.

There is just one little problem here, as follows. Suppose efficiency throughout the public sector can be raised by X%. That means (given constant output from the public sector) that roughly X% of public sector employees are then unemployed! Shock horror: it’s precisely the “recession” or “unemployment” that we are trying to deal with here isn’t it?

But never mind, those spare employees can always be employed by the well known Keynsian cure for unemployment: increasing the deficit. Oh b*gger! That’s torn it. The whole object of the exercise is to REDUCE the deficit. Now we’re right up shit creek.

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