We don’t need more taxes – we just need to collect them better

“A giant suction pump had by 1929-30 drawn into a few hands an increasing proportion of currently produced wealth. In consequence as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When the credit ran out the game stopped.” 

– Marine Eccles, chairman of the US Fed 1934-1948, on how a fast rise in inequality caused the Great Depression (thanks to David Blake). 

The above quote will have a familiar ring to it. After all, there is a growing body of opinion – and one we have written on many times – that suggests that our own great financial crisis has been caused by pretty much the same thing. See my blog below and these ones from earlier in the year: How the bonus culture caused the financial crisis – and how we can stop it happening againWhy workers aren’t getting their fair share; and Bonus culture is killing opportunity.

Look around you. Look at the falling real incomes of most people and the vast wealth of the top 0.5% of the global population, and you might well end up thinking that the once democratic world has effectively been hijacked by the rich over the last few decades.

Everyone will have their own examples of just how this has happened (banks, central banks and Mitt Romney being the first ones that come to mind – this Rolling Stone article is a must read) but there is a neat one in the US that sums up what we might call ‘political capture’ by the rich.

In last week’s Sunday Times Money section there was an interview with US financial guru Suze Orman. In it, she told us all about how she spends her time between her houses in South Africa and America, how she keeps $2m in cash, likes to hold high-paying dividend stocks and would take stocks over property as an investment any day (“I think it won’t be until 2023 when we start to see real estate as a solid investment again”).

But amid all this sensible stuff there is mention of one investment not available to UK investors – municipal bonds. ‘Muni’ bonds are issued by states and cities to fund various infrastructure projects. She owns bonds from “all over – from Puerto Rico to Pennsylvania”. Why? Simple: she owns them because the income from them is tax free: “municipal bond income is often exempt from federal income tax as well as many state and local taxes”.

This is not a strategy for the poor, of course – “you should have at least $200,000 to invest if you are buying individual bonds”. But if you have the money you can, says Orman – who has 95% of her money in municipal bonds – end up with a tax-free income of 4-5%.
 
Orman isn’t the only one who is on to this. In 2011, 35,000 US citizens with an income of over $200,000 paid no federal income tax at all. They used various wheezes for this, including the charity tax relief that irritates us so much. But how did most of them do it? As Josh Barro of Bloomberg notes, 66% of them did it like Orman does – by receiving all their income as tax exempt interest from munis.

The bondholders will say that it isn’t really they that benefit from the tax free status of the bonds; that all it does is allow US cities to issue their bonds at a lower interest rate than they would otherwise. In that sense it is not a subsidy offered by the central government to the rich, but one offered by the central government to its states and cities.

But that isn’t entirely true. The Congressional Budget Office says that the issuers end up getting about 80% of the value of the tax subsidy. But that still means that about 20% of the subsidy (so about $36bn over the next five years, says Barro) goes to bondholders.

To the outside eye this makes little sense. If you want to subsidise the financial disaster that is local infrastructure (see this week’s magazine for more on this) why do it indirectly with billions of dollars’ worth of ‘leakage’ to the already rich? Why not just subsidise directly? Give cash, or follow Barro’s suggestion of directly subsidised ‘Build America Bonds’. I’ve now spent several hours reading the arguments against this (Google “abolish tax free munis” and you can read the anti-Barro fury for yourself) and I still can’t see the reason beyond because that wouldn’t be nice for people who like to get a tax free income.

It is this kind of thing that makes some people receptive to the idea of the kind of wealth tax that Nick Clegg is suggesting. Everyone knows that both here and in the US the very rich don’t necessarily pay their way. So there might be some satisfaction in forcing a percentage of their accumulated wealth out of them.

But that doesn’t make it a good idea. Why? Our tax system, like that of the US, is complicated and corrupt. Depending on how you define them, you could say that we already have three wealth taxes –inheritance tax (although this could also be defined as an income tax on the recipients of inheritance), capital gains tax (as it isn’t inflation linked it taxes real wealth), and of course stamp duty.

We have also already had a good go at the ‘sort-of-rich’. We’ve taken away income tax allowances from everyone earning over £100,000. We’ve put in place a permanent income tax top rate of 45% (remember the 50% was temporary so in that sense it is the Tories, not Labour, who have raised income tax). And we have pushed up stamp duty on very expensive houses. It is also worth noting that wealth taxes are hideously impossible to calculate and collect – the apparatus needed to do it (inevitably badly) would be huge and expensive in itself.

So what do we do instead? We put in place the ‘tycoon tax’ I thought Osborne was getting at in his last budget (a minimum rate of income tax everyone has to pay). We insist that the super-rich stop using the UK as a cheap portfolio manager via their huge London houses on which they pay no tax. And we get rid of every single loophole there is – from charity tax relief down. Then we stop. We don’t need new taxes. We need fewer taxes  – just better collected.