The dangerous attraction of wealth taxes

I’ve written about the deceptive attraction of wealth tax in my Telegraph column today, and I wish I was wasting my time. Once, you could say it was an idea so flawed that it stood no chance of getting into government. In the coalition era, there is no such thing.  Tory ministers will wave through an idea they regard as nuts because the Lib Dems want it, and that coalition is about compromise. Political horsetrading has supplanted rational economic debate, and if the Lib Dems want a wealth tax there is a horribly high chance that Osborne may give way — as he almost did over Mansion Tax. Not because he is weak, but because that’s how this coalition works. Here are my main points.

1. The idea of a wealth tax is superficially attractive. You pick something — property, or even all assets — and say that the state will take 1 per cent of the value of this every year. And you use the money to cut taxes on income. It seems fair, as wealth is certainly distributed far less equally than income, and use the money to help the low paid. Two of writers whom I greatly admire, Tim Montgomerie and Janan Ganesh, have spoken in support about the general idea, and I can see what attracts them. As Tim tweets: would I rather save the money of a £2 million homeowner, or give it to a striver? It’s a no-brainer: if that were a genuine choice, I’d tax the rich guy and lift the burden from the poor guy. But taxes never quite work out the way you think.

2. Denis Healey agreed with Tim Montgomerie when he was Chancellor, and his experience is instructive. A wealth tax (a kind of Mansion Tax writ large) had been on Labour’s wish list since the 1950s and was in its 1974 manifesto. The case was clear: 1pc of the nation held 33pc of the wealth. Couldn’t they pay a little more? But when it was tried in government (and announced in a Green Paper) it had to be abandoned. We now know why, thanks to declassified Treasury memos unearthed by the LSE (pdf) and published last year. Healey was delighted to be told by Treasury officials that they’d get right to it:-

“Although there will of course be many problems to be resolved we see no reason why a wealth tax should not be introduced reasonably quickly

Within a year, the headlines on these memos had changed to stuff like ‘Wealth Tax — possible exodus of UK capital’ a warning that it just wasn’t doable. Healey wanted to squeeze the rich “until the pips squeak” but even he worked out how naive he had been about advocating a wealth tax without thinking of the practicalities. In his 1989 memoirs, he he had this to say:-

“Another lesson was that you should never commit yourself in Opposition to new taxes unless you have a very good idea how they will operate in practice. We had committed ourselves to a Wealth Tax: but in five years I found it impossible to draft one which would yield enough revenue to be worth the administrative cost and political hassle.‟

3. Practical problems of wealth tax. Think about a Mansion Tax: do councils externally value every house? Do they factor in who has a massive mortgage and who has none? Who would do that, and how much would it cost? How about those who have massive mortgages: are they taxes as much as those who have none? Indications are that a Mansion Tax on properties over £2m would bring in under £2bn, a Treasury rounding error nowadays. Is it really worth re-rating everyone’s houses for such a paltry sum?

If you want a broader wealth tax, do you tax just the UK-held assets? If so, people will move their investments abroad. Or tax worldwide income? If so, much-needed foreign businessmen would stay away. As these problems became more apparent to the Treasury in late 1974, they admitted to Healey that his wealth tax would have the following likely impact:-

‘1. It will lead people to seek non-resident status, result in a considerable outflow of funds in the form of dividends and interest.

2. Since it will apply to all wealth held world-wide foreign employees in foreign companies resident here would be subject to tax. This would result in a big movement of banks, insurance and shipping business moving out of the UK.

3. Assets held here would be affected. This would reduce the level of business in UK’

4. That’s why wealth tax has been abandoned all over Europe. Dumped by Austria, Denmark and Germany in 1997, by Finland, Iceland and Luxembourg in 2006 and by Sweden in 2007. These countries ditched the wealth tax to get more revenue, not less. If the world was too mobile for wealth taxes in the 1970s, just imagine what it’s like now.

5. Osborne probably thinks a mansion tax is a daft idea, but he’s not 100 per cent in control of economic policy. If he was, he wouldn’t have gone along with a mansion tax in the last Budget to assuage Clegg (until David Cameron stopped it.) Perhaps Osborne thought it would collapse under its own contradictions (that the hassle of evaluating everyone’s house would be too much). But after this year’s Budget, the Treasury needs to recover its reputation for competence. It can’t really afford the instability of announcing something it needs to scrap later.

6. Osborne will now have learned: never work with children, animals or new taxes. They never behave the way you think. The surprise North Sea raid led to a 50pc drop in exploration. His last Budget became defined by pasty taxes, granny taxes etc – and this stunned him. Since his 7 per cent stamp duty on properties over £2 million, the effect has been stunning. Forthcoming research from Savills has this to say: ‘since the 2012 budget we have seen sales in the £2.0 million to £2.2 million price bracket fall by 29 per cent, whilst those between £1.8 million and £2.0 million have risen by 37 per cent.’ Does anybody think the Treasury factored this in, when projecting how much money its new tax would make?

The 7pc stamp duty, of course, was just to assuage Clegg. It is a bad, ineffective and hugely distorting tax brought in so Clegg could have something to show his party members: precisely the mechanism through which  a wealth tax could emerge. Even the Institute for Fiscal Studies attached the 7pc stamp duty:-

“To see another Chancellor increase again such a poorly designed and distorting tax does not bode well for tax reformers. It will now cost at least £140,000 in stamp duty to buy a house worth more than £2 million. That may not cause much popular outcry but the problem is that this will do even more to lock people into their current housing.

I met a Londoner recently who said he now afford to move thanks to this stamp duty, so was staying put in his six-bedroom house, even now that the kids had left. This is just one tiny example of the unintended consequences of new taxes.

Osborne will have a few people urging him to tax wealth, many of them on the right. He should resist this. There is a good reason that pretty much everyone in Europe has dumped wealth taxes. A gamble with wealth tax would be the biggest Tory fiscal mistake since the Poll Tax.

7. If I believed that a wealth tax was workable, I’d back it too. My heart does not bleed for millionaires, but so often the people who end up getting hit are middle-income taxpayers who are already confronted by living costs, etc. The worst mistake you can make in politics is to judge something by its intentions, not its results. And if the result of a policy is to chase away the super-taxpayers, leaving everyone else to shoulder a heavier burden and retarding growth, there can be nothing progressive or compassionate about a wealth tax.

8. The last word ought to  go to Geoffrey Howe and Keith Joseph in a pamphlet they wrote the last time a wealth tax was a popular idea in 1977. It feels odd referring to the seventies to make a point about 2012, but it really has been a while since these ideas have been advocated. Here’s what they had to say about wealth tax:

‘We will have no part in introducing a wealth tax in the United Kingdom. We can see that if there were an opportunity in an ideal and simplified world to redesign the entire tax system, there might be a place for a wealth tax instead of other capital taxes. In Britain today, with its multiplicity of different ownership patterns, varied investment forms, property rights and existing taxes on capital and investment, we believe a wealth tax is out of the question. Either it would be crude and unjust, leaving a mass of loopholes to be exploited by the ingenious, or it would be equitable and level handed, in which case it would be extremely expensive to run.’