It all adds up

7th April, 2007

Most people reading this column probably believe that taxes are a bad thing, but why? Popular wisdom is that taxes are bad because it’s painful when you pay them. That’s pretty much the opposite of the truth: taxes are a bad thing only when you don’t pay them.

When you pay a pound’s worth of tax, the government collects a pound’s worth of tax. The economy has not shrunk. (It might shrink, if the government then spent the money unwisely – but we’re talking about taxes here, not government spending.)

The problem comes when you don’t pay the tax. If Gordon Brown plans to tax your overtime pay at 41 per cent, you may decide to stay at home. You’re denied your income, and Mr Brown is denied his tax revenue. For this reason, economists like taxes that avoid such problems – which we call ”deadweight losses” – as much as possible. But this leads to some arresting concepts: the rich should pay lower tax rates than the poor, for instance, and there should be a tax on being middle-aged. It’s not as crazy as it sounds.

Take the idea that the rich should pay less than the poor. By this I don’t mean that the rich should pay less of their incomes in tax, but that if the Duke of Westminster earns one extra pound, he should pay less tax on it than I would pay if I earned one extra pound. Organising the tax system in this way reduces deadweight loss. If you raise taxes for the low-income bracket – as Gordon Brown did by abolishing the 10p rate of income tax – then you discourage overtime for people in that bracket. But you collect cash from those earning above the bracket without discouraging work and causing deadweight loss, because their overtime pay will not attract extra tax.

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