Tax and Fiscal Policy

Taxation is a black hole

David Cameron and George Osborne may be shifting on “sharing the proceeds of growth” but they can’t bring themselves to “come out” for wholesale tax reduction. Yet my estimate is that two thirds of UK tax simply disappears into a black hole, before the tax is even paid.

How can this be? Basically, all taxes are taxes on trade or exchange. Only do-it-yourself (DIY) escapes. Income tax, company taxes, VAT, and all other taxes boil down to levies on internal trade (there’s nothing else to tax), making a total tariff of almost 50% and rising. And just as international trade tariffs reduce international trade, internal taxes reduce internal trade.

All this is hidden from view, tucked away in the architecture of the economy. For example, most travelling salesmen drive themselves around; lower taxes would make it economic to use specialist drivers – thus creating more working time (and probably safer journeys to boot). In the same way, nannies (except the political ones) are a rarity. And just think what a 50% tax on the division of labour within a household would do. We’d all do everything ourselves – our own washing, cooking, gardening, shopping, and so on, most of it incredibly inefficiently.

So at a marginal rate of 50%, each pound of extra tax payable has already inhibited the division of labour, and the economy (allowing for all costs and benefits) has shrunk by perhaps two thirds of the tax involved. I suggest that this estimate is perfectly credible when one remembers that a total tax rate of 100% would mean no division of labour at all!

Terry Arthur is the author of Crap: A Guide to Politics.

IEA Pensions and Financial Regulation Fellow

Terry Arthur is a fellow of Pensions and Financial Regulation at the Institute of Economic Affairs and has written on this subject for a number of publications, working closely with Philip Booth, Editorial and Programme Director at the IEA.