Thursday, 16 August 2012

Two points on taxes

They’re not all that recent but can come in handy any time. The first one is on the progressivity of taxes and transfers, while the second one is on the morality of tax evasion. A well informed reader would probably guess instantly (based on the vividness of the ongoing debates) that the first one is concerning the US, while the second one is concerning the UK. And he or she would be right. 

A post by Gerg Mankiw a month ago introduced a different perspective on the unfair income tax debate. It shifted the attention from low taxes on the 1% of high income earners to the high transfers received by the rest of the public. He got the numbers from a recent CBO report on the distribution of income and taxes. 
"Because transfer payments are...the opposite of taxes, it makes sense to look not just at taxes paid, but at taxes paid minus transfers received. For are taxes less transfers as a percentage of market income (income that households earned from their work and savings): 
Bottom quintile: -301 percent
Second quintile: -42 percent
Middle quintile: -5 percent
Fourth quintile: 10 percent
Highest quintile: 22 percent
Top one percent: 28 percent 
The negative 301 percent means that a typical family in the bottom quintile receives about $3 in transfer payments for every dollar earned.  
The most surprising fact to me was that the effective tax rate is negative for the middle quintile. According to the CBO data, this number was +14 percent in 1979 (when the data begin) and remained positive through 2007. It was negative 0.5 percent in 2008, and negative 5 percent in 2009. That is, the middle class, having long been a net contributor to the funding of government, is now a net recipient of government largess."
However such a brief overview has its flaws as Nancy Folbre notices on Economix. She stresses that the lowest quintile's numbers are biased since they contain the most numbers of retirees, young children and the disabled, which explains why they receive really high net government transfers. Also many retirees that are receiving Social Security or Medicare now were net contributers before, distorting further the temporary numbers. She also points out that the value of net transfers is measured inaccurately, since total transfers include both state and local govenment transfers, while taxes are only federal taxes. Taking this into account the middle quintil would surely be positive, which Mankiw also notes in his update to the post.  

The post nonetheless diverts the reader's attention into taking a different approach in thinking about the progressivity of the tax system in the US. One should also look at the transfer side, which will show a net value of contributions given and entitlements received from the federal (and state and local) government offering a more precise inquiry into the US (re)distribution of income. 

The second point comes from Tim Harford in the FT, a couple of weeks ago, and is regarding the morality of tax evasion. Harford reacted to the following statement from a UK Treasury Minister David Gauke: "Getting a discount with your plumber by paying cash in hand is something that is a big cost to the Revenue and means others have to pay more in tax. I think it is morally wrong."
"And if I agree to pay cash in hand, am I helping the plumber to evade tax?

Economically speaking, the plumber is helping you to evade tax. Lawyers and accountants look at the legal responsibility for paying tax and that lies with the plumber. But economists look at something called “tax incidence”, which is who ultimately bears the cost of the tax. A tax on plumbing might well increase the post tax cost of plumbing far more than it lowers the post-tax wages of plumbers.
...Assume that most plumbing work is not price sensitive: if the lavatory is leaking, you pay to have it fixed, whatever the cost; at the same time, nobody has cheap plumbing work done for the joy of a bargain. Assume also that the supply of plumbing services is quite elastic; if plumbing becomes more profitable, more plumbers will arrive from Poland and prices will fall; if plumbing becomes less profitable the Polish plumbers will ply their trade elsewhere...If these assumptions are broadly true then any tax on plumbing would ultimately be paid by consumers, not by plumbers. Tax evasion would help consumers themselves, not the plumbers.
....So tax evasion is really a blue-collar crime, then?  
No, I think that is wildly over-interpreting. But it is certainly not the exclusive preserve of the Monaco set. One important thing is missing from the HMRC definition of “tax gap”, however. It’s an estimate of how much tax is demanded yet not paid. But remember that how much tax is demanded is itself a function of opportunities to evade tax. If multinational companies are footloose, for instance, governments may offer low rates and generous tax breaks. The tax gap would then be small on paper but large relative to the taxes the Treasury might fantasise about levying."
Read the whole text, it's really interesting.

In terms of liquidity and access to finance problems surrounding UK businesses, prompt cash payments can prove to be very helpful. So I don't see any issue of morality in offering discounts to pay in cash, particularly in uncertain times of today. It helps the small and medium-sized businesses access money faster and adjust to the market conditions quicker. If invoice payments are late, liquidity is low, and bank loans are scarce and /or impossible to get, it is only normal for a small business to ask for cash to survive. In fact, it would be immoral from the government to force them to do otherwise, especially in a situation where they are ones increasing uncertainty and making the situation harder. 


  1. it's a great idea to look at taxes as a net value of contributions to the government. However it is often too hard to do so since you have to take into account that many of those who are now recipients of transfers were contributors before. In a life cycle I don't think anyone can be a net negative taxpayer, as all those transfers in retirement almost never equate the total amount of taxes paid in a lifetime.

  2. Harford makes an excellent point there! Gauke's argument is ridiculous, particularly in the perspective of businesses like plumbing. Besides if he really wants to tackle tax evasion, he should start with multinationals, not plumbers, as I certainly doubt they are in the category of worse offenders to the HMRC.

  3. There is no moral hazard in paying cash to the plumber as it is totally his responsibility to pay the tax (yes I understand the user is actually paying). In other words. He may pay it or not, The user does not even know.

    As to the first part of the article. I would like to see a comparison done on households instead of individuals and include state and local tax as well as FICA payments.