Let's talk about national insurance

Most people think rich people should pay more tax than poor people. There are at least three reasons for this. First, governments have to get their money from somewhere, and if everyone paid what poor people are able to pay, there might not be enough to run the government. Second, a given tax bill will do more damage to a poor person’s standard of living than to a rich person’s, so you can minimize the damage by having poor people pay less. Third, some people think it’s fair for rich people to pay more.

There are several ways of having rich people pay more tax. We tend to do this by taxing people more if they have higher incomes, although income and wealth aren’t the same thing. Taxing income instead of wealth doesn't really make sense to me, but maybe it's because it’s easier for rich people to avoid wealth taxes. But there are also different ways of taxing higher incomes more.

You can have a flat tax, so people pay in proportion to their income. 20% of a million pounds is more than 20% of ten thousand pounds. But that’s not what countries normally do. Normally they have what’s called a progressive tax. A progressive income tax is one where people with higher incomes pay a higher proportion of their incomes. The income tax in the UK is a progressive tax. Here are the rates:

You don’t pay any tax on the first £11,000 of yearly income, and then you pay 20% of the next £32,000, 40% of the next £107,000, and 45% of anything after that. People with higher incomes are paying higher rates. People making under £11,000 aren’t paying any income tax at all.

A progressive income tax has the “rich people pay more” effect to a greater extent than a flat tax does, and so leftwing people tend to like progressive taxes. Leftwing people these days also often call themselves “progressives”. As far as I know, this is a coincidence.

Now, as well as a flat tax or a progressive tax, there’s also the theoretical option of a regressive tax. You could just reverse the numbers in the table above: people pay 45% of the first £11,000, 40% of the next £32,000, 20% of the next £107,000, and nothing on income after that. Rich people are still paying more, just to a lesser extent. (Well, very rich people are all paying the same if the top rate is 0%. But very poor people are all paying the same, i.e. nothing, under the existing set-up. It still counts as rich people paying more than poor people.)

A regressive tax would probably be pretty unpopular. People would think it wasn’t fair, and to raise enough money to run the government you’d have to collect a lot of money from poor people, with inevitable damage to their quality of life. So it might surprise you to hear that the UK - the very same country that has the rather progressive income tax we talked about earlier - also has a very regressive tax. It’s called National Insurance. It doesn’t have the word “tax” in its name, but it’s still a tax. Here are the rates for employed people:

Eagle-eyed readers will have noticed that £155 a week is a lot less than £11,000 a year, so while the poorest workers aren’t paying any income tax, they’re still paying plenty of national insurance. £827 a week does also put you more or less on the cusp of the basic and higher rates of income tax, which I suppose counts for something. But the fact remains that the UK has a progressive income tax which politicians and journalists talk about a lot, but makes up for it with a regressive tax that they hardly talk about at all. I don’t know if other countries do this, but it certainly seems odd. It’s hard to see what ideology a government could have which would motivate levying both taxes.

Before the 2015 general election, David Cameron said he had raised the personal income tax allowance a lot. “That is three million people taken out of income tax altogether”, he said. And I suppose that technically it was, but they were still paying plenty of tax on their income and their marginal rate was still 12%. So what Cameron said was a little bit misleading.

I think it’s very likely that the reason we have a progressive income tax and a regressive employment-income tax to make up for it is because the government and the electorate don’t agree on how progressively they want income to be taxed, and so the government divides the tax into two and mostly talks about the one that sounds less nakedly plutocratic. Maybe that’s not why they do it, but I’d at least like an explanation.

Piketty and Paul

Regular readers will know that I’m pretty leftwing, but that doesn’t mean I’m blind to the fact that people respond to financial incentives. Sometimes people on the left get viewed as thinking we should act as if financial incentives didn’t really affect people’s behaviour much, and if this idealization results in a bit of inefficiency then you just have to suck it up. At the extreme that sort of thing might lead to something like communism, but maybe some lefties who aren’t communists are guilty of the idealize-and-suck-it-up mindset too. But I try not to be.

Given this, I think it’s a bit of a shame that we pay people to be unemployed, even though we don’t want people to be unemployed, and we charge people for earning money, even though we want people to earn money. (In case you can’t tell, I’m talking about unemployment benefits and income taxes.) The thinking behind these prima facie wacky policies is that if you don’t pay people to be unemployed then the unemployed will starve, and if you don’t charge people for earning money then you won’t be able to raise enough money to run the government. In the past I’ve expressed an interest in the idea of replacing unemployment benefits with a universal basic income that you give to employed people as well as unemployed people. But what about income tax? Is there a better way to raise money?

First let’s remind ourselves why income tax is such a shame. Suppose I’m rich and I’d rather have Lancelot Capability Brown landscape my garden than have £100,000, and Brown would rather have £80,000 than not landscape my garden. In an ideal world, I’d pay him somewhere from £80k-£100k to landscape my garden: it's a win-win situation. But if there are income taxes, the state will probably charge us so much to make this transaction that it isn’t worth either of our while to make it. I don’t get my garden landscaped, Brown doesn’t get his money, and the state doesn’t get anything out of it either. That’s no good. And everyone knows it’s no good, but we can’t think of a better system, so like the hypothetical lefties I mentioned earlier, we just suck it up. Where income taxes apply, people don’t just work when they value their time and labour a bit less than the employer does; the employee has to value it a lot less, so they'll still both be happy with the deal once the income tax is factored in.

What’s the alternative? Well, on the face of it, maybe it’s wealth taxes. If the wealth’s going to get taxed at the end of the year whether I have it or Brown has it, then transferring it to him doesn’t cost anything, and the inefficiency goes away. If I value his time and labour more than he does, we do the deal. I don’t know whether libertarians like wealth taxes – they sometimes seem to talk about sales taxes as better than income taxes, which I don’t really get – but I think there’s a case that they should. Libertarians don’t like the state charging people to engage in harmless activities, and that includes employment. With a wealth tax, the state’s taking some of your money anyway, but for the money you’re allowed to keep, you’re equally allowed to give it away. I’m not a libertarian, but I like freedom as much as the next person, so this seems like a nice feature. There’s also a case that libertarians shouldn't even see wealth taxes as a necessary injustice, because the state is the body enforcing continued property rights over people’s wealth and so it’s only fair for it to take a cut. (I sometimes wonder what would happen if big countries insisted that tax havens bear the burden of enforcing the property rights and contracts officially under their jurisdiction. Maybe Luxembourgish police officers would have to travel the world chasing up second-hand books people bought on Amazon and never received.)

So what’s the problem? Why are modern democracies nuts for income tax, while often having no wealth taxes at all? (Unless you count inheritance tax, which is a bit like a crude wealth tax.) Maybe it’s because they wouldn’t work the way I’m imagining, which is perfectly possible; my understanding of this stuff is pretty basic. Or maybe it’s because wealth taxes would hit the wealthy more than income taxes do, and so they use their wealth to stop it happening. Or maybe it’s because income tax is the only one people can’t rampantly avoid. I remember when Thomas Piketty’s book came out and he was pushing wealth taxes, he thought they’d need a lot of multilateral co-operation, and maybe he was thinking about avoidance. If that’s all it is, though, it seems a real shame, and economic libertarians are arguably the people who should be most bothered by it. Maybe if Rand Paul becomes US president then something will be done.