Friday, March 16, 2012

Peak Taxes?

In TMM's careers there has been no shortage of talking heads calling something a "peak". We've had "Peak Oil", "Peak Housing", "Peak Demographics", "Peak Credit", "Peak Deficits", "Peak Liquidity" etc... All of which come down to some assertion (whether valid or not) that said "thing" cannot go any higher for some sustainability reason. And readers will know, the UK is something of an obsession for TMM given they reside there, so ahead of the Budget - especially given the various calls to drop the 50p tax/introduce a Mansion Tax/introduce a Tycoon Tax etc etc - they decided to have a bit of dig. And TMM reckon that they've spotted another peak: Peak Tax. Or more accurately, Peak Tax Revenues.

Much has been said and written over the years about the cultural willingness to pay higher tax rates in Scandinavian countries, and the relative lack of willingness in Anglo-Saxon countries. TMM do not want to start a political debate about either, and generally consider themselves to not be particularly wedded to any political ideologies having voted for all the main parties in the UK from time to time. They are guided by the pragmatism: if something works, then it's worth doing. Which is why they think this particular subject is important. Because whether or not one believes some form of progressive redistribution is a good thing or not (for the record, TMM do), you can only spend what you reasonably expect to raise in revenues over the cycle.

And this is where the problem lies, because since the mid-1960s, the UK has only managed to raise an average of about 35% of its GDP in taxes (see chart below, blue line), with variations largely being driven by the economic cycle. By contrast, it is clear that expenditure has been on a pretty consistent upward trend (red line), rising to 43% of GDP. Since the mid-1970s, the expenditure share of GDP also oscillated roughly around the same 35% of GDP level, and from the mid-1980s in a counter cyclical manner (Keynesian automatic stabilisers). But then something went wrong. Instead of falling in the aftermath of the 2001 mid-cycle slowdown, expenditure continued to rise and well, you know the rest of the story...

Now, calls for wealth taxes, hikes in corporation taxes and higher income taxes etc all might seem reasonable ways of raising revenue. Except, the evidence in the UK would suggest that they don't. Because over the past 40-odd years the UK has had many different types of tax regimes and combinations of various types of tax rates, ranging from income surtax at 83%, high corporation tax and VAT to low versions of all of the above (see the below chart). Despite all these different types of taxes being tried in many different ways, the overall tax take as a share of GDP has barely budged. It appears that the only reason that taxes on production have increased is due to VAT hikes over the years, which obviously, are really taxes on consumers rather than on companies. Of course, that then reduces the amount of money consumers have to spend on things which may or may not be a good thing as far as rebalancing goes, but it is evidently a regressive tax. It is of some irony to TMM that the highest ever tax share raised came under Mrs Thatcher in 1982.

TMM digress. The gist here is that TMM reckon that the UK has hit Peak Tax Revenue at a cyclically-adjusted 35% of GDP. And that going forward, expenditure will have to take this into account. Because under TMM's pragmatic approach, Keynesian counter-cyclical stimulus during a deep recession would kind of, you know, be nice. It is a shame that the UK has been unable to do this properly as a result of the mistakes made between 2001 & 2007.

The point TMM are trying to make is that it really doesn't matter what the Right do with 50p tax rates or the Left scream about for justice and retribution, the most any of them will receive is a cyclically-adjusted 35% of GDP. Expenditure will have to take account of that no matter which party is in power. A corollary, but well beyond the scope of this post, is to what extent do the various tax approaches/combinations affect the rate of GDP growth, the numerator in this equation. Meanwhile, we are sure that Ed Balls and George Osborne will continue to be the source of many column inches as they fight over the wheel of a ship that is not actually connected to the rudder.


CV said...

Brilliant post TMM, I am jealous. In fact so jealous that I will steal this idea.

So here is the research question;

What is the cyclically adjusted tax/GDP revenue run rate for OECD economies relative to their expenditures? And how much more can be squeezed out?


Secret--Sauce said...

Interesting stuff. Perhaps Team Macro Malthus would consider an alternate sequence; namely, it is the slowing of GDP growth (or - eek - economic contraction) that will lead to lower tax receipts and thus force lower expenditure. In such a case, taxes/GDP could remain constant, or even rise. (As an aside, Zimbabwe has one of the highest ratios in the world, and it ain’t because they got great taxmen.)

There may also be a generational psychological issue. Those that lived during the great economic expansion of the last few decades are used to rising expenditure since rising GDP led to higher tax receipts, basically kicking any potential problems down the road. Now, we are in an entirely different situation, but try explaining to a 66-year old about to retire that we have to cut benefits and/or time for a few more years in the salt mines.

But What do I Know? said...

I wrote something about "peak revenue" regarding US tax intake last year and I think some people thought I was crazy--I guess that means that we're on to something :>)

"Cassandra" said...

TMM - While few would wish to return to the days of Mssr Heath & Wilson, it is worth making a few observations. First, is that the proprtion of revs from regressive taxes (VAT & Fuel Duties) has substantially increased during a time when, for the lower quartiles, real incomes have been stagnant to falling. Second, is that drops in wealth and income components during the 70s reflected what one might call "shared pain", of high marginal rates AND massive whacks to asset prices themselves, in comparison to the present era where asset prices (bonds, shares and in particular real estates) have vaulted upwards coincidental to historically lower rates of capital gains, income and property levies. Granted, the government has, until recently been increasing its redistributionary efforts to compensate, but hasn't raised the offsetting revenue in order to pay for it. Morevoer, monetization during times of financial repression only further rewards existing asset owners (and even more those asset owners with leverage) at the expense of labour. Now one can argue (as the right has) that its expenditure which needs to be reined in, but one should note that in the absence of better distributed incomes, such transfers are likely required to keep the UK from becoming the Sao Paulo-of the Northern hemisphere as wealth pools in ever increasing eddies (See Robert Fernholz's recent paper with his son attempting to prove the nearly unstoppable feedback loop over time in the absence of countervailing policy like progressive taxation). "Growth-oriented" policies in this context, i.e. those that support more employment (hence less direct transfer) would tend towards both cutting government spending AND VAT as well as the low and median marginal rates while raising windfalls on unearned asset inflation, and the highest marginal earners, though probably not in excess of what one call Peak Taxes. It seems to me that increasing VAT, cutting redistribution, lowering the highest marginal rates and allowing assets to inflate and remain undertaxed and incomes to further bifurcate will have a corrosive and a deterministic end, and it isn't pretty - either economically or socially. Got your own private army yet??

Anonymous said...

Interesting points Cassandra.

I've given this some thought recently. I don't know if I'm way wrong, or stating the obvious.

I think the major factor behind the general increase in debt (and therefore assets) is the trend of coalescing income into the top 10%, 1%, 0,1%, 0,01% earners. This puts downward pressure on aggregate demand, leading to anemic growth. CBs react by lowering interest rates, but it only leads to increase in the debt of the losers of the income disparity trend and corresponding increase in assets of the winners of this trend.

I think the major problem is that the wealth redistribution program has failed to access capital income. Capital can flee to tax havens, people can't. As a result they are taxed more. But higher taxation will eat into middle class primarily, undermining aggregate demand.

The share of taxation as % of GDP fails to rise because as the wealth (and income) coalesces, larger part of it is capital income. The growth stays anemic, because middle class income is eroded from both ends: Wages stagnate and/or taxes increase.

You're free to laugh at me now.

Anonymous said...

...the problem of not sleeping enough. Managed to parrot someone who stated it more eloquently. Should always remember to read before you comment.

"It seems to me that increasing VAT, cutting redistribution, lowering the highest marginal rates and allowing assets to inflate and remain undertaxed and incomes to further bifurcate will have a corrosive and a deterministic end, and it isn't pretty - either economically or socially."

Anonymous said...

This blogpost and comments deserve mainstream play.
Top Notch! Keep it up.

Anonymous said...

Brilliant post! Seen same empirical evidence from other countries as well and the rate seems to fluctuate around 1/3 there as well. From the low income worker to the global multinational company, they all find ways of doing business more effectively with higher rates, from bartering to legal entities in different countries.

Amplitudeinthehouse said...

Another week ahead.Big run in still in whats it's this week?

More jawboning, blah blah..

the market still sits there...

More jawboning,,blah blah blah blah blah blah blah blah blah blah!

Steve said...

We have a very similar phenomenon in the US, a subset of total tax revenues that you refer to in this post.

In the US, income tax revenues as a proportion of GDP has remained very stable since at least the 1950s if memory serves, at about 19%.

Interesting, and reassuring I suppose, that those results show up across the pond.

Leftback said...

This isn't Macro, strictly speaking, but AAPL has become a large component of overall market cap, and it just made itself into a <2% dividend stock. So it offers more yield than CSCO or IBM but less than INTC or MSFT.

Whether that matters or not here really depends on which large shareholder block is now the most important for price action. Real Money or HFs? One assumes that both groups can do elementary mathematics.....

Minty said...

If you get Peak Oil etc then is this kid the peak of paranoia? Found it quite funny all the same, anyone know which bank he works for?


Steve said...

Cassandra, Anonymous 2:21,

I've been thinking about this over the past few months too. Somehow it seems like a reasonable assumption to presume that uneven wealth distribution is one of the factors for our economic ills.

I think the jury is out on this (there are other potential causes), but what to do? I will speak an an American: over 47% of Americans pay no federal income tax. (We also have no national VAT, though we do have sales tax that depends on individual states: call it 7.5%)

Do we create a welfare state to redistribute income, paying out tax collections to prop up the bottom half?

It's a baited question of course, and I don't have any alternatives.

Leftback said...


Break up the largest banks, bring back Glass-Steagall and appoint a really hungry young prosecutor to help enforce the laws of the land. Eliminate the blatant criminality that supports salaries at the top, just by enforcing the laws on the books and add on a few strategic luxury taxes, that would go a long way towards reducing the rampant inequity in the US.

It is time to call time on the Second Gilded Age and rein in the American ├╝berclass, which now exceeds even France in the reign of Louis XIV in its sense of entitlement, its gaudiness, arrogance and tasteless excess.

As for the welfare state for 50%, well, it is pretty much already in existence. Most people don't see it b/c their contact with poor neighborhoods is limited. But you can see it in the Food Stamps data, or right at the checkout in the supermarkets - not in Greenwich or Scarsdale, but not far away, in places that Betty Bankster and Henrietta Hedgie would fear to tread. The US is a giant electronic Soup Kitchen, my friends. All you have to do is get out there on foot in America and look, and you can see the truth quite easily.

CV said...

Some very interesting issues being raised here. I am with LB and Cass in spirit, but the problem is that it is always very difficult for a bloated state apparatus to claw back money and assets it has already willingly/unwillingly ceded to a minority upper class.

"Enforcing the laws of the land" won't do it I am afraid. You need some very aggressive progressive wealth taxes which in the current system and with our current "democracy" seems very difficult. I.e. the asset holders are largely in collusion with the wealthy if they are not one and the same.

I am from Denmark where equality is high and I can tell you that it is very difficult to tax more there, BUT the state apparatus is still extremely over-bloated and unsustainable.


Anonymous said...

You might want to dig into the seminal work on this subject, The Laffer Curve anyone?

Let's not forget what level of taxation has to be maintained just to get at 35% of GDP... it's a soul-crushing amount of taxation that robs the economy of its motivation and industry. So, while you might be getting a consistent 35% of GDP, it's 35% of a smaller and smaller pie. What genius! Why didn't I think of it?

But, let's also not forget that for you redistributionists, taxation is not about generating revenue to meet necessary operating costs - it's about radical egalitarianism.

Ask the French, Russians, Vietnamese, Chinese, Cubans, Cambodians, North Koreans, etc. how that "radical egalitarianism" worked out for them...

Peak Tax (actually, Peak Revenue) is an interesting topic - but you should really give appropriate attribution to Arthur Laffer.

CV said...

Ah, that old chesnut (the laffer curve) ... Sorry, but this is hocus pocus (written originally of a napkin I believe).

So, the laffer curve states that beyond some point the bang for the buck in terms of taxation reaches diminishing returns. I agree, BUT it is also used to argue that you can LOWER taxes and increase revenue through "dynamic effects". I would HIGHLY contest this.

So, the key is one of balancing revenue with expenditure. If there is a natural limit to the level of tax revenue that a government can sustainably claw in as a percentage of GDP, then the backdrop is that expenditures must match.

Drawing curves on napkins, taxing the rich etc etc won't solve a structural overspending problem.


Anonymous said...

Is the reason why Messrs Osborne and Balls are fighting for the wheel of the ship not decide to raise or lower revenue generated but to decide how the revenue generation is split amongst the population?

Leftback said...

Trickle down economics has always been a Laugher. That you, Arthur?.

Poelinggb Yuette said...

If you had the choice between taking out $40,000.00 of your inherited cash which is part of a larger IRA to pay off debts (but did not have to sell stocks to get that $ & your tax bracket is $15% but perhaps less since I am on SSD & earn less than 14,000.00 a year) or take out a 9% re-fill on a 2nd home, which is being rented for $1000.00 a month that will be sold in 3 years with a contract)- is it as simple as comparing interest rates to decide that a 9% re-fill is a better deal than a 15% deal? ( the 9% is non-negotiable as I can only get a "no doc/no asset loan" at that 2013 tax bracketsunfortunately)or are there other matters to consider.