Skin In The Game: Why Taking People Out Of Tax May Not Be Such A Good Idea

George Osborne: 3.2 million people will pay no income tax by 2015. But is this such a good idea?

UK Chancellor George Osborne: 3.2 million people will pay no income tax by 2015. But is that such a good idea?

A philosophical thread ran through yesterday’s UK Budget linking the historic changes to pension rules with the increase in the amount that workers can earn before they start paying income tax.

It is better for people to have control over their own money rather than it is to let insurance companies do it through pension annuities or government to take it through taxation, the argument goes. And who, apart from the most ardent big-state socialist, could possibly disagree?

The increase in the tax-free earnings limit in particular has been loudly trumpeted by both Conservative Chancellor George Osborne as well as by his Liberal Democrat cabinet colleagues who have been pressing for some time to take ever more people out of the income tax net by raising personal tax allowances. The government said that as a result of this policy more than 3.2 million people will have been lifted out of income tax altogether by April 2015 – a small but significant slice of the electorate.

The knee jerk response of many on both the right and the left of the political spectrum has been to welcome this move – and for the Labour front bench to, at least, resist criticising it.

So, raising personal allowances to take people out of income tax is a universally good idea that should be welcomed, then?

Not quite. There is a flaw in this approach which if continued will ultimately result in significant negative economic and political consequences. And it comes down to a combination of psychology, economics and political advantage.

Insidious

Reducing taxation – that is cutting the cost an individual “pays” for state services – might, according to the ordinary laws of supply and demand, be expected to increase demand at the margin for certain “discretionary” services.

Now it is important not to be too simplistic about this. The issue, of course, is that in the UK most public services – health, education and the police, for example – are seen as free-at-the-point of-use already. So it would be absurd to suggest that people taken out of tax will visit their doctors more frequently, have more children to exploit “free” education or start phoning their local police station on a regular basis, simply because they have been taken out of income tax.

However, there is a more subtle and insidious way in which demand will increase. People will start to ask for greater state spending on these services – more doctors and nurses, more schools, more police officers – if they do not see any direct cost to themselves. And who could argue with the logic of that? Why not demand a new hospital closer to where you live and smaller class sizes for your children if someone else will have to foot the bill, rather than you?

All politicians, particularly those on the left, will find it difficult to resist promising greater spending on a group of voters who will receive the benefits but will not see the costs.

It is also important to remember that just because someone pays no income tax does not mean that they pay no tax at all, since there will still be value added tax on sales and duties on alcohol, tobacco and fuel, for example. However, it is the case that the direct link between an increase in state spending and the money that an individual pays for it out of his or her own pay packet is broken when people are taken out of tax.

But is gets worse. For research reveals that we view “free goods” in a special light and that demand for free goods does not increase smoothly in line with the supply and demand curve but actually jumps hugely when a good is zero priced.

Zero is a special price

In a 2007 paper (see below) researchers in the US and Canada showed that “zero” is a special price and that demand for a good increases disproportionately if its perceived cost is reduced to nothing as compared with reducing it to small but non-zero amount. The implication for politics is clear: demand for greater state spending will grow hugely among those who do not feel that they have to pay for it – for those who believe the price of extra services as “zero”. On this logic, we would be well advised to ensure that everyone pays something – however little – and that no one sees increased state services as a cost-free or zero priced option for themselves personally.

We are creating a climate in which politicians are encouraged to promise to spend more and a proportion of voters are incentivised to elect them confident in the belief that someone else will pay. The danger is that we are constructing a one-way ratchet that will, over time, increase rather than decrease the size of the state. Worse, the growing reliance on someone else, an easy to label group of others – “the rich” – to pay will increasingly result in a divided Britain as more are lifted out of tax and more is asked from those higher earners left in the system.

False choice

The great investment guru Warren Buffett coined the term “skin in the game” to explain his belief that a business performs better when its bosses have invested some of their own cash into the enterprise. This logic has been spread throughout many companies via employee share ownership schemes. And there is a case for suggesting that what is true of business is also true of the nation as a whole.

With the freedom to vote comes the responsibility to choose, and some options inevitably cost more than others. To remove the link between the benefits associated with a particular option and the costs of choosing that option is to offer a false choice and risk dividing the country between those who benefit and those who pay. This psychology has been partly responsible for driving the growth in government debt over the last half century as society spends more now while leaving future generations – who had no choice in the matter – to pay later.

There is a moral case for saying that we should all have to pay a little more  when we decide to vote for policies that increase public spending. Taking people out of tax may sound like a good idea but we risk becoming a poorer, more divided nation that is lumbered with a larger, insatiable and growing state if we continue with this policy.

Far better to ensure that each earner pays some income tax, however small.

Far better, that we should all benefit when income tax falls and that we should all pay more – even if it is just a tiny amount – when it needs to rise.

Far better that everyone has some skin in the game.

Source

Zero As A Special Price: The True Value of Free Products by Kristina Shampanier of the
Massachusetts Institute of Technology, Nina Mazar and Joseph L. Rotman from the School of Management, University of Toronto and Dan Ariely of Duke University, Durham, North Carolina published in Marketing Science Vol. 26, No. 6, November–December 2007, pp. 742–757 and available here.

Spare a moment…

If you found this article thought provoking or informative then please take a second to Like it and share it with friends and colleagues via social networking using  the buttons below.  And if you enjoy reading this kind of article then press the follow button!

Advertisements
Comments
One Response to “Skin In The Game: Why Taking People Out Of Tax May Not Be Such A Good Idea”
  1. Thomas says:

    “However, there is a more subtle and insidious way in which demand will increase. People will start to ask for greater state spending on these services – more doctors and nurses, more schools, more police officers – if they do not see any direct cost to themselves. And who could argue with the logic of that? Why not demand a new hospital closer to where you live and smaller class sizes for your children if someone else will have to foot the bill, rather than you?”

    That’s a rather simplistic point of view, as you go on to say, income tax isn’t the only tax people pay. Policing and Fire and Rescue Services for example are funded through Council (Poll) Tax which everyone now pays regardless of their actual income (even the much derided unemployed) so increasing the number of police officers or firemen as a public demand would be fair if it were required, as everyone IS footing the bill through regressive taxation; In this regard, these services are not “free” by any stretch of the imagination and is therefore a fallacious argument.

    The logical extension of your argument would seem to imply that everyone should pay more tax, which whilst laudable, however, it is noteworthy that the Conservatives have reduced income tax at the lower AND higher ends, something which you appear to gloss over as interestingly you make a detailed argument for not lifting people out of the income tax bracket at the lower end, but you make no mention of the Tory plan to reduce the number of people paying the higher rate of 40p for having an income roughly four times higher than someone ostensibly not paying tax.

Comment

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

  • Copyright © 2014. iExpon Limited
  • Enter your email address to follow this blog and receive notifications of new posts by email.

    Join 81,676 other followers

%d bloggers like this: