What should be taxed? Not wealth and land, if we can help it.

By Paul Goodman
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The debate about replacing the 50p income tax rate with a new mansion tax was bubbling away when I went to France a week ago, and I found it still doing so on my return.  While I was away, David Willetts lined up with Vince Cable - who also wants a land tax - on the 50p rate, Eric Pickles came out against a mansion tax.

So disagreement exists within political parties as well as between them.  (Nick Clegg seems to believe that a mansion tax should replace the 50p rate.)  I hereby enter it in the friendly spirit that has pertained to date, moving gradually from abstraction to reality.

To begin at the beginning: what should be taxed? Nothing, say anarcho-capitalists and anarcho-libertarians of one kind or another.  But most libetarians concede that there must be a state, however small, and that the state must levy taxes, however minimal, if only to ensure that security is provided and order maintained.

Very little - or a lot not very much - add many conservatives, acknowledging that the state must also tax to ensure the provision of public services for those who can't work because they're too young, old, ill, destitute or disabled.

A bit more, say some other conservatives, perhaps because they believe that higher taxes will fund more public services, at least in the short term; or because, like Willetts, they think that “it is very important that people see that when times are tough, we are, as they say, all in it together".

A bit more still, at least in some areas, say others, as - in this gradual journey from abstraction to reality - they worry about how to cut the deficit, boost economic growth, and "tax income less and wealth more".  This is Tim's position: he wants, if the tax burden can't be cut overall, to rebalance the tax system.

This returns us to my original question, and raises another.  First of all, what should be taxed in the first place? Second, is there a strategic alternative to trying to boost growth by rebalancing the tax system - in other words, by cutting the rate of increase in public spending still further.  And if so, how?

Let me deal with the first question today.  (I am taking it for granted that the Government should also be pursuing a package of measures to boost growth.)

Tim's order of economic damage wrought by taxation is as follows, going from least damaging to most damaging:

• "Sin" taxes.
• Wealth and property taxes.
• Taxes on pollution.
• General expenditure taxes.
• Income taxes.

I have scoured the comments on his pieces about rebalancing the tax system in search of other types of taxation.  I'm sorry if I've missed any suggestions but have spotted none to date.  So I will refine his categories slightly and juggle his order, as follows.

• "Sin" taxes.
• Taxes on pollution.
• Wealth taxes.
• Property taxes.
• General expenditure taxes.
• Income taxes.

You'll have spotted that I've separated wealth and property taxes, and the reasoning for my order of all six tax types is as follows:

• "Sin" taxes such as alcohol and cigarette taxation can harm shopkeepers and help smugglers - proof that no form of taxation is without its downside.  However, if set at the right level such taxes can strike the delicate balance between deterring people from health-damaging smoking and drinking (or at least encouraging them to switch to less harmful forms of fags-and-booze), discouraging smuggling and raising revenue which will help fund public services or allow taxes to be cut elsewhere.

• Some businesses pollute, and taxing them for doing so will presumably reduce the profits of a wider variety of firms than those that either produce alcohol or cigarettes or sell them.  But pollution has its own costs to the taxpayer: to property that must be cleaned up, and to people who must be treated.  And taxing pollution encourages businesses to switch to cleaner technology. (P.S: Since carbon dioxide isn't a pollutant, the debate about taxing CO2 emissions is a separate one.)

• I write wealth third into my list of most damaging taxes - they are fourth on Tim's - with a reluctant pen and a heavy heart.  Tim quotes Ross Douthat's support for taxing the  "reckless, unproductive rich" approvingly.  But experience suggests that the state isn't expert at distinguishing between the reckless and unproductive rich and their productive brethren.  Wealth taxes are likely to drive both abroad to places where taxes are lower - to the long-term cost of everyone else.

• All wealth involves property, but is all property really wealth?  If so, a person on a relatively low income who part-owns and part-rents his property must be judged wealthy.  While I admit that such a person has a stake in capital, I contest the claim that he's wealthy by western standards.  It therefore follows that a wide tax on property - such as removing the CGT exemption - wouldn't be a wealth tax in the sense that a mansion tax would be.  It might even be less economically harmful.

• There is a case for arguing that wealth taxes and property taxes are even more damaging than general expenditure taxes.  Conservatives usually believe, as Tim and I do, that taxing income discourages greater productivity, higher earnings and more prosperity.  It therefore follows that taxing the fruits of that income - capital - will have much the same effect.  But very high expenditure taxes for all would presumably wreak wider economic damage.

• It's not just Conservatives who think that higher income taxes can yield little extra revenue, if any.  Vince Cable thinks so, too: glance back to his remarks about the 50p rate during a fringe meeting at the last Liberal Democrat conference.  His case for retaining the rate, echoed by Willetts, is a purely political one.  I understand the politics.  But what about the economics?  Uncompetitive tax rates threaten everyone's wealth.  Which is why I've argued that George Osborne must ditch it.

So if some taxes have to be hiked in order to allow others to be cut, I would be very reluctant to go down the route of new taxes on wealth, property or income, and take the road first of taxing pollution and cigarettes/alcohol more heavily.

If some taxes have to be raised so that income and business taxes can be reduced, I would even weigh the merits of a further small rise in VAT.  There is an obvious objection to choosing this general path: namely, that expenditure taxes fall disproportionately on poorer people.

To which an answer is: the social security system exists to protect people in genuine need - and it would need to respond if that need grew greater.  But there is a better one - namely, that the Government should aim to cut the growth in spending faster rather than raise taxes further.

That said, I don't see how the spending review can now be unpicked without Ministers' reputation for competence and decisiveness being fatally damaged. In the longer term, however, I think there is an alternative to debating the niceties of which taxes should be raised so others can be reduced.

I will set it out tomorrow.  But offer this warning first.  You will like it even less than the prospect of higher taxes on wealth and property.  Which is probably as it should be.  None of these choices are easy if the deficit is to be cleared - and Asia isn't to eat our breakfast and dinner along with our lunch.