Would a wealth tax work?

Roll up, roll up! The biannual Lib Dem half-baked tax policy circus is in town! Last time, the so-called ‘mansion tax’ show never lived up to its billing, as ringleader Clegg tried juggling too many ideas. We had the mansion tax, tycoon tax, new stamp duty bands and the more noble income tax threshold rise to watch. Now, it seems, the spectacle is back – with the big beasts of the Liberal Democrats prowling the airwaves to push for a new wealth tax to ensure the rich ‘pay their fair share'.

Unlike the mansion tax, this policy suggestion would not, we are told, be a permanent feature - but rather a time-limited way to fight our ‘economic war’ and ensure ‘national cohesion’. It all sounds a very dramatic spectacle.

With recent polling suggesting Clegg is walking a tightrope with Lib Dem members, it’s obvious he’s learnt from his experience in March: don’t give up on the mansion tax just yet, but suggest something even more left-wing in addition in order to appease the social democratic wing of your party.

But would it work? As many have pointed out, economic literature suggests taxes on property are less distortionary than taxes on income. Therefore, if Nick Clegg and co were offering up an entire well-thought-through redesign of the tax system for a wealth tax to replace other capital or income taxes, we could take it seriously. But they are not. They are after another new tax to make up for the Coalition’s inability thus far to make inroads into current government expenditure.

There are other reasons to object:

We have a spending problem, not a tax problem: Between 1996/97 and 2007/08 average government spending as a proportion of GDP was 38.8 per cent. Last year it was 45.8 per cent. In contrast, tax receipts as a proportion of GDP were last year 37.5% compared to an average 37.6% between 1996/97 and 2007/08. Does that look like a tax problem? Quite simply, we don’t need new taxes. We need lower government spending.

A temporary tax won’t solve a structural problem: The Coalition is trying to eliminate a structural deficit. If the Coalition agrees with the OBR that lots of the deficit is structural, then relying on a temporary tax to plug some of the gap will not help in the long-term.

A temporary tax isn’t very often temporary: The 50p tax rate was the last ‘temporary’ tax. It was never fully reversed, and now people are arguing it needs to be replaced with a wealth tax. Taxes are never temporary, and this would be expanded and increased over time.

Wealth isn’t a fixed pie: we need policies for growth that will raise the living standards of all, not to share current wealth around as our economy continues to stagnate.

The Chancellor will surely see through this nonsense. But the risk is this new act is designed to shift the debate further, and will end up with the Lib Dem ‘mansion tax’ as a compromise.

Let’s be clear: the mansion tax is still a bad tax. The UK already has by far the highest property tax take of any OECD country (property taxes contribute 4.2 per cent of GDP compared to the OECD average of 1.8 per cent). In contrast, a Mansion Tax set at 1 per cent of the value over £2 million would yield just £1 billion (or 0.2% of total tax revenues) at most – but would unfairly target the income poor, equity rich, would be both difficult and expensive to value all relevant properties (and would then be open to huge legal disputes), and would undermine our competitive position at a time when other countries (France’s Socialist government excepted) are abolishing wealth taxes.

What’s more it would not fulfil the Lib Dem definition of ‘fairness’ (that rich should always pay more) because it is a wealth tax that only applies to single properties. It takes no account of whether you have a mortgage to pay. It takes no account of how many homes you own. It ignores the history of your investment. It doesn’t consider other assets or wealth that an individual has.

It is so depressing to have to go through this debate all over again when the priority should be policies for growth. It’s doubly depressing when genuine tax reform proposals could form part of that growth agenda. We need a tax system based around Adam Smith’s principles of fairness, simplicity, certainty and efficiency. Lord Jacobs, a former Lib Dem, has put forward thoughtful contributions for how this can be achieved. He recognises that for economic health and greater prosperity for all, the UK does not need a new complex tax targeted at the aspirational and successful. It needs lower, simpler taxes aimed at encouraging, rather than penalising, wealth.

The Lib Dems should therefore stop clowning around with these current proposals, and instead start jumping through hoops to come up with the desperate supply-side and tax reforms we desperately need.

Ryan Bourne is Head of Economic Research at the Centre for Policy Studies.