3rd Week Tax from scratch

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Economics focus

Tax from scratch

A new report lays out a blueprint for the ideal tax system

Nov 11th 2010

“DEATH, taxes and childbirth! There’s never any convenient time for any of them,” wrote Margaret Mitchell in “Gone With the Wind”. There may also be no convenient time for radical tax reform. But the global recession, which reduced tax receipts even as it forced governments to spend unprecedented amounts to prop up their economies, has left government budgets across the rich world in tatters. Many countries will have to make some changes to their tax systems as a result. A group of economists, headed by Sir James Mirrlees, a Nobel-prize-winning founder of the modern theory of optimal taxation, this week urged governments to do more than tinker at the margins.

The economists acknowledge that taxation always imposes economic costs, both because money is needed to collect taxes and because it distorts people’s consumption and work choices. But in a review of Britain’s tax system from the Institute for Fiscal Studies, a think-tank, which was released on November 10th, they argue that most governments could find a way to raise the amount of money they need from the tax system while imposing much lower costs than they currently do.

The economists propose a tax system with three main features. It would be progressive (that is, it would place a larger burden on richer people); it would not discriminate between income earned in different ways; and it would be simple. Such ideals are not new, of course, but Sir James and his colleagues contrast them with Britain’s current system, which they describe as being marked by “a jumble of tax rates, a lack of a coherent vision of the tax base, and arbitrary discrimination across different types of economic activities”. Other rich-world countries also fall short.

Most income-tax systems are already progressive, and who could disagree with a simpler system? The challenge lies in reconciling these principles. In practice progressivity has tended to imply more than one rate of tax, for instance, which is necessarily less simple than a flat tax rate. The Mirrlees review has some useful ideas on how to square the circle: indeed, perhaps its biggest message is that thinking holistically about the tax system helps resolve some of these conflicts. It is the system as a whole that needs to be progressive, not every single tax.

For example, Britain and Ireland currently justify not charging value-added tax (VAT) on a number of “essential” products like children’s clothing on the ground that doing so would hurt the poor, who spend more of their income on these goods. But such a system distorts people’s choices. Moving to a single rate of VAT without exemptions would eliminate this distortion but it would also be regressive. No matter, argue the economists: far better to have undistorted consumption choices and to fulfil the government’s redistributive aims more efficiently through the income-tax system. The report reckons that the British government could get rid of most reduced- and zero-rate VAT, compensate those whose welfare was hurt and still have ￡3 billion ($4.8 billion) left over. As Richard Blundell of University College, London, points out, one of the more redistributive societies on earth, Denmark, does pretty much what the panel recommends.

The Mirrlees review also has some interesting thoughts on progressivity itself. This is usually taken to mean that people who earn more should pay a larger share of their income as tax. But the economists argue that people whose income is temporarily low—perhaps because they have taken time out to study—often borrow and therefore consume more than their immediate income would allow. Basing taxes partly on expenditure rather than just income would therefore go some way towards the ideal of progressivity over a person’s lifetime. How that might be implemented is a different question entirely.

The economists also worry that many tax systems, including Britain’s, do not provide enough incentives for people to work. Here they recommend a departure from simplicity, urging governments to use the tax system to target incentives to those who will be most responsive. This might involve making tax rates conditional on certain demographic features such as age. Mothers of school-age children, for instance, could be urged back into the workforce by changing the way child tax credits are structured, making them more generous when the child is younger than five and less generous afterwards. The authors reckon that this change could increase employment in Britain by 52,000, or 0.2%. Similarly, using the tax system to give those nearing retirement age a bigger incentive to keep working could increase employment by 157,000 and add ￡2 billion to British national income.

The report also argues that the costs of generating income should not be taxed. This has some interesting implications. Since forgoing consumption in order to save money can be thought of as the “cost” of future income, the report suggests that the normal, or risk-free, return on saving should not be taxed, but that returns above this amount should be taxed exactly like other income. More generally, the report says tax systems should not differentiate between income earned in different ways—between working for someone else, say, and self-employment.

But will it happen?

The economists are well aware of the enormous political difficulty such reforms would face. But they argue that elements of the optimal tax system already exist in some countries. The report advocates a corporate-tax deduction equal to a fraction of a firm’s outstanding equity, which is designed to remove the bias towards debt finance when interest is deductible. James Poterba of the Massachusetts Institute of Technology, a member of the group, points out that this concept has been implemented in several countries, including Brazil, Austria and Croatia. Even if few governments are likely to undertake wide-ranging reform of the type the group advocates, having an idea of what a better tax system might look like is no bad thing.

Finance and Economics

YOU, THE CONTROLLER

Is the Microsoft Kinect even more family-friendly than the Wii? Tom Standage investigates ...

From INTELLIGENT LIFE Magazine, Autumn 2010

Controllers—who needs them? That’s the idea behind Microsoft’s Kinect system. Previously known by its much cooler codename Project Natal, Kinect is essentially a camera that plugs into the Xbox 360 and lets players control games using just the movement of their bodies. As the old name hints, Microsoft hopes the Xbox will be reborn as a family-friendly, easy-to-use console—more like the market-leading Nintendo Wii, in other words.

The Wii’s leap forward was replacing complicated buttons and joysticks with a motion-sensitive controller that you just wave around. Kinect does away with controllers altogether and replaces them with you. This is not a new idea. The EyeToy, which does something very similar on Sony’s PlayStation 2, has been around for years without setting the gaming world on fire. Kinect is supposed to be much cleverer, capable of things like voice and facial recognition, as well as body tracking. But will it translate into exciting new games?

The games lined up for the launch are a mixed bag. There’s “Kinect Sports”, an obvious nod to “Wii Sports” (the bestselling video game of all time). It too consists of several activities, including bowling, ping-pong and boxing, some of which work well, while others resemble technology demos. Similarly, “Kinect Adventures”, a set of mini-games, is reminiscent of “Wii Play”. Microsoft has also demonstrated driving games (move your hands to steer) and a “Star Wars” game (wave your arms around to kill bad guys with a lightsaber). Wii-like yoga and virtual-pet games are in the works.

Although these games look great, they do not seem to have depth. True, the same can be said of a lot of Wii games, many of which do little more than demonstrate new ways to use the controller. But the Wii has enough games which transcend the novelty value and draw you in. Kinect’s strongest candidate in this regard is “Dance Central”, in which players mimic the moves of on-screen dancers in time to songs of different eras, from “Push It” to “Poker Face”.

Shigeru Miyamoto, the resident creative genius at Nintendo, knew the Wii would be a hit when he saw Nintendo’s elderly directors, some of whom had never played a video game before, jostling to try a prototype of its tennis game. As Wii owners know, even granny can be persuaded to wave a virtual tennis racket (and she may well win). But not everyone wants to get down to Lady Gaga. If Kinect is going to take off, it needs a game that can pass the granny test.

Kinect  November, ￡130/?150/$150, incl “Kinect Adventures”

(Tom Standage is editor of Economist.com. His last gaming article was on cheating.)