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Keith Rankin: Tax Reform - What Not To Do

Tax Reform - What Not To Do

by Keith Rankin

The global financial crisis was caused, in large part, by excessive income inequality. With very high levels of inequality in an industrialised world (ie a world in which the rich make their profits by selling goods and services to the non-rich), the rich have to lend their surpluses to the non-rich if the non-rich are to keep spending. Hence the bubble-like growth of financial assets, globally.

(For our purposes, and for simplicity, we may think of the rich as the top 10% of income earners. Thus the non-rich are the remaining 90%.)

Eventually, in an economy that has a core dynamic of the rich lending to the non-rich, the non-rich default as their collective debits accumulate beyond some tipping point. (The non-rich, collectively, cannot repay their debts to the rich, because the rich earn too much to run deficits. In essence, the rich, taken collectively, refuse to be repaid. The non-rich can only 'repay' the rich - or even pay interest to the rich - by borrowing even more from the rich; borrowing from rich Peter to pay rich Paul.)

This default constitutes a financial crisis. The crisis is over once sufficient correction takes place. The global economy then reverts back to its pre-crisis mode (as it is doing now), until the next default and correction take place. And so on. It's the same boom-bust cycle that was apparent in the capitalist economies in the years from 1850-1914. 2007-09 has echoes of 1907-09.

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It is therefore economically efficient that the tax system operates to address and reduce inequality, thereby reducing the size of the loans that the rich must pay to the non-rich to keep the world economy going, and thereby stabilising the boom-bust dynamic inherent in any capitalist economy with a high degree of inequality.

A key problem is that, at the national level, many tax experts keep arguing that the rich should pay even less tax (which means that they will need to lend even more to the non-rich if the non-rich are going to be able to keep buying the goods and services that the rich become rich - and stay rich - by selling).

This argument, conducted at the national rather than the global level, is one of "competitiveness". (It is an example of the mercantilist fallacy, which treats the global economy as being like an Olympic marathon race, in which the winner produces the most regardless of whom - if anyone - actually benefits from the use of all of the resources consumed.)

If the rich and the companies they work for pay comparatively little tax in some other countries, then those countries will have a competitive advantage over our country. Therefore, the reasoning goes, our country must also reduce taxes for the rich and the companies they work for.

Taken to its logical conclusion, this is the "race to the bottom". The rich will end up paying zero tax as a way of assisting them to win this race for their companies to be more competitive sellers in global markets. Under this mercantilist reasoning, any tax rate can be deemed to be too high. This "commercial system" in which nations race against each other to squander resources is the complete antithesis of "economics" which is supposed to represent economy in the allocation of resources. (Adam Smith's famous 1776 book The Wealth of Nations was principally written as a polemic against the "commercial or mercantile system" of his day.)

If too few taxes are levied (and the most efficient taxes are those which are most consistent with the optimal distribution of resources on the planet) by a country, then the difference between the correct level and the actual level is in fact a subsidy. Substantial taxes are required to fund global and local public and other collective goods, and to fund the transfers required to address the inequalities inherent in a form of pure-market capitalism that bases its income distribution solely around private property rights, hence ignoring public property rights.

When traded goods are subsidised, it is fully consistent with the principles of free trade (indeed it may be a requirement of free trade) that a protective tariff is levied on such goods. Hence our fiscal response to 'cheating' on the part of our trading partners (aka 'mercantile rivals') should be to counter the cheating with customs tariffs rather than to take an "if you cannot beat them then join them" approach.

While there may be some benefits of introducing land taxes as a way of funding the "competitiveness" tax cuts (mooted for example by our latest tax review committee;, our policymakers should look carefully at our substantial history of land taxes and the reasons they were abandoned.

Our policymakers also should pay careful attention to the distinction between "landlords" and "tax-avoiding property investors". A number of landlords only own one home; they rent the home that they are living in while letting out the home they own.

This option - equivalent to but not the same as owner-occupation - is a very important part of economic flexibility. For example it might make more sense for parents with children to buy a small rental property while themselves living in a larger rental house. The parents then have the option to move into their own home when their family size is reduced. For another example, it will often enhance labour force mobility - and hence economic efficiency - if persons can let their provincial homes while renting a home in the city where they are currently employed.

Thus any new tax rules designed to collect more revenue from multiple-home-owning tax avoiders should not apply to a person's first home, whether or not the person is actually living in the one home that they own.

Finally, when considering targeting landlords as an easy source of more tax revenue, full consideration must be placed on the critically important issue of rental housing affordability. If the costs associated with the supply of housing are raised, then the rental value (price) of housing must rise. Government rent controls are no solution. Rather, we could largely see the increased taxes collected going into the payment of increased government accommodation supplements.

From what I've heard so far, the tax review currently taking place is addressing the wrong problem - the need to be more "competitive" relative to our "trading partners" - with solutions that will exacerbate the real problem by aggravating inequality within countries, and by intensifying the race between countries to see who can market the most goods to people who don't need them and can only buy them by borrowing from the vendors. The rich creditors of the non-rich spenders accumulate more income than they themselves are able to spend or are willing to spend, and must therefore lend (mainly through financial institutions) their savings to whoever can be persuaded to spend their surpluses.

The mercantile game is to maximise sales; end of story. We need tax rules that refocus economic activity towards living standards and sustainability; not rules that facilitate mercantile competitiveness.


keith @ pol-econ . com or krankin @
visit for further conceptual analysis of the global financial crisis

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