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Dissecting the budget – off the point

The budget will be discussed and dissected for the next couple of weeks, as usual. People are naturally concerned about how it will affect them. There will no doubt be unintended winners and losers in this annual game. But most of the discussion about the wider economic impact will be off the point, because it ignores the phenomenon of tax incidence: that the individual or body nominally responsible for paying the tax is not necessarily the one who finally foots the bill.

Council tax, for instance, is nominally payable by tenants, but it is the landlord who picks up the tab because the amount of Council Tax cuts in to the rent that the landlord could charge.

Arguably the incidence of all labour related taxes is on the employer – this includes all taxes nominally paid by employees. In other words, functionally, these are payroll taxes under another name, since “Gross Pay” is a purely notional amount. Real wages are the goods and services that people can actually purchase in exchange for the work they do.

Thus, the first effect of income tax cuts is to reduce the cost of labour to employers, and so reduce the incentive to replace labour by expensive capital – supermarket self-scanning is a recent example. It also reduces the incentive to export work – eg Scottish prawns are flown to Thailand for peeling, and then back again. In the public sector, eg the NHS, these taxes simply result in churning. Taxpayer’s money is paid to people so that they can pay tax!

Tax incidence does not end with the employer. Money to pay the taxes nominally paid by employees must ultimately come from customers – it cannot come from anywhere else – and is built into the cost of everything throughout the chain of supply and manufacturing. What cannot be passed on leads to reduced demand and gives rise to deadweight losses, as production does not take place which would have done in the absence of the tax.

Finally, as these taxes cut into profits, companies find themselves unable to pay as much rent as they would otherwise have been able to do. This leads to a general depression of rental values. The incidence of these taxes falls, in the end, on landowners, thereby confirming the penetrating observation made by the French Physiocrats 250 years ago, that all taxes come out of rent.

From which it follows that taxes might as well be levied directly on rent in the first instance, thereby avoiding all the mucking about.