Don’t tax sweat – An Independent View from Thomas Colignatus

With our intelligence and enterpreneurship we create micro-chips and send crafts into space, but the creation of jobs for the disadvantaged seems out of reach. The rich countries in the world still have a huge pool of unemployment and poverty at the bottom of society. A close analysis gives the insight that we actually create unemployment and poverty ourselves.

The following table gives the legal minimum wage in the US (dollars), in the UK (pounds) and in Holland (euros) as key examples for the rich world. The table is best understood from the principle of “don’t tax sweat”. That is, workers at the minimum should be exempt from levies.

The Dutch economist A.J. Cohen Stuart in 1889 (120 years ago) gave the perfect analogy: “A bridge must bear its own weight before it can carry a load.” In the same way a worker at the minimum cannot pay taxes since he or she must first earn subsistence. When levies are included then the cost of labour rises above productivity and the worker becomes unemployed – and must be supported by family or the dole.

As we can see in the table, the tax wedge at the minimum is 18.1% in the US, 23.7% in the UK and a huge 48.5% in Holland. This table disregards sales tax (VAT) so that the problem is actually bigger: eg, in the US another 8%.

The US estimate is from own calculation. The UK estimate is by courtesy of Mr Donald Hirsch and Mr Chris Goulden from the Joseph Rowntree Foundation. The Dutch data are from its Central Planning Bureau.

The legal minimum wage means that workers are not allowed to work below that wage. Hence, the taxes and premiums below the minimum wage are not collected either. Thus the tax wedge below the minimum wage is also a “tax void”. Levies are imposed but entirely fictional. The beauty of the tax void is that these levies can also be abolished overnight. What is not collected can also be abolished for free. By a rather simply measure we can create employment opportunities for large sections of the labour force.

Historically the tax void has arisen in three ways. Firstly, social insurance was enacted but this had no exemption, which is a logical error.

Secondly, tax exemption is internationally adjusted for inflation but subsistence rises with both inflation and the general rise in welfare.

Thirdly, over the last decades neo-liberal economists have been emphasizing lower marginal tax rates. This is because economic theory tells us that optimality is found with marginal analysis. For the UK for example the top marginal tax rate was 40% and becomes 50% as of April 2010, and economists tend to argue that this should be as low as possible.

However, this standard theory neglects dynamic changes over time. For dynamic optimality the analysis results into a dynamic marginal rate, that is close to the average rate. Marginal analysis remains important but gives a different conclusion. With high exemption a somewhat higher marginal statutory rate is acceptable as long as the average is acceptable. A full discussion of this can be found in my economic papers. Here it suffices to say that unemployment and poverty came about from an application of economic theory itself, but an inadequate theory. We can now understand how they have been so persistent in our societies that are so rich and creative in so many other ways.

Unemployment and poverty are not external events like earthquakes, but internal results of our economic system. They are evidence of errors in policy making. Since these errors are structural we must look for structural solutions. Within the realm of national decision-making, Montesquieu’s checks and balances of the executive, legislative and judiciary branches have failed.

We need a fourth branch, a scientifically based Economic Supreme Court, that checks the quality of the information used for decision making. The structural neglect of science in the political process has become too costly, not only for unemployment and poverty but for policy making in general.

* Thomas Colignatus is an econometrician in Scheveningen. His website is here.

The Independent View‘ is a slot on Lib Dem Voice which allows those from beyond the party to contribute to debates we believe are of interest to LDV’s readers. Please email [email protected] if you are interested in contributing.

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7 Comments

  • John Condor 4th Apr '10 - 11:43pm

    Great Article! A political party could get a lot of votes and attention by implementing some of the ideas which have been stated here by Mr. Colignatus.

  • Tom Thomson 9th Apr '10 - 12:12pm

    Don’t tax sweat is an extremely important principle that has been consistently igored for at least the last 50 years by all political parties – and even now only the lib dems are coming close (but not close enough) to backing it.

    Tax land instead (Jock Coats) has been the battle cry of the left wing loony class worrier for at least as long.

  • Tom Thomson 12th Apr '10 - 2:58pm

    I didn’t imagine for a moment that it was a call to tax land, my comment was simply expressing my amazement at seeing that ludicrous suggestion in one of the first comments.

    Taxation of income below subsistence level is a nonsense, creates unemployment, discourages part time working, in conjunction with benefit reductions as income increases it creates ludicrously hight marginal tax rates at lower income levels which are a very strong incentive to avoid work and instead susist on benefits, and I can’t think of anything good to say about it. In other words I agree completely with the sentiments expressed in the article, in fact if anything I feel you have failed to mention all the benefits of getting rid of this nonsense in our current tax systems. However, while the idea that abolishing tax on income below this level costs nothing is probably true when all effects (such as increased employment reducing benefit spend and higher incomes leading to higher revenues from indirect taxation) many will read you description as meaning that there is no net effect on revenue from income tax, which is not going to be true since those on high incomes will pay reduced tax as a result of abolishing tax below the threshold unless other thresholds (between different tax bands) or tax rates are changed to compensate (they probably should be so changed along with the raising of the minimum threshold to match or exceed the income needed for reasonable subsistence, since with the current economic crisis any risk of increasing the fiscal deficits of our governments is something to be avoided).

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