Black Holes & Pots of Gold

“Full fiscal autonomy”: blessing or curse?

•It would mean Scotland’s government must raise all its own revenues to finance what it spends.

•But the IFS predicts a £7.6bn “black hole” for 2015/16 (8.6% of Scotland’s GDP against 4% for UK)

=> Options: 1. Borrow more?

2. More austerity? 3. Faster growth?

1. Borrow more? = More debt; higher interest rates?2. More austerity?

= More spending cuts and/or higher taxes?3. Faster growth?

- How?? (i) More borrowing?

(ii) Less austerity?

Neither option tackles the debt crisis.

So, can they produce the sustainable growth that is a precondition for achieving the SNP’s declared goals?

The SNP’s declared goals

• Dynamic but sustainable growth• A living wage, with full employment• Social solidarity and fair distribution• Work incentives / less welfare dependency• Enterprise incentives• High environmental standards• Greater fiscal responsibility/ independence

Can these goals be achieved with conventional fiscal policies?

• Do they address the debt problem?• Do they tackle boom and bust?• Do they address both fairness and incentives?• Do they guarantee faster growth?

Can they be achieved through what is currently thought of as “land reform”?

• What is land? And how radical is the SNP’s definition and related reform proposals?

• The First Minister claims it is a radical reform that will make Scotland’s land “an asset that will benefit the many, not the few.”

• The focus is on rural “community buy-outs” and “trusts”.

• But “Land” is not just crofting land. Nor even just agricultural land.

• It is the whole of the natural universe, other than man himself and man’s products.

• It includes all the earth’s surface (including the sea), and the natural resources on, above and below that surface.

• Thus rural “community buy-outs” barely scratch that surface.

• These buy-outs (Assynt, etc) invariably require subsidy: the Scottish Land Fund has about £3m a year for this.

• But even £100m a year would be small relative to the value of all crofting estates.

• Nor can favoured crofting communities resist increased competition from commercial farms, or the pull of the cities, or the impact of wider environmental degradations.

• Even where successful, they may disadvantage the unsubsidised communities.

• Thus “Land”, properly and comprehensively defined, includes North Sea oil, though the value of this finite resource is highly volatile; and it may be economically depleted by 2040.

• Far greater is the (non-depleting) value of the land on which our towns and cities are built.

• Like all land, urban land is fixed in supply and place. => Adam Smith: “The landlord loves to reap where he has not sown”

=> David Ricardo: “Land is the free gift of Nature”

“The landlord loves to reap where he has not sown.”

but

Ricardo’s “free gift”

• Our planet has had no labour cost of production. • But demand exceeds the fixed supply of land –

space and natural resources• This means that Land commands a market price and

annual rental value, dependent on its locations.• This price or rent is a pure surplus over its (zero) cost

of production (but it’s a necessary rationing device).• This surplus value rises secularly, as demand for

land increases with growth of population and GDP.

• Values are greatest where natural resources are most easily extracted.

[Less and less true of the North Sea]• … or where amenities are most abundant, notably in

our cities.• The social infrastructure – the transport system,

schools, hospitals, etc. – yields rising rents to owners of surrounding land but is largely financed by taxpayers.

• But, more generally, rents are created not by land ownership but by people working in cooperation - and investing also in private capital: shops, offices, factories, theatres, houses.

• And this cooperative action creates not a depleting but a sustainable flow of social income, in perpetuity.

• This is a natural, community-created surplus after workers and entrepreneurs have been paid the going rate of wages for their labour, and the normal rate of profit on their use of man-made capital.

• All of this means that Scotland has no choice but to go beyond conventional fiscal policies and piecemeal “land reform”. For these do not address the underlying causes of poverty.

• If we cannot spend our way out of crisis and dependency we must instead embrace systemic change based on a more radical fiscal reform.

Radical Fiscal Reform

• But radical reform is actually an option available under the Smith proposals, notably the power (i) to abolish income tax (ii) to replace those tax revenues with revenues from the rental value of Scotland’s land.

• These rents are community-created values. Surely, then, they are the most natural and ethically defensible source of state (community) revenue.

The Principled AlternativeSo the principled alternative we propose is the

replacement of taxes on earned incomes with a unique charge on unearned economic rents.

This would lay the foundations for the democratisation of the public’s finances.

The key principle is that people should be free to keep what they create, and pay for what they receive.

Instead, this is how things went wrong:

Taxation up; Rents privatised

Adam Smith’s “peculiar tax”

“[Rents] are a species of revenue which the owner, in many cases, enjoys without any care or attention of his own.

Though a part of this revenue should be taken from him in order to defray the expenses of the state, no discouragement

will thereby be given to any sort of industry.

The annual produce of the land and labour of the society … might be the same after such a tax as before.

[Rents] are, therefore, perhaps, the species of revenue which can best bear to have a peculiar tax imposed upon them.”

• Adam Smith’s insight calls into question the need to accept the IFS’s gloomy “black hole” predictions under full fiscal autonomy.

• The IFS base their projections on continuance of current funding policies.

• They fail to consider the offsetting gains to GDP (transforming the fiscal balance) if Scotland embraced Smith’s “peculiar tax” instead.

• A full audit of the fiscal implications requires some idea of the full costs of current tax policies.

• Those costs are the “excess burdens” or “deadweight losses” of taxes.

• The potential gain to Scotland from a radically reformed fiscal system is measured by the scale of these deadweight losses.

• They include the disincentive effects of taxes on work and enterprise; plus the distortions on resource allocation and patterns of expenditures.

• These losses are absent if the state instead raises revenue from a charge that inflicts no damage on producers and consumers. That is, one in which

“the annual produce of the land and labour of the society might be the same after such a

(“peculiar”) tax as before.”

“deadweight loss ratios”

• IFS: Their estimate is 30%. But they count only the collection costs

• Martin Feldstein: 78% - 206%. He counts the losses in wealth and welfare for every extra $1 raised in income and social security taxes.

• Mason Gaffney: 100%. This he regards as a reasonable average estimate of deadweight loss per $1. (So do we.)

Some of the disincentives and distortions of conventional taxation

• Unemployment and under-employment of labour and capital; and of land too.

• Distorted relative prices, => inefficient allocation of resources and expenditures.

• Low wages to workers; high wage costs to employers.

• Speculative purchase and holding of land.• Boom-bust cycles.• Unaffordable housing. • Poverty and inequality => conflict, crime and

drugs.

• Furthermore, these burdens reduce market size. This means less specialisation.

=> Adam Smith again: “The division of labour

is limited by the size of the market”

Increasing the Wealth of Nations

Freedom increases market size => increased specialisation increased growth => increased specialisation

=> further growth

Thus this freedom should yield a benign process of cumulative and self-sustaining growth.

But the restrictive burden of destructive taxes reduces both the creation of wealth and its rate of growth.

It converts a virtuous growth path into a cumulative vicious circle of slow growth.

So our 1:1 deadweight loss ratio may be too conservative.

• As a party that asserts its “progressive” credentials, wouldn’t the SNP wish to replace deadweight losses with net gains?

• So how could we achieve these benefits? • As a first step, the government could zero-rate

the Income Tax. Under the powers devolved to Edinburgh in 2015, control over the Income Tax, alongside the existing control over property taxation, makes such a reform possible.

• The net gains are shown in the bottom row in Table 1.

• Replacing the Income Tax with revenue raised through rental charges would deliver an annual net gain to Scotland of circa £11bn.

Scotland’s Finances Under Competing Scenarios: £bn

2013–14 2014-15 2015-16 2016–17 2017–18 2018-19 2019-20

Net Fiscal Balance (IFS Projections) -3.8 -5.9 -7.6 -8.2 -8.5 -8.9 -9.7

Net Gain to GDP from Zero-rating Scotland’s Income Tax 11.5 11.5 11.5 11.7 11.9 12.2 12.4

The gains to GDP – based only on replacing the projected income tax revenues under the current fiscal system with land rent charges instead – would easily convert fiscal deficits into fiscal surpluses. Even greater gains would arise from replacing VAT etc. And there would be no sacrifice to current public services; but plenty of scope for increases. And the “ATCOR” principle ensures that rent revenues would be more than adequate as replacement for taxes.

Conclusion

Black holes can indeed be turned into pots of gold!