Monday, May 23, 2011

Oh look—a free lunch!

It's one of those great truisms that there is no such thing as a free lunch in economics—only trade-offs. However, over at the Adam Smith Institute blog, Timmy highlights the fact that—like most truisms—this particular aphorism is not always true.
Our usual method of describing this is to mutter about the debt to GDP ratio. As reasonable rules of thumb, below 30% it's irrelevant, once it starts going over 60% we see future growth being constrained, above 100% something really must be done and over 150%, unless you're something very strange like Japan, you're bust.

So, in all our talk about how we're going to deal with the national debt yes, there's room for cutting spending so as to avoid adding to the debt and thus make everything more difficult. But there's also room to increase the size of the economy so as to reduce the ratio. No, not by simply borrowing more and splurging in some hope that the Keynesian Fairy will sprinkle growth dust. But a change in the tax system.

Here's the growth, the extra growth, that could come from a simple change in the way we raise taxes:

Clean income tax is flat rate no allowances, standard flat is with an allowance, transition relief means don't do it all at once.

No, we're not raising any different amounts, we're raising the same amount of tax in a different way. This doesn't mean cutting anything, this is purely the extra growth we'd get by changing the method, not amount, of taxation. As you can see, simply changing the method of taxation could give us a lovely little bolus of growth, one that reduces the national debt as a percentage of GDP and thus reduces the overall problem we face.

We can still do all the other things, or not, as the mood takes us, but this is a free lunch, that rarity in economics. And free lunches, given their rarity, really should be eaten.

As Timmy also gleefully points out, the ASI have been advocating a flat tax for some time...


AntiCitizenOne said...

Which is strange as Adam Smith advocated the one tax not on your list. An LVT.

Mark Wadsworth said...

DK, I used to be a fan of flat income tax, which is clearly better than the current shite, but having thought about this long and hard and looked at actual real life, it is even better to go back to basics, scrap income tax (and all its offshoots, VAT, corporation tax, National Insurance, capital gains tax) and just have Land Value Tax, which has been proven to be far better than flat income tax, and rather bizarrely, even better for the economy than no publicly collected taxes whatsoever.