21 November 2019

Labour’s manifesto is extraordinary – and not in a good way

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Labour’s manifesto is nothing if not bold.

Jeremy Corbyn and John McDonnell have committed to hundreds of billions of pounds of new spending commitments, part-financed by the £80 billion in tax rises the party outlines in its costings document. Most of these taxes would fall on investment – in total, Labour claim they would increase the revenues from capital taxes by more than 50%.

Altogether, these would be among the largest tax rises on investment and business in British history. Whatever the party’s rhetoric about soaking the rich or ‘the corporations’, the tax rises set out in this manifesto would mean lower wages for workers and slower economic growth.

Corporate raiding

The biggest hike in revenue terms would be to corporation tax, which Labour plans to raise from 19% to 26%. This, it says, would raise an additional £23.7bn on top of the £59.5bn currently raised by corporation tax, effectively increasing the revenue raised by this tax by 39%.

Together with plans to effectively nationalise 10% of every company with over 250 employees through “Inclusive Ownership Funds”(IOFs), this would give the UK the highest corporation tax rate in the OECD. Boris Johnson was right, and the New Statesman’s George Eaton was wrong – Labour would give the UK the highest corporation tax in Europe. The IOFs would also set in place a mechanism by which a Labour majority government could, if it wanted to, nationalise more and more of every company in the UK by increasing the share that had to be part of these Funds.

On top of this, Labour propose to treat dividend income and capital gains income (the money you make when you sell an asset for more than what you paid for it) as normal income for tax purposes, meaning that anyone earning £50,000–£79,999 would pay a marginal rate of 40%, anyone earning £80,000–£124,999 would pay a marginal rate of 45% and anyone earning more than £125,000 would pay a marginal rate of 50%.

These would be gigantic tax increases. Dividends are currently taxed at 38%, and raise £11.4bn – Labour expects to raise an additional £9bn from its tax increases, which would increase the revenues raised by this tax by 79%. Capital gains are currently taxed at 20% (or 28% for residential property, though primary residences are exempt), so the extra £9bn Labour plans to raise would mean a doubling of the money raised from capital gains (a 103% increase).

This doubling of expected capital gains tax revenues comes largely through the scrapping of the Annual Exempt Amount, which currently allows people to ignore the first £12,000 of capital gains that they make, replaced with a de minimis threshold of just £1,000.

This is a much bigger story than the rises to income tax that have attracted the attention of most journalists, up to 45p on earnings above £80,000 and 50p on earnings above £125,000. These would raise £11.4 billion before adjusting for behavioural responses – the increased capital taxes would, by Labour’s calculations, raise £41.7 billion, a 52% increase in the total amount raised by these taxes.

What the FTT?

As well as these taxes, Labour would extend stamp duty on shares to other financial transactions, including most derivatives trades and corporate bond transactions. This is based on the idea that high frequency trading is driven by random market ‘noise’, so taxing it just eliminates an element of randomness from the system. (This is probably wrong.)

Labour claims that this would raise £8.8 billion. However, similar taxes in Sweden and France have raised much less than had been predicted, because their advocates had underestimated the reduction in trading volume that such taxes cause, and the flight of trading to other, less taxed jurisdictions.

These taxes also tend to reduce market liquidity and raise volatility, because small price adjustments do not take place. In France, for example, after the introduction of a financial transactions tax, market liquidity fell by 20% for affected stocks. Revenues were much lower than anticipated — an estimated €475m instead of the €1.6bn that had been predicted – which, in the words of a European Central Bank review, “once again points at an underestimation of the impact on revenue-generating market activity”.

That paper concluded that the French FTT led to less efficient pricing of assets and more volatile price movements, and effectively priced high-frequency trading out of existence altogether in affected shares. “The decrease in volume associated with the FTT hurt liquidity and crowded out “useful” trades [such as those that incorporate new information into asset prices].”

Another revenue-raising measure is ‘unitary taxation’ of multinational profits, in a move they say would raise £6.3bn. This would mean that instead of taxing firms on the profits they make in the UK, firms are taxed on a share of their consolidated global profit determined by a formula reflecting their UK share of global sales, labour, and assets.

While this may be a reasonable move to do in concert with other major economies, for the UK to do so unilaterally would likely freeze the UK out of any economic dealings with the United States, Japan, Europe and China. We would become a pariah.

Both the FTT and a unilateral shift to unitary taxation would also be, in effect, new taxes on capital, meaning that at least £57 billion of the £80 billion in tax rises Labour has proposed would be capital taxes (although, to be fair, the financial transaction tax may end up raising much less than they expect).

High tax, low investment

Why does this matter? Capital taxes are in effect taxes on investment, and investment appears to be highly sensitive to the level of tax on it. The net effect of these measures would be to tax up to 65.5p per pound of corporate profit earned – first 31% taken in corporation tax and the effective tax created by Inclusive Ownership Funds, then up to 50% when taken either as dividends or in capital gains.

Lower returns to investment means less incentive to invest in the first place. Lower investment – less money spent on new machinery, research and development, and other business activity – means lower wages and lower growth.

This is not a controversial claim: most economists, including politically left-leaning economists, believe that in an idealised tax system the optimal level of tax on capital would be zero. (Obviously, we do not live in an idealised tax system, so in practice many believe that some level of capital taxes are a necessary evil – but certainly not a costless way of raising money.) It is not a stretch to say that capital taxation is a not-so-indirect tax on economic growth.

Because business investment raises wages, taxes on investment result in lower wages across the income distribution. Estimates about how much the taxes lower wages vary, but an Adam Smith Institute literature review found that the average empirical result put the burden on workers at 57.6% of the total tax raised. Since that was published, at least two new papers have found that workers bear much of the burden of higher corporation taxes – one finding that they bear 30-35% of the burden, another that they bear 51%.

The Johnson Treatment

It’s rare for the fiercely independent Institute for Fiscal Studies to really lay into a party manifesto, so hearing its Director, Paul Johnson, react to Labour’s yesterday was startling:

“It’s impossible to understate just how extraordinary this manifesto is in terms of the sheer scale of money being spent and raised through the tax system. Hundreds of billions of additional spending on investment, £80bn on spending on day-to-day things…and matched by supposedly an £80bn increase in tax. You can talk about tens, hundreds of billions of pounds – take it from me, these are vast numbers, enormous, colossal in the context of anything we’ve seen in the last…ever, really.

“The Labour manifesto suggests they want to raise £80bn of tax and they suggest all of that will come from companies and people earning over £80,000 a year. That is simply not credible. You cannot raise that kind of money in our tax system without affecting individuals. Now, obviously corporate tax affects individuals anyway, someone has to pay that tax. But if you’re looking at transforming society, which the Labour Party are absolutely upfront about doing, then you need to pay for it and it can’t be someone else doing it, we collectively need to pay for it.” 

He’s right. This is the manifesto of a party that plans on undoing everything that’s happened in the UK since 1979. It is proposing one of the largest tax hikes in history as the first step towards that, and putting in place a mechanism that would let it take ownership of as much of any company as it likes. As bad as Brexit may be for business and growth if it’s handled badly, it’s nothing compared to what Labour’s got planned.

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Sam Bowman is a Principal at Fingleton and a Senior Fellow of the Adam Smith Institute