Ricardo's Law: House Prices and the Great Tax Clawback Scam

By Fred Harrison

Presenting insights into how income and wealth are produced and distributed, this study analyzes how, despite two centuries of capital accumulation, poverty persists in rich nations. Relying on the theories of David Ricardo—a 19th-century economist credited with developing the theory of rent—a thorough presentation of the history of this economic law, from the inscriptions on the clay tablets of ancient Babylonian merchants to statistics that portray the modern economy, is provided. Presenting readers with conceptual tools that will motivate them to reengage in the democratic process, this examination dispels the myths of contemporary fiscal policy while providing keen insights into the history, and future, of economics.

• Language: English
• Publisher: Shepheard-Walwyn Publishers
• Release date: Nov 30, 2006
• ISBN: 9780856833151

Fred Harrison

Fred Harrison is a graduate of the Universities of Oxford and London. He was chief reporter for the Sunday People when he secured the jail cell confession of Ian Brady. During the 1990s, he worked in Russia as a consultant on how to transform the wrecked command economy. Harrison was the only economist to give a ten-year warning to the Blair government in Britain that house prices would peak in 2007, to be followed by depression. He is currently director of the Land Research Trust, London. He is the author of Brady and Hindley: Genesis of the Moors Murders and As Evil Does.   

Book preview

21.

Part I

THE TAX STATE

1

The Tax Clawback Scam

1.1 Fifteen Million Victims

IN BRITAIN, fifteen million people – a quarter of the population – are permanently locked into poverty by their elected politicians. To humiliate them further, the income that is taxed out of those 15m people is substantially transferred to the 15m people who are the richest in the nation. Sandwiched in the middle are 30m people who are deceived into thinking that ‘progressive’ taxes help them to acquire the health and education services they need. This is a perpetual process of torture-by-taxation.

The Welfare State, according to conventional wisdom, is a permanent feature of society, and it has to be funded out of taxes. I will show that the Welfare State, whatever the intentions of those who fathered it, is no such thing. Far from being part of the solution to poverty and the enlightened distribution of life-giving chances, it is part of the problem.

The middle classes are also trapped in a whirlygig of taxation-and-subsidies that lower their standard of living. Government intervention contributes directly to problems like:

adults who cannot afford their own homes, so many of them have to live with their parents long after they should have flown the nest;

pensions that are below what they should be after a lifetime’s hard labour;

mothers who are driven into the labour market not out of choice but to try and make ends meet for their children.

Since 1945, in the name of social justice, politicians have ratcheted up the amount they taxed and spent to nearly half of the nation’s income. This was driven by a philosophy of ‘progressive’ equalisation of people’s rights and living standards. It was a gigantic sham. Table 1.1 reveals some of the evidence.

First, focus on direct taxes such as those on wages and salaries, and the payroll tax which is deceptively called employees’ National Insurance Contributions (NIC). People at the bottom of the income scale pay 9.5% of their gross wages as taxes. Those at the top end pay 23.7%. That seems fair – until we add in the indirect taxes. Most of these may be called stealth taxes. The poorest 20% are required to fork out 28.5% of gross income in taxes. The richest people only pay 11.3% into the public coffers.

Table 1.1

Taxes as a Percentage of Gross Income

All households, quintile groups (2002-3)

Source: Simon Briscoe, Britain in Numbers, London: Politico’s, 2005, p.252.

If we add direct and indirect taxes together, we find that the poorest people hand over 37.9% of their gross income to the tax man compared with 35.1% from the richest people. What is ‘progressive’ about that?

But it gets worse. The traditional analysis of the distribution of after-tax income is calculated to mislead the losers. I will explain that the richest people do not pay taxes at all. They are the free riders on the backs of the people on the lowest incomes. The poor subsidise the high life of the rich, an injustice that is driven by a tax system which governments administer in favour of wealthy people.

How is the scam worked? Over the past 50 years, governments rigged taxes so that they escape the naked eye. We cannot see that they discriminate against those on the lowest incomes. The redistribution of income from the poor to the rich is camouflaged to avoid censure for this injustice.

The rich never cease to protest that they are heavily taxed. The truth comes as a shock to people weaned on the doctrines of the Welfare State. Taxes paid by top-rate taxpayers are cancelled out by covert government-funded rebates. What can be called a slush fund for the rich is a very public event, but the language we use to discuss politics and economics has been so perverted that no one challenges the legitimacy of that slush fund. How does it work?

When government invests taxpayers’ money, it creates a huge economic value. That value can be measured, and it runs to billions of pounds of annually created wealth. That value, as income, can be – and is – taken to the bank.

But although it is funded out of the general pot of taxpayers’ money, the proceeds are not distributed equally among all taxpayers. The lion’s share goes to the minority who own the bulk of debt-free property. And that value escalates over time, so that the rich become relatively richer with the passage of time. The gap between the poor and the rich, when it is properly measured, is continuously widening.

This exercise is executed in the name of fairness, driven by progressive taxation, in a society that claims to champion every person’s human rights. That language is pounded into our collective consciousness day in, day out, the drip feed of brainwashing that makes it possible for politicians to claim that black really is white. What does that language conceal?

When government invests taxpayers’ money in capital-intensive infrastructure, such as railways, it creates a value which it fails to recapture. That value is allowed to cascade down on to the country, where it is netted by the land market. The territory of the United Kingdom is one giant sponge for soaking up that value as it flows out of taxpayer-funded services such as highways and hospitals.

That value is not left to lie unclaimed on the ground. People come along and pocket it. And why shouldn’t they, if the government is derelict in its duty to taxpayers? But the collection is not a random event, like wins on the lottery. If it were, we might excuse it on the grounds that we all had an equal chance at winning. In fact, because of the way that the law of the land is written, that value can only be collected by one group: the owners of land.

Now, let’s probe a little deeper into this system.

Low income people who do not own land are obliged by the state to yield part of their income to pay for the services that we share as a community. In exchange for their money, they receive benefits. Their children go to public schools or use public hospitals; and they enjoy the security of the military defence of the kingdom. That is a fair deal. Low-income earners pay their way. But they don’t get a share of the additional value – which their money helps to create – that cascades to the ground from the heavens.

Let us consider the significance of that fact by examining the financial fate of someone who owns his home and who expects to pay substantial tax out of a handsome salary. Let’s imagine someone who is married with two children. He earns £50,000 a year. This is not a super salary, but it is double the average wage.

The tax obligation. Income tax liability on this salary in 2005 was £11,957. The employee’s National Insurance liability came to £3,237, which meant that £15,194 was deducted from the salary.

That revenue, we are told, is used in part to cushion the conditions of people on much lower incomes. Fair? We need to probe beneath the official veneer that is wrapped around this doctrine.

What kind of a house does this person own? At a multiple of four or five times the salary, his home is likely to be worth at least £250,000. For illustrative purposes, I will adopt the standard price of houses in London used by Halifax, the mortgage-lending bank. This was £44,446 in 1984. Twenty years later it had increased to £242,296. Over those 20 years, Halifax found that the average annual increase in London house prices was 10%.

The capital gain. During 2005, a 10% increase in the value of a house worth £242,000 was over £24,000. This windfall gain more than covered what the home owner paid as tax on his salary – £15,195.

Our home-owner lived a tax-free life! After tax deductions ‘at source’, he was better off to the tune of £8,800. He did not have to ‘monetise’ his capital gain immediately. But he could have borrowed against the enhanced asset value and spend the money as if it were earned income. And that money would be tax free.

He pays tax on some of the goods and services that he buys. But as we have seen, the burden of indirect taxation falls more heavily on low-income people than on people who receive handsome salaries. That is why indirect taxes are regressive. Those that fall on our home-owner are modest relative to the capital gain that he reaps, thanks to the government’s slush fund.

The conclusion is astonishing. Our comfortably-off home owner receives the use of the transport system, schools and hospitals for nothing. He is the classic free rider. He rides on the back of the tax-paying tenant family that is not able to store up capital gains for a glorious spend-up in the future.

Our home owner does not intend to sponge off the poor. He would be horrified to learn that this perverse tax regime punishes people on low incomes while enriching those who own land. But the facts of life are inescapable. And they are all the more intolerable, in a democratic society, because politicians impose most of their taxes on the poor by stealth.

1.2 Stealthily Does It

POLITICIANS who legitimise this outrageous redistribution of the nation’s income do it by subterfuge. Direct taxes take from the rich to help the poor. People at the bottom have about 10% of their gross incomes taken as taxes, compared with more than 20% for those on the top incomes. But this effect is more than cancelled out by the indirect taxes, which are shrouded in the small print that most of us fail to read. Those on the lowest incomes pay between 20% and nearly 30% of their incomes when they purchase the goods and services that they need, compared with an 11% tax-take for those on top incomes. The net effects:

the poorest people subsidise the rich

the rich have their taxes cancelled out by the windfall gains which they receive by courtesy of the government’s wealth distributing tax-and-spend policies

The process of immiseration is not the fault of the free market, but everything to do with the philosophy of ‘welfare’ taxation. The housing market is the primary conduit for the worst abuses. To understand how this outrage discriminates against those who add value to the nation, we need to distinguish between land and the buildings that stand on it. The value of land operates on a different level compared to bricks and mortar.¹ We will track the way this mechanism works across a kingdom disunited by courtesy of Her Majesty’s Government.

Taxes were increased during the years of Tony Blair’s administration. But the benefits were not shared out to close the gap between the rich and poor. One result surfaced in the classroom. Researchers found that, in the reading skills of children, the gap in achievement widened between those receiving free school meals and the rest. A full explanation would describe how families on the lowest incomes had less choice – for example, in their mobility (fewer cars) and in the range of schools from which they could choose. But refine the description with whatever detail you like, in the end it boils down to the fact that their incomes are low and they are forced by taxation to transfer part of their wages to the rich.

The rich laugh all the way to their banks. As their homes escalate in value they withdraw equity and splash out on the finer things in life. They purchase holiday homes in France and Spain, and four-wheel-drive vehicles in which to deliver children to the schools of their preference. The high achieving schools give their children the best start in life; this is reflected in the higher income earning capacity that these children will achieve, perpetuating the divide into the next generation. That is why people are willing to pay more for the locations in the catchment areas of good schools. So the school’s performance is partly measured by the value which is externalised (this is a technical term that we shall explain later in this study). If that value were captured and recycled back into the school, government would not need to tax people’s wages and savings. But government does not do so. That is why low-income people are discriminated against: they pay their taxes, which they cannot recover as property prices rise in the vicinity of the school to which they send their children. This is part of the scam which works because government and its agencies bias the statistics to withhold the truth from taxpayers (see Box 1:1).

But there was a consolation prize for the poor. In July 2005, the then Secretary of State for Education (Ruth Kelly) announced that a bag of books would be delivered to parents for children when they reached the age of three. It remains to be seen whether children on free school meals will benefit. Their mothers tend to be working parents, tired at the end of the day, many of them without the energy to provide private tuition for their offspring. The two-income family has become a routine feature of family life, the result of the escalating cost of financing a mortgage.

The discrimination between home-owners and those who rent goes even deeper. Take the problem of the cost of money. Interest rates are sometimes driven up as part of government policy. For home owners, a rise in interest rates is offset by the windfall gains that continue to accrue to them. The total value of homes in 2004 was estimated by the Office for National Statistics to be £3.2 trillion, an increase of £352bn over 2003. That was an increase of 12% in 12 months, a rate of increase three times greater than the increase in people’s wages. The Blair government’s Pensions Commission, chaired by Adair Turner, conceded that people could draw on that value to fund lifestyles in their years of retirement. But that option is not open to people who spend their working lives paying rent to landlords. The injustices of this arrangement did not escape Adair Turner. He noted that the windfall gain for the present generation would be a windfall loss for the next generation that would have to buy houses at ever increasing prices.²

Thus, we see a pathological system at work. Through the land market, parents are turned into predators, devouring the livelihoods their children had hoped to enjoy when they grew to maturity. Instead of having a fair start in life, the offspring of today’s generation have to vault the hurdle of the housing market. Some of them survive and land on their feet. They acquire property. They will have to pay a higher share of their wages to buy their homes, so that their parent’s generation can retire in comfort. But at least they have an asset that will rise in value, courtesy of the taxpayer. However, the millions of young people who are excluded from the possession of property will have their lives permanently crippled.

Box 1:1 Government’s 3-Card Trick

WE ALL add value to the wealth of the nation over and above what we take home in wages and salaries. That value ends up as land value, but it is not shared out between us. To conceal this injustice, government invokes the doctrine of progressive taxation. By selective use of statistics, taxes are deemed to be ‘fair’. Take a closer look at the numbers.

On May 12, 2006, the Office of National Statistics (ONS) offered its analysis of taxes and subsidies. People in the lowest 20% income bracket received an average wage of £4,300. This was bumped up by state subsidies to an average of £ 13,300, a gain of £9,000. The average income of those in the top 20% bracket was £66,300, which after taxes was reduced to £47,400 – a loss of £ 18,900. So the rich fund a better lifestyle for the poor. Right?

Wrong.

The £ 18,900 paid by the average top earner is more than offset by the rise in the value of his property. That rise is funded by taxpayers, and disproportionately so by those on the lowest incomes who do not own property. The ONS, in computing the tax-and-benefits share-out, audits what is transferred to the poor (such as incapacity and child benefits), but ignores the windfall gains that are allocated to the rich out of the government’s slush fund.

High-income earners, insists the ONS, ‘pay more in tax than they receive in benefits’.b True or false? The answer depends on how you cook the books. The Financial Times reported the ONS figures in these terms: ‘The figures show how the tax system is progressive, with the richest paying more of their income in direct tax than the poor’.c In fact, the Tax State has rigged the rules so that the rich claw back more than they pay into the public coffers. But nobody notices: that is the government’s 3-card trick in action.

1:3 Bonanza for the Asset Rich

TAX POLICIES give the run-around to people on middle incomes.

Caroline Lakin of the Office for National Statistics examined the flow of income back and forth between government and the middle quintile group whose original income was, on average, £19,320 (Table 1.2).³ What these households pay as direct and indirect taxes is all but cancelled out by what they receive in handouts of cash and kind. At the end of the tortuous process, they are better off by a fraction, with a final income of £19,750. Was it worth going through the bizarre system to end up with little more than £400 better off? The personal costs of filling in the tax returns, and the losses inflicted on them by the costs of collecting the taxes, more than cancel that benefit. Why not let them live a tax-free, subsidy-less life?

Table 1.2

Whirligig Taxes

Middle quintile household group income (2002-3)

How do governments get away with it? They claim that they are obliged to use broad-based taxes to minimise the distortions to the way people work, save and invest. The truthful way to translate this message is as follows: governments seek to deceive people into thinking that they are not paying taxes, in the hope that they do not alter their behaviour in negative ways that result in the under-production of wealth and welfare. This exposes the anti-democratic character of taxation, but also the cynical attitude of politicians. Governments, by avoiding the obligation to make taxes transparent, avoid being held accountable for their actions.

People are not deceived. They sense that taxes are unjust. But they also know that they must pay their way in life. All they want is fair play on a level field. But that equality of opportunity is not afforded them, and their democratically elected representatives are ultimately to blame. Parliament fixes the rules of the economic game.

Table 1.3

Windfall Gains from House Values @ 5% per annum

The cruel discrimination of the land-and-tax scam is highlighted by the data in Table 1.3. This compares the fate of people who rent their homes with those who own their properties. The cumulative effect is to enrich the wealthy disproportionately, and grind down those who are asset poor. I use a conservative 5% per annum growth rate for house prices. Over the course of 12 months, families that rent their homes are no better off. The owners of homes worth £500,000 are wealthier by £25,000 – this is about the average wage in the UK. People with more modestly priced homes – mainly to be found in the ‘peripheral’ regions of the North, Wales and Scotland – are better off by a modest £5,000. For many of them, that is not enough to claw back the taxes they pay during the year.

Now reflect on the fortunes of people who live on Millionaire’s Row. They pocket a handsome £50,000 at the end of Year 1. At the end of 10 years, the owner of what was a million-pound dwelling now finds himself occupying a house that has risen in value by £629,000. Compare that with the £63,000 increase received by the owner of the house that was originally valued at £100,000.

This is not the result of either skill on the part of the home owner, or the random luck of a lottery. It is the result of tax-and-spend policies that discriminate against those who do not own land, or whose sites are not located in the best areas. The discrimination is sanctioned by Parliament.

The real-world impact of this process is enormous. Halifax estimated that the value of the UK’s private residential housing stock, which was £3.3 trillion at the end of 2004, had increased by 15% in that year. That was more than 50% higher than three years earlier, and it was three times the value of the housing stock in 1994.⁴ Families that rented their homes were excluded from these windfalls. In fact, far from sharing in those windfalls, the cost of renting their accommodation was higher than if they were buying their homes (see pages 87-8).

Families that rent their homes are locked into a vicious spiral of deprivation. Wages are now tied closely to the rate of inflation. The core retail price index (RPIX) rose by 28% over the 10 years to 2004. Living standards were tailored to this rate. But the value of residential property increased by more than 200%. This gave incomparable buying power to people who owned homes, setting them apart from taxpayers who were excluded from the tax-financed bonanza of the property market.

1.4 What’s Going on Here?

THE EXPLANATION used by social scientists to account for the unequal distribution of income was inherited from Karl Marx. Class conflict is supposed to drive the process. But as we are now beginning to see, class theory offers an inadequate representation of the way in which people are victimised. The ogre of the Marxist narrative is the capitalist. Our competing explanation identifies the state as the villain. The housing market offers evidence that reveals a complex reality at work.

Draw a straight line on a map from the centre of London to (say) the North-Eastern corner of England, and we traverse six statistical regions. If we plot the value of houses on a graph, we perceive remarkable regional variations (Graph 1:1). The riches are concentrated in the South-Eastern corner of England. But over the decade to 2004, the value of the housing stock did not rise equally across Britain. House prices rose by 246% for Greater London compared with 197% for the North. Over the long run, the gap between people who own land in the South East and those who own it in the North increases inexorably. This discrimination is the result of the failure of the state to employ policies that equalise the benefits which it creates, with taxpayer money, for the benefit of all taxpayers.

In identifying the state as culpable, we acknowledge that society needs government to deliver services that people cannot provide for themselves. The state does contribute to the nation’s wealth and welfare. Government spending on infrastructure increases the productivity of the economy. But because of the way that the market economy works, the consequence is the externalisation of part of that value out of the hands of the people who fund it. The impact of this is the nub of the economics of wealth production and distribution which receives all but no attention from economists.

Today, economists rely on a one-dimensional model of income distribution. The highest incomes are at the top of the scale and the lowest incomes are at the bottom. But this does not explain how income on the bottom rungs is transmitted to the top. For that, we need a spatial dimension to measure what is going on across the territory. If we place this dimension on a horizontal axis, the evidence reveals a horrifying tale of social exploitation that is driven by governments in the name of the people.

Graph 1:1

Value of UK Private Housing Stock

By region, £bns (2004)

Source: Halifax, ‘Value of UK Residential Housing Stock hits £3.3 trillion in 2004’, Press Release, February 5, 2005.

Figure 1.1 offers a stylised portrait of the forces at work. When low-income earners in North-East England pay taxes, the net gains from the public investments which they help to fund surface as an increase in the value of assets owned by high-income people in London. The contra flow of welfare payments to the North East is poor compensation for the value that haemorrhages out of the region.

This seemingly magical transformation of the income of one section of the population, in one place, for the benefit of asset-rich people in another place, is not a necessary outcome of the market economy; and it was not legitimised by a democratic mandate. Low-income families that struggle to make ends meet do not voluntarily hand over their hard-earned cash for the benefit of the rich. The process is driven by forces that governments have chosen to foster.

There are two reasons why we should abandon the flat Marxist theory of class in favour of the dynamics of the spatial distribution of wealth. First, the deeper appreciation of how the economy works leads to commonsense answers to the questions of what and why. Challenging the power of the state is a daunting task, an exercise not to be undertaken frivolously. Previous attempts at changing the rules of the financial game (trying to redesign the structure of society by altering some of its key financial buttresses) failed because people did not fully comprehend the forces that were at