Why Nick Clegg is right (and wrong) on the wealth tax

29th August 2012

With companies hoarding over £754 billion worth of cash on their balance sheets – more than 50% of UK GDP – the major sticking point in the economy relates to the velocity of money, not government deficits. As argued by the likes of Paul Krugman, trying to plug holes in government finances during the downturn, whether through austerity or taxation, would be to canabalise the resources available rather than provide the conditions for growth.

What is Clegg asking for?

The interview in the Guardian suggests that the policy will come in the form of a "time-limited contribution" targeting wealth, not incomes. As Clegg says:

"The action is making sure that very high asset wealth is reflected in the tax system in the way that it isn't now, making sure that we continue to crack down very hard on tax avoidance, making sure that tax breaks don't go disproportionately to people at the very top."

Even for a hard-nosed free market capitalist, wealth taxes should be less objectionable than income tax. In essence, large pools of idle wealth lead to a long-term misallocation of capital with ensuing erosion of value both to the individual and society at large. This applies as much to individuals as it does to corporations.

Indeed the behaviour of the wealthy during periods of economic uncertainty can drift increasingly towards self-defeating attempts to insure themselves against catastrophe. Steve Randy Waldman spelt out the dangers of this on his interfluidity blog. Waldman argues that when an economic system is threatened those who have most to lose try to preserve their relative status by holding onto any available capital.

This is the exactly the opposite of what policymakers need them to do and renders monetary policy designed to alter this behaviour (such as dropping interest rates to around the zero bound) far less effective.

A one-off tax on wealth, or the threat of it, would help to free up some of this capital either by placing it into government coffers or by reducing the incentive to hoard.

Why sometimes politicians can do the right thing for the wrong reasons

The reality of worsening inequality and the growing pressure on the government to formulate plans to address this should by now be well understood in Westminster. Much like fiscal adjustment, however, these are long term goals that cannot be solved by temporary measures.

Clegg argues that "what we are embarked on is in some senses a longer economic war rather than a short economic battle" but it would be a mistake to characterise this as a conflict between the wealthy and the poor. Instead it is a battle to achieve meaningful reform in our economic model that should allow for growing prosperity without becoming once again beholden to the financial sector.

If this was Clegg's point it deserves widespread, cross-party support. If, however, he is talking about ways to "spread the pain" of austerity then I am afraid he is simply throwing good policy after bad.

While fiscal responsibility is a necessary long-term goal for all governments, there is a growing consensus that front-loaded austerity can have a perverse effect. This is because the demand destruction caused by cutting government spending can lead to the private sector scaling back investment. Creating a vicious cycle out of "virtuous" policy is perhaps the definition of unintended consequences.

How to proceed from here

Clegg's public commitment to a wealth tax has put the cat among the pigeons to an extent. On The Telegraph's website the story has already garnered more than 1700 comments from readers, few of them complimentary.

Yet the Liberal Democrat leader may have more to worry from those who support his proposal that the traditional oppositionists. Mehdi Hasan, political director of The Huffington Post UK, links it to a speech Clegg gave to Demos last December in which he claimed:

"Wealth inequality is very much greater than income inequality, and widening. The bottom third of households hold just three per cent of the nation's wealth."

If this policy is to work and gain cross-party support it will have to be more than a nod to wealth redistribution. Inequality is not simply about absolute wealth but control over the means of achieving it. These types of measures, therefore, treat the symptoms not the underlying condition.

Moreover, for the economy to recover in a sustainable way what is required is not a temporary confiscation of wealth to prop up a failing policy but a sense of common purpose.

No policy can be assessed in isolation. Supporters of a wealth tax should see it as the stick balanced by the carrot of economic growth through investment, which the wealthy can benefit from as much as the rest of society.

By all means let us discuss positive visions for the future but we should be under no illusions – there are no quick fixes.


More on Mindful Money

Tax avoidance schemes under scrutiny

Is the Quantitative Easing debate obscured by partisan papers?

What the BoE left out of their QE report

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