On London Riots and Taxation Myths

One of the most surprising news stories that I heard this year was the one about the London riots. I say that because I lived in London throughout the decade of the 1970s and it was one of the most peaceful and fun-loving places that I have ever known. It is hard for me to imagine that the people there would ever take to rioting in the streets.

I arrived in London in 1970 as an American tourist, liked it so much that I decided to stay for a while. One day, while sipping on a cup of coffee at a Piccadilly Circus cafe, I half-jokingly asked the manager, who happened to be standing in front of me, if he could use some help serving coffee. That feeble attempt to acquire a job in London was successful.

Imagine something like that happening today: a company going through the formalities of getting a Work Permit for a foreigner, just to have someone to serve coffee! That's how desperate the British were for workers.

During the course of current year in America, and especially so during the debt-limit debates, I read or heard on the Internet that taxes absolutely cannot be raised on the country's millionaires and billionaires because that would cost jobs. I read or heard that over and over again, sometimes almost daily. From that, one might think that when I was in London, the rich over there paid low taxes, granted that it was so easy for me to find a job.

As I recall, the tax rate on the British rich at that time was not low, but quite high. In fact, it was 83%, and you did not need a real lot of income to reach that level. But that was only the top rate on earned income. There was another tax of 15%, called a surtax, on investment income like dividends and interest, bringing the combined rate up to 98%. You are reading that correctly, the rich of that country were paying taxes at the rate of 98%.

And now comes the task of reconciling the 98% tax rate with London's full employment. It's really quite easy to explain. You do not possibly think that the wealthy were going to sit around idle and watch their income get taxed away at 98%, do you? Some of the wealthy tried to sneak their money abroad, establishing phony corporations in tax havens like the Cayman Islands or whatever, but a lot of them decided to bite the bullet and go for business expansion.

The logic behind business expansion was as follows: If you had a private company, you would try to grow it so that it became large enough to float as a public corporation, thereby making a vast future. Or if your company was already public, you would simply sell the shares at enormous profit. Either way, you drop out of income tax and fall into capital gains tax, which was only 30%. Of course, this 30% rate compared very favorably to the 98% rate on income. The economic impact of this process was massive efforts on part of the rich to grow their businesses, and business expansion translated into new jobs.

The British tax code of that epoch also had other ideas for creating jobs, one of which was called Research and Development. Invest in that, and you got tax breaks. Research and Development produced a surprisingly large number of jobs in and of itself. And then one must consider the developed products, which are going to need manufacturing and marketing, leading to even more job creation.

Above, I was referring to employment in the city of London, and I don't want to think that everything was rosy throughout the entire country. As I recall, there was one area in particular, called Northern Ireland, that was somewhat depressed economically, but I believe that was mostly attributable a local civil war. In any case, once again the Inland Revenue code went to work to help improve the situation, designating Northern Ireland as an “enterprise zone,” meaning that companies who created jobs there got special tax breaks. In contemporary America, a comparable strategy would be to give tax breaks to companies that create jobs in especially hard-hit areas like the Rust Belt.

At the heart of the job-producing ingenuity of the British tax code was the differential tax rate, dependent upon the type of activity. Uniformly low taxes on both income and capital gains, of course, would have done no good at all as there would then be no incentive for the rich to invest in business expansion. But unproductive activities were taxed highly, and productive activities a lot less so. The rich of that country were willing to do anything to avoid the 98% tax and move into lower tax brackets, even if that meant creating jobs. The tax laws did not prevent them from becoming richer, but they had to do it in a way that created jobs.

One might ask: If things were so wonderful in Britain at that time, why did they ever change the status quo? As is often the case throughout history, good things may not last long. Little by little, greedy entrepreneurs, wire-tapping experts, and other unscrupulous individuals gained control of the country's media outlets, and they then used those outlets to deceive the voting populace in believing that the rich were sacrosanct and should be exempt from taxation. Over the course of a few decades, with the rich no longer paying their fair share of taxes, the strong sense of social justice that had been inherent in the British people all but evaporated. Then with unemployment soaring, it is easy to understand why people took to the streets to riot.

Let's pause for a moment to consider the opposite scenario: What would be the actions of the rich when their tax rates are low? Almost certainly their primary goal in this situation would be to maximize short-term profits, to take advantage of low taxation before rates go up again. Typically, the wealthy take the following actions to maximize short-term income:

a) They lay off workers, and especially so if demand for their products is weak. Every laid-off worker directly contributes to their bottom line, and they figure that when and if demand for their products improves, they can simply re-hire the workers. Meanwhile, every laid-off worker leads to a further deterioration of the overall economy, producing the spiral effect of causing other companies to also lay off workers.

b) They try to shift production of their products to areas or countries where wages are lower. Lower wages directly translate into higher profits on which they will have to pay little or no tax. Again, their only objective is to maximize short-term profits to take advantage of the low tax rates. Loyalty to current workers and country is a secondary consideration.

In conclusion, the notion that low rates of taxation on the rich will produce jobs is merely a myth propagated by the agents of greed. Neither historical data nor common sense can support such a notion. To the contrary, the contemporary correlation between high unemployment rates and historically low taxation on the rich is no coincidence. Low tax rates on the rich is one of the primary contributors to high unemployment rates.