In The Millennial Manifesto, the ASI’s President Dr Madsen Pirie advocated a series of policies that the Conservatives could implement to win over young people attracted by Corbyn’s radical socialist manifesto. Like many ASI reports it advocated tax cuts, but controversially Madsen argued that we should cut taxes on the young. In particular, it argued that for under 25s, we should abolish air-passenger duty, create a lower band of national insurance at 8% (instead of the 12% it currently is), and bring in a 50 per cent council tax discount (on top of the current student exemption).
When Madsen speaks politicians are wise to listen, and today we have Conservative MP Nadhim Zahawi advocating that to win over young voters the Tories should cut their income taxes. Nadhim goes further than The Millennial Manifesto by suggesting that for as little as £2.4bn we could cut the basic rate of income tax for under 30s to just 10%.
It’s easy to dismiss targeted tax cuts for young people as just another bribe. But as my colleague Ben argued persuasively in The Times, people vote for the good of the country not for election giveaways.
However, there’s actually a serious economic logic behind it, going back to a paper by legendary mathematician, philosopher and economist Frank Ramsey in 1927. Ramsey argued that the optimal consumption tax (optimal in the sense it caused the least possible distortion) would vary depending on the supply and demand elasticities of each different good. Goods where big changes in price have little effect on overall consumption should be tax heavily, while goods which are incredibly responsive to prices changes should be taxed lightly. That’s part of the reason why cigarettes and petrol are taxed more heavily than other goods (heavy even accounting for negative externalities like pollution and the burden on the NHS). Smokers and motorists make good cash cows because few of them stop driving or quit smoking in response to higher prices at the pump or the tobacconist.
Ramsey’s insight does not simply apply to sales taxes, it applies equally to taxes on labour income. Each individual has a different response to wages and taxes. Elon Musk for instance would probably still work on Tesla and Space X all day if he had to pay a 95% tax rate. Others might choose to cutback their hours or pick a more relaxing lower-paid job at such high tax rates. If the goal is to raise revenue without slowing growth, the aim should be to tax ability but not effort.
We currently tax income, which is a function of ability and effort. But if we wanted to maximise growth we would tax ability and not effort. We can imagine all sorts of dystopian systems where people are tested at birth and those with the genes for hard work or high intelligence are assigned a higher tax rate than those lacking. Or given that taller people on average earn more we could simply use a ruler. Economists call this tagging.
But there’s an even less intrusive way to tax ability more and effort less – age-based taxation. The average middle-aged person is more productive than the average young person. By picking up experience on the job middle-aged people are able to access senior management roles that are typically not open to younger employees. We could tax graduates more and non-graduates less, because on average that’d hit high ability but not necessarily high effort individuals more. But the problem is that it’d discourage studying in the first place. Ageing is different; it’s very difficult to avoid turning 30.
But it’s not simply ability that we care about. It’s also the willingness to work and to move countries. It’s harder for a middle-aged person to flee Britain’s taxes than a young person. Middle-aged people typically have families to support that they can’t simply uproot and some countries even have age-related penalties in their immigration system. Young people typically have a smaller incentive to seek out high-paid work. They could seek out further study or go travelling. And the wage gap between a high-paid but unfulfilling job in finance versus a low-paid but fulfilling job in a charity is smaller for young people than older people.
For those reasons, cutting taxes on the young and raising them by the same amount on the middle-aged would likely boost output. Cremer, Gahvari and Lozachmeur find that if you cut taxes for under 35s (and over 55s who have the option of retiring) and raised them on 36-54 year olds to compensate, you would boost overall economic welfare.
We also implicitly tax younger people more than older people already. By taxing income and not consumption. As I’ve argued previously even relatively low taxes on income can imply high taxes on future consumption from savings. This in effect shifts the tax burden from early work to later work.
Tagging is certainly controversial and has costs. It adds complexity to an already complex tax system. But there’s a clear, if unintuitive, economic rationale beyond simply bribing younger voters. So for the sake of efficiency not intergenerational justice, let's tax the young less.