Tinker or radical change?

Today its widely expected that the Chancellor of the Exchequer will announce some sort of a tax on banker's bonuses. This is yet another futile gesture that will have no real impact on the future of the economy. It is largely a political move aimed at appeasing the electorate: punishing the bankers for the mess they are perceived to have caused.

I say ‘perceived’ because the bankers have behaved over the years in a way that has been allowed to happen by the structure of incentives created by the tax system in this country. As I see it there are a number of problems that need to be addressed.

1.We have no taxes on wealth.
2.No distinction is made between earned and unearned income.

Many economic commentators, including the esteemed BBC Business Editor Robin Peston, describe the banks as ‘wealth creators.’ While it’s true that they generate income for themselves this is not the same thing. Much of their profits come from speculation in one form or another, some from taking a slice of transactions brokered by them and a small part from providing services to consumers.

The banking industry generates a lot of income, but this income is largely ‘unearned.’ So what’s the problem with unearned income?

Well, for one thing it reduces wealth creation. If you have enough wealth to generate sufficient income without working and adding value to society, then why work? People have an incentive to save and invest to make unearned income, so consumption is at the very least deferred. Lower consumption means economic activity is reduced and society becomes worse off in total, although this is largely hidden by inequality.

I’ve been reading up on Islamic Banking and at first the law prohibiting interest seemed a good one. The Qur’an classes money as a means of exchange and not an asset in its own right. As such, we should not benefit from lending money. On further reflection, I would take this argument and expand it. If money is a means of exchange, and profiting from lending money is wrong, then surely profiting from lending any asset is wrong too, as any asset can be exchanged for money. The Qur’an should really outlaw all income from wealth.

I don’t agree that profiting from lending an asset is wrong, but I think we need to reduce the incentives so that we can redress the imbalance in our economy between unearned and earned income.

Tax policy must be changed radically, and tinkering with bankers’ bonuses is not going to have any impact at all. We need a structural change that taxes excess wealth and taxes income from that wealth at a rate that incentivises the creation of wealth rather than the hoarding of assets.