Taxes – The magic ingredient for success in the market economy
Taxes, no one seems to be happy about them. Too high, too progressive, too regressive, too much of a disincentive for effort, too onerous too……….. the list goes on.
No wonder taxation policy is always at the forefront in any election campaign with the general consensus being that less tax is best. Good for the individual and good for the economy. Looks, as usual, can be deceiving. Like the arguments trotted out for the promotion of small government many of the calls for low taxation are nonsensical and in many cases are at odds with creating the right environment for an efficient market economy to thrive.
Whether taxes should be high or low depends on the unique circumstances facing the particular economic system. These circumstances are normally filled with complex interactions and for simple solutions based on ideological considerations to work would be a purely random and coincidental event. The reality is that in a market economy, taxes are an essential part of the governmental framework that enables all of us to enjoy the bounty which the markets efficiency brings
Taxation has three major functions in a market economy. Firstly, and most importantly, as an avenue for governments to raise funds to finance their expenditure programs. Secondly as a means to facilitate the creation of economic efficiency by directing wealth flows from inefficient use to efficient use. Thirdly to promote social harmony by ensuring that even the most disadvantaged are able to share in the economic bounty produced by an efficiently running economy.
The heavy lifting in a market economy is done by government expenditure on such things as infrastructure, education, health, social security, defence and police. These form the bedrocks upon which the twin pillars of the market economy rest on. The twin pillars being Equal opportunity for all and a socially cohesive society where all feel valued and safe. The stronger these pillars are the better that innovative capitalist enterprise can do its job.
When framing its budget, a government must first address what they need to spend on these basic building blocks to give the market economy the best chance of achieving the optimal result in delivering economic success. It’s important to note that in many areas the market economy, by its nature being mainly concerned with its individual elements is not really concerned with the big picture, it is not able to provide an efficient outcome for the economy as a whole.
The glaring example of this is the education system. Left to private enterprise it is hard to see how we could have achieved the economic success we have today. If everyone had to pay private school fees for their children’s education. Participation rates would plummet. We would not have the trained and skilled workforce that a modern economy needs.
Most importantly it provides that essential glue for economic success – equal opportunity. An economy that denies talented and innovative thinking individuals the ability to use their skills because of a lack of access to education denies itself the ability to achieve its full economic potential.
So, before you can even consider a rate of taxation, we must know what the government proposes to do with it. The two questions that need to be raised are 1. what is the most appropriate level of expenditure needed to fund these foundation stones such as education, infrastructure etc. and 2. Do the governments programs address the issues in an efficient and fair manner.
All these questions need to be answered before we can look at how are we to fund them. Once the expenditure pattern has been settled on then we look at how can we fund it. To do this we must look at the cornucopia of taxation measures open to government. There are three criteria governments must follow in formulating taxation measures 1. Will it raise enough money? 2. Does it promote economic efficiency? 3. Does it promote social harmony by being fair?
Answers to the first question are complex and depend on the circumstances facing the government of the day. Essentially money is raised in two ways, by Taxation and government borrowing. Normally it is a mixture of both. Broadly speaking in times of economic downturn a government would increasingly turn to borrowing to bolster the tax stream. In an economic upturn the government would be looking at paying off debt and/or decreasing tax rates
The second question raises more complex and interesting issues. In Australia there are quite generous tax depreciation provisions for resource companies. A recognition that the lead time and expense between starting a project and receiving revenue is often significant and some incentive is required for organisations to undertake the work. In the end the expectation is that the whole Australian economy will be much better off than if that project had not happened.
Wealth taxes such as Capital gains, Death duties or inheritance imposts though vastly underused in Australia provide a very effective way to transfer money to more efficient use. One of the great dangers to a capitalist market economy is the tendency towards wealth inequality. Wealth inequality means that equal opportunity to capital reserves by innovative entrepreneurs is diminished. Inherited wealth tends to flow to conservative but not very productive areas of the economy such as property.
The third question revolves around what society believes fair and reasonable and can change from generation to generation. In Australia it is generally agreed that the marginal tax rates for wealthy individuals should be higher than for ordinary citizens. An interesting question at present in Australia is the tax treatment of superannuation. There are still significant numbers of senior Australians living in poverty. Should we be subsidising a superannuation industry where the most benefits go to the already well off when we still have seniors in poverty?
In an ideal political world parties would present their plans for expenditure first and then explain how they propose to fund them. All too often they put the cart before the horse by focusing on the tax level and then adjusting their expenditure to fit the level of taxation that they want to impose. The pressure to get elected leads to short term measures largely based on ideological considerations that appear to sound good. Economic and social reality often forces these governments to change tack on their grand plans and eventually put the horse before the cart but not always!!!
