Hopefully this makes tax interesting..
“In this world, nothing can be said to be certain, except death and taxes.”
The dreaded tax man is an age old character, an the enemy of the people. Our collective memory tells us that we despise the tax collector and detest paying taxes. The government is taking straight from our pockets… but is this really true? Is the government taking or giving more benefits to us? And how do governments actually view and manage taxes?
The Bible, the hieroglyphs, Warren Buffett and the Beatles all have writings on taxes. The trouble with tax is it links in to our behavioural heuristics. One such powerful heuristic is loss aversion. Believe it or not but most of us aren’t rational. Apparently our emotions can get the better of us sometimes; and taxes are no exception in this field. Taxes are seen as a loss and boy are we prone to loss aversion. The behavioural trait that the desire to avoid losses is almost twice as strong as the want to make equivalent gains. Simply put, we are more afraid or emotional if we lose $5 than if we win $5. So when we give up $5 of our hard earned income to the tax man we are OUTRAGED! Even more outraged than when that same tax man gives us $8 worth of benefits in roads and healthcare. One factor that extends the outrage is that it’s quite difficult to see where the money and benefits flow back to us but it is quite clear on how it is taken away. These behavioural quirks of ours are the foundation to our irrational and sometimes intense dislike of taxes. Seriously, have you ever heard someone be happy about their tax bill?
Tax is often quite opaque and the rhyme and reason to taxation is often lost in the political spin and hoo-ha that goes on. I thought that we could strap on our red slippers and go for a wander down the twisting, turning path into tax land. An adventure about a dry topic that turns out to be anything but boring. A jungle of complications, tyrants, armies and revolutions will spark up a cacophony of changes!
The purpose of taxation is in itself a bit contentious. Some might argue it’s the government trying to be Robin Hood, taking from the rich and giving to the poor through tax and wealth redistribution. Some say it’s an unfair taking from those that work hard and rewarding the lazy. Others may shout and scream that it is the government taking taxes to make the rich and elite even richer and more powerful than they already were. And others may say it is about generating revenue for the purpose of spending money to protect the lives and welfare of a nation.
In 1775 a war began that would change the course of human civilisation. The American Revolutionary War or the War of Independence broke out. What started as a battle of taxation resulted in huge bloodshed and the rising of the United States of America. In part Americans were sick of British rule and the high levels of taxation being forced upon them. A foreign monarch was imposing exorbitant and unreasonable costs onto businesses and the people and they would stand for it no longer. Over 150 years later the Brits were to make the mistake again. This time in India, Mahatma Gandhi would go on to protest and lead a passive revolution and march to the Arabian sea. The end of the Salt March saw Gandhi collect salt from the beach and fail to pay the infamous Salt Tax. Thousands of people were arrested by the British and it marked the end of British rule in India just as the Stamp Tax did in the U.S. Taxes have the power to write and change the course of history. There is little else that has caused so many revolutions and so much bloodshed in our colourful world history.
But what is the true cost of tax? We all know that it may be x dollars or x percent of our wage or a cup of coffee but how does that effect the economy? Are there costs beyond our own personal costs, that as general citizens we don’t pay much attention to?
Let’s start at the personal level. It’s still pretty cool at the moment and I realised my slippers were incredibly tatted and old. I jumped in the car and headed on down to the shops and bought a pair of slippers for $20. They’ll do the job. In Australia the goods and services tax (GST) is included in the price, making it nice and easy. GST is 10% so the tax I paid was around $1.82. In microeconomics this gap between the actual price and price including GST is considered a deadweight loss. What that means is that the tax has distorted the price of the item and therefore supply and demand will not be able to achieve equilibrium. They will be permanently out and our economy will be inefficient. We either won’t be supplying enough goods or buying enough goods for consumers and manufacturers to win. As this purchase is expanded out and multiplied by all the purchases we make and we get the GDP and total tax revenue then we see there is a big mismatch. There is a big leakage in the flow of money in the economy. At this point we see that tax is more than that 10% cost when we bought something, it is actually hurting overall production in the economy and reducing the number of jobs, investment and consumption that could be occurring. It appears that the taxes are reducing the income of our economy; but we are yet to factor in where those taxes are going.
The government isn’t or at least shouldn’t be collecting taxes for no reason. It shouldn’t be trying to hoard money and reduce money supply… well unless there’s an overheated economy and market. In that case hoarding some money to stop a bubble from bursting could be a good thing. In reality the government is collecting that tax to fulfil its purpose we looked at earlier. It is redistributing wealth and protecting the welfare of its citizens. Taxes pay for a huge number of benefits and depending on the economics you believe in, can have huge benefits to society.
The multiplier effect is the idea that an injection of spending will have a greater positive effect than its cost. For example that $5 of tax we were avoiding losing earlier is spent by the government on an infrastructure project. That dollar starts its heavy lifting by being transferred to a construction worker building a bridge for the community. The worker then spends $3 and banks $2. The $3 is enjoyed by a worker elsewhere and then follows the same path. The $2 is sitting in the bank and the bank then engages in fractional banking. It keeps $1 in the bank and lends out $1 to someone else, whilst our worker still has $2 to draw on. This effectively creates more money in the economy. What we see here is that by the government injecting funds into the economy by purposeful spending we have created a chain of spending and stimulation. The worker gets a job building a bridge, they buy food and keep a caterer in business, they put some money in the bank which gets lent out to someone who builds a house and so on and so forth. The positive impact is immense.
The government constructively spends money and helps the economy through spending such as infrastructure, education and arguably healthcare. Some governments engage in social welfare where they transfer funds to those less fortunate/of lower socio-economic standing. This increases overall quality of life and standards of living in the country which should lower crime and continue to stimulate growth in the economy. However not all government spending is good and not all taxes are good. Even finding the right amount of tax to charge is a challenge.
There is a concept called the Laffer Curve that attempts to determine the perfect amount of tax. Essentially it demonstrates that at 100% tax no-one would work and business wouldn’t exist because there is no incentive. All the money would go to the government and no-one would take anything home. At the other end of the spectrum at 0% tax the government would be getting 0% revenue. There would be all this activity but the government wouldn’t get a cent! It then goes to make the argument that in certain instances lowering taxes will incentivise business to produce more which will in turn increase spending and revenues. In essence it claims that at certain points lowering tax will increase government tax revenue. Reagan was a big campaigner and supporter of this concept and is often called Reagonomics.
We must also consider efficient and inefficient taxes when we think about taxation rates. An efficient tax is one that doesn’t deter an agent from engaging in production/consumption. For example, in a progressive tax system where taxes go up according to your income. 10% from $0-$20,000 earned, 20% from $20,001 — $50,000, 30% from $50,001-$100,000 and 70% from $100,001 +. I don’t stop working and earning money when I go from $98,000 to $110,000. I happily earn more money and pay more tax. This is an efficient tax, it doesn’t stop me from working. An inefficient tax is one that inhibits business or consumption. A company tax rate at 50% may stop some businesses opening as they only take 50c from every dollar they earn. Making it harder to become a profitable business. That isn’t to say that businesses shouldn’t pay tax though. Tax is important at all levels but we must consider what are effective tax rates.
Across the OECD tax rates and government benefits vary accordingly. So let’s have a look at some random graphs hey. An economics paper isn’t a paper without graphs after all.
Whatever conclusions you just drew from those tables….. ignore them. Dump them. Wipe them from your memory. There are so many variations in what does and doesn’t get taxed that it’s virtually impossible to accurately compare taxation in other nations. Varying demand for particular goods and services, different core aspects of GDP, different government spending regimes and social benefits make it incredibly difficult to draw any true conclusions. Instead taxes need to be addressed on a case by case basis as to whether or not they are effective in addressing the nations current and future needs.
Those tax tables ignore things like tax credits, imputations, tax breaks and the myriad of tax avoidance strategies that someone can use. Under GST for example there are goods and services that are exempt from the tax. Doesn’t make sense for a broad base consumption tax but there are. In Australia there is a strategy called negative gearing. Which is where you may buy an investment property and if your expenses (mortgage repayments) are more than your rental income the government deducts the balance from your tax bill.
Let’s have a quick look at an example of a tax, a tax change, and a change in a nations needs. Let’s go back in time, the world has recovered from the dot com boom and is going on a bull run into 2005. The Australian economy is tearing along at a rapid pace the government has had a string of budget surpluses. The argument is that we are paying too much tax! 2007 comes around and the GFC is coming but Treasurer Peter Costello beats it to the punch and cuts income tax rates. $34Billion in tax cuts are given. The GFC arrives.
The government is voted out. The Rudd-Swan administration is in and readying to deal with the mess. They unveil an emergency stimulus package, infrastructure projects and anyone earning $80,000 or less is paid $950 and instructed to go and spend it. It boosts consumption, the government avoids recession but it has a gaping black hole in its budget and a giant deficit ensues. Almost 10 years later the government is further into debt and the economy has stagnated. Politicians are afraid to raise taxes as they believe they will be grossly unpopular and won’t be reelected if they go down this path. They rely on bracket creep to increase tax revenue. That is the government is counting on inflation to push nominal wages up and into the next income tax bracket. Inflation is at record lows.
The economy is still slowing and there is still indecision at the executive level. The government is afraid to use its tax levers for fear of being unpopular. What we see is that a huge income tax cut has not helped the Australian people. Rather it has made their situation far worse.
Taxation provides fantastic levers to curb behaviour, to push economies in certain directions and to provide the incentives for growth. Taxation when used as a mix of taxes, a portfolio of taxes is the carrot and the stick to the nation. It is however only really effective when used in a mix. If we lower one tax then another tax should be created or raised to ensure adequate revenue for expenditure. Most of the globe is facing an ageing economy. Ageing is a natural part of life but it comes with increased costs to governments. The nature of ageing is that you are out of the workforce and may be reliant on the government for income. You are also likely to require increasing medical treatment which will most likely be paid for or at least subsidised by the government. If the majority of our economies are going through this process or about to embark on this transition then we need to realise that the costs to society will be large. We need to accept that we will need to pay for these benefits and ensure that our elders have a high quality of life. The expenditure related to the benefits comes from tax revenue. If expenditure goes up then…… revenue must go up. For revenue to go up, taxes must go up.
We can raise taxes in a productive way though. Tobacco, alcohol, sugar, and carbon taxes are all positive/productive taxes. They curb behaviours that cost society and either pay for themselves as an aggregate or can provide income to pay for other benefits.
Other productive taxes include taxes that will stimulate growth and future development. Tax incentives for sustainable/eco/green production that are paid for by taxes for environmentally hazardous/costly production. Tax breaks for regional growth paid for by taxes for metropolitan payrolls. Taxation for car use paying for improved public transport. The list could go on and we can be creative with taxes. There are debates in Canada about vacant property taxes. Essentially we need to think outside the square for what we can provide a carrot and stick for.
We also need to think of our taxes as a whole picture. We need to consider it as a suite of taxes. So instead of focusing just on income tax and targeting that we need to see how can we supplement or make income tax better by using a payroll, production or consumption tax/tax break. This approach of a portfolio of taxes will maximise the multiplier effect and drive positive growth.
Taxation as a suite of taxes can assist in regulating and prevent bubbles, booms and busts. Taxes and tax breaks can act as automatic stabilisers to prevent the economy from shifting too far in either direction. Targeted tax can both stabilise an economy that is booming or retreating and it can assist with addressing structural changes.
The economies of the western world are moving from manufacturing to services. From mining coal to solar panels and wind farms. Targeted tax can assist in retraining and re-skilling the labour force and society to ensure the future prosperity and sustainability of those peoples. Tax has a bloody history, it’s despised but it actually has so many positives.
When you’re down on your luck the government is there to catch you. Lift you up and get you back on your feet so you can get back to contributing to society in a meaningful way. We know that money as a form of happiness has diminishing marginal returns. At a certain point the more money you have makes no impact on how happy you are. But if you’re at the bottom then a bit of extra money makes a significant difference. So let’s think of tax as paying it forward. Helping our kids, helping our friends, our neighbours and ourselves. We all like roads, health, education and feeling safe in our homes.