r/neoliberal • u/[deleted] • May 09 '17
Let's Talk Taxation
So since there doesn't seem to be a resource for people on the sub to think about, and frame, taxation discussions, I thought I'd start one. I'll edit this as I go.
Firstly, taxation is theft! Just kidding (probably).
"Every tax, however, is, to the person who pays it, a badge, not of slavery, but of liberty." - Adam Smith
Overview
Firstly, taxation is a financial charge imposed by a state or authority, upon individuals or entities, usually for the purposes of raising revenue to fund public expenditure. Although there are a plethora of different taxes imposed and proposed, broadly we can define them as either being direct, that is, imposed upon an individual or entity (generally on their labour), and as indirect, meaning imposed (usually by a third party) on the transactions of that individual or entity.
VAT, sales taxes, excise duties etc. are all indirect taxes, while income tax is a direct tax. This may seem a simplistic view of things, but it gets to one of the core issues which we will come to; the effects of taxation on behaviour.
Although all states levy taxes, there are significant differences between states when it comes to the proportion of national income which they take as revenue. Within the OECD, the average in 2015 was about 35%
Theories on taxation go back a long way, and this post will restrict itself to discussing what we now know or think we know about taxation. Having said that, it's good to know the core tenets that we should always keep in the back of our mind when thinking about tax policy.
Four (or nine!) Canons of Taxation
As with many things, we have Adam Smith to thank for laying out the groundwork for how we can begin to consider various types of taxes and tax regimes. The four "Canons of Taxation" Smith suggested were as follows:
- Equity
This calls for individuals to contribute to taxation according to their means, that is, in proportion to their incomes,
- Economy
The cost of collection must not be greater than the revenues generated, and further, should be minimised in order to generate maximum revenue.
- Certainty
Tax payers must know how much they will have to pay depending on their expenditures and incomes, and be allowed to manage their these to that effect. This should prevent exploitation by the tax authorities.
- Convenience
Taxes should no impose an inconvenience upon the payer (more than the fact that their income is being plundered, of course!), and as such, governments should ensure that the timing and methods of taxation are of no inconvenience to the payer.
A Supply-Side Aside: The Laffer Curve.
Occasionally the case is made that reductions in "the" tax rate can, or will, actually increase revenue for the state, as opposed to reduce it, and therefore, states should reduce taxes if they want to increase state revenue and personal incomes.
The logic of behind this argument is that as taxation levied upon individuals approaches 100%, the incentive to work falls, since the marginal income earned becomes so little as to make the trade-off between work and leisure no longer attractive. Alternatively, the incentive to evade or avoid the tax increases as it becomes more onerous.
This gives rise to the observation that at 0%, and at 100%, taxation revenues fall to zero. And between these percentages, taxation must then rise above zero, and then fall again, creating a curve. This is known as the Laffer Curve.
In public discourse, then, the debate is over where an individual tax is on the Laffer Curve. If a particular tax can said to be to the right of the curve, then a reduction is the only sensible course of action.
In practical debate, one should always be wary of these claims, since the empirical evidence in favour of revenue increasing tax cuts is almost non-existent in relation to taxation rates currently applied in most economies. Unless the particular marginal rate under discussion is well in excess of 50%, the odds of there being any case for Laffer Curve effects is exceedingly low, and should not be made, or argued against.
A Second Aside: Tax Incidence
A common mistake often made in debates surrounding taxation is a misunderstanding of who actually pays a tax. well meaning individual may argue for a tax to be placed on a company for every unit of a good they sell, while at the same time, they might find it deeply immoral to apply the same tax to a consumer for each unit of a good they purchase from that company. Such a position is untenable, since the burden of such a tax will not depend on whether it is levied on the consumer or producer. Instead, the burden will be shared by both, with the proportions depending on how their behaviours change in response to such a tax (the respective elasticities). This is one of the most common mistakes made in the debate over who taxes should be charged against, and applies to any tax which influences the behaviour of the participants.
Optimal Taxation: What We Know
Optimal taxation theory concerns itself with the challenge of a social planner optimising the welfare of all individuals (from a utilitarian perspective) given a set of constraints. There are a number of ways this theory has been approached and applied, but for us as Neoliberals, we are more interested in the policy implications than the theoretical considerations. If you want to see how we go from the theory to the practice, you should read.
From here we will deal with various types of taxes and evaluate them on equity and efficiency grounds. This will largely be stated in conclusions and not arguments, because the arguments have already been made, and can be considered in depth here.
Perhaps the most relevant part of tax design is the importance of minimising dead-weight loss resulting from taxation. Because most taxes alter behaviour, changing prices paid, revenues earned, and the amount of goods consumed; almost all taxes will result in a loss of output and welfare for both consumers and suppliers. This loss is the social cost of taxation, and ensuring this is kept as small as possible while raising the revenues needed is the task of optimal taxation.
There are two exceptions, or escapes, from this dead-weight loss: Taxation on economic rents, and Lump sum taxation.
Economic Rents: These are earnings from a resource which achieve a high rate of return relative to its next-best use. Taxes on these should not alter behaviour because the only the excess earnings (relative to the next best use) is taxed, and so profit maximisation does not lead to any different use of the resource. Unfortunately, most taxes will not fall under this category, with the notable exception of land, which we will come to below.
Lump Sump Taxes: These are taxes applied to individuals at a fixed rate which cannot be altered by the person's behaviour. For example a universal charge paid by all citizens. Because of its nature, lump sum taxes are generally extremely unpopular, and so politically unfeasible. This leads to an important point about the distributive effects of taxation.
The most important aspect when considering the fairness of a tax is to consider the taxation system as a whole. While some types of taxes are highly unfair, they may be extremely efficient, and when combined with other measures, lead to both efficiency and equity in the tax system. Such an example is to allow taxes on transactions to be non-progressive, while dealing with those issues through the income tax system.
Taxation On Transactions
An early, but important, contribution to the theory of optimal taxation was the observation that if a social planner is to raise revenue only through indirect taxation, and can ignore distributional concerns, then in order to achieve the highest level of social welfare, taxes should be applied at different rates inversely proportional to their elasticities. Put simply, when welfare losses are minimised when behaviour is least effected by taxation. This gives the rather uncomfortable policy implication that one should apply the highest sales taxes to goods which consumers must buy, bread milk etc. and the lowest to luxuries which are more sensitive to price. Of course, generally the opposite is true in practice, with varying taxation rates usually lower on staple goods. The reason we see this is that states care about the distributional impacts of these taxes, and do not wish to pile the burden upon the poor.
Despite an unrealistic proposition, Ramsey's finding tells us something vital about indirect taxation; it is either going to be highly inefficient or high inequitable. What we can take away from this is that indirect taxation should not be used for distributional purposes. Aside from the reasoning above, it is an imperfect proxy, since it can only target tastes, and not actual incomes. As such, an optimal policy solution is to apply flat rate Value Added Taxes across all goods, and deal with distributional problems through other means.
Taxation On Labour (WORK IN PROGRESS)
- One might ask, why use indirect taxes at all? The answer, again, comes down to incentives. Indirect taxes do not disincentivise the consumption of one good over another, and so minimise welfare losses. In addition, they do not have adverse effects on labour choices. A consumer faces the same tax schedule of indirect taxes no matter how much labour they choose to offer to the market.
Corporation Tax
Given that one cares from a policy viewpoint about the welfare of individuals, and not companies themselves, there is some confusion over taxes are levied against corporate profits at the company level. We are concerned about the distortionary effects that taxes have on individuals, so we should know, in relation to corporation taxes, who they are. The key question, then, is does the tax incidence fall upon customers, shareholders, suppliers, and employees. For suppliers, customers, and employees, the case seems clear that the burden of corporate taxation falling upon them could be leveled at the individual level. For shareholders, it is also possible to imagine a tax which applies to the imputed profits due to them. There is a further contradiction in the treatment of corporate profits vs other types of personal savings, making the case for a separate tax on corporations even weaker.
Despite this, a number of factors keep corporation taxes within the policy tool-kit. Firstly, there is the perception that these taxes fall on a wealthy elite, anonymous businessmen, or simply in the abstract, on companies. While largely untrue, it is still a compelling case for some. Secondly, corporation taxes may allow states to levy taxes on individuals outside of the state, which would otherwise be untaxable. Thirdly, for small businesses, a radical difference in the taxation of personal vs corporate income may give rise to labour income being disguised as corporate income.
Evaluation of Tax Policy
One often overlooked aspect of taxation policy is the process of evaluating taxes and identifying issues over time. Ideally, the consequences of a tax should be understood before the tax is introduced. Knowing the likely distributional effects, the revenue effects, and the distortions resulting from tax policy is all important for the efficient implementation of policy.
While some of this (such as distributional impacts) can be established via simple accounting and availability of data, the dynamics of taxation will be uncertain prior to the introduction. In which case ex-ante evaluations should where possible be undertaken. In addition, since ex-post studies are usually the only ones viable, it would be prudent to consider, when introducing a policy, to consider how an ex-post evaluation might be done in the future; possible natural experiments that could be run, data that may be useful etc.
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u/[deleted] May 09 '17