The Politics of Taxation
The government must obtain resources in some way if it is
to carry on its activities. The way it obtains resources
from the private sector will affect economic efficiency and
the distribution of income, though government may not always
consider these effects. If government raises funds by
taxation, the price one party in a transaction sees can
diverge from the price the other party sees, which can
either lead to economic inefficiency or correct a case of
market failure. The ability of taxes (and subsidies, which
are negative taxes) to change the way people act is the key
to their ability to affect economic efficiency.
The normative biases of the majority of economists can be
seen in the terminology they use to discuss the effects of
taxes on the distribution of income. A tax is a
progressive tax if its rate increases as the
level of income increases, it is a regressive tax if
its rate decreases as the level of income increases,
and it is a proportional tax if its rate
remains constant as income changes. A key word in each
definition is "rate." Suppose that people earning $10,000
pay an average of $100 in a tax, and that people earning
$30,000 pay an average of $200 in this tax. This tax is
regressive in this range of income because the tax rate
falls from 1% to .67% as income goes from $10,000 to
$30,000.
The unintended consequences affecting both economic
efficiency and distribution of income that occur as a
government raises funds have long interested economists and
have been a major topic of a subfield of economics called
public finance. However, the private interest view of
government suggests that the issues that fascinate
economists may not play an important role in the
considerations of elected politicians who write the
laws.
Taxes are unpopular with the electorate but are necessary
to pay for government programs that are popular with the
electorate. A successful politician will be one who seems to
give the benefits of programs and not the burdens of the
taxes (or one who seems to lift the burdens of taxes without
substantially cutting the benefits of programs).
Taxes that are hidden from the electorate should be very
attractive to the completely self-interested politician, as
should taxes that seem to raise large amounts of money while
affecting very few. Taxes can be at least partially hidden
when they are shifted, which means that the
incidence of the tax is not borne by the person who
visibly pays the government.
A major example of shifting involves the corporate income
tax. The employee of the corporation who writes the check to
the government does not feel the burden of the tax because
he pays with corporate funds. Neither does the corporation
because the corporation is merely a contractual
relationship, and as such it cannot see, think, use
resources, or feel pleasure or pain. When government takes
resources from the private sector, it must reduce the
resources available for real flesh-and-blood people to use.
It is not clear, despite much effort that economists have
spent on the problem, which flesh-and-blood people have
resources diverted away from them by the corporate income
tax. It might be the legal owners, the holders of common
stock. It may be the employees--both blue-collar and
white-collar--and others who supply resources to the
corporation. It may be those who buy from the corporation.
It may be all owners of capital because if the corporate
income tax reduces the return investors can get from
investing in corporations, they will reduce investments
there--driving up the return--and increase them in the
noncorporate sector--driving down returns. In the complex
and interdependent system of a market economy, a change in
one place can have effects in other places that at first
glance seem totally unrelated.
The value added tax (or VAT) is very popular in Europe,
but is not used in the United States. It is a sales tax
based on the value added at each stage of production. Value
added is computed as final sales minus the cost of raw
materials and unfinished goods. The tax in Europe also
allows the deduction of expenditures on capital goods
(machinery, tools, etc.). In its effects, the VAT is similar
to a retail sales tax, only the tax is collected at each
level of production instead of being collected at the retail
level. The advantage of the VAT from the viewpoint of the
self-interested politician is that the tax is hidden in the
final sales price of the product. A reason that this tax has
not been adopted in the United States is that the state
governments make heavy use of sales taxes to raise revenue,
and they fear that the federal government may eventually
seriously undermine the abilities of the state governments
to raise revenue if it adopts the VAT. They prefer that the
federal government stay away from sales taxes and leave
sales taxes to the states. As a result, state governors and
legislators have strongly lobbied against all proposals for
any sort of federal sales tax.
Another tax that is partially hidden is the tax for
Social Security. The amount of the tax that is shown on the
worker's pay stub is only one-half of what his employer has
paid to the government in his behalf. The other one-half is
not reported to the employee, but in the eyes of the
employer is just as much a cost of employing a person as are
wages that the employee does see. A reason that the
employee's pay stub shows any of the tax is that the Social
Security program has always been promoted as a pension fund,
and the amounts paid in as "contributions" rather than
taxes. If a majority of people considered them as taxes
rather than as contributions, there might be more opposition
to this tax because it is clearly regressive.
The whole Social Security program raises interesting
problems of incidence, because not only may the tax be
shifted, but so may benefits. The granting of money to
retired persons lessens the need for children to support
their parents in their old age. Instead of John and Jane
directly giving money to their parents, the Social Security
system takes the money from John and Jane and gives it to
their parents. The large transfer of money from young to old
that the Social Security system seems to entail may be
largely offset by reductions in other payments that would
take place in the absence of the system.
We next continue on to a question that has long been
central in public finance, the question of how
taxes affect economic efficiency.
Copyright
Robert Schenk
|