On taxes and government spending

Economics is intertwined with politics, indeed in Adam Smith’s time no distinction was made between the two disciplines. One of the great questions right at the heart of this intersection-from-hell is that of how involved the government should be with regard to the economy. Everybody has an opinion, ranging from the extreme left’s Soviet-style planned economies to the extreme right’s libertarianism and laissez-faire approach. Neither approach can be shown to be empirically unworkable, yet planned economies were tried, and failed, and a completely “free market” is an elusive fantasy – fairytale economics.

So it would seem that the sensible approach would be a mixture of the two, but how to mix them is crucial, and economic success doesn’t always mean political success, especially in the short term. That is because you humans are very short-sighted when it comes to your comforts. Most of you would choose a lifetime of poverty if it meant you could be rich for just one day, as long as that day is today. But I digress….

Taxes – Spending = Surplus (or Deficit). Even politicians can understand the mathematics of this (you’d think). Raise taxes or cut spending (or do both), you get a surplus. Lower taxes or increased spending puts you in deficit. Countries are not corporations; a budget deficit is not necessarily a bad thing and, as David McWilliams points out in this piece: if everyone and everything is balancing their budget at the same time, that’s a recipe for disaster. Because my spending is your income, and vice versa. A targeted mix of policies is necessary to balance a myriad of potentially conflicting forces.

In general, I like taxes. But taxation is a powerful tool and should be used responsibly. It’s a bit like chemotherapy, it might kill the cancer but could also kill the patient. Tax policy needs to be simple. The simpler the tax, the harder it is to avoid. I love VAT, I could wax lyrical about VAT for hours (don’t worry, I won’t). VAT is a beautiful tax because it’s simple, impossible to avoid, and all the work in its collection is borne by VAT vendors, not the government. It’s also about the most fair tax you could imagine; because it’s a tax on consumption, everybody pays, and what’s more everybody pays the same percentage. Whoever invented VAT should be knighted and sainted.

I cannot understand how, in general, the same people who favour cutting taxes also want spending cuts. Lower taxes and increased spending are two sides of the same coin, they bring you to the same point, and can even complement each other. Of course you can’t always substitute one for the other; roads won’t be built and maintained if we cut taxes. And governments can be wasteful spenders. A low corporation tax, as we have in Ireland, is another way for the government to invest money (that would otherwise be raised by a higher tax) in job creation. This is an example of a sensible, targeted policy. It involves one tax type, and achieves a very specific outcome. Now think of the govt spending equivalent: Family Income Supplement (FIS). This is a social welfare payment made to working people  with families, to supplement their income (the clue is sort-of in the name). This effectively allows employers to get away with paying lower wages; it’s not only the employee who is being subsidised here. Now why would you be in favour of a low corporation tax, but averse to a government income subsidy? The answer is that some humans hold economic ideas the same way they do religious ones, and they don’t think about the implications of those ideas; this applies to left and right equally.

Which brings me to a final musing; there’s a growing fascination in right-wing economics with an unsubstantiated fantasy called “Supply-side theory”. One of the central dogmas of this religion is that lowering taxes leads to increased government revenues. Even if the Laffer Curve was an actual curve, and not just a series of disjointed dots (with very different results for different countries) which is what the actual data gives us, it’s still the Laffer Curve not the Laffer Vertical Line and you might just still be on the left hand side of it. It’s amusing that this is presented as a serious economic study……….sure, and Alice in Wonderland is a great work of non-fiction. To be fair to supply-siders, other economic factors, especially shifts in demand, are always getting in the way of them ever proving their theory. Which kinda just goes to show that those factors are much more important.

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