Introducing Taxes: Expecting something for nothing

This article appeared originally in Gulf News: link to original article

Everyone expects the government to build roads, highways, bridges, ports, schools, universities, hospitals and many more; and then to hire people to work and manage them. Yet, we seem less keen on the huge amounts of funds that the government would need to raise to support such high spending. In other words, we expect the government to spend and make things right when the private sector doesn’t, or when the private sector normally can’t or fails to.

Historically, empires generated revenues through mining, acquiring new lands and their fortunes, as well as taxation. The world is not too different nowadays, except now; sectors can be privatised or jointly managed with the government, i.e. Public-Private Partnerships. The cash then raised by governments is used to pay salaries to government employees; current spending, and to invest in projects like transportation, power generation, etc. which is referred to as capital spending. Why do you think people start protesting when governments decide to curb their spending?

In the broad definition of GDP, four main components exist: consumption, investments, net exports, and government spending. For any economy at any given time; all four are important. The state that governs the economy, however; has direct control over its spending only and indirect influence over the rest using different tactics. Lower income taxes result in higher disposable incomes which trigger consumption, lower tax rates spur foreign direct investments, competitive exchange rates promote exports, and the government makes sure that friction between these four is kept at minimum. Besides that, when the former three do not achieve desired levels, governments increase their spending to make up for that. The challenge remains in whether or not this spending is channelled into appropriate sectors to stem growth. That is, spending on a one-time off infrastructure project creates jobs temporarily, if the project wasn’t outsourced, but the construction of hospitals and schools is more long-term thinking. The costs of government spending are closely related to the sources of funding, be it taxes or otherwise.

Even though many believe that markets do correct themselves if left on their own, that is not entirely true. And it’s not true either that governments are out of harm’s way. To the surprise of not too many nowadays, governments do fail as well. In the recent events that took place in Cyprus, a tax imposed on bank deposits to secure a bailout is, plainly put, weird. Consumption will be hit by unemployment and lost tourism, investors will be wary about putting their money into banks, and reduced economic activity will keep this rolling for some time. To be precise; inefficient spending.

In Nordic countries, excluding Iceland, people seem to be satisfied with what the government offers them in terms of quality health care, unprecedented educational system, high unemployment benefits and more. Whilst keeping payroll taxes low, these countries provide individuals with everything other than daily nutrition. It might be after all that you can’t identify a moderate tax model, but instead one that tackles different stakeholders differently. If taxes levy a dead weight loss on an economy, proper government spending might be one way out.

Taxes, fees, import customs, road tolls, speeding tickets; are all revenue generators for the respective government institution. Eventually, it all comes down to what you impose these on, for what purposes, and what kind of effects that’s likely to have. Then, and more importantly, what the generated revenues are channelled into. It has always been argued that taxes limit consumption, production or both in an economy; added to a dead weight loss that is believed to be psychological and cannot be materialised. Though, can this argument still hold if revenues were invested in projects that add value to the economy by creating real sustainable jobs? This can be to the advantage of countries seeking to nationalise jobs and set an example to the private sector.

How about tax revenues that are channelled towards covered medical care and more comfortable retirement? Would people accept taxes, if none exist, or higher tax rates for the latter? Now the last thought that I want to leave you with is this: how can taxes be introduced in economies that have no direct taxes, not yet?

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