It is commonly – albeit erroneously and counterfactually – thought that taxpayers are intimidated into the fulfilment of their fiscal obligations and that tax collection is mainly about coercion. The truth is different.
People pay taxes because they want to belong to a collective, share a communal fate and a common lore, and enjoy the benefits of membership in the exclusive club of productive citizenry. To be a taxpayer is akin to sporting a badge of honour: it is a proof of personal integrity and industriousness, and, depending on the tax bill, a hallmark of success and prosperity. The payment of taxes bestows civil rights upon the payee: the cries “I am an honest tax-paying citizen” or “no taxation without representation” resonate in many a film and book.
To motivate wayward denizens of the realm to discharge their pecuniary obligations towards the state, governments rely on police powers, incarceration, asset forfeiture, and sometimes (for instance, in China) worse. Yet, a far more effective method would be to name and shame tax evaders and to maintain a publicly-accessible registry of tax offenders. Peer pressure and public opinion are mighty weapons and the bulk of tax delinquents who are not utterly psychopathic are susceptible to it.
To tax or not to tax: this question could have never been asked twenty years ago.
Historically, income tax is a novel invention. Still, it has become so widespread and so socially-accepted that no one dares challenge it seriously. In the lunatic fringes there are those who refuse to pay taxes and serve prison sentences as a result. When they try to translate their platforms into political power and established parties they invariably fail dismally in the polls. Still, some of what they say makes sense.
Originally, taxes were levied to pay for government expenses. But they underwent a malignant transformation. They began to be used to express social preferences. Tax revenues were diverted to pay for urban renewal, to encourage foreign investments through tax breaks and tax incentives, to enhance social equality by evenly redistributing income and so on. As Big Government was more derided and decried so were taxes perceived to be its instrument and the tide turned. Suddenly, the fashion was to downsize government, minimize its disruptive involvement in the marketplace and reduce the total tax burden as part of the GNP.
Taxes are inherently unjust. They are enforced, using state coercion. They are an infringement of the human age old right to property. Money is transferred from one group of citizens (law abiding taxpayers) to other groups. The recipients are less savoury: either legally or illegally they do not pay taxes (illegal immigrants, low income populations, children, the elderly, the ultra-rich). But there is no way of preventing a tax evader from enjoying tax money paid by others (this are known as the commons and free-rider problems).
Research demonstrates that most tax money benefits the middle classes and the rich, in short: those who need it least. Moreover, these strata of society are most likely to use tax planning to minimize their tax payments. They can afford to hire professionals to help them pay fewer and less taxes because their income is augmented with transfers (of tax receipts) paid for by the less affluent and by the less fortunate. The poor subsidize the tax planning of the rich, and the latter pay fewer taxes. Thus, tax planning is widely regarded as the rich man’s shot at tax evasion. The irony is that taxes were intended to lessen social polarity and friction – but they have achieved exactly the opposite.
In economies where taxes gobble up to 60% of the GDP (mainly in Europe) taxes became the major economic disincentive. Why work for the taxman? Why finance the lavish lifestyle of numerous politicians and bloated bureaucracies through tax money? Why be a sucker when the rich and mighty play it safe?
The results are socially and morally devastating: an avalanche of illegal activities, all intended to avoid paying taxes. Monstrous black (and gray) economies sprang up. These economic activities went unreported and totally deformed the processes of macroeconomic decision making, supposedly based on complete economic data. This apparent lack of macroeconomic control creates a second layer of mistrust between the citizen and his government (on top of the one related to the coercive and skewed collection of taxes).
Recent studies clearly indicate that a reverse relationship exists between the growth of an economy and the extent of public spending. Moreover, decades of progressive taxation did not reverse the trend of a growing gap between the rich and the poor. Income distribution has remained inequitable (ever more so all the time) despite gigantic unilateral transfers of money from the state to the poorer socio – economic strata of society.
Taxes are largely considered to be responsible for the following:
- They distort business thinking;
- Encourage the misallocation of economic resources;
- Divert money to bizarre tax-motivated investments;
- Absorb unacceptably large chunks of the GDP;
- Deter foreign investment;
- Morally corrupt the population, encouraging it to engage in massive illegal activities;
- Adversely influence macroeconomic parameters such as unemployment, the money supply and interest rates;
- Deprive the business sector of capital needed for its development by spending it on non productive political ends;
- Cause the smuggling of capital outside the country (capital flight);
- Foster the formation of strong parallel, black economies and the falsifying of economic records thus adversely affecting decision making processes;
- Facilitate the establishment of big, inefficient bureaucracies for the collection of taxes and of data related to income and economic activity;
- Force every member of society to – directly or indirectly – pay for professional services related to his or her tax obligations, or, at least to consume resources (time, money and energy) in communicating with authorities and navigating the bureaucracies that handle with tax collection on behalf of the state.
Thousands of laws, tax loopholes, breaks and incentives and seemingly arbitrary decision making, not open to judicial scrutiny erode the trust that a member of the community should have in its institutions. This lack of transparency and even-handedness lead to the frequent eruption of scandals which unseat governments more often than not.
All these malignant side-effects and by-products might have been acceptable if taxes were to achieve their primary stated goals. That they fail to do so is what sparked the latest rebellious thinking.
At first, the governments of the world tried a few simple recipes:
They tried to widen the tax base by instituting better collection, processing, amalgamation and crossing of information. This way, more tax payers were supposed to be caught in “the net”. This failed dismally. People found ways around this relatively unsophisticated approach and frequent and successive tax campaigns were to no avail.
So, governments tried the next trick in their bag: they shifted from progressive taxes to regressive ones. This was really a shift from taxes on income to taxes on consumption. This proved to be a much more efficient measure albeit with grave social consequences. The same pattern was repeated: the powerful few were provided with legal loopholes. VAT rules around the world allow businesses to offset VAT that they pay on consumables and services against VAT that they are supposed to pay to the authorities. Many enterprises end up receiving VAT funds paid by individuals who do not enjoy these tax breaks.
Moreover, VAT and other direct taxes on consumption were almost immediately reflected in higher inflation figures. As economic theory goes, inflation is a tax. It indirectly affects the purchasing power of those not knowledgeable enough, devoid of political clout, or not rich enough to protect themselves. The salaries of the lower strata of society are eroded by inflation and this has the exact same effect as a tax would. This is why inflation is called “the poor man’s tax”.
When the social consequences of levying regressive taxes became fully evident, governments went back to the drawing board. Regressive taxes were politically and socially costly. Progressive taxes resembled Swiss cheese: too many loopholes, not enough substance. The natural inclination was to try and plug the holes: disallow allowances, break tax breaks, abolish special preferences, and eliminate loopholes, write-offs, reliefs and a host of other, special deductions. This entailed conflicts with special interest groups whose members benefited from the tax loopholes.
Governments, being political creatures, did a half-hearted job. They abolished on the one hand – and gave with the other. They wriggled their way around controversial subjects and the result was that every loophole-cutting measure brought in its wake a growing host of others. The situation looked hopeless.
Thus, governments were reduced to using the final weapon in their arsenal: the simplification of the tax system.
The idea is aesthetically appealing: all tax concessions and loopholes are eliminated, on the one hand. On the other hand, the number of tax rates and the magnitude of each rate are pared down. Marginal tax rates go down considerably and so does the number of tax brackets. So, people feel less like cheating and they spend fewer resources on the preparation of their tax returns. The government, on its part, no longer uses the tax system to express its (political) preferences. It promulgates and enforces a simple, transparent, equitable, fair and non-arbitrary system which generates more income by virtue of these traits.
Governments from Germany to the USA are working along the same lines. They are trying to stem what is in effect a tax rebellion, a major case of civil disobedience. If they fail, the very fabric of societies will be affected. If they succeed, we may all inherit a better world. Knowing the propensities of human beings, the safe bet is that people will still hate to see their money wasted in unaccounted for ways on bizarre, pork-barrel, projects. As long as this is the case, the eternal chase of the citizen by his government will continue.
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