It's the economy, stupid!

No zero-price lunch in public finance

Yesterday I published an article here at The Conversation on the GST - specifically on the notion of a 20 per cent GST with offsetting tax cuts elsewhere in the system.

Reading through the comments the notion that high tax rates retard economic growth appears to be somewhat controversial. The notion that taxes impose deadweight losses, however, is uncontroversial. The impact of taxation on the economy has generated a large literature - very nicely summarised here by the Tax Foundation.

The important question isn’t whether taxation imposes costs on the economy, but rather whether those costs worth paying. As James Buchanan has indicated the challenge we face is in deciding which goods and services are best provided through the market and which goods and services are best provided through some collective choice mechanism.

Civilisation doesn’t come cheap; those aspects of civilisation best financed by government need to be financed through taxation.

There are always “good” reasons to spend more money. Indeed there is a whole industry dedicated to encouraging government to spend more. Politicians don’t say “no” to more spending because they are callous and hard-hearted, they say “no” because they understand that raising tax revenue imposes costs on the economy.

People who imagine that government spending is cheap - even free - money must find the bipartisan commitment to balanced budgets (actually small surpluses) very frustrating.

Now we can debate whether Australia levies taxes at the revenue maximising tax rate or not. That is a legitimate argument. It is also legitimate to argue that taxes should be increased despite the economic cost of doing so. Not that I would agree with that proposition. But to argue that there is no opportunity cost associated with taxation (or government spending for that matter) is to ignore important real world constraints that policy-makers face.

We live in a society and not an economy and so it is easy to appreciate that the costs of taxation are borne by people; by ourselves, by our friends and by our neighbours. While some of these costs are well worth paying, it is not correct to assume them away.