B Guy Peters. Handbook of Public Policy. Editor: B Guy Peters & Jon Pierre. Sage Publications, 2006.
Taxation is one of the oldest and most important activities of government. Governments have always needed money in order to pay for the services they provide, and that has meant that they needed to tax. Despite its necessity, taxation has never been popular with the public and therefore governments have had to find ways of raising the money with the minimum political opposition. As governments have undertaken more functions, growing from the Nightwatchman State to the contemporary Mixed Economy Welfare State, the need for tax revenue has grown, and with that the need to find politically acceptable means of taxing has also become more important for governments. Citizens have become somewhat more resistant to taxation, even in high-tax, high service political systems such as the Nordic countries, so government also consider more carefully other forms of revenue collection, such as fees for services that do tend to be more palatable to the public.
Although the primary purpose of taxation is to raise revenue for government, tax policy also can be used to achieve a number of substantive policy goals. Governments can advantage some products and activities in the private sector by taxing them more lightly than other types of income (capital gains), or by allowing the taxpayer to deduct expenditures from taxable income (mortgage interest payments in many countries). Governments may effectively ban some products and actions by taxing them heavily, or attempt to reduce consumption by high taxes (tobacco, for example). Taxation can also be an important tool for managing the economy, with lower taxes presumed (especially by analysts and political parties on the right) to stimulate economic growth, and higher taxes being useful for controlling inflation. In short, taxation is a powerful instrument for the public sector that can be used in a number of ways to move resources, both from the private sector to government and from various segments of the private sector to others.
Politically, tax policy is often a more convenient mechanism for coping with complex issues than are public expeditures, or many other forms of implementing public policy, such as regulation (see Peters, 2001). Citizens talk a great deal about taxes but the process through which taxes are made is often more technical, and less visible to the public, than are expenditure politics (see Steinmo and Tolbert, 1998). Benefits created for individuals or businesses through taxes tend not to involve creating service programs, hiring employees or all the other trappings of “big government”, but rather can be created through complex changes in the rules used to collect taxes. These complexities also create difficulties in the international environment as organizations such as the World Trade Organization attempt to maintain fair competition in the world economy.
Making Tax Choices
Making tax policy, as is true for any policy involves a number of choices. For taxation these choices include the total amount of tax to be raised, the type of taxes to be used, the rates at which those taxes will be charged, and the specific exclusions from taxation that will be used to benefit particular groups in the economy. These choices have a wide range of consequences, so that making the choices involves balancing a number of considerations, and the different views of a wide range of actors. Taxation is usually considered primarily from an economic perspective (see Salanie, 2003; James and Nobes, 1996) but there are also crucial political, legal, and even ethical considerations that must be considered when making tax policy choices. Many citizens would not consider any tax a good tax, but some choices may be better than others. The virtues of particular taxes may, however, be contingent and what is a good tax in some settings will be a less wise choice in others. Those contingencies are, in turn, both economic and political, and a tax that may be a good technical instrument for achieving certain economic goals may be politically unacceptable, and in this game politics is generally trumps.
When governments tax they have a wide range of possible targets for their actions, but these targets are basically three: income, expenditure and accumulated wealth. Less developed economies, in which a good deal of production is not monetized, e.g. the importance of subsistence agriculture, may have fewer options to tax and hence may have to focus on imports and exports (Radian, 1980), but more modern economies will have a very wide range of options. As already noted, the choice of any one of these, or more commonly the choice of the mixture among the three, will influence the success of government in raising revenue, the political acceptablity of the choices, and the economic impacts of the tax system.
Income is the principal tax handle for modern governments. In addition to the income tax (personal and corporate) per se, the other major tax relying on income as a tax handle are social insurance contributions used to fund social programs in many countries, especially in Europe. The logic undergirding taxes based on income is that individuals and firms earning incomes have the ability to pay, and therefore income taxes are a relatively fair form of revenue collection. Likewise, the income tax is generally at least somewhat progressive, with higher rates charged on higher incomes; with the logic being that for the more affluent the marginal value for each additional unit of income is less, and therefore again the tax can be considered fair, and fairer than imposing average rates across the whole income spectrum. Not only would this facilitate collection, but it would also mean (it is argued) that each member of the society is funding government at an equal level.
As implied, income taxation of various sorts has been central in financing the welfare state in the affluent democracies. There have been, however, marked differences in the tax choices made by governments in financing similar service programs, and those differences have real consequences for the impacts of social programs on the distribution of income in society through public action. Some countries fund social security from general income taxation, thus producing the most redistributive possible outcomes. Other countries have used dedicated social insurance contributions for these purposes, but impose more of the burden on employers than on the employees, while many tax systems split the total social insurance contribution more or less evenly between workers and employers.
Although perhaps the most fair, income taxation also may be the easiest form of tax to evade. The average person earning most or all of his income from an employer required to keep records and report that income to government may not be able to evade taxes, but independent workers, such as plumbers or gardeners or taxi drivers, may receive a good deal of their income in cash and simply not report part of that income. More highly paid professionals, such as dentists or lawyers, may have the same opportunities for evasion, having a good deal of their income in cash. Some countries have established themselves as tax havens for corporations, with very low taxes and strict laws preventing corporate or individual income information to tax authorities as a means of assisting individuals who want to evade taxes to do so.
The second major alternative source for tax revenue is consumption. The Value Added Tax, for example, is paid by consumers in European countries whenever they purchase an item in the stores, although they may not notice because the tax is included in the price. Consumers in North America and Australia pay sales taxes and goods and services taxes that are added to the costs of the product on the shelf, and hence are more visible to the consumers or taxpayers. Tariffs levied on imports are also consumption taxes because, in the end, they will be passed on by the importer and paid by the final consumer of the products. Excise taxes — the famous sin taxes on products such as alcohol, tobacco and gambling, and simple necessity taxes on products such as gasoline and phone service — also come out of the pockets of the consumers of these products. Most citizens find that they are helping to fund government every time they go to the shops.
In most instances consumption taxes fall more heavily on the less affluent, but may be considered fair politically because everyone in society should be obliged to pay at least something for the maintenance of the society. The actual incidence of consumption taxes can be altered somewhat by careful design of the taxes, e.g. not charging VAT on food or medicines, but the impact still tends to fall more heavily on those less capable of paying. Consumption taxes also are generally more difficult to evade than are income taxes, and have the additional advantage that government can use stores (or casinos, or wherever) that sell the products to collect the taxes. Given that the incidence of consumption taxes is general rather than on industry, many countries have been shifting their tax burdens somewhat in this direction in the face of pressures from globalization and tax competition.
For the less developed countries of the world consumption taxation tends to be the principal form of revenue collection. If the economy is highly decentralized and has a number of segments that are not conducted in cash, then counting money incomes may be difficult. Further, to the extent that incomes are in money they may well be in cash that is difficult to trace, as compared to salaries paid by larger firms. Therefore, these countries may find it easier to collect excises and customs rather than attempt to tax incomes, or even attempt to impose consumption taxes on personal consumption, such as sales taxes.
Finally, governments can also tax accumulated wealth. One of the most common forms of tax using this “handle” is the property tax, a mainstay for local taxation in Anglo-American countries. This tax also is justified on the ability to pay, with ownership of a house, or other assets, being evidence of that ability, although it is also assumed that homeowners benefit more from services such as fire protection and public utilities than do other citizens. Inheritance taxes also use wealth as a basis for collecting revenues as that wealth is passed between generations. While these taxes do appear fair, given the possession of the assets, some people (especially the elderly) find that their incomes do not match their assets, and have to sell their homes simply because of the taxes imposed. Further, heavy taxes on accumulated wealth may discourage investment and savings, and hence have negative long-term economic consequences.
Again, governments can fine tune a tax instrument in order to produce the type of outcomes desired. For example, if there is a desire to keep the elderly in their homes, governments can provide a “homestead exemption” up to a modest amount to protect those homeowners from tax. Likewise, property may be passed on to spouses without tax, and to children with limited tax, but other forms of transfer may be taxed more heavily. These tax instruments may appear to be rather blunt when first considered, but governments can make them into very sensitive tools for altering the distribution of income and providing incentives for certain types of economic and social behavior.
To this point I have been speaking about taxes per se, but governments have other important revenue sources as well. In particular, governments provide a number of goods and services for which they can charge their “customers”. Governments have been raising an increased amount of revenue from fees and charges over the past several decades. This shift in revenue patterns has come about for several reasons. First, this form of revenue collection tends to be more acceptable politically than does taxation, given that there is a direct exchange of money for the service rather than the perception that tax money goes into some vague general fund. Secondly, governments also use fees as a means of rationing consumption of certain types of services that might otherwise be overused by the public. Finally, the ideology of the New Public Management and of the political right has emphasized the capacity to use more business-like mechanisms within the public sector.
The choices among these tax handles, as well as among individual forms of taxation within those broader categories of taxes, involve economic, political, administrative and ethical criteria. One of the most important strategies that governments have adopted in attempting to be able to raise adequate revenue without creating large-scale resistance among taxpayers is to spread their tax net as widely as possible. Most governments take at least some revenues from as many sources as possible. This broad-based approach to taxation may help reduce political opposition, but it may also make achieving other policy goals through taxation more difficult. If all aspects of the economy are being taxed, or being given tax relief, then there is little that any one type of economic action is likely to gain from government. Thus, taxation, perhaps more than policy areas, involves a set of complex trade-offs among a number of competing values and critieria for assessment.
Criteria for Assessing Taxes
The above discussion has implied the application of criteria for assessing taxes, but I should present those somewhat more systematically. As noted, tax policy tends to involve very large-trade-offs of these criteria. Economists have tended to dominate policy-making for taxation, and hence the economic criteria discussed below tend to be the dominant values. That having been said, in the public sector politics is usually trumps, so, even though there may be good economic arguments for a tax policy if that policy produces political difficulties, it may well be rejected for a program that economists might consider inferior. Economists do vote, but there are fewer of them than of many other groups in society and politicians in democratic systems have to appeal to majorities.
Many of these criteria for taxes are distributive, and are concerned with the economic, political and ethical consequences of who pays taxes. That assessment is, however, somewhat incomplete without a simultaneous assessment of where the money is being spent. A tax, such as the Social Security “contribution” in the United States, that is negatively redistributive because it is not charged on earned incomes above $90,000 (2005) and not charged on incomes from investments, is used to fund a program that is slightly progressive. The net effect, therefore, may be roughly proportional among economic classes. In general tax systems have become less progressive in most of the industrialized democracies, but spending continues to go to the programs of the Welfare State, and perhaps in larger proportions, because of the aging of the populations, so that the net effects may not be altered as much as expected.
Economic values tend to be considered first when assessing taxes, and the political criteria discussed below are often seen by economists as introducing distortions into the more efficient solutions that might be produced by focussing more single-mindedly on the economics of taxes. Indeed, to some analysts any tax may be considered a distortion in what might otherwise be a more efficient economy, but, given the needs for contemporary governments to raise money in large amounts, these distortions must be minimized rather than eliminated. The tax distortions of markets may be especially apparent when tax systems favor one use of money over others. For example, tax expenditures for housing favor personal homes over other forms of investment, even though housing may be less productive than many other potential uses of capital. Politically, however, houses are widely held in many economies so that a tax advantage for this use of capital is very good politics indeed.
The desire to eliminate distortions arising from taxation does not, however, necessarily imply removing all special treatments of income and expenditures. Indeed, creating a tax system that is free of distortions might involve introducing a large number of special treatments and the creation of a very complex tax code. For example, although depletion allowances for oil and gas producers have been written into tax codes in part because of the political influence of those industries, they also reflect a real economic consideration about the short lifetime of returns from what can be significant investments. Given this and numerous other needs to fine tune taxes, the resultant tax code may have to be extremely complex if the goal is eliminating distortions in the tax system.
Economists are also concerned with the incidence of taxation. That is, who finally pays the tax? While for the personal income tax it is clear that the individual is the payer, for the corporate tax there continues to be a debate about who pays, and under what conditions. Do consumers pay corporate taxes through higher prices, or do stockholders pay through lower dividends, or do employees through lower wages, or is it a combination? The answer is that it is probably a combination, but that the mixture will differ under different conditions, e.g. the elasticity of demand for the products of the firm. The incidence of taxes is important for more than technical reasons. If taxes are being used to attempt to affect the behavior of firms, or to alter the distribution of income, then it is important to understand who really pays.
Economic analysis of taxation focuses some of its attention on the incidence of taxes. Levying a tax on a business or on an individual is one thing, but the question of incidence is who actually bears the burden on that tax. For example, the corporation tax is apparently a tax on businesses, but in reality that tax is paid by employees, by customers, and/or by investors. The actual incidence of the tax will depend upon factors such as the elasticity of demand for the product and therefore the ability to pass along the tax in higher prices. Determining the true incidence of a tax is important because it allows determining just where the burden of the tax falls within the economy. For example, if corporations can pass along their taxes they may be less interested in opposing those taxes politically, and indeed may be more than willing to publicize the amount that they pay as “good corporate citizens”.
The economic criteria above may appear scientific and rationalist, while the political criteria discussed here are more difficult to quantify or link to specific analytic justifications. That having been said, however, these criteria are often crucial to the success of the policy. The most important political criterion for taxation is fairness, and most citizens are willing to pay their taxes if they believe they are fair. People do not like paying taxes, and, unfortunately for governments, a significant propotion of the populations in many countries do not believe that the tax system to which they are a party is fair. Most people believe that they and people like them pay too much, and other people (whether the rich or the poor, or whoever) do not pay enough. Likewise, many citizens believe that other people in the society are evading taxes, although the respondents to surveys often lump together illegal evastion with legal avoidance of taxes through tax expenditures (Seldon, 1979).
Perhaps the most fundamental political criterion for taxation is that an old tax is a good tax. This statement reflects not only public resistance to new taxes but also indicates the strong path dependence in tax policy (Kato, 2003). For example, the property tax, especially as a means of funding local governments, is a traditional form of revenue collection in Anglo-American countries and, despite a number of serious problems in administration and equity, remains in place. The political traditions of countries in taxation persist and make some taxes appear quite normal and acceptable to citizens, while introducing others might be politically infeasible. This cultural impact on taxes may even affect the level at which a tax can be used. Citizens in the United States are accustomed to consumption taxes levied at the state and local level, but the idea of a national consumption tax is considered innovative, and perhaps too innovative.
As already noted, one of the most important political criteria is minimizing the visibility of the tax to the public. Taxes are not popular, so if the money can be raised without the public understanding the exact impact of the tax on their own resources, then political resistance can be reduced. Therefore, although economists might prefer direct taxation, e.g. taxes on income, politicians might prefer indirect taxes that are included in the price of a product rather than charged directly to the citizen. Another means of reducing visibility is to use the full range of taxes available, charging each at a small rate, but have the total add up to the needed revenue. Citizens may see that their disposable income is lessened, but not have a clear target as they might with a few large taxes.
Although most politicians in government may like the idea of less visible taxes, some politicians on the political right have been opposed to reducing tax visibility. They argue that if citizens really understood how much they were paying in taxes they would mobilize politically (presumably on behalf of those conservative politicians) and oppose the expansion of the public sector. Constitutional rules, such as requiring referenda for tax increases in some American states, and in Switzerland, have been devised to ensure that citizens are indeed aware of the level of taxation, and have the opportunity to oppose any new taxes or increases in rates.
Earmarking is another of the political strategies that can be utilized to enhance political support for taxes, or at least minimize adverse political reactions. A good deal of survey evidence indicates that citizens are more likely to accept a tax if they can be sure that it is being used in a particular way. For example, gasoline taxes in a number of countries have been dedicated to highways and other transportation purposes. In the United States and Switzerland, even in periods in which there is strong public resistance to taxation in general, citizens have voted for taxes so long as they could identify the actual use of the revenues. So-called “sin taxes” may be a particular form of earmarked taxes. Although governments do derive some general revenues from taxes on alcohol, tobacco and gambling, increasingly some or all of that revenue is dedicated to particular purposes, and often to dealing with the problems created by the substance or activity being taxed. Revenues from taxes are often used to pay for advertising against smoking, and some revenue from alcohol is used to fund rehabiliation and advertising.
To this point I have been talking about taxation, but it is important to remember that this is but one of the possible revenue sources for government. Governments have a number of other ways to raise revenues, notably through charging fees for services. For example, when taxation may be politically impossible, governments can charge for services such as garbage collection, recreation facilities, passports, and a host of other activities. This source of revenue has the obvious advantage of being directly related to services, and, further, are paid only by the people who actually avail themselves of the services.
Public lotteries are a special case of “user fees” to finance public services. These gambling programs have been successful in providing a great deal of money for the public sector where they have been used. For example, in the American states in which they are used, lotteries provide a percent of public revenues. Likewise, in the United Kingdom the lottery has been used to fund a number of major public works. In most instances lotteries are in essence an earmarked tax, paying for services such as education and the support of the elderly. Although lotteries are often critisized as being negatively redistributive, and as government sponsored gambling (see below), they are too dependable a source of income for governments that have the option to use them to ignore.
As well as minimizing the resistance to taxation, redistribution is a major political concern when making tax policy. While economists may want to ensure the neutrality of taxes, politicians generally want to use the tax system to move money around among social groups, especicially social classes (for a somewhat polemical view of this debate, see Shugart, 1997). Thus, the income tax — the principal source of income for industrialized democracies — tends to be at least moderately progressive. Taxpayers pay a higher marginal rate after certain levels of income, although the strength of conservative politics in recent decades has tended to reduce the level of progression. The Bush tax cuts in the United States, for example, have gone primarily to the most affluent members of the society, with the economic justification that their investments will produce economic growth.
A good tax (although some people might argue there is no such thing) must be fair, it must not distort economic activity more than is absolutely necessary, and it must also be collectible without imposing excessive administrative costs. There is little use in having a tax in the law books if it cannot be collected, or if it imposes so many costs on government to collect that it is not worth the effort. While the fortunes of government in collecting taxes are to some extent a function of the laws and policies themselves, they are also to some extent a function of the social and economic environment in which the taxation is being conducted. Some countries have a long tradition of ignoring tax laws, and reducing evasion in these cases may present a major challenge for government. Likewise, in societies in which a good deal of the economic activity is not traded in the market for money, attempting to collect taxes from most of the population may be rather pointless.
One common strategy for coping with the problem of collecting taxes is for government to have private sector actors bear a major part of the burden. This practice goes back to “tax farming” in Roman times, in which tax collectors were private individuals given the right to collect taxes in return for the option of keeping a part of the take. In more recent times governments have come to depend upon firms to do a major part of the record-keeping and administration. Most employers have to withdraw a portion of their employees’ incomes as tax and turn that over to government. Likewise, firms and individual proprietors are responsible for collecting the Value-Added Tax (VAT) and other consumption taxes for government. In the case of the VAT, this can impose a substantial administrative burden on the private sector actor, given the often complex questions involved in this tax.
Ordinary citizens also do a good deal of work for government in collecting taxes. Many countries now use self-assessment of taxes, requiring citiziens to retain records and then file annual tax forms detailing income and deductions. Government will still have to review these returns and audit a percentage to prevent fraud, but much of the work is done by the citizens. The Internal Revenue Service in the United States estimates that the average filler of the principal tax form (1040) spends nn hours per year keeping records and another mm hours filling out the form. More complex tax issues require the citizen to engage lawyers and accountants, again imposing a good deal of the cost of administration on the private sector.
The necessity of actually administering the tax code and collecting money from the public may conflict with several of the economic and political criteria already advanced. For example, if governments attempt to fine tune taxes in order to prevent significant distortions in the economy, they increase the administrative problems of government (and citizens) in complying with that code. Governments in a number of countries have been attempting to simplify their tax codes in order to facilitate administration, as well as to respond to political claims that the complexity of the codes actually hides numerous benefits for more affluent citizens. Simplification of tax systems has not been as easy as the political advocates have made it appear, and many of the provisions written into law appear to have some justification.
Finally, taxes, like all public policies, also have an ethical dimension (see Hughes and Moizer, 2005). The ethical dimension of analysis centers on the issue of the fairness of taxes, and the need to balance the other criteria. On the one hand, it can be argued that all members of the society should bear some of the cost of maintaining basic public services, so that tax programs that spread these costs broadly and find ways of extracting at least some revenue, even from the poorest segments of society, are indeed fair. On the other hand, fairness may imply that those most capable of paying should pay the largest share of taxes, and that the operations of government (taxing and spending together) should make the distribution of income more equitable.
Raising revenues from lotteries and from sin taxes raise some of the more vexing ethical problems for government. While these taxes are paid by everyone who smokes, drinks or gambles, it is well known that lower income citizens engage in these activities at higher rates, especially in relationship to their income. Thus, especially lotteries and the tobacco tax have a negative redistributive effect, and take a substantial amount of money out of the pockets of the less affluent. Part of the logic of having high alcohol and tobacco taxes is to deter consumption, but it is not clear that this is effective, and the continued use of these substances, especially by poorer people, has those taxpayers who are less able to do so funding many important public services.
Current Issues in Tax Policy
Although tax policy is indeed a very old activity of government, there are some recent developments in the use of this instrument that demonstrate the continuing development of this policy area. The majority of these issues concern the use of tax policy as a means of achieving other policy goals, and therefore are in some ways merely extensions of a logic that has been in place for some time. That having been said, however, several of these uses of tax policy are more extensive and innovative, and demonstrate the limits of using tax policy as an instrument of policy.
The Carbon Tax
The carbon tax is a mechanism for addressing the issue of climate change and global warming, as well as the more general question of the continuing use of scarce, non-renewable resources in a profligate manner in contemporary economies. The basic idea of the carbon tax is simple. Given that increasing levels of carbon-dioxide is a major cause of global warming, a tax should be levied by each country on the amount of carbon in fuels. This tax should create an increased cost for inefficient use of energy and drive firms to find better ways of producing, and create incentives for individuals to use less energy at home and in transportation. The tax could be fine-tuned to advantage renewable sources of energy, such as ethanol, even if carbon-based.
Although the basic idea of the carbon tax is simple, there are a number of technical and political issues that are raised about the implementation of the idea. One of the most important of the objections arises around issues of equity. On the one hand, raising carbon taxes from all countries will disadvantage the less-developed countries, while raising it only from the more affluent countries will disadvantage those countries that already feel that they are losing industrial jobs because of globalization. While some sense of equity might argue for facilitating the development of the poorer countries, an unemployed textile worker in Lancashire might not find the argument compelling.
The Tobin Tax
Another variant of using taxes on an international level in order to alter behavior is called the Tobin Tax, after James Tobin (1978) the Nobel-laureate economist who first proposed this means of dealing with the problems of globalization. The idea of the Tobin Tax is to impose a tax on foreign exchange as a means of imposing some restraint on the global movement of capital. This tax would, it is argued, first help to reduce distortions in the international capital markets because of the herd behavior of currency traders who tend to exaggerate runs on currencies (as in the Asian currency crisis in 1997). Further, borrowing and lending might be considered more carefully were there some additional costs involved.
While this tax may be able to produce some real benefits for the world economy, it poses several interesting implementation problems for governments and international organizations. How could the tax be collected, and by whom, in an already decentralized and complex market in foreign exhange, and would not such a tax drive exchange operations into less stable instruments such as derivatives? Further, how would the revenues from the tax be used? The usual assumption is that the revenue from this tax would be used by the International Monetary Fund (IMF) to ameliorate some of the consquences of speculation for poorer countries. This tax is hardly the solution for all the problems of globalization, but it does illustrate the possibilities of using tax instruments even in the international environment.
Taxing the Internet
Coping with globalization is one of the issues for contemporary taxation, but the increasing importance of internet commerce represents another interesting challenge to traditional forms of managing tax programs. The magnitude of commerce conducted on-line is difficult to estimate, but is certainly substantial in most of the wealthy democracies, and is also certainly increasing in importance in the international marketplace. This form of commerce is, however, extremely decentralized and some aspects can be anonymous, and it therefore can pose difficulties for governments attempting to monitor the flow of funds and extract the revenue that it believes is appropriate from these transactions.
For tax authorities there is little doubt that the transactions on the Internet are in principle subject to tax, just as if they had taken place in any shop in the center of town. Money is changing hands — or perhaps goods are being bartered — but this is market activity. For citizens, however, shopping, selling or bartering on the internet is perceived as a means of escaping from the long arm of tax authorities. Governments are encountering a number of legal and administrative difficulties in coping with the growth of e-commerce, and have been generally effective at tapping the tax revenue that might be derived from these activities (Lymer, 2005). The amorphous nature of e-commerce makes basic issues like the locus of the activity, and hence the responsible taxing authority, difficult to determine.
Tax competition is hardly a new concept, or a new concern for governments, but globalization and increasing levels of international trade have brought it forward as a significant concern in the contemporary economy. Countries, as well as sub-national units within countries, compete with one another to have businesses locate within their territory so that there will be more jobs and greater wealth in that territory. Offering lower levels of taxation is one of the many incentives that can be manipulated by governments to encourage firms to select one area over another. Part of the critique of globalization of economies is that destructive tax competition has reduced the capacity of governments to raise revenues in the manner, and in the amounts, that they would like and, therefore, the overall quality of government programs have been declining.
It is important to note that taxes are but one of many factors involved in making decisions about industrial location, and perhaps not the most important. Some research indicates that taxes, in fact, fall rather far down the list of the factors that are crucial for location decisions, although firms may still act as if receiving tax breaks will be the central factor in the decision. Indeed, for some types of industries requiring highly skilled workforces, low levels of public revenue, usually associated with a poor education system, may in reality be an impediment to persuading a firm to locate in an area. Further, the range of possibilities available to governments in raising revenues means that sacrifices in some types of taxation may be made up in other forms of taxation, or in fees levied for services.
Although they have been most evident in the United States, many of the industrialized democracies have been reducing some of their taxes, especially taxes on personal and corporate income. The assumption is that this reduction in government revenue will result in more spending by the public, which will, in turn, increase economic growth. This strategy is a variation on the familiar Keynsian logic of enhancing effective demand as the means of coping with a slow-down in the economy. The difference is, in part, that many of these tax reductions (again, especially those in the United States (Pollack, 2003)) have benefitted the more affluent rather than the less affluent, who are most likely to spend any additional income they may receive. On the other hand, the advocates of the contemporary tax cutting strategies for the top of the economy argue that these are the people who are most likely to invest in the economy and produce long-term economic growth. For some countries the important issues are, however, cutting corporate income taxes and other business taxes as a means of promoting investment and economic growth.
The pressures for reducing taxation are obviously related to the issue of tax competition mentioned just above. The competition over taxation is often discussed in terms of corporate taxation, or perhaps individual income taxation, but some of the important contemporary issues concerning cutting are about the social costs of employment. When firms are deciding whether to add new employees, in addition to the actual wage being paid to the individual, the firm must consider the tax costs — especially for social security taxes — that are involved with the job. Especially in countries where collecting direct taxes is difficult, there has been a tendency to impose high rates of social insurance contributions on both individuals and firms, so that the marginal cost of the additional employee can be very high.
The logical question then becomes whether tax cuts are indeed an important tool for economic management, or simply an ideologically driven device to aid the more affluent to reduce their contributions to the public purse. The answer to that question may depend in large part upon the political persuasion of the individual answering. The answer may also depend upon the nature of the economy at the time, and the need for stimulus from more cash in the hands of citizens — even the more affluent. What is clear, however, is that many, if not most governments, now face increasing pressures to justify any taxes they may impose, or even those they choose to retain. At the same time that governments may want to reduce levels of taxation, many are constrained by their involvement in institutions such as the European Union that constrain their economic actions. Even in those constrained situations, however, there are increasing pressures in some countries to reduce taxes to address continuing unemployment, even in countries, such as Germany, with a significant social welfare system.
At the same time that there are some political pressures to reduce taxation there are other changes in tax systems that are having the effect of increasing taxes. In particular, many countries (see Brixi, Valenduc and Swift, 2004) have been eliminating tax expenditures, or “loopholes” that had advantaged certain types of activity. Even some of the more popular tax expenditures, such as supports for home ownership, have been reduced or eliminated to simplify tax systems. The logic of tax expenditures has been that the tax system can be as efficient, or even more efficient, a mechanism for moving resources about in the economy as is public expenditure. Allowing citizens to escape taxation on certain types of activity, or to receive tax credits for others, have had something of the same effects as spending, but did not require governments to go through the political pain of taxation to fund the program, nor the economic costs of managing a program.
While there is certainly some evidence of abuse of tax expenditures, providing tax relief for some activities can also constitute an important policy tool for governments. In addition to the political advantage of lessened visibility of the programs that are developed, using tax expenditures also displaces much of the administrative burden for programs on to the individual taxpayers and can save the public sector itself a good deal of money. If we use the familiar example of deductibility of mortgage interest as a tax expenditure, then a major housing program is being administered through the individual actions of taxpayers, who retain their own information about their costs, file the forms, and do all the work that would normally have to be done in the public sector.
Tax expenditures do, however, tend to have negative redistributive consequences. Tax relief from these exemptions and deductions is more significant the higher the individual’s tax rates are. Therefore, most tax expenditures tend to benefit the more affluent differentially (Howard, 1997; Greve, 1994). These benefits available through the tax system, therefore, tend to reflect the political power of the middle and upper classes. That having been said, however, there are notable examples of tax expenditures being used to produce benefits for the poor, notably the Earned Income Credit in the United States, and the Integrated Child Credit in the United Kingdom. These mechanisms have used the tax system as a means of providing something approaching a guaranteed income to the working poor. Again, these benefits might not have survived the more visible politics involved in adopting expenditure programs.
Summary and Conclusions
Taxation is one of the oldest areas of government policy, and many of the questions raised by the first attempts to raise revenue continue to be important today. Although primarily designed to raise the money governments need to fund their spending activities, taxes can also be used for a variety of other purposes, advantaging some activities and disadvantaging others. Even the simple choice of what type of tax to impose in order to raise the revenue will have consequences other than simply collecting money. Therefore, taxation involves a number of complex decisions that involve political, economic, administrative and ethical concerns. Different political forces will stress one or another of these criteria as the most important for any decision, but there will have to be some trading-off of values.
In the end, however, governments have to raise revenue, and their first priority must be to find the money they need. Even when faced with an international environment that poses substantial economic competition for industrial location, governments have to find a way of getting enough money to fund their expenditure commitments. This ever increasing need for public revenue now means that a greater proportion of the burden of government finance is falling on average citizens and perhaps even the less affluent in society. On the one hand, that change in revenue collection patterns makes funding government very democratic, and everyone is contributing to maintaining the public sector. On the other hand, however, the process may now be less fair than in the past, given that the more affluent are in many societies now bearing a smaller proportion of the total costs of governing.