Say five cops barge into your home at night. They locate and remove your television set. You wake up, become hysterical and start yelling at them. But they restrain you and threaten to arrest you. So you calm down, and let them have your TV.
The next day on Facebook, you notice my status update:
“You guys won’t believe what happened. Five policemen just came into my home and gave me a brand new television. For free. What nice guys. I love the government!”
That, my friend, is exactly how taxes work. The government takes money from some people, and gives it to others, giving those others the impression that they got their money for “free”. It’s inefficient because it’s taking money from those who made wealth and giving it to those who haven’t. As a result, both parties are less motivated to create new wealth.
With that said, taxes are necessary for a government to work (even for an economy-friendly government). Taxes are like death: inevitable. So instead of complaining about taxes being inefficient, it’s better to ask: “How can we make taxes less inefficient?”
Imagine you were elected dictator of America. Just for fun, will you tax me more than anybody else? At about 95%? Think about it. Be honest …
… I anticipate your answer for the last question was yes; so I’m afraid I’ll have to assassinate you.
Not only was it mean; it was foolish. If you tax me for everything I do, then I won’t want to do anything, and you will thus get little (if any) tax revenue from me. As a leader, you have to be more pragmatic.
Whatever tax rates you choose, it’s best for them to be at levels where creating wealth is still somewhat profitable. This will be different based on the time and place, and what is being taxed.
Here’s a quick list of tax effects to keep in mind:
-A sales tax discourages consumption.
-A tariff tax discourages trade with foreigners.
-An inheritance tax discourages bequeathers from amassing estates for their heirs.
-A property tax discourages realtors from owning and building property.
-A capital gains tax discourages corporations from making capital gains.
-Etc.
You have all these taxes to choose from; stop picking on me.
You are sitting in your throne, depressed about how you had to hang me (after I tried assassinating you). You can’t stop thinking about it, even though you’re in a meeting. There are two guys in the room right now trying to argue their case on why you should lower taxes for their respective income brackets. One guy is a poor construction worker; the other is a rich doctor. Both are idiots. They’re each using big words and convoluted reasoning to confuse you, rather than being direct and honest. And that makes you miss me even more.
Don’t worry, buddy. I’m still here in spirit. I’ll tell you what you need to know.
Taxes are progressive if the tax rate is higher for richer people. Taxes are regressive if the rate is higher for poorer people. A tax is flat if the rate is the same for everybody.
Because rich people tend to save more than they spend, a progressive tax can hurt a country’s total investment. Because poor people tend to spend more than they save, a regressive tax can hurt a country’s total consumption. Which type of tax is better depends on your country’s needs. Low investment now means a less prosperous future. But low consumption means a less prosperous present.
Say you and I own pizza restaurants on the same block. To be frank: my restaurant is better. I pay my employees more; so they’re nicer to customers. Your average cost of producing one pizza slice is $1.50. Because I give generous wages, my average cost is $2.50. We both sell pizza for $3.00 a slice. We are happy with this price level, since it’s profitable for both of us.
But one day, our douchebag uncle named Sam visits us, spinning his handcuffs around his finger. He tells us we can only sell pizza for $2 max, or risk being thrown in jail.
I decide to close down my restaurant, because my average cost exceeds this price. Now people are stuck with your shitty customer service, in a block where half the pizza restaurants are gone. And with the price being capped at $2, you and anybody new who wants to sell pizza will make less profit per slice. So it’s unlikely that more pizza restaurants will open than we had before.
If you stay open, most of my old customers will go to you, and because people will learn about the lower price, there will be more potential customers than previously existed in the market. But because Pizza can be made only so quickly, and because there is only so much space: you may not be able to serve them all.
When the government forces a price to go below a natural level, the amount of suppliers will decrease and the amount of demanders will increase. This results in a shortage of the product.
Imagine an alternate universe though, where Uncle Sam is another kind of douchebag. Here, he forces us to sell Pizza at $100.00 a slice. Few people want to buy Pizza at that price; so we both go out of business. We are then forced to live in a world where Pizza can be made; but never is.
Now imagine a third universe, where Uncle Sam seizes my Pizza shop. Here, the government pays Sam a fixed salary, and his job is to give out as much pizza as he can, for free. Enticed by free food, your customers ditch you, and you go out of business. All that’s left is one government-owned pizza restaurant.
Note: Because Sam is being paid by the government, and not by the people coming in, the pizza store will become more focused on pleasing the inattentive government rather than pleasing the people it should serve.
So far, I talked about how taxes, price controls and crowding-out can destroy motivations to create wealth. These are concerns that economists usually have.
But there is also another concern: poverty relief. How does a society treat people who have little potential in creating wealth? The elderly, the crippled, the orphan, the mentally ill, the illiterate immigrant, etc. These people can’t participate effectively in the economy, no matter how hard they try. For such cases, it is common for compassionate economists to overlook efficiency, and think more about humanity. Less fortunate people are still people; so at the very least, they deserve just enough free money to survive.
Note: Don’t say that the less fortunate can be cared for through the free market, via charities. Yes, charities can help people; but they can’t do it alone. Charities can’t coerce generous donations out of people the same way the government can.
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