One proviso on tax …

Kiwiblog blogs about to a good sounding report by the Maxim Institute on tax.  I especially like this line:

We need to design the tax system so that it allows the government to take the money it requires, while doing the least amount of damage to the economy and so too our potential prosperity

However, there is a proviso that needs to be taken into account when we say this.  Any redistribution that we as a society deem is appropriate given our value judgments needs to occur through “the money the government requires”.

The tax system that is solely based on efficiency will not be a tool for redistribution.  Depending on our value judgments, we will want a certain level of redistribution, and this has to occur through the level of government spending.  The higher redistribution is, the higher government spending is, and as a result the higher the tax rate will have to be.

Yet, according to this post, the recommendations of the report switch from the design of optimal tax to the equity-efficiency trade-off associated with redistribution:

A 2001 OECD study found that about one half of a percentage point increase in government consumption (the expenditure to GDP ratio) could cause a 0.6 to 0.7% direct reduction in per capita output.

Yes, there is a trade-off.  However, the level of government spending and redistribution should be premised on this trade-off.  By saying something like “If we can limit spending so that over time it is under 30% of GDP” we are making a value judgment regarding the amount of redistribution that is in societies interest – we aren’t discussing the role of optimal taxation.

My main point here is, there are two separate issues:  Firstly, the design of an optimal tax system GIVEN the level of redistribution.  Secondly, the socially preferred level of redistribution.  The first question is easy, even an economist can answer it.  The second question is incredibly difficult.

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