The Purposes to Taxation

There are four purposes to taxation.

1: Destroy money. The government doesn’t need to tax to spend money. It just has to write the check. However, money it spends adds to the money supply, and this would cause inflation if an equal amount of money wasn’t taken out of circulation or destroyed. If money is taken out of circulation but not destroyed, as when the government borrows to spend, (which it rarely has any need to,) and this money is accumulated by the financial sector, the potential for inflation remains, and increases as the amount of money in the financial sector increases.

2: Discourage certain behaviors, or, through negative taxes, ie subsidy, (a word for particular forms of spending,) encourage certain (other) behaviors. All spending, of course, encourages the production of what it is being spent on. (Allowing for profits, of course.)

3: Redistribute demand, and therefore wealth. More or less egalitarian societies, such as democracies, cannot survive an excess of economic inequality. Money represents economic rights. That is, economic rights are proportional to wealth and income. Economic rights cannot be completely separated from political rights. An unequal distribution of economic rights results in an unequal distribution of political rights. This phraseology, however, is sort of a contradiction, since political rights may implicitly be regarded as those rights held, and that wealth shared, equally by all citizens in a society. Precisely: The only difference between economic rights and political rights is the method of allocation, and their resulting distribution. A more proper phrasing, then, would be that increasing economic inequality results in an increasing conversion of political rights to economic rights. A sufficiently progressive tax system can prevent this from arising, and so help to maintain a system of political rights. An egalitarian government, therefore, will tax economic rights, so limiting the scope and degree of inequality, and subsidize political rights, so enlarging the scope and degree of equality. The dynamics and stability of this process is itself interesting, but beyond the scope of this question. However, the first goal of every proto- oligarchy is the reduction of the progressivity of taxation to a level insufficient to prevent the increasing of economic inequality.

4: Validate its currency. By requiring that taxes be paid in its unit of money, the use of that money is (very strongly) encouraged in that economy. Since using a single unit of money increases economic efficiency, this increases the quantity of free resources in that economy. This increases both the rate of sustainable consumption, and the rate of wealth accumulation in that economy.

Hidden Benefits of Taxes

Hidden Benefits of Taxes  A revision of the Social Benefits of taxation                                   

A large tax wedge can lead to a dramatic increase in economic efficiency. The market share of 'deadweight loss' produced by a tax wedge consists of inefficient producers and indifferent consumers.  The high costs in resources involved in production of the relatively small quantity of 'deadweight loss benefits' can be much more efficiently applied elsewhere in an economy.  Because of this increase in efficiency, we find a substantial government sector and its services may be maintained with very little net cost to a society.

Historically, taxes have been considered to be a burden on the productive capacity of an economy.  Many of us have at least little bit of a feeling that they’d be better off without them.  Even critical services such as police and fire protection are suspect expenditures to some. Spending tax money on infrastructure, like roads, public water supplies, in some countries health care and retirement, some claim to be an imposition on their liberty.  Some say all taxation is theft. We will not arguer these philosophical points, we will merely argue that an economy, a society, is materially better off with taxes, almost irrespective of what those taxes are spent on.  This is because some of the most important benefits of taxes are not in what they provide, but in how they can shape an economy. Here they can provide a massive increase in economic efficiency, a much higher amount of goods and services for a given amount of resources consumed.

Let us look the standard Econ 101 supply and demand diagram of a free market, and see what happens when we impose a tax.  We will look at the market for that commodity familiar to economics students everywhere: Widgets. Sure, it could be  a market in anything, but most markets have unique characteristics, and we want to talk generalities.  So we’ll use widgets.

1:XXX

In a supply and demand diagram for the market of widgets, the quantity of  widgets bought and sold is plotted against the price.  The more money is offered for widgets, the more producers are willing and able to make, so the supply curve slopes upward.  The demand curve slopes downward because the higher the price for widgets, the fewer widgets consumers are willing to buy.  Where they come together  (at the equilibrium point e)  is that price where consumers are willing to buy as many widgets as producers are willing to make and sell.

The green and blue triangles are the benefits (welfare) society gets from widget production. The benefits are divided between the producers and the consumers.  The blue is what the producer gains from producing widgets.  This includes his profits. The green is the net benefits consumers get from using their widgets. Not all consumers derive the same benefits.  Some need their widgets more.  Some may just have more fun with them.

The price is the market price, and is the same for all producers and consumers.  The quantity of widgets produced, and the price they are sold at on the market, are determined from where the supply and demand curves come together.  (At e.) Looking at the diagram, we see the widget producers on the left are able produce at a lower cost than producers on the right, so they are able to make higher profits.  They get more benefits than the less efficient, more marginal producers.  Similarly, the consumers on the left get more benefit from the use of the widgets they buy. This is shown by their willingness to pay a higher price along the demand curve.  The difference between what they are willing to pay for widgets and what they actually have to pay is the net benefit they derive from what they are buying.

To the right of the equilibrium point, the cost to producers for making widgets is greater than consumers are willing to pay for widgets.  The cost of production per widget goes up, but with more widgets produced than consumers are willing to pay so high a price for, the price goes down.  So producers don’t make more than quantity Q  widgets, because consumers won’t buy more than Q at that price. 

So what  happens when we put a tax on widgets?  Here we put a production tax T on every widget.  This results in a price difference between P’, the price consumers pay, and  P*, the price producers collect, on every widget produced. This is called a tax wedge.  It effectively increases the cost of production for widgets.  So it shifts the supply curve up by that amount, as shown in the following diagram.

2:XXX

Since the  price P’ paid by consumers is higher, they don’t want to buy as many widgets as before. Instead of wanting to buy Q widgets at price P, at the higher price P’ they only want to by Q’ widgets.  Meanwhile, at the quantity Q’ of widgets that consumers want to buy, producers can only receive P*.  The difference between the prices P’ – P*, times the quantity Q’ produced and sold, is the revenue received by the government.  So we have three regions of benefits, Producer Welfare and Consumer Welfare are both reduced.  Much of this welfare lost by consumers and producers goes instead as Government Welfare.  For their loss in taxes, consumers and producers gain the benefit of government services. The remainder is the region of deferred welfare, benefits which society does not receive, because the tax makes the production of more than Q’ widgets unprofitable to producers, and too expensive for consumers. So the combined benefits to society with the tax are less than the benefits which accrue to society without the tax.

However, this region of lost benefits, the region of so called ‘deadweight loss due to taxes,’ consists of benefits which are both costly to produce, and therefore of low benefit to producers, and of low benefit to consumers, because the remaining consumers in the market are unwilling to pay much more than what the market price would be without taxation.  In fact, with taxation, they are unwilling to pay the price for widgets at all.  They just don’t want widgets that badly. The resources spent in producing these small benefits, now, could be more efficiently spent elsewhere in the economy, as we show in the next diagram.

3:XXX

Here, in Market W,  S’ is the new Supply curve brought about with the increase in costs imposed on widget producers from taxation.  The marginal benefits (green striped triangles) otherwise attained by marginal producers at higher cost are forgone, the resources which would have been spent to obtain those marginal benefits are instead available, and here allocated, to be expended more efficiently in Market T of the economy, the market for thingbobs,.  Market T can be similarly taxed, the resources applied still elsewhere in the economy. Eventually, of course, the entire economy is made more efficient, as a portion of the otherwise inefficiently used resources in other markets are distributed to other markets, are some even eventually returned to more efficient use in the markets for widgets and thingbobs.  

Now the freed resources are not actually re-allocated by government.  Private enterprises, rather than trying to inefficiently compete in an unprofitable market, simply choose to place their resources in other markets where they can be used more efficiently.  One can argue, of course, that they should do this anyway.  But it is simply the fact that every market has marginal and inefficient producers, trying to make a dollar.  The tax provides them with additional incentive to enter markets where their use of resources will be more socially efficient, where for lesser cost they provide greater welfare.

To be sure, the difference is harvested by the government. And if we examine the diagram with two markets, we see that the net benefits to the private sector are smaller, with the tax, by about the welfare society would gain from the inefficient producers.  The diagrams are generic, and results will vary.  However, in the example sketched, with a tax wedge in place transforming the inefficient producers in one market into efficient producers in another, for the same cost, society gains government welfare in amount about 4 times the total welfare provided by the inefficient producers. (The direct gains in government welfare from taxing widgets replaces some of the welfare society would gain if the market in widgets were untaxed. So, for the cost of expensively produced widgets, we gain efficiently produced thingbobs, and a total of government services of value more or less equal to the value of the combined social value of the production of both widgets and thingbobs.    .

Under judicious taxation, as a result of this increase in efficiency in the use of resources, most of the services of government can be provided for for free.  That is, resources which would be applied in some inefficient productive process, and so largely wasted, may be applied more efficiently in providing economically useful government services. And many of the services provided by government, by eliminating many of the costs of transaction and overhead that producers would otherwise bear, also act to increase the efficiency of the private productive economy.  Inadequate taxation, and the necessary reduction in economically useful services purchased with these taxes, far from increasing the competitiveness of an economy, decreases it, and nations with an inadequate public sector are at a competitive disadvantage with respect to foreign producers in countries with more robust public sectors. Further, even with the light tax burden, the citizens of countries with small public sectors are less provided for, and are a greater burden to the industry of that country, than countries with a larger government service sector. 

In the example illustrated by the diagram, without taxation the total social welfare is about twice the cost of resources expended. (  The size of the green plus the blue triangles compared to the pink triangle in the first diagram.) With the tax wedge as illustrated, the total social welfare is almost 4 times the real cost to producers.  (The size of the solid green and blue regions in both markets of the previous diagram compared to the solid pink regions.)

Although we have drawn the diagram for two particular and identically composed markets, it is apparent that for a wide variety of supply and demand diagrams, and thus, for a wide variety of economic sectors, the application of a tax wedge will result in a large increase in economic efficiency.

By implication, the opportunity costs of the small amount of marginal benefits forgone are huge. The benefits forgone would be obtained by essentially wasting resources in producing them, and are a small fraction of the benefits produced by allocating these resources more efficiently.  Indeed, we may expect this improvement to be even better than it initially appears, since we would expect the most marginal producers to be those most eager to externalize their costs in order to remain competitive.  Pressure to externalize costs is thus also reduced on the more efficient producers. The economic results from failing to apply a tax wedge in a market are, apparently without exception, far inferior

The very pejorative “deadweight loss,” has been used by those ideologically opposed to government intervention in an economy as a justification for their position. However, they, and the economics profession as a whole, have totally over-looked the high opportunity costs involved in the creation of these marginal benefits.  Taking these costs into consideration inverts the conclusion:  The gain in freed resources, in almost any reasonable scenario, far outweighs any gain involved in wastefully spending these resources for these relatively small benefits.  Indeed, in the scale of economic activity, these resources are much more wisely spent elsewhere.  And the tax wedge causes this to happen.  Far from being a burden, taxation in a market, and at what is traditionally considered a rather high level of taxation, can yield much closer to optimal economic results. .

I leave it to those ideologically opposed to government intervention to find exceptions to the tax wedge increasing efficiency. I do observe that the apparent requirement for monotonicity in the supply and demand curves would seem to make finding these exceptions difficult. 

One interesting argument, though, which remains, is the argument from liberty.  This argument would seem to suggest that the wanton destruction of scarce resources is, somehow, ‘liberating.’ And indeed, acquiring the ability to squander society’s resources seems to be one of the primary motives for becoming wealthy, and indeed the ability, and under capitalism the right, to squander society’s resources is the very defining characteristic of wealth. And this would seem, for example, to be the argument against higher gasoline taxes in the United States. The case shown here is that a higher gasoline tax, even with money spent (more efficiently) on public transit, would free up resources for everyone, as the European experience seems to show.  To be sure, there would be less joyriding, and tickets to NASCAR events might become more expensive.

There does remain the issue of determining the balance between efficiency and quantity of production in any particular market required for the proper functioning of an economy.  Considerations of scale indicate that, contrary to what is shown in the diagrams, the first unit of anything is seldom the most efficiently produced.  Rather, there is an optimum scale of production, that which minimizes the average cost, (This ignores issues of demand, and thus actual profit.) and we must consider this to be true for an entire economy as well as for a particular production process.  While with this consideration the improvement in economic efficiency would not be as great, it must still be expected to be impressive.

Also, it should be easier to tax economic wants as opposed to economic needs.  (Although see problem three, below.) A more efficient economy, however, needs less to sustain its function, and so has relatively more resources available for the servicing of wants. 

 “Deadweight loss” is also found in other market situations.  Regulated markets, markets with price controls, and markets restricted by private actions such as monopoly formation and oligopoly usually also involve deadweight loss. Increases in efficiency should also be expected in these situations, so It would seem that these other situations also, at the least, need to be re-examined.

Now direct consumer benefits per se are also much less under taxation, the same as under monopoly, and the producer surplus is also much less. However, the government spreads much of its income widely. It is, in its way, both a consumer and a producer. It re-distributes consumption, and capitalizes production, both directly, through capital investments, and indirectly, through subsidy of production, and creation and maintenance of infrastructure. And all of its expenditure, purported to be for the public benefit, does, one way or another, enrich the diverse sectors of the economy.

One problem with the tax wedge, however, because it favors the more efficient producers, it also favors the economic drift toward concentration of ownership, and the creation of oligopolies and eventually monopolies.  We will address this issue here shortly.

Narrowly held monopolies cannot be expected to spread their profits.  Neither can monopolists be expected to spend their profits to provide services which increase the efficiency of the larger economy.   Monopolies once formed, and where not widely owned, further to aggravate the natural tendency of economies to concentrate wealth and power, a concentration which leads to economic instability and collapse. This is especially so because the power concentrated in monopolies tends to translate into political power.  And the monopolist must be expected to use this power to further his power, and mitigate the impact of a tax wedge on his revenue. 

A second problem is that producers which escape taxation will eventually displace those producers which are subject to taxation. The result will be a reduction in both taxes collected and in economic efficiency.  This problem must be considered especially acute in open economies, where tax paying domestic producers can be expected to be displaced by non-taxpaying (and these producers which can often be less efficient) foreign ones The interesting implication here is that, while a nation’s economy may be producing less and consuming more, as an increased share of what is consumed is imported, (much of what is considered production actually either enables consumption, or is a form of consumption,) that economy need not be any better off for this increase in consumption.  Because of the decrease in economic efficiency, fewer consumables will be efficiently used, and more of this consumption will be squandered.  A country running a deficit is essentially externalizing costs, and these costs may in reality be greater to the country than if the country were to internalize them.

A third problem is, of course, the politics of taxation.  Nobody likes to be taxed, and the powerful, more than others, are capable of avoiding it. (This also bears on the second problem.) This first suggests that the markets which serve the wealthy will be the least efficient, even though these are the markets where an economy can most easily bear the loss of marginal producers.  (Marginal producers may be needed in the production of an economy’s necessities.)  And this further suggests that a disproportionate share of an economy will be dedicated to servicing the wealthy, even at the expenses of the necessities of that economy, such as maintenance of infrastructure.  For instance, a recent study has shown that in the United States today, essentially no policies are enacted by the government which are not also approved by the wealthy elite.  An implication of this is that the tax burden upon this elite can only be expected to diminish, and thus that the burden of taxation on the rest of economy and the population can only increase.

One final note.  As an economy increases in efficiency, it inherently becomes less stable, and more vulnerable to collapse. An efficient economy becomes dependent on its efficiency in order to be productive enough to sustain itself.  The greater the efficiency, the greater its dependence.  A reduction in efficiency will result in a reduction of production, perhaps sufficient enough that that economy can no longer sustain itself. 

A particular consideration regarding improvements in efficiency brought about by regulation and a tax wedge, where a wedge and/or regulation is already established, is that removing or even merely reducing these factors will result in a reduction of that efficiency, and a resulting reduction in the productive capacity of that economy.  That economy may no longer be able to sustain itself. With a critical reduction in production, cascades may result, and the possibility of sectoral and even general collapse.  Great care, therefore, should be exercised in the reduction of the size of tax wedges, or the elimination or alteration of any significant regulation. 

Given the tightly coupled world economy, the efficiency of production of any  major economy is a concern for all other nations.

On the Social Benefits of Taxation II

On The Social Benefits of Taxation II                                               

Taxation has historically been considered to be a burden on the productive capacity of an economy.  However, it is easy to show that taxation can increase the efficiency of an economy by rendering inefficient producers unprofitable, and so eliminating them.  What is eliminated from a particular market by proper taxation are the most marginal producers, and the least avid consumers.    Under judicious taxation, as a result of this increase in efficiency in the use of resources, the services of government can largely be provided for for free.  That is, resources which would be applied in some inefficient productive process, and so largely wasted, may be applied more efficiently in providing economically useful government services. And many of the services provided by government, by eliminating many of the costs of transaction and overhead that producers would otherwise bear, also act to increase the efficiency of the private productive economy.*  Inadequate taxation, and the necessary reduction in economically useful services purchased with these taxes, far from increasing the competitiveness of an economy, decreases it, and nations with an inadequate public sector are at a competitive disadvantage with respect to foreign producers in countries with more robust public sectors. Further, even with the light tax burden, the citizens of countries with small public sectors are less provided for, and are a greater burden to the industry of that country, than countries with a larger government service sector. 

We show this in Diagram 1.  Where the marginal benefits attained at higher cost are forgone, the resources which would have been spent to obtain those marginal benefits are instead available to be expended more efficiently in other sectors of the economy.

In the diagram, the tax wedge is the difference between the price paid, P’, and the income received by the producer, P*.  The total tax revenue, the pale green block in each market defined by: Q’ x (P’ – P*) is the welfare received by government.  The lower brighter green triangle is the producer surplus; the upper brighter green triangle the consumer surplus. In each particular market, with the application of a tax wedge the ratio of social welfare obtained to costs, that is resources expended, increases from about two to one, roughly the ratio of the all the greenish areas to all the pinkish areas in each market, to almost four to one, the ratio of the solid green areas to the solid pink area. Although we have drawn the diagram for two particular and identically composed markets, it is apparent that for a wide variety of supply and demand diagrams, and thus for a wide variety of economic sectors, the application of a tax wedge will result in a large increase in economic efficiency. By implication, the opportunity costs of the small amount of marginal benefits forgone are huge.  Indeed, we may expect this improvement to be even better than it initially appears, since we would expect the most marginal producers to be those most eager to externalize much of their costs in order to remain competitive.  Pressure to externalize costs is thus also reduced on the more efficient producers. The economic results from failing to apply a tax wedge in a market are, apparently without exception, far inferior

Historically, of course, this relatively small region of forgone welfare has been labeled “deadweight loss,” the "Harperger Triangle," whose existence has been considered a counter-argument to the efficiency and usefulness of taxation. Indeed, the very pejorative “deadweight loss,” has been used by those ideologically opposed to any government intervention in an economy as a justification for their position. However, their argument, and the economics profession as a whole, has totally over-looked the high opportunity costs involved in the creation of these marginal benefits.  Taking these costs into consideration inverts the conclusion:  The gain in freed resources, in almost any reasonable scenario, totally outweighs any gain involved in wastefully spending these resources for these relatively small benefits.  Indeed, in the scale of economic activity, these resources are much more wisely spent elsewhere.  And the tax wedge causes this to happen.  Far from being a burden, taxation in a market, and at what is traditionally considered a rather high level of taxation, can yield much closer to optimal economic results. .

I leave it to those ideologically opposed to government intervention to find those exceptions. I do observe that the apparent requirement for monotonicity in the supply and demand curves would seem to make finding these exceptions difficult. 

One interesting argument, though, which remains, is the argument from liberty.  This argument would seem to suggest that the wanton destruction of scarce resources is, somehow, ‘liberating.’ Indeed, we might almost define a wealthy individual as a person who has the power to inefficiently consume and waste and destroy large quantities of such resources. Indeed, the production of costly rich boy toys, of little to no benefit to the rest of society, can be considered a "Harberger Triangle" which could, and should, be taxed away. (Even the game Monopoly(TM) has a "Luxury Tax," though totally inadequate to the needs of its little society.)

The 'argument from liberty' would seem, for example, to be the argument against higher gasoline taxes in the United States. The case shown here is that a higher gasoline tax, with money more efficiently spent on public transit, would free up resources for everyone, as the European experience seems to show.  And in the US, the situation is even worse, since the production of oil and oil products is subsidized, and the price kept depressed.  The reality is, however, that the production of real resources cannot be subsidized.  While the notional price may be kept down, this can only be done by higher taxes on the real value of other economic necessities.

This is simple physics. And by the triangle inequality, such taxation of one necessity to subsidize the production of another has its own cost, and the net result is a reduction in the total real value of resources available to society.  Society is the poorer as a result.

There does remain the issue of determining the balance between efficiency and quantity of production in any particular market required for the proper functioning of an economy.  Considerations of scale indicate that, contrary to what is shown in the diagrams, the first unit of anything is seldom the most efficiently produced.  Rather, there is an optimum scale of production, that which minimizes the average cost, (This ignores issues of demand.) and we must consider this to be true for an entire economy as well as for a particular production process.  While with this consideration the improvement in economic efficiency would not be as great, it must still be expected to be impressive.

Further, it should be easier to tax economic wants as opposed to economic needs.  (Although see problem three, below.) A more efficient economy, however, needs less, and is more capable of servicing wants.  

 “Deadweight loss” is also found in other market situations.  It would seem that, at the least, these other situations also need to be re-examined.

For example, the most marginal producers and the least avid consumers in a particular market can also be eliminated when the costs of production are increased by the costs of meeting a regulation. (It is cheaper just to make the cost of not doing nasty things marginally cheaper.  The nasty thing tax will restrict supply of benefits by forcing the internalization of costs. We accepted the pollution of our wor(ld)k for the individual benefits they provided. But with great inequality, for most of society (>85%) the benefits of for the individual outweigh the costs to societ(ies)y (value to the individual) (benefits)These kinds of regulation also can increase economic efficiency.  Unlike the cost to the producer imposed by a tax, however, the government does not directly recover the costs imposed by such regulation. These costs are instead spent meeting the requirements of the regulation. In Diagram 2, P* is the price retained by the producer, which is the price P’ paid by the consumer, minus the cost to the producer of meeting the regulation.

Instead of the tax wedge, we have the revenue in the area Q’ x (P’ – P*), revenue which with a tax wedge would be going to the government, going instead to pay for meeting the regulation.  The benefits are reaped by other sectors of society. A regulation against pollution, for instance, benefits the consumers of an otherwise contaminated resource.  As such, it essentially represents a rightward shift in the supply curve for this resource.  (Similarly, an increase in pollution of a resource represents a leftward shift in the supply curve of that resource.)   This increase in economic efficiency does provide compensation to the economy at large for the cost of the regulation. 

Further, the purpose of regulation is to attain some benefit for the economy which cannot be captured in some unregulated market, and which is presumably greater than the cost of the regulation.  While one might hope, and expect, that the benefit to society of the regulation would be at least equal to its cost, it can be seen that, because of the increase in economic efficiency, society can gain even when the direct benefits from the regulation are substantially lower than its cost to the producer.  (For the same reason, although one can hope, and the government should of course try, to make sure that the direct benefits to society of its expenditures are equal to the costs, even when the direct benefits of government expenditure are below their costs, there can still be a net gain to society, if these resources are not too thoroughly wasted.)  Certainly, in the provisioning of an economy’s necessities, the inefficient application of scarce resources may be necessary. However, even in these situations, alternative and more efficient means of supply may be found.   

Interestingly, however, applying a tax wedge, or imposing regulation, or other forms of government intervention, such as price ceilings or price floors, are not the only ways to increase economic efficiency.  Monopolies also eliminate much inefficient production of goods and services, as shown.

Monopolies produce at quantity Q_M, (Diagram 3) the quantity where the increase in cost for producing another unit equals the increase in revenue for selling another unit.

 This quantity maximizes their profit.  (This is different from a competitive market, where the sum of production of all firms would be where the Marginal Cost, or the Supply curve, intersects the Demand curve.) With monopoly, the striped areas are the costs (Red striped) and benefits (Green striped) forgone by society. These resources which would otherwise be consumed, these costs, may be more efficiently applied to other sectors of the economy. The solid areas are costs borne (Red) and benefits provided (the Greens) under monopoly.  The light green regions are monopoly profits which, since a monopoly is a part of society, does count as an increase in social welfare. We may expect something similar with monopsonies, and to a somewhat lesser extent, with oligopolies, and oligopsonies. With oligopolies and oligopsonies, we would expect a greater elimination of inefficient production when they are collusive, and a less but a still significant degree of elimination when they are competitive. With oligopolies, although some inefficient producers may be protected because of the higher prices resulting from the reduced quantity produced, (See: anamecon.blogspot.com/2012/02/oligopoly-and-economy.html) a reduced quantity is produced, and those firms which remain in production limit their production to their most efficient processes. The so called deadweight region of forgone costs and forgone production lies between the kink in the demand curve, the equilibrium point for oligopolistic producers, and what would be the competitive equilibrium which would result from the production of many small firms. 

To return to monopolies, the great majority of benefits accrue to the owners of the monopoly, typically a small minority of the members of society.  The consumer benefits, on the other hand, are much less, and much reduced from the competitive case. Indeed, by comparing the tax wedge in a competitive market with the monopoly case, we find the social welfare under monopolies is exactly the same as social welfare under a government tax wedge, where the wedge is such that the marginal cost to producers equals their marginal revenue.  The competitive case results in a more equitable distribution of benefits between consumers and producers. Of course, consumer benefits per se are also much less under taxation, the same as under monopoly, and the producer surplus much less. However, the government spreads much of its income widely. It is, in its way, both a consumer and a producer. It re-distributes consumption, and capitalizes production, both directly, through capital investments, and indirectly, through subsidy of production, and creation and maintenance of infrastructure. And all of its expenditure, purported to be for the public benefit, does, one way or another, enrich various sectors of the economy.

One problem with the tax wedge, however, because it favors the more efficient producers, it also favors the economic drift toward concentration of ownership, and the creation of oligopolies and eventually monopolies. Narrowly held monopolies cannot be expected to spread their profits.  Neither can monopolists be expected to spend their profits to provide services which increase the efficiency of the larger economy.   Monopolies once formed, and where not widely owned, further to aggravate the natural tendency of economies to concentrate wealth and power, a concentration which leads to economic instability and collapse. This is especially so because the power concentrated in monopolies tends to translate into political power.  And the monopolist must be expected to use this power to further his power, mitigating the impact of the tax wedge on his revenue.  

A second problem is that producers which escape taxation will eventually displace those producers which are subject to taxation. The result will be a reduction in both taxes collected and in economic efficiency.  This problem must be considered especially acute in open economies, where tax paying domestic producers can be expected to be displaced by non-taxpaying (and hence often less efficient) foreign producers.  The interesting implication here is that, while a nation’s economy may be producing less and consuming more, as an increased share of what is consumed is imported, (much of what is considered production actually either enables consumption, or is a form of consumption,) that economy need not be any better off for this increase in consumption.  Because of the decrease in economic efficiency, fewer consumables will be efficiently used, and more of this consumption will be squandered.

A third problem is, of course, the politics of taxation.  Nobody likes to be taxed, and the powerful, more than others, are capable of avoiding it. (This also bears on the second problem.) This first suggests that the markets which serve the wealthy will be the least efficient, even though these are the markets where an economy can most easily bear the loss of marginal producers.  (Marginal producers may be needed in the production of an economy’s necessities.)  And this further suggests that a disproportionate share of an economy will be dedicated to servicing the wealthy, even at the expenses of the necessities of that economy, such as maintenance of infrastructure.  A recent study has shown(1), for instance, that in the United States today, no policies are enacted by the government which are not also approved by the wealthy elite.  An implication of this is that the tax burden upon this elite can only be expected to diminish, and thus that the burden of taxation on the rest of economy and the population can only increase.**

One final consideration.  As an economy increases in efficiency, it inherently becomes less stable, and more vulnerable to collapse. An efficient economy becomes dependent on its efficiency in order to be productive enough to sustain itself.  The greater the efficiency, the greater its dependence.  A reduction in efficiency will result in a reduction of production, perhaps sufficient enough that that economy can no longer sustain itself. 

A particular consideration regarding improvements in efficiency brought about by regulation and the tax wedge, where these increases in efficiency are already established, is that removing or even merely reducing these factors will result in a reduction of that efficiency, and a resulting reduction in the productive capacity of that economy.  That economy may no longer be able to sustain itself. With a critical reduction in production, cascades may result, and the possibility of sectoral and even general collapse.  Great care, therefore, should be exercised in the reduction of the size of tax wedges, or the elimination of any regulation. 

*Efficiency is a multiplicative factor in production, not an additive one. Although unlike thermodynamic efficiency, economic efficiency may be greater than 1, it is also subject to diminishing returns, at least where matters of the production of real goods and services are concerned.

**This statement assumes that the wealthy are actually taxed at all, which my studies indicate is not, in any real sense, the case. Taxation of the wealthy is merely nominal.  Real taxation of the wealthy is only against their future consumption, a future which, for almost all of the wealthy, is ever receding.  However, a merely nominal rate of taxation is not without real consequences for an economy.

(1)Testing Theories of American Politics:  Elites, Interest Groups, and Average Citizens   Martin Gilens and Benjamin I. Page  https://scholar.princeton.edu/sites/default/files/mgilens/files/gilens_and_page_2014_-testing_theories_of_american_politics.doc.pdf

Taxation, the States, and Trade

The State of Connecticut, and other states, are having increasing difficulty meeting the conflicting demands  of a declining tax base and increasing need for its services.  Next year the state must cut over $1 Billion of valuable and even critical services in order to balance its budget.

A recent article in Forbes ascribes the cause of the deteriorating tax base to the imposition of a personal income tax 25 years ago. (25 Years, $13 Billion Lost: Connecticut Income Tax Continues To Fail) *

But let’s look at something else which could be a cause:  According to “State Smart,” ** the state of Connecticut, in 2014, paid out  $53 Billion dollars to the United States government in taxes.  However, that year, it only received am estimated $45 billion in benefits from the federal government. Every year the people of the Connecticut give out to other states $8 billion.  The state and local share of that $8 Billion, (about 13%) works out to about $1 Billion in lost taxes.   And that is just one year.

It is up to the state’s Congressional delegation to address this problem, if they can.  In the meantime, the state is running the race with one foot in a bucket.  While bad, this can be mitigated.  The problem for the state, since it is easier for rich people, and more generally for businesses and corporations, to move than the working and the poor, is that the state is only allowed a regressive tax system. Since Connecticut is stuck in the shadow of pricey New York City, it must also pay more for what it buys.  These are not insurmountable problems.  They mean, however, that the state must attract enough wealth generating business activities that the tax load is not so burdensome upon the poor and the working class that it cannot be mitigated by proper state expenditures. And this means the state must have tax policies, and spending policies, and regulatory policies, which are attractive to those kinds of business activities which bring in money.

For instance, Corporations collect wealth from their many operations, and the place they accumulate the most of this wealth is at their headquarters. Other business activities which accumulate wealth are corporate offices in general, laboratories and factories.  All of these activities bring money into their communities, and into the state. 

These are activities the state wishes to attract and encourage.  While it cannot directly subsidize them, (Well, nominally, it could,)  it can capitalize the infrastructure these businesses rely upon.  Investing in roads and railroads, human capital, but perhaps even more importantly efficient institutions and the resolving of conflicts, including those inevitable conflicts businesses have with the state itself.   This will reduce the many costs of doing business in this or any state, and enhance the profit margins. 

For comparison, stores, in particular chain stores such as Walmart, Home Depot, CVS, McDonalds, (and Amazon) and so forth, take money out of communities, and out of the state.  Walmart itself takes several billions of dollars out of the state of Connecticut each year, and sends those dollars off to Arkansas. Much of the money which goes to the larger cable and telecommunications also leaves the state. This loss of money the state can, with proper taxes, and by taking the part of the communities and local store owners in their struggle with these large retail chains, diminish. 

There are other activities, which themselves do not generate wealth, but merely rearrange the ownership of wealth.  These may also be taxed.  Some of these businesses, like real estate, cannot leave.  The others, since they do not actually generate wealth, may be allowed to leave without penalty to the state’s economy.  These would include many personal services of all kinds.  Most of these personal services are elective, and raising their costs would not affect the well being of most people directly.  Most especially, these taxes would not have a critical affect on the well being of the poor.  For those services which were not elective, such as child care, the needs of the poor could be supported.  Indeed, for something like child care, the state would in general have and interest in subsidizing it for all possible clients, as this would form a more attractive workforce environment and this would be something to attract businesses.

The state is in the business of allocating resources.  Taxes take those resources from one use and expenditures put them to another.  In many cases, this fulfills social needs that the market cannot fill.  Quite simply, the market simply cannot supply any particular thing or service to everybody.  The laws of supply and demand guarantee that there will always be those who cannot afford fuel, who cannot afford shelter, who cannot afford adequate food, without intervention into the marketplace.  Private intervention, that is, charity, cannot suffice. For the charitable will find themselves at a competitive disadvantage to the mean and selfish.

As the production of resources within the state declines, the state must reach out to the production of other states, by attracting the functions of businesses which accumulate the production from other states.  And the state government must adopt policies which attract those functions.  It is only once this income is spent by the corporations and businesses that the state attracts, that the state can begin to collect taxes on it. And increasingly, the state becomes unable to directly tax its own production.  As due to increasing offshoring, domestic production declines, (And without tariffs, taxes cannot be collected on production in foreign countries,) competition for the remaining factories, other remaining production facilities and the headquarters of domestic enterprises, the offices and laboratories, will intensify. Only the intervention of the US government can stop this spiral to the bottom.  But in the absence of such intervention, a state government which understands this reality, and which is able to adapt to it will, for a time, prosper.

So only the actions of a government can assure that the needs of all of society are met. A government which fails in this, will eventually fail altogether, one piece at a time, as first the bottom, and then each higher level of society falls below its ability to sustain itself.  Only by capturing an adequate share of the incomes of the very wealthy can the government succeed at this. But first it must attract these incomes to itself. 

Since all taxation is against production, the government must capture all productive streams, in order to extract necessary income. Any streams it does not capture will be more competitive than those which must bear the additional cost of taxation.  When an economy runs a trade deficit, it must also tax foreign production, since otherwise domestic production will be uncompetitive with foreign production, and domestic production will be replaced, and government revenues decline.

Non-productive activities must also be taxed. Otherwise, economic activity will preferentially go to non-productive activities, since these will have the greater nominal profits.  In particular, the non-productive activities of the wealthy must be taxed, to prevent decapitalization of the economy.

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* http://www.forbes.com/sites/rexsinquefield/2016/05/23/25-years-13-billion-lost-connecticut-income-tax-continues-to-fail/#589c29771b80  (and others)

**https://www.nationalpriorities.org/smart/connecticut/