Not all taxes are equal

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The premise of Tax Freedom Day is relatively simple to understand. It takes the total amount of taxes paid and divides it by the number of individuals in that jurisdiction to calculate how many days it would take them to pay those taxes. The first day of the year when all the income would remain with its owner is Tax Freedom Day.

As Professor Richard Grant explains, “If Tax Freedom Day were on January 1, taxpayers would be paying no tax, and if it falls on December 31 government would be taking all of our incomes as tax and we would have nothing left. The later in the year the day occurs, the worse for the average taxpayer and for anyone who needs a job.”

Grant did the calculations for South Africa and found Tax Freedom Day “has migrated from mid-April to mid-May” corresponding “to an increase in general government expenditure from 30% of GDP to 38%.” It’s a simple way to take a complex issue and get a core truth about it.

But, as I like to warn, reality is complex so nuance is usually a good idea. So some details are wise.

First, it is critical to investigate how taxes are spent—not all spending is equal. The core function of any government in a free society is to protect the rights of the individual. This allows people freedom to produce more goods and services and improve their standard of living and that of those around them.

Protecting people from criminal actions is vastly different from spending billions to bailout failed state-owned enterprises. The latter destroys economic efficiency while the former enhances it. In other words, spending R1 billion to prevent crime furthers economic production while the same spent to protect the well-paid jobs of political-appointees doesn’t, if anything it harms productivity.

The concept of Tax Freedom Day is useful to understand the general burden of taxes on the “average” citizen, but one of the realities is there are few people who are actually average. If you have two individuals earning R500 per month and one earning R14,000 the average income is R5,000, but no one in the group earns that

In reality the Tax Freedom Day varies from individual to individual. This is further complicated by the fact that not all taxes do the same amount of harm—some are quite harmful to one class of people but not others. The same harmful tax can have disproportionate impact on different groups of taxpayers.

Consider the Value Added Tax (VAT), which is a tax on consumption. Politicians tend to like VAT because the tax is added at each step of production and is hidden in the price. This means consumers who are paying the bills don’t easily know what percentage of the price is ultimately taxes. It becomes much easier for them to blame the producer, or the retailer rather than the politicians. Of course, the politicians love that.

In that sense it encourages “government gone wild” as those doing the spending are not blamed for the higher prices of goods. At least with a sales tax consumers know how much they are handing over to the state.

A major harm is that poorer consumers spend a higher percentage of their income on goods and services. The well off may spend more in total, because they have more, but they are paying a lower percentage of their income. The Tax Policy Centre of the Brookings Institute explained: “A value-added tax (VAT) is a tax on consumption. Poorer households spend a larger proportion of their income. A VAT is therefore regressive if it measures relative to current income and if it is introduced without other policy adjustments.”

They found a 5% VAT imposes a tax of 3.9% on income earners in the bottom quintile but those in the top 1% economically would be paying 2.5%. Of course, the higher the VAT the greater the disparity and South Africa charges a VAT three times higher than the Brookings example.

One further complication for the architects of taxation is even a relatively small tax burden can have monumental implications for those at the very bottom of the economic ladder. A family that is just surviving on their income, if forced to pay 1% of their income in taxes, would be hard pressed to do so without sacrificing food, clothes, shelter or other fundamental needs.

This can trap them at the bottom. If the disparity between expenses and income are sufficiently high the only economic opportunity some of them will have would be to resort to crime. To the degree taxes reduce economic prosperity they increase poverty, and to the degree they increase poverty they increase crime, something to consider when they propose the next billion rand bailout for a state-owned enterprise.


James Peron | President | Moorfield Storey Institute | Contributing Author | Free Market Foundation | mail me |


 



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