NCPA - National Center for Policy Analysis

TEN PRINCIPLES FOR TAX REFORM: PRINCIPLE FOUR

November 6, 2009

Australia's tax system needs principles that go beyond efficiency, equity and simplicity, says Robert Carling, a Senior Fellow with the Center for Independent Study.  For example, he recommends that minimizing economic harm should be the dominant consideration in the selection and design of taxes.

The purpose of taxation is to transfer resources from private sector to government command.  Taxes therefore have the tendency to impose an excess burden by causing the private sector to modify its behavior in ways that make the total economy smaller than otherwise, says Carling:

  • Individuals and businesses cut back on taxable activities.
  • They divert their efforts from more to less heavily taxed activities that are less beneficial to economic welfare.
  • They engage in tax minimization strategies that are wasteful of scarce resources from a national perspective.

Designing the tax system to minimize these costs is desirable, and is what economists refer to as "economic efficiency," says Carling:

  • In general, capital taxes are the most damaging and consumption taxes the least, with labor income taxes in the middle.
  • Narrow tax bases, high tax rates, and large concessions and exemptions are the more damaging design features, as are steeply graduated (or "progressive") tax scales.
  • The trade-off between "economic efficiency" and equity has to be confronted because the pursuit of income redistribution through the tax system will reduce the size of the economic pie to be distributed, and if taken too far will be self-defeating in that beneficiaries will be worse off.

Putting efficiency first means recognizing that certain types and structures of taxation designed for income redistribution are more damaging to wealth creation, productivity, innovation and economic growth than other types and structures and should be avoided or minimized, say Carling.

Source: Robert Carling, "Minimizing Economic Harm Should Be the Dominant Consideration in the Selection and Design Of Taxes," Policy, November 29, 2009.

 

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