NCPA - National Center for Policy Analysis

Ten Golden Rules of Taxation

April 17, 2012

The federal and state governments are each entertaining numerous plans to close substantial budget gaps.  Many of these plans involve necessary spending cuts, but others also employ fundamental changes to the way government entities tax citizens.

In regard to this second strategy, it is enlightening to better understand the foundational principles of taxation that determine its aggregate effect and economic impact.  To this end, the American Legislative Exchange Council has published 10 "golden rules" of taxation that should guide policy in this sphere.

  • When you tax something more you get less of it, and when you tax something less you get more of it -- thus, governments should avoid taxing good activities such as working and investing.
  • Individuals work and produce goods and services to earn money for present or future consumption, and therefore respond negatively to higher taxes.
  • Taxes create a wedge between the cost of working and the rewards from working, thereby lowering the amount of labor supplied in the economy.
  • An increase in tax rates will not lead to a dollar-for-dollar increase in tax revenues because economic activity will decrease in response to higher taxes (which makes the tax base smaller).
  • As is illustrated by the famous Laffer Curve, if tax rates become too high, they may lead to a reduction in tax receipts as economic activity decreases and tax avoidance increases.
  • The more mobile the factors being taxed, the larger the response to a change in tax rates; this is a particularly important point in a globalized world full of mobile capital.
  • Raising tax rates on one source of revenue may reduce the tax revenue from other sources (a point that speaks to the wide-ranging impacts of taxation changes); for example, a higher corporate tax rate my reduce employment, thereby reducing individual income tax receipts.
  • An economically efficient tax system has a sensible, broad base and a low rate, because this will allow for as little economic distortion of markets as possible.
  • Transfer payments represent a tax on production and a subsidy to leisure that aggregately harms long-term employment and production.
  • A differential between neighboring tax jurisdictions will encourage migration toward the low-tax region.

Source: Arthur B. Laffer, Stephen Moore and Jonathan Williams, "Rich States, Poor States," American Legislative Exchange Council, 2012.

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