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| Adam Smith also had strong views on public finance |
Adam Smith (1723-1790) wasn't only the father of laissez faire capitalism, he also had a profound influence on the principles of sound public finance especially as it referred to the revenue raising powers and activities of central government. He was an enemy of monopoly and distorted competition in markets and an advocate of free trade as long as the UK's military position was unharmed. He also had a lot to say regarding the public finances of the state and these are issues we will consider below.
In respect of taxation of he wrote in an era where taxation of the population was characterised as being regressive meaning that larger shares of the income of poorer people were taken as revenue by the state than the shares of richer people's income. He proposed that there should be a proportional tax -- where everyone should pay the same proportion of their income to the state. In modern parlance this would be deemed a flat tax where the average rate of taxation would equal the marginal rate. In Smith's time this was viewed as a radical way of helping the poorer people in society. He did not appear to advance support for a progressive tax system (where richer people pay a higher share of their income to the state than poorer people) -- It is not wholly clear why he did not openly support a progressive approach but it can be surmised that if marginal tax rates were constantly escalating and especially at lower levels of income, this would act as a disincentive for workers to offer more hours of work to their employer. In modern times the effects of such a flat tax would be considerable in terms of its impact on society as a whole -- with those in the middle of the income distribution taking a bigger tax hit than now. Nevertheless Smith's implied focus on the cliff edge dis-incentive effects of high marginal tax rates and applying those high marginal tax rates lower down the income distribution are still important to-day.
He was also a firm believer that tax payers should be kept up to date with the facts of the tax regime which applies to them. Tax payers should know in advance how much they owe and when they are required to pay it. Tax laws should not be changed frequently because this would lead to confusion with uncertain tax flows coming into the state's coffers each year, thus making the state's financial planning process arbitrary and uncertain.This would not bode well for the country's welfare.
Taxes should be levied at a time and in a way that would make it as easy as possible for people to pay them. Taxing capital gains on assets only when the gains are realised is a good example of this approach. Taxes should be easy and cheap to collect. There should be no need for huge armies of tax collectors and taxes should not undermine taxpayers' economic incentives nor should they create a pervasive climate of tax evasion. In Smith's time the main tax evaders were smugglers but in modern times this has widened a lot to huge multi -national corporations named after fruit and South American rivers. Taxes should be at a level whereby taxpayers will be in a position to pay them,albeit reluctantly. They should not be at a level where taxpayers will move mountains to evade tax payments.
Finally the state should not impose penalties on tax evaders that are so severe that the tax evaders will be financially ruined. The level of penalties should be adequate to ensure that evaders change their behaviours but the medicine applied should not kill the patient. Can this be achieved in the modern era? Many public campaigns have forced companies,like Starbucks, to pay more in UK tax and there are moves to implement general anti avoidance tax rules (GAAR) in the UK.
All these principles are designed to ensure that taxes raise as much as possible for the state whilst minimising the financial blockers to a country's economic growth and to workers' incentives. We need to ensure that governments do not ignore these important principles when they set their tax policies.
In respect of taxation of he wrote in an era where taxation of the population was characterised as being regressive meaning that larger shares of the income of poorer people were taken as revenue by the state than the shares of richer people's income. He proposed that there should be a proportional tax -- where everyone should pay the same proportion of their income to the state. In modern parlance this would be deemed a flat tax where the average rate of taxation would equal the marginal rate. In Smith's time this was viewed as a radical way of helping the poorer people in society. He did not appear to advance support for a progressive tax system (where richer people pay a higher share of their income to the state than poorer people) -- It is not wholly clear why he did not openly support a progressive approach but it can be surmised that if marginal tax rates were constantly escalating and especially at lower levels of income, this would act as a disincentive for workers to offer more hours of work to their employer. In modern times the effects of such a flat tax would be considerable in terms of its impact on society as a whole -- with those in the middle of the income distribution taking a bigger tax hit than now. Nevertheless Smith's implied focus on the cliff edge dis-incentive effects of high marginal tax rates and applying those high marginal tax rates lower down the income distribution are still important to-day.
He was also a firm believer that tax payers should be kept up to date with the facts of the tax regime which applies to them. Tax payers should know in advance how much they owe and when they are required to pay it. Tax laws should not be changed frequently because this would lead to confusion with uncertain tax flows coming into the state's coffers each year, thus making the state's financial planning process arbitrary and uncertain.This would not bode well for the country's welfare.
Taxes should be levied at a time and in a way that would make it as easy as possible for people to pay them. Taxing capital gains on assets only when the gains are realised is a good example of this approach. Taxes should be easy and cheap to collect. There should be no need for huge armies of tax collectors and taxes should not undermine taxpayers' economic incentives nor should they create a pervasive climate of tax evasion. In Smith's time the main tax evaders were smugglers but in modern times this has widened a lot to huge multi -national corporations named after fruit and South American rivers. Taxes should be at a level whereby taxpayers will be in a position to pay them,albeit reluctantly. They should not be at a level where taxpayers will move mountains to evade tax payments.
Finally the state should not impose penalties on tax evaders that are so severe that the tax evaders will be financially ruined. The level of penalties should be adequate to ensure that evaders change their behaviours but the medicine applied should not kill the patient. Can this be achieved in the modern era? Many public campaigns have forced companies,like Starbucks, to pay more in UK tax and there are moves to implement general anti avoidance tax rules (GAAR) in the UK.
All these principles are designed to ensure that taxes raise as much as possible for the state whilst minimising the financial blockers to a country's economic growth and to workers' incentives. We need to ensure that governments do not ignore these important principles when they set their tax policies.
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