This episode delves into Adam Smith’s four maxims of taxation and examines their relevance in today’s economic environment. Host Gene Tunny explores the balance between efficiency and equity, discussing historical perspectives and contemporary debates, such as the proposed billionaire tax.
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What’s covered in EP239
- Introduction. (0:00)
- Important taxation principles. (5:33)
- Taxation principles and maxims from Adam Smith’s “The Wealth of Nations”. (13:19)
- Wealth inequality and proposed taxes on billionaires. (20:30)
- A classically liberal perspective from Simon Cowan. (28:33)
- Taxation principles, including horizontal and vertical equity, convenience, and efficiency. (33:29)
- Taxation and its impact on economic activity. (41:19)
- Adverse impacts of high taxes: example from Australia’s tobacco industry. (47:54)
- Wrap up of taxation principles from Adam Smith’s “Wealth of Nations.” (54:04)
Takeaways
- Adam Smith’s maxims of taxation remain highly relevant, advocating for efficiency, equity, certainty, and convenience in tax systems.
- Contemporary tax debates often reflect a trade-off between efficiency (minimizing economic distortions) and equity (ensuring fairness across different income groups and treating similar people in the same way).
- The episode highlights the potential adverse consequences of high taxation, such as reduced economic growth and black markets and organized crime.
- Discussions on billionaire taxes illustrate ongoing disagreements about how to design tax systems that balance economic incentives and equity.
- The taxation principles discussed are essential for understanding governmental approaches to raising revenue while minimizing negative economic impacts.
Links relevant to the conversation
Recent episode with Dan Mitchell on US debt:
Episode featuring Simon Cowan on tax:
Episode with Miranda Stewart on Billionaire and inheritance taxes:
https://economicsexplored.com/2021/11/06/ep112-taxing-the-rich-billionaire-and-inheritance-taxes
Episode with Steve Rosenthal on Tax rules benefiting tech titans and hedge fund managers:
Adam Smith’s The Wealth of Nations: Books IV-V:
https://www.amazon.com.au/Wealth-Nations-Books-IV-V/dp/0140436154
One of Dan Mitchell’s posts at International Liberty on adverse impact of taxation on economic growth:
Transcript: How Good was Adam Smith? 4 Tax Maxims from 250 Years Ago that are Still Fresh – EP239
N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.
Dan Mitchell 00:03
Now I’m never one to say, Oh, you raised this tax or that tax, there’s going to be a recession. I worry worry about if you raised this stature that tax in the long run growth rate will decline. And even if it only declines a small amount, maybe two tenths of 1% a year that has massive long run implications because of the wedge effect.
Gene Tunny 00:32
Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, and welcome to the show. This episode, it’s just me, there’s no guest, I’m going to talk about one of the issues that I’ve been covering in the book that I’m writing. So over the last few months other than my business other than this podcast, the thing that’s really occupied my time has been this book. So I’ve been working on this book. It’s titled government budget analysis principles for policy. So this was a book that Tony Macon and I proposed to Routledge, which is a major international academic publisher. And we got an agreement to, to write the book. But if you’re a listener to this podcast, and you know that I had Tony, on my show, we talked about the pandemic stimulus. And then I had Alex Robson on in white 2021 to just talk about the terrible news that that Tony had, died, unexpectedly died suddenly, at age 67. And, yeah, I mean, huge blow. We’re about to start working on the book. And I didn’t know whether I’d be able to go through with it. But people like Alex and also Fabrizio come and Yanni, who’s a professor of giveth now at Griffith University, where tiny was and now Fabrizio is over at University of Southern Queensland. They encouraged me to continue on with a book and that’s what I’ve been doing. And I’m going to dedicate the book to Tony, for sure. So I’m at the stage where I’m trying to finalise the book, tidy it up getting comments from reviewers, it’s, it’s been a huge effort. If you’ve written the book yourself, then I mean, you’d know just how much work goes into it, and how much work there is just getting it across that finish line. So that’s where I am at the moment. And in researching and writing the book, I’ve come across so much, great material and, and some that I want to share with you. I think there’s some some great stuff that I’ve learned along the way. And what I want to talk about today is taxation and how we determine what a good tax system looks like, what are those principles for taxation? So, I mean, tax is something we all grumble about. It’s, I mean, particularly at tax time, I mean, it’s, it can be very trying. But ultimately, you know, it’s inevitable as what do they say about the only two things that are inevitable in life are death and taxes, we need taxes to pay for the public services? And there are, I don’t know exactly who said this, but there’s that quote that taxes are the price we pay for civilization. And there’s something to that, I suppose. There are other perspectives, of course, that I’ll talk about a bit later a bit is the libertarian perspective, the extreme libertarian perspective that taxation is theft. That’s another way of looking at it. But generally, I think most economists, or the vast majority of economists would recognise that we need taxes to pay for government services. As. On the other hand, if we resort to money printing, we essentially pay taxes and other way we pay the inflation tax. That’s, that’s perhaps a bit tangential to this discussion. And I have talked about that before. The main point is that taxes are inevitable. And we should be thinking about principles for having a well, a well designed tax system. There’s a great quote that was attributed to the finance minister for Louie, the 14th of France. I think John Baptiste Colbert and the way he described it, and I’m not going to get these words. Exactly. Well, in any case, they would have been in French. And will which I’m not going to try to quote, The basically said that the art of taxation is basically trying to pluck a goose to get the maximum quantity of feathers for the least amount of hissene. And, to this day, I don’t think anyone’s really described the process of taxation, or what governments are trying to do with taxation with in such a clear, and brilliant, why I mean, it’s a great way to describe it. It’s very illustrative of what the process involves. So we’re essentially trying to tax the population in an efficient way, also an equitable way, as we’ll talk about soon, it’s a way that’s going to prevent a lot of hissing because either a tax is too burdensome, or it’s seen as unfair, it’s seen as inequitable. And, to this day, that’s the way that political scientists economists tend to think about taxation. economists talk about the main principles of a tax system or the main goals of a tax system. Depending on which economists you ask or which textbook you read, there might be three or four different principles, or there could be five in some cases, but generally, the major ones are efficiency. So there’s widespread agreement that the collection of taxes has to be efficient. And that encompasses various different things, which we’ll talk about in a moment. And it also has to be equitable. And there are two types of equity. There is horizontal equity, which is we treat similar people in the same way. So there’s no arbitrary taxation. The government doesn’t tax its political enemies more than the people that likes there’s equity and in that way, and then another concept of equity. And this can be controversial, which we’ll talk about in a moment, is vertical equity, which is probably what we probably first think of when we think of this concept of equity or fairness. It’s about people who have a greater ability to pay a greater capacity to pay, they contribute more, so they pay a higher tax rate. So the wealthy attacks more than the poor. And so I think a lot of people when they think of equity, they probably think along those lines. Okay, so they’re the major ones that economists talk about. Sometimes I’ll add in simplicity, as another principle, I tend to think of simplicity as part of the whole efficiency of the tax system story. So the big, the big items are efficiency and equity, the two different components of equity. And usually what we find or often what we find is that there’s a trade off there’s a, there can be a trade off between efficiency and equity. That’s when you have the really difficult policy decisions. Arthur Oaken, who was a a famous American macro economist. He was Lyndon Johnson’s chair for his Council of Economic Advisers. He talked about that big trade off between equity and efficiency. So that’s something that will come up in taxation, such as debates over consumption taxes, increasing the consumption tax. consumption tax might be an efficient tax, it might be better than income tax, for example, but it is regressive. If you’re on a to lower income, then you’re proportionally spending more of your total income on consumption items, then someone who’s wealthy who’s saving a lot. So there’s a trade off there. I mean, that’s one of the big issues that comes up in taxation, these these trade offs. Okay. Now, what I want to go over this episode in particular on tax having, you know, provided that background on how economists are thinking about it, is what Adam Smith, what the father of economics, thought about tax. And as happens in economics, we find that a lot of these, these principles that we talk about, that we that we espouse many of them, go back to Adam Smith, to 1776, to the Wealth of Nations. Now, not everything’s in Adam Smith, of course, I mean, there are insights, great insights from later economists such as Ricardo Keynes, Milton Friedman, but there is so much that is in Adam Smith is just extraordinary. It’s if you haven’t read Wealth of Nations, I thoroughly recommend you grab yourself a copy of Wealth of Nations, there’s, it’s generally in two different volumes as volumes 123, which is where most of the famous passages from says stuff about invisible hand, etc. But then there’s also volumes, four to five, and it’s in the book four to five, and it’s in book five, where the principles of taxation aren’t they’re the ones I’m going to talk about today. Now, just on the importance of Adam Smith, I mean, if we go to John Kenneth Galbraith, it’s the age of uncertainty which is one of those great books on the history of economics. Now Galbraith, as a, as someone with Scottish ancestry, he saw a connection with Adam Smith and Adam Smith was, of course, one of the the intellectual giants of the so called Scottish Enlightenment in the 18th century. And Galbraith wrote, The Greatest of Scotchman was the first economist, Adam Smith. Economists do not have a great reputation for agreeing with one another. But on one thing, there is wide agreement. If economics has a Founding Father, it is Smith. And there’s absolute truth in that I mean, Galbraith absolutely nailed that there have been economists often will will argue, but there is general agreement that, you know, Adam Smith was, was the founder was the greatest. It didn’t have the same analytical conceptual apparatus that Alfred Marshall and later economists had. But there was just, there’s just so much wisdom in Adam Smith, it’s, it’s extraordinary going back to it nearly 250 years later. So it’s absolutely extraordinary. And the what I, what I uncovered when I, when I was working on this book, because I was writing a chapter on tax policy. So it’s the fourth chapter in this, this book on writing. And I remembered are these taxation principles. We owe them to Adam Smith diet, we all they were inspired by Adam Smith, I vaguely recall that from something I read, or a lecture I went to a couple of decades ago, now. And it made me seek out the fifth book of the Wealth of Nations. And there’s the, in the section in part two of taxes under the sources of revenue, we have Adam Smith, lay out these four Maxim’s as he calls them of taxation, which, arguably, are still as you know, as relevant today as they were in the 1770s. And they’re just so descriptive. And you can you can see the connections between what Adam Smith laid out here and these principles of a good tax system that I was talking about before, equity, the two different types of equity, horizontal and vertical and efficiency. So without further ado, we might get into Adam Smith’s maxims of taxation. Now, I won’t read all of them all. Well, I won’t read all of the passages in the book, but I’ll just give you the, the headlines. Because I definitely encourage you to, to get a copy of the Wealth of Nations. Okay, so number one, maximum one, the subjects of every state ought to contribute towards the support of the government as nearly as possible, in proportion to their respective abilities, that is in proportion to the revenue, which they respectively enjoy. Under the protection of the state, the expensive government to the individuals of a great nation is like the expense of management to the joint tenants of a greater state, who are all obliged to contribute in proportion to their respective interests in the estate. Right, oh, so that is essentially the vertical equity principle, you can think of it that way. You should contribute in proportion. So it says, contributed in proportion to the revenue that they respectively enjoy. So in proportion to your income. Right. So and that’s, that’s Maxim number one. Now, I think that’s interesting, the way that Adam Smith, the first thing he puts down as a principle, it does relate to that, what we would think of as the vertical equity principle, it’s not efficiency. So generally, when we’re whenever I talk about the principles of taxation, or when public finance economists generally talk about them, they would generally put efficiency first. But I think it’s interesting. I don’t know whether to make too much of that. I’m not a Smith scholar, maybe I’ll look further into that. I just find that interesting that he’s put equity as the the first principle. And this issue of equity is, I mean, it’s it’s at the heart of a lot of the the tax debates that were that we’re having now. And I just saw a couple of months ago, there’s talk about how the Biden administration had Biden’s reelected. Now. I mean, who knows? I think it seems pretty close. I mean, Trump’s just a political phenomenon. No one’s seen any anything like him in the past is just incredible. Just just the I mean, he’s just got some sort of political skills that are, you know, hard to hard to comprehend. I mean, he clearly could win again, there’s no doubt about that. He is embattled now with all of these lawsuits. But given what we’ve seen in the past, I mean, I, it’s very possible he could win. So I mean, who knows. But if Biden wins, he’s saying that there could be a billionaire tax. So I think this is something that we’re talking about a few years ago, Elizabeth Warren called for it. And CNBC reported in March 2024, outlining his 25 budget proposals on Monday Biden to game at the Uber affluent and reiterated plans for a 25% tax on Americans with a with a wealth of more than $100 million. Okay, so I mean, who knows, they probably would never get a pass through Congress. Perhaps it’s just all political talk. But I guess what it shows is that there is this there is a lot of talk about taxation and the appropriate taxation of of the wealthy and a big debate about whether taxation levels are right or not, or whether Are they too low? Are we taxing the wealthy enough? And particularly in the US, there are concerns about taxation, policy settings around capital gains, there’s this whether it’s a loophole or not, that’s hard to say but there’s the rules around carried interest I talked about with Steve Rosenthal, I think it was from Urban Institute a couple of years ago, and this step up in basis that occurs when we when estates are passed on when the if the when someone dies, someone wealthy and there’s receive the the estate and effectively, there’s no taxation on the capital gains that were that were earned. During the their their benefactors live. So that’s something that is controversial. Hopefully, I’ve described that right. I’ll put a link in the show notes to the Steve Rosenthal episode. Uh, so there’s a lot of discussion about appropriate tax settings. And I had a great conversation with Miranda steward from ASU from Australian National University on this issue of the billionaires tax and talk about inheritance tax and what’s driving it all. And I think she gave a really, really nice, really good explanation of what’s going on. So I might play that for you. Let’s, let’s replay this. This is with Miranda Stewart, this is from about three years ago, I’ll put a link in the show notes.
Miranda Stewart 20:30
But so I suppose we’re observing what’s going on in the US, as we always do here in Australia, and I guess, to some extent elsewhere in the world. So if we think in that context, and then think how might that affect our our ideas about Australian Taxation, the big driver of both the US billionaires tax as it’s been, you know, marketed in the, in the papers. And I guess, by the Democrats, to some extent, is income inequality in the US. And another big driver of the US policy, Democrats policy is wealth inequality. So I guess we should see these two things are related, but they’re not the same. So the US has, probably, among OECD countries, almost the highest income inequality of any OECD country, I mean, there’s a couple of others. Costa Rica is another example. You know, some of the Latin American countries have rather high inequality, Brazil has very high inequality in income. But the US really stands out compared to most developed countries in its income inequality. And the inequality is both at the top, you know, the billionaires have very rich that is they have a lot of income. And at the bottom, poor people are very poor, you know, so you sort of have that extreme. Australia In most in the UK, and most European countries are nowhere near as extreme as that in terms of income inequality, although, of course, we do have some in the US that inequality was sort of trending upward, as well, I suppose, over the last 10 years and 20 years. And of course, the other thing that we’ve seen in the US is, is these billionaires, you know, the the tech boom, and the the tech billionaires, the ones that really stand out, although they’re not the only ones, Bill Gates, you know, on musk, Apple, and, and so on. So, they, the owners of those, those tech companies, of course, are massively rich in ways that none of us perhaps can ever remember being the case in terms of their access to kind of global capital. And these global monopoly markets that they have. Most of their wealth, of course, is not in their own personal hands. It’s in the stock that they hold in their companies. You know, it’s of course, they own that they’re in those shares. And they they’re worth billions, but it’s not income so much as as wealth. So the US billionaires tax, it’s bit it’s a bit mis described, the the Biden proposal is two things. One is that it’s essentially just a higher income tax write to include some amounts of more of income and gain in the income tax in the US. And then the other part of that is to strengthen some of the districts in the USA state tax they do have an estate and gift tax, and there have been lots of proposals in the US for a wealth tax. Gabriel Zucman. refound was famous for proposing an actual kind of accrual wealth tax on the very richest. Right, come back to Australia. Well, I can. Coming back to Australia, of course, we don’t have inheritance taxes, as you said, the Queensland Joe Bill key Peterson started that trend in the late 70s in Queensland, abolishing the Queensland estate and gift duties and we had a classic tax competition reaction to that, within among the states and territories, they all really quickly abolished their estate taxes. And then the feds, you know, with one of those things where with hindsight, probably they shouldn’t have done it. They abolish the federal estate and gift tax, although there was no tax competition issue there. Nonetheless, it was very unpopular tax and it was a political campaign to abolish it. And as we’ve seen more recently, it is possible to abolish unpopular taxes. Federal Governments do do it from time to time. So we have growing wealth inequality, we don’t have quite so much income inequality, although that is growing a little bit but we do have growing wealth inequality and I think that’s why the interest again in these issues.
Gene Tunny 24:51
Okay, so I think that was a really good summary from Miranda as to what’s going on On and it’s why why do we have all of this talk about the billionaires tax and, you know, inheritance taxes now, it’s because of, you know, the the trends we’ve seen in the inequality of wealth. We’ve seen that in the United States. I mean, I mean, that’s really where you see the big, the big increase in wealth inequality. We’ve had some of it in Australia, we haven’t had much of a change in income inequality, or there’s a debate about whether that’s really changed a lot. But definitely, wealth inequality has increased, particularly with, with housing with. I mean, we’ve got, you know, some ridiculous house prices now in Sydney and Melbourne. And now I’ve got young people unable to enter the market, we’ve got a real crisis there, arguably. Now, I guess what I would say about this is that, and this is where it gets tricky is because equity is in the eye of the beholder. So there’s value judgments that that come into it. And I mean, maybe I wouldn’t go so far as to say, a lot of these proposals are motivated by envy or class warfare. So those will often be the criticisms of proposals like that. I mean, you know, in some cases, maybe there’s some truth in it. I wouldn’t go there immediately, I would say the people advocating for them, they have a different way of looking at the world. They have particular values, and they think that well, this is unfair. So it’s what do we see as unfair? So that’s one set of value judgments you could make. Now, another perspective on this is that, that libertarian perspective I was talking about before. So there’s another perspective, and this is, you know, you could say, it’s this taxation is theft perspective. I mean, if you have a presumption in favour of the individual in favour of private property, then you would be very resistant to taxation of any sort, you’d be resistant to, to these moves to have a billionaire’s tax or have a have a heavy inheritance taxes. And, I mean, it could be based on a libertarian argument, or it could also be based on an argument that this is the sort of thing that will stifle entrepreneurship. So we’ll talk a bit about that later. But I want to play a clip from a conversation I had with my colleague at the Centre for independent studies, Simon Cowen earlier this year, Simon is research director at CIS. And you may be aware, I don’t know, it depends on how often you listen to the show. I am a an adjunct Fellow at Centre for independent studies in Sydney. So I’ve had a long association with with CIS. That goes back, g must be this must be the 27th year I’ve had an association with CIS 26 through 27. It’s been a long time. But here’s a clip from my, well, my friend and colleague, Simon Cowell. And so let’s listen to what Simon has to say.
Simon Cowan 28:33
What you actually really need to do is lower the tax rates across the board. And this is one way to start that process. Right? And
Gene Tunny 28:42
is that that’s to encourage work effort and innovation. Entrepreneurship. Yeah, so
Simon Cowan 28:47
absolutely all of those students, but I think there’s also a moral argument to this, where, you know, the government is acting as if your income belongs to them, and you should be grateful when they allow you to keep some portion of it. And, you know, the analysis seems to be that people who are receiving government benefits or low income deserve more of the higher income people’s income than they do. And I mean, you know, I think there’s a moral difference there. People who people should be entitled to receive as much of the benefit of their hard work as they can and at a tech to redistribute from the perspective of trying to sort of equalise incomes rather than trying to provide a safety net for people at the bottom it I think the more that our tax system tries to create that that equalisation for equity purposes, and the less that it focuses on, on you know, sort of the the issue of absolute inequality, the the absolute poverty issues. Is the people bought again, I think that’s a mistake. I think people should be entitled to keep their income, regardless of the income level there. Okay,
Gene Tunny 30:10
so that’s an alternative perspective. That’s from Simon Cowan. And Simon is expressing a classically liberal perspective. A libertarian, you could say, perspective on taxation. And look, that’s a that’s a fair perspective on perhaps reasonably sympathetic to that perspective, having been associated with the CIS myself. And that’s in contrast to another perspective, the thing I’d say is that, look, there’s going to be debates about values. And I mean, you know, and to an extent, we just can’t really say that there is one right answer, there’s not necessarily a solution. What’s that saying about? What would Thomas soul say? There’s no solutions, only trade offs? So look, you know, this is a tactic when it’s when when it comes to taxation, we’ve got a whole range of considerations, equity is one and we will argue about what is equitable. So we might leave it there, I think I’ve played I’ve given two perspectives on that. And if you’ve got your own views, let me know, get in touch. Right, I’ve got to move on to some of the other Maxim’s of taxation, or I’ll also, just before I get onto that to vaccin, to I’ll put the context for that. Simon Cowell and clip in the show notes. What what it was all about was about this debate we had earlier this year about this stage three tax cuts that we’re having here. And there were redesigned, so there wasn’t so much going to the top end. And arguably, well, what Simon in some of his colleagues at CIS were arguing is that well, those tax cuts will go into the top end, because they’re the ones paying the bulk of tax in the first place. And this was just given giving them back bracket creep. So what they were all the extra tax our pain, because inflation pushed them into a higher tax bracket. So he was saying, Look, you know, there’s nothing really wrong with that. And you had a lot of the people advocating to redesign the tax cut, they were essentially assuming that all his money belonged to the government in the first place. So that’s what he was. That was the context for that. So I’ll put some links in the show notes, so you can understand that a bit more. The key thing is that, yeah, I’ve given you two different perspectives, and I would be interested in your own So yep, please get in touch. Okay, we’ll take a short break here for a word from our sponsor.
Female speaker 32:51
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Gene Tunny 33:20
Now back to the show. Right oh, let’s get on to the other Maxim’s number two. So Maxim to the tax, which Each Individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid ought to all to be clear and plain to the contributor and to every other person. Okay. So, to me, this is essentially the horizontal equity principle. You’re not being treated arbitrarily, you know, what the rules are? It’s not going to depend on the tax assessor or the person assessing your taxes, there are clear rules. And I think generally, in advanced economies, this is something that that we do reasonably well. I mean, we’re gonna have lots of debates about vertical equity and efficiency, as we’ll talk about in a moment, but I think generally, this is, this is something that is, is reasonably well, well taken care of, in terms of having clear rules. I mean, maybe you could argue, and this gets into one of these equity arguments, I suppose. Like some people will say, Well, isn’t it unfair that you know, so and so billionaire pays less taxes or proportion of their income than someone who’s a teacher or, you know, an administrator worker, okay. So, yeah, there’s that’s maybe that’s more vertical equity than than horizontal My view is that that second maximum relates to horizontal equity and our systems are probably reasonably okay in that regard. But if anyone has any different views on that, please get in touch we, we might move on to another, the third Maxim, every tax ought to be levied at the time or in the manner in which it is most likely to be convenient for the contributor to pay it. Okay, so this is, this just gets to the burden of the tax system. And I think this relates to efficiency, whether it’s efficient or not, whether it’s minimising the the regulatory burden on on taxpayers, and Smith gives the example, a tax upon the rent of land or of houses payable at the same term at which such rents are usually paid is levied at the time when it is most likely to be convenient for the contributor to pay, or when he is most likely to have where with all to pay. K? Well, I mean, I suppose that I can see why this would be an important principle, it doesn’t usually, I guess, it does come under efficiency, you can think of it under efficiency, but generally, what we find is that the tax officers, the tax agencies, they want to, they want to get your money, they want to get money from people as frequently as they can. So I suppose with with employees, the employers have to withhold the tax on behalf of the employees. So this is the withholding tax in, in the US. And in Australia, as I suppose the the wage earners are paying the tax at the time that they’re paid. So that’s consistent with this third maxim of Adam Smith’s. And even though they don’t even see the money, the employer handles at all. So perhaps you could say that that’s consistent with it. And then, depending on the type of business, you are in Australia, so if you’re a company, I think you have to pay those those tax instalments every month to the ATO or if you’re a large company, and if you’re not a large company, you pay quarterly. So I mean, arguably, that’s more convenient than then just having to make one big payment at the end of the year, which, which could cause cashflow issues. Right. So I think, you know, that’s a reasonable principle. I find it funny, it’s a bit a bit odd that it’s elevated to its its own Maxim, but Adam Smith obviously thought it was important, it was obviously a big deal at that time back in the 1770s. So fair enough, I can understand why it’s in there even even if I would have probably rolled it up into an efficiency principle. And in fact, I think it’s, I mean, when I think of when I think of the tax system in the big thing I’m often concerned about is that economic efficiency, and maybe that’s, maybe I’m not giving as much weight to those equity considerations that aren’t as others maybe that you know, that’s a that’s a value judgement on my part. I mean, obviously do care about equity to an extent. But then I’m also thinking about how do we ensure that the economy is as productive as possible for the benefit of us? All? Right, oh, so we get on to Maxim for every tax ought to be so contrived, as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the state. Now, that is a very good maxim that is a really intuitive are a really nice summary or explanation of the efficiency principle of taxation. He’s basically saying that, well, we’ve got to minimise what economists in the technical language of economists what we now call the excess burden, or the deadweight loss of attack. So when the government raises $1 of tax revenue, that’s actually taking more than $1 away from households and businesses as well. It’s a transfer of $1 from the households and businesses to the government. But then there’s an extra excess burden or deadweight loss which could be say 25 cents or so. $1 are a tax actually, it costs $1.25. So there’s the dollar. And then there’s the 25 cents on top of that, from the disruption to economic activity that lost economic activity. So the marginal cost of public funds, so to speak, is higher than then $1. So in that example, it’s $1.25. There’s that excess burden of, of 25 cents. And I think that is, that’s what Smith captured quite nicely in that maximum his. Okay, so how does that excess burden come about? And I think this is where Smith provides some, you know, some really good illustrations, he talks about how a tax may either take out, or keep out of the pockets of the people a great deal more than it brings into the public treasury in the four following ways. First, the levelling of it may require a great number of officers whose salaries may eat up the greater part of the produce of the tax and who’s perquisites may impose another additional tax upon the people. Okay, fair enough. I mean, the tax office has got administrative costs, given given modern accounting systems, and computerization, given the fact that the tax collections outsource to big business, a lot of it through withholding tax and company tax, maybe that’s less of a big deal than it was in in Smith’s stay. But certainly, I mean, yep, there’s administrative costs with taxation, no doubt about that. And I suppose that’s why you probably want to rely on a smaller number of taxes. And one of the things you do see, and this is this, this arguably is an issue when Ken Henry, my old boss, in the treasury, he did his tax review in Australia, about 15 years ago, and I remember there was a chart of some kind that showed that will, across Australia, across commonwealth and state agencies, there will, there’s over 100 different types of, of taxes. And I mean, there’s basically only 10 of them that, you know, raise the bulk of the revenue, or I don’t know, whatever, some 8020 rule, basically going on with taxation, I’ll try and track it down and put the the exact figures in the show notes. And when I did some work with Darren Nelson, and with Dan Mitchell, we did some work for a think tank in Maine, the state of Maine in New England, we discovered the same with their their state tax system. I mean, you had 90 or so maybe, yeah, oh, you had dozens and dozens of taxes, maybe it was 70 or something like that. But there was only, I think it was only like four of them, it was a handful of them that raised 90% of the revenue or something like that. So you got to wonder about the administrative costs of having all of those other, you know, dozens of small taxes and charges, is it efficient to have them? Or should we just raise the revenue with the big tax levers? Should we just use things? Like, if we have an income tax, or if you have a consumption tax or or a sales tax or whatever, should you just use those rather than having taxes on on all of these different to different things, all of these different activities like a bed tax or taxes on the production of specific commodities, particular particular crustaceans, for example, if I remember correctly, so yeah, I think, you know, Smith’s onto something there. And then he gives some other examples. Secondly, he’s talking about taxes, they may obstruct the industry of the people and discourage them from applying to certain branches of business, which might give maintenance and employment to great multitudes. Okay, so when economists think about efficiency, costs of taxation, this is essentially what they’re concerned about. They’re concerned about taxes, discouraging work effort. They’re concerned about taxes discouraging investment in new projects of our topical example, in the state of Queensland where I am in Australia. We have a state government that a couple of years ago, introduced some new tiers in the coal royalty rates, which could be seen as some sort of super profits tax in a why they were they saw the coal price just shoot through the roof really just incredible. Up to 400 500 US dollars a tonne for coking coal at one stage, I mean prices that they never ever thought they’d see. And so they tried to get some of that upside. And, you know, it’s brought it brought a lot of money into the state. And there’s a, you know, there’s a big debate about I mean, if it was really a windfall gain that these coal companies were getting, then you know, what’s the big what’s the big deal? The Capitol is sunk. They’re still making a lot of money, the state governments just getting a share of it, what’s the big deal? But then the company said, Well, how can we trust you in the future, there’s this, there’s risk that you could do something, something, you know, that could be expropriation, more expropriation in the future. So there’s this there’s this risk there. And look, you know, there’s something to that. I mean, I mean, I wouldn’t like to say that we’re an emerging economy here in Queensland, but this is a sort of thing that does happen in emerging or developing economies in from time to time. And we’ve seen various examples of, of, of populace who have tried to nationalise or take over assets of, of foreign companies. And then you had well, you know, various examples. Masa, DAG, in, in Iran in the 50s, you had NASA in Egypt with Suez Canal. So look, it’s not something that never happens. And, you know, maybe there is some risk there. So there’s that argument about that. And, and then bhp, I think it was one of the companies came out and said, Well, this is going to stop us from investing in the future. Okay. So that’s an example of where you have a tax and it could discourage investment, it could discourage economic activity, the creation of jobs, likewise, with income tax, if the income tax rates too high, then why would I go and work an additional hour? Maybe I’d rather take some leisure time. And I think we’re probably all, you know, all understand how that mechanism could work. There is a debate about just how significant that is. And people like John Kenneth Galbraith would argue that, well, high income earners are people who are driven, they’re just going to work hard anyway, they’re not really going to care about how much tax they’ll pay. But, look, I think the evidence is pretty clear, it does have an impact of some kind. And, I mean, you’re not going to be completely altruistic and, and work for all those additional hours and work hard for nothing. So there’s obviously some sort of impact there. And this is a point that that Dan Mitchell often makes, and in fact, I chatted with damage. Also, Dan Mitchell, the well known us commentator on public finance issues, Dan was on the show, several episodes ago talking about his new book, about the greatest Ponzi scheme on Earth. So he’s talking about the problems with the US budget, particularly with Social Security, the trust fund is going to run out of money in the early 2030s. And that means there’s an automatic cut in benefits, and less, they can sort things out before then. So great interview, I’m gonna put a link in the show notes. But right now, what I’m going to do is I’m going to play a clip from my conversation with Dan, to give you a taste of what we talked about. And this is Dan on the link between taxes and growth. It’s illustrating well link between high taxes and lower growth. And it illustrates the point that I’ve been talking about with efficiency, about efficiency.
Dan Mitchell 48:59
Now, I’m never one to say, Oh, you raise this tax or that tax, there’s going to be a recession. I worry more about if you raise this tax or that tax, the long run growth rate will decline. And even if it only two times a small amount, maybe two tenths of 1% a year that has massive long run implications because of the wedge effect over time. And then, and I think that even left wing economists, the honest ones are going to admit that higher marginal tax rates on work saving and investing are not good for growth. So as GDP gets smaller and smaller over time, at least in terms of compared to some baseline projection, that means Oregon tax revenue because there’s less national income to tax.
Gene Tunny 49:45
Okay, so that was Dan Mitchell. That was from a recent episode where we talked about his new book, The Greatest Ponzi scheme on Earth. So yeah, I think Dan really gave a good you know, a good summary there or he made a good point about Are these these taxes and they can have adversely affect economic growth? And he’s right there is. There is evidence from international bodies or the OECD or IMF, there are cross country econometric studies that, that do that do show that link. So, yep, good stuff from damage. All right, we’re getting getting toward the end a bit to try and wrap this up. I never thought I’d be able to talk so much about these. Maxim’s of taxation The time has really flown right. And then Adam Smith gives a a couple of other examples of how this adverse efficiency impact can come about. He talks about thirdly, by the forfeitures, and other penalties, which those unfortunate individuals incur, who attempt unsuccessfully to evade the tax, it may frequently ruin them, and thereby put an end to the benefit which the community might have received from the employment of their capitals. Okay, so So and then he goes on to talk about smuggling in in judicious tax offers a great temptation to smuggling and then he talks about, well, you know, people have this temptation to smuggle, and then they get into trouble with the law, and that ruins them. So that’s, that’s all very terrible. And look, I think, I mean, this is still going on, right? And there’s an example of this that’s very close to home. For me. Well, allegedly. We’re having this. There’s this. Well, there’s all I mean, there’s organised crime involved in illegal tobacco here in Australia. So we have just massively jacked up the taxation, the excise on tobacco. And so a pack of cigarettes now costs 40 Australian dollars or whatever it is, I mean, I don’t smoke. But I mean, I don’t know how people afford to smoke. I mean, this is why, you know, hardly anyone smokes anymore, right? Compared with 30 years ago, or even even 20 years ago, it’s that we’ve had a huge reduction, maybe, I don’t know 10%, or something about old smoke now, whereas once it would have been 60 or 70%. And we’re having this there’s a gang land war going on, because there’s all this illegal tobacco being sold. And it’s it’s been driven by the high excise the high cost of cigarettes and so I’ll put a link in the show notes to an article on this. It may be paywalled I, what I better do is just put some of the quotes from it in the show notes and what the story is, it’s how the price of a path is putting profits in gang Lords pockets. So criminologist say the de facto prohibition of cigarettes by successive federal governments hiking taxes and increasing regulation for health reasons, had created a booming illicit tobacco trade. The more government restricts a product, the more they say you can’t have it, the more it’s driven underground, and that’s when organised crime enters Bond University criminologist Terry Goldsworthy said, and then they quote another crime expert Dr. Martin, he said illegal tobacco products accounted for about 25% of the entire market. With a huge illicit trade in vapes also emerging following recent government crackdowns, the black market for smokes is huge, is growing bigger because the government is continuing to increase the price of smokes more and more. The more that happens, the more the criminal groups that supply the black market, lick their lips and think fantastic. We can just grow our market share even further. Dr. Martin said government policies aimed at stamping out smoking completely were foolish and unrealistic. Absolutely. So I think that’s consistent with how economists think about these sorts of things. I mean, you can’t really prohibit things we know that from prohibition, you just create this massive black market and you end up putting profits in the pockets of gang wards and I said this this hit close to home because around the corner from me now I don’t know exactly what happens. So you don’t want to create an awful but this is there was a vape shop around the corner from me on wicked terrorists that Spring Hill. That was well there was this suspicious fire. So police are in there’s a there’s a shot of it in this article. With the burned out shop, police investigating a potentially suspicious fire at a vape shop on Wickham terrace at Spring Hill and this is in an hour article on how the price of a puff is putting profits in gang Lord’s pockets. So it says tobacco shops in Queensland and interstate have been targeted in a spate of fire bombings and a bit of turf war as incredible figures show just how rough the black market is and how easy it is to get hold of dirt cheap illegal cigarettes. Okay, so maybe there’s some scope to have a higher excise on smokes on tobacco, because there are those health risks with tobacco, no doubt, I mean, all the deaths from lung cancer. But if you set it too high, then you’re going to have these adverse unintended consequences. And I think that is what Adam Smith was getting at, in that. That third type of efficiency cost of taxation. So, again, well done Adam Smith, and his final, the final way that you end up with his efficiency cost. He says, fourthly, by subjecting the people to the frequent visits and the odious examination of the tax gatherers, it may expose them to much unnecessary trouble vexation and oppression. And though vexation is not strictly speaking, expense, it is certainly equivalent to the expense of which every man would be willing to redeem himself from it. Okay, so some, some brilliant writers from Adam Smith. And that’s, that’s the final maximum of taxation of his principles of taxation as one about efficiency. And I mean, not that it’s not all, not every principle of economics is in the Wealth of Nations, but a lot of them are, and his writing on taxation on what makes a good taxation system that is still fresh, 250 years also after he wrote it. So absolutely. Go out and grab yourself a copy of the Wealth of Nations books fortifies Penguin Classics as a great addition of it that I’ve been that I’ve been reading. Do yourself a favour, brilliant book, says, So are the first three books of the Wealth of Nations. And I’m gonna have to come back to Adam Smith, because I think there’s so much in it. If you’d like to hear more about Adam Smith, let me know if you’ve got any thoughts on what I talked about with taxation? Do we agree, do you disagree? Let me know. I’d love to know what you think about how we design our tax system. What improvements do you think we could make? What’s your perspective on equity? Are you concerned about wealth inequality? Or are you more of the taxation is theft? View? So please let me know I’d love to love to hear your thoughts. Right. I better wrap this up. Thanks for for joining me. It’s been really great to talk about Adam Smith and, and talk about these public finance issues that, that I think about a lot and that I’ve been writing about in my new book. Okay. Thanks for joining me. Right. Oh, thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com, or a voicemail via SpeakPipe. 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59:01
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Credits
Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business, www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.
