Principles of TaxTheory
1. Tax revenue is relative to economic growth.
An economy in recession will provide a drop in revenues to the government, whereas an economy in expansion will provide an increase in revenues to the government. When an economy shrinks, so does the tax base. Businesses start to close down, leaving fewer businesses to collect revenues from. More people are unemployed and left without an income, this leads to more people collecting unemployment benefits from the government. This leads to a smaller tax base and increased outlays for the government, which is a double-negative. With a shrinking economy also comes a lack of investing, savings, and spending. More businesses, people, and capital begin to move out of the country and the incentive to avoid any means of taxation goes up. All of which shrinks the tax base, because of the shrinking economy. When an economy is expanding, the tax base also expands. Businesses start to open, more people have jobs and incomes, the incentive to avoid taxation is less, more people invest, save, and spend their money, and more people, businesses, and capital enters the country. This all leads to a larger tax base which increases revenues. Tax revenue is relative to economic growth.
2. When a recession hits, current tax rates are ineffective.
Even if the tax rate is less than ten percent, since economic conditions during a recession are poor, you will have to either keep tax rates the same or lower them to improve economic conditions. If high tax rates are the cause of the recession, it is obvious that one must lower them. It is best to lower taxes during a recession to improve economic conditions and to expand the tax base. Keeping the tax rates the same can lead to a slow natural market recovery, which can take a very long time. Increasing taxes, however, would harm the economy and shrink the tax base. Such an action during a recession would lead to fewer revenues and a deeper recession. That is why it truly is best to just lower taxes during a recession, which would provide immediate relief to people. Taxes are a fixed cost, considered to be part of the cost of living. Lowering them lowers that cost of living, thus increasing the standard of living. It makes perfect sense to cut taxes during a recession to ensure a strong and dynamic economy which can provide the government with the revenues needed to balance the budget in the long-term. Moderate tax hikes are best issued during times of strong economic expansion, where the tax hikes do not impede or retard economic growth. But even if you have a zero percent tax rate, recessions will always eventually occur due to the business cycle.
3. When you tax something, you get less of it. When you tax something less, you get more of it.
Yes it’s true; taxes do create incentives and disincentives. The best demonstration of this is how taxation affects investments. The tax on Capital Gains directly affects investment decisions, the mobility and flow of risk, and the ease or difficulty of obtaining wealth. The lower the tax on Capital Gains, the easier it is and the less riskier it is to obtain wealth through investments. If it’s easier to obtain wealth through investments, which are always risky, investors will be more open to investing. Therefore we would see more people taking risks and investing. If the tax is higher, the difficulty of obtaining wealth through investment is higher. Therefore, with a higher tax on Capital Gains, we usually see less investment throughout the economy.
We see the same thing with the taxation of alcohol or cigarettes. If one was to lower the tax on cigarettes, we would see more people smoking – or the same people smoking even more, simply because it would be easier and more affordable to obtain cigarettes. If the tax on cigarettes were much higher, we’d see less people smoking or the same people smoking less – all because the ability to obtain and purchase cigarettes is made much harder. Taxes do create incentives and disincentives and they can regulate behavior. Lower taxes can be seen as a reward, while higher taxes can be seen as punishment for a certain activity.
4. Good tax policy rewards success and creates the incentive to invest, save, work, and to take risks; Good tax policy creates the incentive to be economically productive.
Good tax policy doesn’t seek to impede or retard economic growth – good tax policy is supposed to encourage investment, savings, risk taking, work, and business, while fostering competitive markets. Good tax policy creates the incentive to be economically productive. Tax policy should never punish success or savings, work, investment, risk taking, or business – it should never punish economic productivity. Investment, work, and savings are the back bone of a free market economy or, as Milton Friedman used to call it, a free private enterprise exchange economy (competitive capitalism.). Punishing those three activities usually ends up with the destruction or retardation of the economy. You want people to invest, you want people to work instead of relying on government hand outs, and you want people to save their money instead of spending it like idiots. Most of all you do not want to punish anyone making a profit. You want businesses to open, you want people to take risks – you want people to be economically productive! To do this, one must keep taxes low on those activities. This is an incredibly simple concept – something we should all learn in Econ Class.
5. People, businesses, and capital move from areas of high taxation to areas of low taxation.
This is a no brainer. It is much easier to sustain a higher standard of living in an area with lower taxation, as opposed to an area with high taxation. Taxes are a fixed cost, part of the cost of living. Lowering them automatically increases the standard of living by lowering the cost of living itself. If you want to simulate an economy, don’t inject money via a stimulus. Just take less of the people’s hard earned money! It’s that simple and history proves to us that people, businesses, and capital truly move from areas of high taxation to areas of low taxation.
6. The higher the tax rate, the higher the incentive is for avoiding taxation.
It’s just human nature for people to not want to pay taxes. People don’t pay taxes because they want to – they pay them because they have to. If a person could choose between not paying taxes and paying taxes, the person would most likely not pay taxes. If a person can find any way to lower their tax burden, they will do it. It could be through loopholes, tax shelters, tax deductions, or tax credits. Some people can afford to move their bank accounts overseas, while others hire lawyers to exploit the tax system’s loopholes and tax shelters. These activities take time and can be stressful – but sometimes the stress and time is worth it. The lower the tax rate, the less incentive someone has to avoid taxation. The higher the tax rate, the higher the incentive is to avoid taxation.
7. A good tax system has a large tax base and low tax rates.
A large tax base with low tax rates can produce the same amount of revenues as a smaller tax base with higher tax rates. The best way to achieve a large tax base is to increase the size of the economy, while eliminating tax evasion. Keeping tax rates low would result in a strong, expanding economy which produces the revenues needed to meet a budget surplus. The best tax system has a large tax base and low rates of taxation.
