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Good and bad taxes

Is there anything like the perfect tax?

Today there exists a multitude of different taxes taxing all kinds of commodities in various different ways. From income to wealth taxes, from lump-sum to flat all the way to progressive taxes. Taxes on commodities, on flows or stacks of goods, there is probably no tax that wouldn’t exist anywhere in the world. And while more than half of the tax literature is German, this does not mean that Germans would have figured out the perfect tax system. Surely some taxes must be better than others, depending on the country and circumstances they are levied under. This is an investigation into decision criteria that could help administer the right taxes.

Benjamin Franklin once remarked that nothing would be certain in life except for debt and taxes. Hence, no state today operates without taxes and the least have ever gone without. What is by some regarded as a form of expropriation constitutes the primary form of government financing, aside from raising new debt (which is its own topic), to fund welfare states, infrastructure projects, national defense and of course the salaries of all public servants. Whether these funds are always employed in the most efficient manner may of course be doubted, but there are certainly many details to consider when you want to raise those funds. Below are some considerations you should keep in mind when thinking about good – and efficient – taxation.

Focus on understanding

It is hard for people to grasp the need to pay taxes when they cannot understand the grounds on which they are taxed and cannot reason about proportionality. While lump-sum taxes seem great in theory for their non-distortionary features, they are commonly disregarded in practice for their lack of proportionality and understandability. Just asking every citizen to pay a certain amount is fine but should understand why. If you rather say you tax labor, income, wealth, consumption, ‘vicious’ goods or anything else, then people can much more easily understand the rationale behind this thought. Another focus point could be to link the charges to clear outcomes. Once you levy taxes with a certain objective and make clear for what you are going to use the money raised, people are much more willing to deliver it (provided they share the concern).

Focus on feasibility

Although frequently called for, wealth taxes are much less feasible than most people think: you have to count all the assets, value them accordingly, account for illiquidity and productive value, deal with all kinds of exceptions and then find a way to levy them correctly and prevent misstatements or fraud. Doing all this could take even more time and money than tax revenues would allow for. Taxing labor or capital income on the other hand, aside from a few exceptions of multinationals and digital companies, is a lot easier to administer as reporting standards and automatic procedures are clearly in place and everything can be measured easily. Hence, one always has to value both the costs and benefits involved with a tax before levying it. In terms of costs, a lot also depends on the bureaucratic standards in place. If you know tax collection is efficient and easy – or explicitly hard in some domains – then this might favor some or other forms of taxes. The same tax could be very feasible in one country but not in another given certain differences in the public sector.

Focus on culture

Countries are different and only because something works in another country this doesn’t need to mean that it works in this country as well. Looking at your neighbors or ‘best practices’ is certainly a good thing but blind adoption of those is not. Policymakers must carefully evaluate whether both the objective and levying of the taxes are feasible and understood in this country. Further, when choosing taxes, tax rates and on progression, one must keep in mind what is seen as desirable in society. A large welfare state or more egalitarian society necessitates usually more taxes than a libertarian meritocracy based mainly on individual capabilities and performance. What is more, one also has to grapple with past experiences or national stereotypes or commonly held beliefs. If something is so sacred that taxing would constitute a ‘moral crime’ then better leave your hands off it, even if other countries have shown that taxation in this area might be beneficial.

In the end one can probably not specify whether there is a perfect tax. Having too many taxes or an inefficient bureaucracy is as bad as having too many taxes and not being able to reason what you are paying all this money for. Hence, it comes down to outlining what one wants to achieve as a government and then finding ways to accomplish that, keeping both the feasibility, cultural appropriateness, and understandability of the tax into account. Surely, there are some countries that do this better than others – and Germany is not necessarily at the top there.