Some of the readers of this column are fortunate enough to live in areas where town water is available all year long. Others, such as myself, live in more remote regions where wells are the only source of reliable water.
As part of our home filtration system, we have a small pump which adds chlorine to our water. Visitors to our place often ask about our well and the water quality, a common chit-chat topic in rural Maine. When I mention that our water treatment system includes a chlorine injection pump, nearly all visitors have commented that this must be needed to eliminate bacteria from our well water.
Actually, this is not the case at all. Our well water is perfectly safe to drink as is, but it has an incomprehensibly high endowment of iron and magnesium. Unfiltered, it is nearly indistinguishable from a cup of cappuccino. Welcome to Newagen!
The chlorine is used as an oxidant to remove, via a carbon filter, the metals which have eluded the ion-exchange-based softener. Then comes the reverse osmosis filter. After that, we have the equivalent of Desani bottled water.
I mention this to introduce another misunderstanding regarding our economy. If asked what is the primary purpose of taxes in our economy, nearly everyone would agree that taxes are levied with the primary purpose of providing funding for the public sector of our economy, i.e., of paying for government. Nearly everyone would miss the mark.
Although it seems self-evident the primary point of taxes is government funding, the reality is different. This issue is not a trivial splitting of hairs. The understanding of the real nature of taxes is critical if one is to properly guide our economy and govern our land.
So here we go. Taxes are a pain to pay and a pain to collect. Consider the infrastructure we have in place to collect taxes. Every store where we shop collects taxes. Our employers collect taxes. The gas pump grabs a piece of our pocketbook. We have branches of local, state, and federal government which monitor taxes.
If this were all designed to fund the government, we have done ourselves a disservice. To fund the government we could simply print money and pass it out. Period. Nothing more. No sales tax; no income tax; no highway tolls; no gasoline tax; no excise tax; no property tax would be needed.
As you read this, the thought might occur to you, “but simply printing money will cause inflation. It would diminish the value of our money and lead to all kinds of problems” This is true. With this thought, you are on the road to discovering the primary reason for taxes.
The primary reason taxes are levied is to regulate the economy. You might want to let that sink in a bit.
Perhaps an easy way to get this concept to take hold is to consider money printing as the go-to method of government funding. Why do we not use it exclusively? Printing money might trigger unacceptable levels of inflation, so we levy taxes to avoid inflation. In other words, we levy taxes to regulate the economy.
Sometimes the economy is trending toward deflation, the opposite of inflation. In this case, less taxes and more money printing is needed. At other times the economy is trending toward inflation. In this instance more taxes and less printing may solve the problem.
Is this a philosophical issue which keeps economists in ivory towers publishing instead of perishing? No. There is great value in considering taxes as methods of regulating an economy, rather than thinking of taxes as funding the public production of goods and services. Conversely, there is considerable danger in thinking of taxes as necessary to fund government.
The axiom that always accompanies the theorem that “taxes fund government,” is the concept the government must receive taxes in order to operate. This idea, in turn, frequently leads to poor policies.
For example, Japan has had a large shortfall in total demand, i.e., spending, in their economy for many years. To keep the country employed and prospering, the federal government has kept taxes very low and spending reasonably high. This has worked as economic theory suggested it would.
However, this policy has also created a large annual government budget deficit which has produced large federal debt. This has not been a problem, but people are worried about it. Few understand this debt can be eliminated at will through central bank action, but that is a story for another day.
The story for today concerns taxes. During the past several years, many Japanese, economists not included, have been concerned the funding of the government should take place through taxes and not through bond sales. (It might be worth noting that Japan pays a whopping .20 percent to borrow 10-year money, despite their huge public debt.) As a result, Prime Minister Abe became convinced to increase the national VAT last year.
The VAT, a national sales tax, alters the path of the economy by increasing the price of everything consumers purchase. Thus, a VAT gives people the incentive to spend less. However, if the Japanese are already spending too little, why was the VAT increased? Because people assumed taxes are needed to fund the government.
They are not. Taxes are not needed to fund the government. The printing press can do that. Taxes are needed to regulate the economy. If the printing press is producing inflation, find a tax best suited to re-regulate the affairs of the economy.
Taxes alter the path of our economy, sometimes in small ways and sometimes dramatically. When our gaze is focused on the ways in which taxes regulate our economy, only then can we assess the efficacy and advisability of one tax or another. If we assume the primary purpose of taxes is to fund the government, we are much more willing to adopt sub-optimal policies that have unfortunate, even disastrous consequences.
The ability to see taxes as a means to regulate an economy is also the ability to more effectively assess whether any particular tax will be a help or a hindrance.
In what ways do taxes regulate the economy? What are the effects of various taxes? And what are the economic implications of the tax proposals by the upcoming presidential candidates? We have our work cut out for the weeks ahead.
(Marcus Hutchins, MA, M. Phil., Economics, Columbia University, NYC, is a former economist, treasury bond arbitrage trader and hedge fund manager. He retired to Southport in 1997 where he resides with his wife Andrea and his youngest daughter Abbey. He welcomes feedback at coastaleconomist@me.com.)
