Taxation, Solidarity and Liberty

25/03/2011

Intro

Governments tend to maximize the receipts from taxation. This precept holds from the pyramid-building pharaohs up to the modern democratic welfare state. The conditioned reflex of the rulers is to maximize their power. Taxation is a mean to that end.

Our genetic inheritance endows us with an ample dose of group solidarity, which is in perpetual conflict with individual liberty and the logic of the market economy. Our basic social reflex is equality. At heart we are all socialists.

Under extreme socialism (communism) state power is total. The tax rate is close to 100%, the state owns and redistributes all the resources of the community as it sees fit. Individuals are relegated to servants of the state. The principle of solidarity holds sway, at least in theory.

In democracies the state exists for the sake of the citizens. The principle of liberty holds sway, at least in theory. State power should be minimized which would reflect in low taxation except in emergencies. In times of war primitive tribal solidarity surges, individual liberty is sacrificed and the state may take over most of the national product.

In modern democracies, peacetime solidarity is gaining ground. The fallout is inexorably rising taxation. It satisfies the needs of the power- and vote-hungry politicians as well as an electorate, eagerly devouring free lunches.

Socialism may be a vague term but the level of taxation offers a good measure of the redistributive inclinations of a society. Let’s face the fact. Western democracies are partly socialist. The upper limit for a free society seems to be about 50% socialism.

In the near future we will approach if not surpass this limit. The pressure on the public purse is bound to increase in all democracies. Demography, longevity and more expensive health care combine into an avalanche of expanded entitlements. How the conflict between liberty and solidarity could be resolved under these circumstances is the subject of the following deliberations.
 

National taxation

In a developed society, infrastructure investments must not be a burden on the treasury. As a rule they should be paid for by the users, directly or indirectly. Obvious exemptions are long-term endeavors like basic research and space exploration.

On principle, citizens should be responsible for their own welfare. Solidarity requires that people who fall short of this goal enjoy government support. But the clear definition of these rights is not possible. Mission creep is the norm and unfunded entitlements escalate. The remedy is to set a firm upper limit for all solidarity-related expenditures.

The cost of a minimal nightwatch state would be around 10% of GNP. On top of that a politically negotiated percentage should be added as a solidarity budget. Changing this number would preferably require a qualified majority. The welfare money would be spent according to politically settled priorities, starting with free, primary education, care of the destitute, preventive health care for children and so on and on.

An efficiency incentive is inherent in this set-up. Any waste would curtail solidarity action by cutting out marginal initiatives. Outsourcing in a competitive but firmly supervised market would be the probable outcome. The citizens could be weaned off welfare by tax deductions for those who rely on their own pension arrangements or health insurance. The combination of improved efficiency and stricter need assessment would sharply reduce the tax bill for a reasonable public welfare level.

Subsidizing university-level education is a typical cause of political conflict. Today public financing covers the whole range of alternatives from near zero to hundred percent government subsidies. A reasonable middle-of-the-road would be full cost fees combined with generous, long term government loan guarantees and a restricted amount of grants for the very gifted.

Old-age care is the worst sticking point, exacerbated by the disastrous demography in most democracies. National pension schemes are seriously underfunded and the treasuries are accumulating enormous future liabilities, which must be covered by taxation. Everywhere governments are trying to cut benefits and raise the retirement age. One way or another, the majority of citizens must be teased or forced into providing for their old age themselves.
 

The European Union and the United States

We Europeans are grappling with the construction of a unique form of national cooperation. The European Union is not extracting any taxes. The contributions of the member states are limited and strictly defined by a GNP-related formula. Tax harmonization is continuously on the agenda, but has so far been rejected on principle. Even a sensible carbon tax was turned down while a much greater burden was introduced by the cap-and-trade system and excessive greenery.

One could argue that the Union suffers from a solidarity deficit. The principle of subsidiarity is the guiding light when pondering the proper division of responsibilities between the Union and the member states. As a solidarity gesture, the Union spends about a third of its income on structural and cohesion funds. They typically finance infrastructure projects in order to decrease the disparities between the countries and regions of the Union.

The profligacy and looming insolvency of some members is testing the internal solidarity of the Union. Support is coming forth, but a harsh financial regime has been imposed on the offenders. The members of the Union should continue to compete with each other as independent economic actors. Union-wide socialism is not the way ahead.

Ever since the great depression, federal power and federal budgets have been on the rise in the United States. An increasing sense of solidarity is behind this incessant pressure for equal rights (and entitlements) for all Americans, regardless of domicile. The states still carry considerable clout, but mission creep is rampant at the federal level.

Notwithstanding the ructions of the last election, the United States is well on its way to a unified high-tax welfare state while the European Union still grapples with the problems of becoming a viable federation. The Europeans must avoid the trap of overindulgent internal solidarity. The Americans, on their part, should beware of the high taxation mode and the deficit-prone, over-centralized administration of most European Union members.

Both super-communities face over-indebtedness and are groping for a level of solidarity, concordant with a vigorous economy and a dynamic society. High taxation exerted over a huge area and population cannot but lead to an oppressive bureaucracy, loss of freedom, moral decay and economic breakdown.
 

Incipient international solidarity

The rich nations pay for the upkeep of the United Nations. The sums are relatively small and irregularities are mostly passed over in silence. Only when the United States demonstratively ceased to pay its due, the UN took note and mended some of its offending ways – corruption and massive inefficiency due to hiring on non-merit, to put it simply.

Among the developed nations, a defined contribution is annually set aside in national budgets for development aid. That most of the money is squandered is another story (see my blog Development Aid – an Exercise in Hypocrisy). No amount of money transfers will eradicate poverty. The poor must be made productive.

In imitation of the European Union, continent-wide cooperative structures are all the rage. They range from the strictly trade-oriented ones (NAFTA, ASEAN) to those with outspoken, political ambitions (UZAN, AU). So far they are not aimed at or have been incapable of extending economic solidarity in any meaningful way.
 

The practice of taxation

Taxation should be neutral, broad-based and simple. Tax exemptions are devious subsidies, which distort economic decision-making to the detriment of all and everybody. Complex legislation sustains an army of lawyers, perverts accounting and undermines business morality while tax loopholes and tax havens supplant strategy in the minds of top executives.

A flat tax would be a simple remedy. It has been applied in Russia and many Central-European countries with some success. But in the rich democracies it has gone nowhere. Soak the rich is still a popular slogan, though dirty rich sport stars are usually exempted, even if they take residence in, say, tax-free Monaco.

The grey economy is a product of excessive red tape and inefficient taxation. As an expression of free enterprise it is tacitly accepted in many countries. Nevertheless it is a symptom of a deep malaise and constitutes a severe drain on the economy. Honest and open plus-sum play is always preferable as it creates maximum added value.

Tax havens are an affront against our sense of justice. It is unconscionable that the European Union accepts open tax dodging within its borders. Overseas tax havens are even more egregious. Politicians are, at best, resorting to hand wringing. The highly publicized resolution of the G20 nations in 2009 has barely scratched the surface. But the goal should be clear. The world must be made unsafe for the ill-begotten money splashing around in the international banking system.

Fairness is the most important and most elusive quality of taxation. Tax evasion is a clear breach of solidarity. But there are other free riders in our high-tax societies. Corrupt officials sponge on the citizens and social benefit cheaters defraud the taxpayers. An increasing number is pulling out of reproduction and gain an unfair economic advantage.
 

The repercussions of high taxation

High taxation is aimed at reducing income disparity in the name of economic solidarity within a nation. This assumption has become questionable as the middle class is increasingly taxing itself in order to recirculate their money through public channels. This certainly implies losses in efficiency, service level and innovative dynamism. The putative increase in solidarity comes at a considerable cost.

High taxation has other, more serious effects on our wellbeing. It puts the morality of the average citizen under severe strain. As taxes increase they lose their legitimacy. Tax evasion escalates and can become a national sport. The general respect for the law deteriorates as oppressive taxation is combined with inefficient enforcement. Corruption becomes a way of life. These effects set the upper limit of taxation. I maintain that most societies operate close at this limit; the government extracts the maximum amount of taxes for its limitless needs.

High-tax countries are running the risk of losing their best and brightest. These people are anyhow drawn to centers of excellence, which often offer a special deal for high-income expatriates. Once in motion, this self-feeding process could prove irreversible and, in the long term, spell doom for high-tax domiciles.

Paradoxically, high taxation signals a high level of morality and attendant solidarity. The Nordics are the prime example. Centuries of strict Lutheran indoctrination has imbued the population with high standards of honesty along with loyalty towards the government. But this moral capital is subject to erosion, which could become a landslide. Then society has lost its most precious resource, which would take generations to rebuild.
 

Conclusions

Freedom and solidarity are hard to reconcile. Taxation is a force of nature like gravitation or obesity. A severe crisis can force some weight reduction, but our appetite for welfare is ever present. The faltering self-restraint must be supported by the right institutional devices. Otherwise we will, sooner or later, go down under the burden of overweight.

The tenability of a public welfare society decreases with increasing size. In a small community, keeping track of individual contributions and public expenditure does not present an insurmountable problem; gossip will keep corruption in check. When societies grow, the bureaucracy expands, legitimacy suffers and the sources of the scarce moral capital may dry up. Therefore the focus of taxation must be local, reflecting the feeling of solidarity within the society. Extending the scope of solidarity is feasible only hand in hand with an increase in moral capital.

The overriding concern is to preserve the incitement for plus-sum play. As we extend the scope of our societies we must call for more individual responsibility among the citizens and must accept more disparity as well as less solidarity within the widened community of human beings. Otherwise we will end up in the democratic dystopia so vividly described by Alexis de Tocqueville (1805-59) in a much cited paragraph:

“The power of the state is absolute, detailed, regular, considerate and mild. It would be like the authority of a parent if, like that authority, its object was to prepare men for manhood; but it seeks, on the contrary, to keep them in perpetual childhood… the government provides for their security, foresees and supplies their necessities, facilitates their pleasures, manages their principal concerns, directs their industry, regulates the descent of property, and subdivides their inheritances: what remains, but to spare them all the care of thinking and all the trouble of living?”

The good news is that such a society is not sustainable. It may be acceptable, even, desirable, for the people but it will in due course implode under its own weight. In any case it will lose out against more enterprising and entrepreneurial competitors. History testifies that liberty is indispensable for human progress, welfare and self-realization. Without freedom, life is not worth living.