Tax policy in their own hands

The nature of social and economic reality shape fiscal outcomes moves reality to conform more closely to such perceptions, thus reinforcing the initial ideas.

The critical point seems to be that adequate feedback mechanisms are in place to warn when sustainable limits are being breached. Such mechanisms may take the form of the €˜exit€™ mechanisms favored by economists, as when overtaxed resources flee a jurisdiction. Or they may be the voice mechanisms stressed by political scientists, as when governments are changed to put into power those who will carry out more prudent policies.

But whatever form they take, such mechanisms must exist if any tax system is to be sustained in a country. Of course, no government is always competent; none is omniscient; and not all are always well intentioned. Mistakes will be made. A central problem facing all societies is finding ways to minimize the severity of such mistakes.

In this regard, redistributive policies that in themselves might be unsustainable in the long run as a result of the excessive distortionary costs on resource allocation they impose are thus made sustainable both by spending wisely (in ways that encourage growth) and by taxing wisely (reducing the distortionary costs of taxation).

Let’s ask, how can the UK simultaneously have both low taxes (and hence high reward to effort) and high tax rates on more elastic factor supplies (thus less pro-growth policy)?

Has the United States adopted low taxes to encourage efficiency and growth but done so in so inefficient a way that it may have decreased both?

History matters in understanding not only why countries adopt different policies but what the effects of such policies are in the particular settings in which they have been adopted. To disentangle such issues, much more work is needed to resolve such conundrums for example, by focusing in detail on such questions as the differential marginal tax rates applied in different countries to male workers between the ages of 25 and 45.

Meaningful use of comparative international data requires close attention to such critical details.

What does all this mean with respect to understanding tax policy and especially the role of VAT in developing and transitional countries?

A recent study of American tax history concluded that the search for the right balance is an endless process. The consensus supporting the legitimacy of the income tax is likely to remain undisturbed. But its progressive nature will always be debated as long as we care about reconciling the competing demands of social equity, economic incentives and the need to pay for an
expanding government.

Looking at Balkans with this perspective in mind, no real consensus on the right balance for tax policy appears as yet to have been achieved.

Some developed countries, notably the UK, may now be groping toward a new, less progressive consensus with respect to taxation. But this implies nothing with respect to what may be right for other developed countries. Every country has to develop its own viable consensus on the right balance between equity and efficiency in taxation.

One point is clear: developed countries have clearly reached different equilibrium positions. Despite all the talk about globalization, there has been surprisingly little convergence in either tax levels or structures among OECD countries in recent decades. Nor is there much reason to expect such convergence in the near future. Equally, there is no reason to expect strong tax policy convergence among emerging economies in Balkans or elsewhere.

As always with public policy, no one size fits all. What is right or at least feasible for France or Greece, for example, is likely to continue to differ from what may be sustainable in Albania or Bosnia.

What matter are not only how high taxes are (revenue adequacy), but also how the tax level has been (implicitly) chosen, how the taxes are actually imposed, and how the funds thus raised are used. History suggests, for instance, that one critical factor is the clarity of the linkage between expenditure and revenue decisions established in the budgetary and political process.

Allocative decisions in the public sector will be made efficiently only if they are financed efficiently.

What this means is that benefit taxation broadly understood in this context as taxes deliberately chosen to finance specific expenditures in the full knowledge of the allocative consequences of both expenditures and taxes is in principle the best way to run a country from either an economic or a political perspective.

Such a good tax system would only be politically sustainable provided that the resulting distribution of income and wealth accorded broadly with what was politically acceptable. What is considered to be a just distribution of income may be very different in different countries, but the distributive outcome is always and everywhere a high-profile matter.

The central question of tax policy is decisions to reflect people’s real preferences as closely as practically feasible, which will be made on both sides of the budget. This concern cannot be separated from the question of the perceived justice of the system or the institutional structure how democratic it is within which political decisions are reached and expressed.

The only way we know to help relevant decision makers make right decisions is to ensure that they  and ideally all those affected are as aware as possible of all the relevant consequences.

The key to good fiscal outcomes in any country is thus to have a public finance system that links specific expenditure and revenue decisions as transparently as possible. What all this really means is that if any country is to have a better tax system better in the sense of giving the people what they want it must have a better political system that translates citizen preferences into policy decisions as efficiently as possible.

In the end if a country needs or wants better VAT or tax policy or administration, it can have it: the answer lies in their own hands.