Friday 23 May 2014

Taxes, Budgets and the Economy

Taxes, Budgets and the Economy

Governments have great power over our lives, so why do we allow them to have such power? The short answer is that Government provides a level of stability that no other human institution is capable of. In return for that stability we give power to the Government. At some points Governments demand more power and sometimes they get it. But there is a limit to how much power a Government can exercise, practical as well as ethical. But to function at all the Government needs money and in nearly all cases they get that from taxation.

GDP (Gross Domestic Product) is the market value of all goods and services produced within a year within a country. 100% of GDP is all of the value created within a country in a year, 50% is half of the value and so forth. The vast majority of taxation must come from GDP, some might come from an inheritance tax which technically taxes past GDP but these are rare. The current GDP provides nearly all goods and services, all food produced, all rents and mortgages, all wages etc. are part of GDP. So when a country owes 100% of it's GDP, it owes everything created within that country that year. So Governments cannot tax at 100% because then no one could eat or pay rent or in fact do anything. Of course a Government cannot tax at 0% either as then it has no money to do anything. Somewhere between 100% and 0% is where tax revenue needs to be, the question is where?

But before we can answer that we need to talk abit about the budget, what the Government is going to spend money on. Before the 1870's Governments spent money on a few core areas of responsibility, War and Foreign Affairs being the big two, in the 1870's education and public health joined them and in the early 1900's the welfare state started by providing pensions, disability and unemployment benefits. During the First World War Governments took control of large areas of the economy to fight the war. This gave many people the idea that if the Government could do these things during wartime why couldn't it do the same to improve society in peacetime. Government expenditure rose and stayed much higher than it had before the war. To give some idea of that expenditure this site gives figures for the United Kingdom from 1692 to today, , I highly recommend it if your interested in such things.

1910 16% of GDP
1930 29% of GDP
1950 36% of GDP
1970 42% of GDP
1990 35% of GDP
2010 46% of GDP

The worst year was 1945 when 70% of GDP was taken as tax revenue, but of course that was during wartime. The years I have given above are years of peace or at least not years of general war. You will notice that between 1910 and 1930 the level of taxation as a percentage of GDP doubles, then remains around 40% after the Second World War until the GFC when it has risen again. Now of course not all countries resemble the United Kingdom but as a general guide I believe it to be quite correct in showing the general levels of taxation as a percentage of GDP.

Modern budgets include many items that once would have been regarded as far outside of the realm of Government. But not all of these are outside of a Governments prime responsibility, to provide stability. So to answer the question of what should a Government spend money on, first we must answer does a particular budget item contribute to stability.

If it does then it should probably stay, if not it should not.

There are two further things I want to discuss, firstly that a budget should, outside of war or other extreme emergency, always be either balanced or in surplus. If an item cannot be paid for then either taxes should rise to pay for it or it shouldn't happen. Since the Second World War there has been a disconnect between revenue and expenditure. That needs to end, as we all know, it's much easier to spend money then it is to save money. But the easy spend is a trap that leads straight to debt and in the case of Government, the debt is going to future Governments and future people. Debt is an insidious way of taxing the future, of taxing wealth that hasn't even been created yet.

The second thing is what percentage should be taxed to provide Government revenue? I believe that there is a sweet spot (not something you hear often when people talk about tax is it!), of 20%-30%. People expect things from Government that 100 years ago or more people would not have expected. There is a limit to how little revenue a Government needs to function and from looking at various sources it seems that anything less than 20% guarantees chronic debt. Anything over 30% seems to be a strain on the economy and I believe is counter productive. That may need to be amended as this only takes into consideration the national Government, but that is my only proviso. There needs to be a balance between what people expect from Government and what a Government can obtain as revenue.

To finish up budgets must be balanced or in surplus, the real enemy here is that short term thinking has taken over when what we need is long term plans and long term thinking.

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