The Carrot or The Stick

Last week we spoke about how government policy develops over time to benefit the few and hurt society as a whole. Whether it is from corruption, manipulation of data for a cause or power, every person can see the growth of government roles, government departments, taxes and regulations. These policies have dealt a blow to the Western World with everything from housing to nuclear power plants taking far longer to build and costing a lot more to do so. On top of this the budget deficits and government spending continue to grow at exponential rates to fund more regulation and more government, that quite simply are disillusioning society. The question is have the tax levels (the stick) gone too far and aside from reducing the size of the government and regulatory costs what else can be done?

The Stick and The Laffer Curve

The Laffer Curve is a representation of an economic argument, developed by Arthur Laffer in 1974 and used during the Reagan error of the 1980s to support cutting tax rates. The curve is basically a Bell-Shaped curve with the premise that at 0% tax the government will receive 0 but also at 100%, as people and businesses will stop working if all their earnings go to the government. The graph shows that there is an optimal level for both the economic output as well as government tax receipts and once the optimal level is reached, tax receipts decrease.

Laffer argued that tax cuts have two effects on the budget – arithmetic and economic.

The Arithmetic effect is immediate – a lower tax rate means lower tax collected. The Economic effect is a multiplier effect, when a consumer is taxed less, they spend more, increasing demand, production and employment.

The Laffer Curve was used under the Reagan government, known as Reaganomics – which saw the marginal tax rate drop, an immediate reduction in tax revenue leading to a decrease in government expenditure, which eventually led to increased tax revenues, decreased inflation and unemployment falling – a real soft landing.

Australian Tax – Laffer Curve

The average full-time salary in Australia is $98,000, if you earnt this you would pay $22,317 in tax, around 23%. However, the other taxes in Australia take this to a much higher level, add in Stamp Duty, GST, Fuel Excise, Council Rates, Road Tolls, Alcohol Tax and some import tariffs and the average Australian is paying closer to 35% - and that is excluding some of the other taxes like luxury car tax, Medicare levy, council building levies and superannuation tax which means this rate is even higher

When Howard sold GST to Australians, Stamp Duty was supposed to be removed. When the Liberals played chicken with the car industry, they touted the loss in jobs and manufacturing capabilities would see the luxury car tax removed – it’s still there. And the Harbour Bridge toll, was meant to pay for the Harbour tunnel and then be removed, but it’s still there. Our tax base or the government stick continues to grow, and government spending continues to outpace GDP meaning this tax needs to grow at a faster rate in the future. The Australian Budget for next year is meant to go up 6%, with GDP forecasts of 2% - the differential will all need to be funded by more taxes or more debt.

Thinking about the Laffer curve, the Worldwide Government Discontent and Government Deficits, it appears something is broken, and a rethink of the current tax systems (and government spending) needs to be reconsidered. The more taxes the Government adds the more disenchanted people become and the less likely they are going to want to work as they are giving away more and more of their income to the government.

The Carrot – Hungary 4 Child - No Tax

Moving away from the Stick, there are some policies in the world right now which are not touting increased tax – but are offering great incentives (carrots) – which will in the long term increase overall taxes collected. Hungary has recently introduced a new tax incentive where if a woman has 4 kids, she will never pay tax again. Looking at this policy as a Thomas Sowell ‘good for society not just the few’ we’d argue this policy is good for society on a whole for the following reasons:

• The fertility rate of Hungary will go up
• A woman who is intelligent and has more capacity to earn a large income will be the most incentivized to have 4 children
• In the future children with intelligent mothers are also likely to be more intelligent, lifting future society as a whole
• Woman will become more likely to start a business creating jobs and opportunities within society
• Taxes from businesses and in the future will lift

So a policy that is encouraging woman to have children to fix a fertility rate problem, that reduces taxes immediately, but increases taxes in the future has a positive societal effect with the likely outcome of increasing overall taxes.

As we hit a clear saturation level for taxes in society – the governments of the world are left with 2 options – decrease taxes and government spending or look for new positive ways to grow society for future generations.