October 5, 2017
Dr. Kui-Wai Li
The Kui-Wai Consultancy for Economic Development, Inc.
In “Redefining Capitalism in Global Economic Development”, which was released in June 2017, the author pointed out the significant differences between economic and political decisions. Economics decisions relate to distribution of resources, while political decisions concern the distribution of power. Unfortunately, political decisions and results cannot be realized without using instruments, and economic variables are passive and could not perform without being deployed by individuals, businesses and government officials. Many people have misunderstood their relationship and often argued that politics and economics cannot be separated. This is not true because political decisions do not have their own form, and need a vehicle to become explicit, and economics becomes the convenient vehicle in which political decisions could be seen and judged. In other words, economic variables have been often used, or abused, as instruments for political ends.
Given that no economy can do away with the government, but like any individual who must earn to spend and consume, governments in capitalist countries normally do not own resources but have the mandate to raise sufficient earnings for their functioning and commit to spending to see to the stability of the economy. The economics is simply that the government earns to spend, but the politics is that government may enlarge its power and influence by imposing more earnings through legislation to have more to spend. Thus, a high or rising tax becomes a convenient instrument through which the government, especially leaders whom were intended to enlarge the government bureaucracy, could raise their “earning” ability. The question is how much and how far the tax instrument should be used optimally, or it has turned political, as some leaders proposed the idea of taxing the richest 1%, but would it be better to enlarge the pool of rich people so that more can be taxed and less is needed for government assistance? A misconception is that people relate “rich” to “wealth”, but it should be rightly related to “ability to earn”. When people have a higher ability to earn, the 1% would expand. In other words, one should examine the “absolute” ability of individuals to earn, and not the “relative” earnings among people with different endowment. Should it be more appropriate economically for the government to engage in policies that promote people’s ability to earn?
II Lessons from the 1%
A common political jargon is “to tax the rich and subsidize the poor”. This relates to few conceptual confusions. The simplest measure on an individual wealth is the monetary possession, such as income and wealth. Behind such richness, however, is the individual’s personal endowment, such as level of education, professional training, work experience, inheritance and innate ability. It is these individual qualities and abilities and endowments that led to the individual’s “richness”. The income scale which is used to measure inequality can be considered as a scale of individual’s ability and personal endowment from most able to least able. A progressive society should help to promote the ability of all individuals through education and training. Most important of all is the provision of economic opportunities, through which individuals can progress and enrich their earning ability. Indeed, it is the equality of opportunity that would allow all individuals to progress unrestricted, but the outcome of individual progress is different and that results in income differences that appear in the income scale.
The societal irony is that while we complain about income inequality, we spend to educate our future generation, and different sorts and levels of education would result in different monetary rewards when educated individuals started to join the work force. Jobs are paid differently due to difference in training, professional requirement and age, businesses are rewarded differently due to levels of risk and investments involved. Hence, on the one hand, the education system creates inequality in ability, but on the other hand people lament on the different outcomes in the form of earning and income levels. The lesson is that in economics, the education system does bring differences in income levels, but such an “economic law in the education system” was politicized by political opportunists and used that as an instrument for political ends.
Indeed, income inequality could be the “best” form of inequality as it can be adjusted and varied and rescued through education and other policies. One should lament more on other forms of inequality that could be “life-long” and permanent that created unfairness on one party forever. Income inequality is often mistakenly looked at when one individual is compared with another individual because the income scale included all income earners of different professions and jobs, different regions and ages. The same job will be paid differently with age, for example, and different jobs require different endowments. Hence, the income inequality measure could best be regarded as a “snapshot”. On the contrary, the society should worry more about whether an individual will make progress in the income ladder. A young school leaver or graduate is earning less but with experience, income rises under normal circumstances. Thus, it would be appropriate to examine the absolute comparison of the same individual over time.
Hence, it would be more fruitful at the society level to consider whether individuals are making progress in their employment and earnings over time, leaving aside how one is compared with another. Apolitically, government resources should be geared more to promotion of opportunities, that includes a wider basis of education, promotion of economic competitiveness to attract investment and business expansions, rather than penalizing the able individuals and discourage investment that eventually reduces competitiveness. The political mistake is to use the 1% as the reason to stir up social disharmony. On the contrary, the society should look for ways and means to promote individuals’ ability and enlarge economic capacity that would allow more to have employment opportunities and progress. The concern on the ability to earn should have a higher priority than how different individuals are earning.
III Welfare Needs
At any point in time, there are bound to have economically weaker individuals whom are faced with difficulty. This is true, especially in countries like Canada where the cold season is long and distance could be a problem even if public transports were available. Provision of welfare needs to people facing with difficulty is a must, and should be made accessible to the needy efficiently. However, that does not necessarily mean there is the need for a big government and a high tax.
Welfare provisions should form an essential part of government spending in the annual budget. The concern is the extent of the provision and the debate is usually between the desire to provide temporary assistance or life-long entitlement to welfare recipients. Welfare is to cover the tough times faced by individuals and families, but one should not rule out the possibility of jobs and employment should the recipients recovered over time. Welfare is not supposed to make the recipients dependent on government assistance. Welfare recipients should also be given a chance and provided with equal opportunity to secure jobs and employment entitlement. The welfare system should best be made temporary, as that should minimize government spending and maximize the chances of employment.
A closely related issue to welfare is the provision of public goods, such as education, health, transport and housing. One common characteristics about public goods is that they are expensive and individual families have affordability problems. Education is expensive but is needed to enrich the individual endowment of the young. Health and medical provisions are expensive but are needed to ensure productivity and employability. Transport must be made economical to ensure mobility of all individuals. Housing is expensive as it may cost a large amount of savings from the individual. On the contrary, having no resources of its own, the government cannot provide free all public goods, partly because the excessive fiscal spending, partly because some individuals may be able to afford their own provisions.
Hence, the optimal outcome is the dual provisions of public goods through the government and private channels. There are privately run schools and universities, hospitals and clinics, ownership of vehicles and private investment in real estate. In pro-socialist countries, it has been politicized that for equality purposes and no one should be “privileged”, government or state provisions are most suitable from the political standpoint. Such an argument failed on two grounds. Complete provision by the state or government usually ended up with a piling of national debt as the government would find it difficult to finance all public expenditures. Secondly, this robs the choice made by individuals. Able individuals should have the freedom to choose between public provision and private provision of schools, universities, hospital and medical care, form of transport and their residence. Private provision would also lessen the financial burden of the government, and serve as check and balances to public provision since there would be a certain degree of competition.
Hence, an effective welfare policy can be incorporated into the fiscal framework such that while the needy would be catered for and at the same time the fiscal burden would be minimized to avoid the rise in fiscal debt. Proper fiscal strategies and policies can be exercised. For example, the temporary nature of welfare provision could fend off recipients becoming dependent on welfare support, while the dual supply or provision of public goods would allow the private sector to take over some burdens and individuals can have a choice in their consumption of public goods. In short, the government can provide the “baseline” so as to ensure adequate support to the public, but anything above it shall depend on private individuals in their selection.
IV Choice between Virtuous or Vicious Cycles
Although it is politically popular among pro-socialist advocates, it is a misconception that a higher tax shall lead to more government revenue, and that with more government revenue, more can be spent on welfare and income could be made more evenly distributed. If such an ideal socialist goal were achievable, it could have achieved already. Yet, socialist politicians today are still shouting loud for higher tax.
Firstly, the income equality goal was used as a reason for politicians to raise tax, thinking that more revenue could be collected and political leaders would have more to spend. What the voters see, in fact, is that higher tax leads to a bigger government and more bureaucracies, and yet income equality remained unchanged in most cases. The worst one saw was the higher government spending and higher government debt. Thus, there was insignificant, if at all, improvement in equality, but the bulk of the voters had to face a larger national debt and a weaker economy as higher tax resulted in loss of economic competitiveness, which in turn could make the economy unattractive to business and investment, and ultimately loss in jobs and lower employment. A higher tax also reduces individuals purchasing power, and when less is consumed at the aggregate level, businesses suffer and a reduction in profits would mean closure of businesses and workers face redundancy. In turn, lower profits, reduction in purchasing power and fall in employment and income would result in lower government revenue, which went against the original thinking of a higher government revenue with a higher tax. In a nutshell, a higher tax does produce a “vicious cycle” of economic weakness and loss in competitiveness. Such an economic vicious cycle could be made more “vicious” when pro-socialist political leaders thought that an even higher tax or more tax would be needed as government tax revenues were not forthcoming, thereby chocking the economic further when more and higher taxes were introduced.
One should think along the line of economics to understand the vicious aspects of the “high tax – higher government spending – higher debt – disincentive to businesses – loss in consumer purchasing power – fall in employment and income – loss in competitiveness” circuit. Pro-socialist politicians mistakenly think tax can be an effective instrument in raising government power, without understanding the political economy of taxation. A taxation normally consists of four elements; tax rates, tax base, tax efficiency and tax payers. Tax rates are the actual percentage of tax that the government can control. Tax base is the extent to which items are being taxed, and government can also control the number of items to be taxed. Tax efficiency is the amount of tax the government can collect from existing tax payers. The typical problem in tax efficiency is tax avoidance and under-reporting. In an honest-system of tax payment, tax efficiency should be high. However, the government cannot control the tax pool or the number of tax payers. Individuals and businesses normally would respond inversely to the tax system. Investment funds are fully mobile and can be transferred to a more investment-friendly destination, and the economy could face a “brain drain” problem should highly qualified professionals decide to migrate to another country. Despite the government’s control on tax rate, tax base and tax efficiency, it must be the tax pool that could have let down the size of the government revenue should the tax system became market-unfriendly.
Having understood how a tax system functions, the most essential element would then be the size of the tax pool. Indeed, it would be more appropriate for the government to build incentives to enlarge the tax pool, which would then automatically provide a large tax revenue. The “vicious cycle” should then be turned into a “virtuous cycle”. On the contrary, a lower tax does not necessary mean a reduction in government tax revenue. Indeed, experiences of many economies have shown that an overall lower tax rates would result in higher government revenue, because it gives rise to the impact of the “virtuous cycle”. A fall in tax rate will mean a rise in incentive to business, which in turn leads to more investment activities. As investment rises, more jobs will be required, and the rise of employment implies a fall in unemployment. A rise in employment will result in rise in household income, which in turn enlarges the household’s purchasing power, and the rise in consumer demand leads to more production and more investment. The rise in investment, employment, income and consumption are the signs of improvement in economic competitiveness. A competitive economy will have greater strength in battling crises or unexpected disruptions. These positive aspects can only benefit all individuals in the entire economy, though as rewards occurred to individuals would be different from each other, income inequality could still present, but its negative impact would be minimized as individuals are fully employed.
The rise in income across the economy will mean a rise in tax payment, as the high-income earners will have to pay their salary tax, and businesses will commit more corporate tax. The rise in tax revenue will provide more resources to the government. Simultaneously, a rise in employment will result in a fall in welfare needs, which then reduces the government’s need for welfare spending. The government gains in two ways: more tax revenue and less welfare spending. The government’s fiscal policy could easily result in a fall in fiscal debt, or even the emergence of fiscal surplus. A progressive, forward-looking and responsible government should then use the fiscal surplus to build up the future capacity or capability of the economy, such as a higher level of human capital, advancement in technology, rise in living standards, industrial and agricultural production that can even be exported. And a stronger economy can compete successfully with other countries, either in the form of stronger production and technology advancement or a higher ability to fend off crises and natural disasters. The “virtuous cycle” will then contain the sequences of “lower tax, rise in investment, businesses prosper, rise in employment as jobs are forthcoming, rise in income and household purchasing power, a larger tax pool and rise in tax revenue, fall in welfare needs as full employment emerges, government saves welfare spending, fiscal surplus can be used to build up the economy’s strength and competitiveness through investment in human capital, infrastructure, advance in technology and production….”. Contrast to the “vicious cycle”, the “virtuous cycle” brought about by the fall in tax is superior economically as all individuals will benefit from the enlargement of the economic pie.
The economic “virtuous cycle” can also have positive social implications. A situation of full employment would lower the crime rate as individuals are engaged with their jobs, and young school leavers and graduates could find their jobs with ease. The next stage of the “virtuous cycle” will be a rise in savings as income rises, and savings leads to wealth generation, and the rise in households’ wealth provide further protection for retirement or raising a family. Hence, the economic equation is simply that a lower tax regime is always preferable to a high tax regime, as the former generates benefits and gains to all, while the latter promotes government power and bureaucracy. Politically, pro-socialist advocates would use the tax instrument for political ends. But because economics does not work like that in politics, it explains why socialist economic policies failed on the one hand, and on the other hand, similar politicians still used the same argument to blind the voters. Indeed, the fight for income equality and the use of the tax instrument has become the “evergreen” instrument that politicians always used to lure their voters into believing that once elected, reduction in inequality could be achieved.
It is indeed naïve to think that income equality can be achieved. Income inequality cannot be eradicated, either because human beings are born differently, or people have different innate ability, or the young generation receive different sorts and levels of education, or similar jobs are paid differently due to age, variation, and so on. But income inequality can be improved through job creation, rise in economic opportunities and promotion of business incentives and competitiveness. These economic ambitions should be the societal goals that voters would like to see in an election. These goals are achievable when political leaders put the citizens and residents, not simply their voters nor their self-interests, first.
In a politically democratic system, voters should be able to have sufficient knowledge and facts to judge the intention of the politicians. Political elections are ex-ante activities, whose results and outcomes can only be considered ex-post. Hence, once elected, an unpromising elected leader could still proceed to carry out the leader’s intention through policy decisions. Even though voters may have their own sentiment, voters should have a more inquisitive mind and be well informed as to the candidate they are voting. Democracy allows voters to change their minds and vote down a sitting politician should the historical performance of the sitting politician does not show favorable results to the entire economy. Politics is an “absolute” game, and once elected, the leaders would rule. However, democracy and periodic elections serve to allow voters to exercise their judgment on the elected leaders.
Taxation is an appropriate instrument for the government to raise its revenue for various spending commitments, but fiscal spending should be used to serve the economy and build up stronger capacity. What one needs to aware is the potential abuse in the use of taxation as a political instrument, which could lead to a “vicious cycle” that results in the weakening of the economy as incentives and competitiveness are lost. In the open global economy, one country’s loss in investment is another country’s gain, as financial mobility would mean the investment departed from one market would quickly appear in another market, thereby benefiting the host country. Thus, to the parent country, the loss of investment and competitiveness is a “negative sum” game.