Tax systems can be perverse -- but that's just how they are.
The Bangladesh tax system is about to get better: “VAT on essential commodities go up, raw materials down” says this very newspaper. The Bangladesh tax system also needs to get much better as the rest of the article goes on to suggest: “A 7.5% VAT instead of 5% on aluminium and kitchen or other household articles … The finance minister also proposed 7.5% VAT instead of 5% on kitchen towels,” -- that's a level of detail and distinction that no tax system should ever be involved in.
The better part is that, yes, we should be taxing essentials. That sounds weird but it is true. We should not be taxing raw materials, so that part is good.
As to why we should tax essentials, the more formal phrase here is “low elasticity.” That is, does the amount of supply, or demand, change only a little bit as the price changes? To go back a step further. Even if people like me insist that we need less government than we get, we do still agree that some government is necessary. Therefore, some taxation to pay for that government must also happen.
There are times when we want to use tax to specifically stop something from happening -- high taxes on cigarettes reduce the number of people who smoke, which is a good thing. But such “sin taxes” aren't enough to run a government, sadly. So we must tax things that we generally consider to be good in order to raise the necessary money -- things like income, consumption, and so on. But we also want to minimize the changes in behaviour that come from such taxres Yes, we tax incomes because we need the money, but we don't want people to stop working because we're taxing them so much. That's what “elasticity” is about. How much does behaviour -- either supply or demand -- change with price? Something with low elasticity changes only a little when the price changes.
Taxes change prices so, to limit the damage that taxation does, we want to tax those things with low elasticity. Folk might grumble but they'll pay and we'll get our necessary taxes.
So, what are the things with low elasticity? Essentials -- therefore we should place our tax burden on necessities. Simply because that's where the money is. Yes, this is, to an extent, counter-intuitive. Shouldn't we tax luxuries, not things people need? But when we do that we don't gain the cash we need to run the government.
Taxing raw materials, however, is simply silly. We want people to be able to make things. We might even want to tax the things that are made, but we don't want to tax the things they're made of. That will just kill off the very thing that makes us all richer.
So, moving taxes from raw materials to essentials is a good thing. True, we might not generally think of it that way, but it is true nonetheless.
It's the third thing here that is making the tax system worse. There is no way that the minister, or anyone else, knows the details of whether 23 gsm kitchen towels, or 27, should be taxed differently from those that fall under the range of 24-26. Really, there is no conceivable way that anyone at all knows this. It would be difficult to support the idea that anyone at all knows whether kitchen towels should be taxed differently from paper napkins. In fact, a usual and general observation would be that no one knows whether one form of paper consumption (or even paper consumption itself) should be taxed differently from another other form of consumption.
That is, our knowledge of the intricacies of the economy does not allow differences in taxation at this level of detail. So, don't do that please. Two taxation rates, maybe -- things we don't tax, things we do. Three if you really want to get complicated, but no more complex than that. Not just because of this knowledge problem, but also because of what happens next. All makers of 23 gsm kitchen towels (also those of 27) are right behind this idea of higher taxation on 24 to 26. As are those of 24 to 26 against it. Which will mean endless lobbying of MPs, the minister themself, political parties, etc to get the new taxation rates, equalized, differentiated, rescinded, enforced more strictly, and so on. Which is of no use to anyone at all other than, possibly, the re-election funds of those politicians involved.
Taxation needs to be not just on those essentials but also the broad brush. We're going to have a VAT? A tax on consumption? OK, so here's the VAT rate on everything and that's that.
To be more cynical about it, variable (in detail) VAT rates make the man who sets the rates really important. There will be endless lines of supplicants looking for an advantage for their products. So, how many politicians do we want to make this important?
Tim Worstall is a senior fellow at the Adam Smith Institute in London.
