We can say that some sorts of taxation are unfair. VAT, for example, weighs more heavily upon the poor than it does the rich.
We might therefore say that we should have more income tax and less VAT to make the system fairer: The rich will be carrying more of the tax burden that way.
Or perhaps we should tax profit, or companies, or dividends, or all the other things we could be doing.
This is the background to the report by Supro and Oxfam Bangladesh that the VAT system is regressive. Regressive in this sense means something specific. More of a poor person's income goes in this tax than the percentage of a rich person's. The report says 12.1% in a poor household compared to 5.9% in a rich one.
A progressive tax would reverse that, a progressive tax gets more of a rich income than it does of a poor one.
So, if we were to run the tax system purely on the grounds of fairness, then we'd change that system.
And that it should be the richer paying for society is an entirely fair idea. Even Adam Smith said that taxes should be “more than in proportion” to income -- the richer pay more of their income as a percentage than the poorer.
But there's something else here as well. That fairness is also called “equity,” and we do not only run the tax system on equity. We also have to include efficiency.
With taxation sometimes, this just means how easy it is to collect the money. How many bureaucrats we have to pay to get the cash. But there's another meaning as well and it's an important one.
Whatever we tax, we get less of. If we tax profits, then fewer people go into business to try to make profits. If we tax building houses, then fewer houses will be built. Tax incomes and some people will just not work so hard.
But how much less we get depends upon what the tax is. How much less business -- or houses, or work -- we get is called the “deadweight cost” of the tax. The things that just do not happen because we have decided to have this tax.
Yes, we do have to have tax. It's also true that the tax we raise can be used to do wonderful things. But it is still true that we get less of whatever we tax and so these deadweight costs exist.
We know the spectrum as well. It is land taxes, consumption, income, capital and profits, transactions. There are also sin taxes -- alcohol, tobacco and so on, but there, we're actually trying to make people do less, so that's not quite relevant.
No one is making more land so taxing it doesn't mean less of it. But as we start moving through consumption -- VAT is the obvious tax here -- to income taxes, corporate and capital gains taxes, then those deadweight costs rise. We lose more in economic activity that just does not happen for each same amount of tax revenue we collect.
Which gives us a problem. Yes, we can design a tax system which is fair and equitable. This would mean making the rich pay for everything out of their profits and high incomes.
But this tax system would be inefficient -- we'd be losing more business, more jobs, more development, if we tried to do it this way.
We could also just say darn to fairness and pay for everything from land taxes. There's actually a whole school of economics, Georgism, devoted to that very idea.
That also wouldn't raise very much which would mean we'd need a VAT as well which is the unfairness we noted up top.
The sad thing here is that there's no solution to this problem. No solution within economics that is. Whether you think we should be fair at the cost of inefficiency, or efficient but unfair, is something from morals, not economics.
You bring your ideas -- ideals -- of morals to economics but economics cannot tell you what the correct morals are.
Which leaves us with that little problem. Yes, we can make the tax system fairer. In doing so, we'll make it less efficient and make the future poorer.
So, just what is the right balance?
The only right answer is that this is a choice we have got to make.
Tim Worstall is a senior fellow at the Adam Smith Institute in London.
