|December 15, 2013||Posted by Fred Foldvary under Editorials|
A tax is neutral if it has no forced effect on the economy or on individual behavior relative to the absence of the tax. Market prices are neutral, because the purchase is voluntary. But taxation is mandatory, and alters behavior. There is no such thing as a neutral tax.
A tax on flows of income or spending reduce the flow. The tax increases the cost of the good, reducing the quantity of demanded. The tax misallocates resources away from their most productive and desired uses. Taxes on production and goods impose a distortion of prices and profits, and a deadweight loss or excess burden on individuals and the economy.
However if the tax is on a resource that has a fixed supply or demand, since the quantity does not change, there is no deadweight loss. Spatial land is the prime resource with a fixed supply, and so a tax on land does not affect the quantity of land, and it does not affect the market rent. Land will not shrink, hide, or flee when taxed. A tax on a good with a fixed demand, where the quantity does not change even when the price rises, also has no deadweight loss.
A lump-sum or poll tax is a fixed amount of money regardless of income, spending, or wealth. While a lump-sum tax does not impose a penalty on marginal or extra income or spending, it is not neutral regarding leisure. If a person would have preferred more leisure to more goods, and has no savings, a high lump-sum tax forces that person to work in order to pay the tax. This forced labor makes a lump-sum tax non-neutral. Likewise, a tax on a good with a fixed demand acts like a lump-sum tax, and is not neutral.
The analysis of neutral taxation also has to account for the spending of the revenue. If the funds are spent for goods and services, the spending affects the economy, and the tax is not neutral. For example, if the government provides roads with the revenue, some will benefit more than others. That benefit is, in effect, an income. In that way, the spending redistributes income unequally. Therefore a tax is completely neutral only if the tax revenues are distributed to the whole population in equal amounts of money.
The anarchist economist Murray Rothbard wrote about “The Myth of Neutral Taxation” in 1981. Rothbard compares taxation to theft by a robber. In both cases, the victim is unable to spend his money as he pleases, and this makes any tax non-neutral. However, Rothbard does not consider the situation in which coercion takes place if there is no compulsory payment.
Pollution without compensation is in effect a tax on the health and welfare on those affected, and a subsidy to the producers and consumers who do not pay the full social cost of the good. A tax on pollution compensates society and removes the subsidy. A pollution tax also reduces pollution, and so it is not neutral relative to the absence of the tax. Pollution taxes are non-neutral in a good way.
When government provides goods and services, this spending makes locations more attractive and productive, raising the rent and land value. If there is no tax on land value, land owners receive a subsidy. Moreover, this subsidy induces greater land holding and speculation, which feeds on itself as land prices rise, until it becomes a real estate bubble that bursts into a collapse, recession, and depression.
Even though a tax on land value does not change the quantity of land, it changes behavior relative to the absence of the tax, by preventing the land-value speculative boom, and by shifting spending from the purchase of high-price land to the purchase of produced goods, including more investment in the tools of production. A tax on land value also promotes an optimally efficient use of land, since the tax is based on land as put to its highest and best use. Therefore a tax on land value or rent is non-neutral in a good way.
In physics, there are particles called “neutrons” that are neutral in having neither a positive nor negative charge. Protons have an electric charge designated by convention as positive, and electrons have the opposite negative charge.
Since taxes are economically positively or negatively charged, we should choose proton taxes with positive benefits rather than negative electron taxes. Yet, people democratically elect representatives who impose negative taxation.
Moreover, the thousands of scholarly economists who have PhD degrees and win prizes have not vehemently advocated a prosperity tax shift. The classical economics of Adam Smith had a positive effect in promoting free trade, but during the neoclassical tide of the past century, by condoning or even advocating market-hampering taxation, the field of economics has perhaps done more economic harm than good.