These two big issues – “what do we do together” (the role of the “state” versus the individual) and “how are we going to fund it” (who pays for the state) have been at the heart of every society, and have challenged the best minds, ever since humans came down from the trees.
How tax and transfer policies interact determines the nature of the redistribution that occurs. This is why we’ve chosen to investigate both policies together, not separately as has become customary for taskforces established by the government in recent years. The silo approach to tax and transfers has led to nothing but trouble.
One way to keep taxation fair:
Vertical equity is the principle that people with a greater ability to pay should hand over more tax to the government than those with a lesser ability to pay.
The world abounds with examples of where extreme widening of the gap between haves and have-nots has turned out to be disastrous for social and political stability and harmony.
The idea that governments should actively apply the vertical equity principle is a relatively modern one.
While tax is an ancient concept and earlier tax systems could have redistributive outcomes, it has really only been since the 18th century – coincident with the start of the Industrial Revolution and its huge impact on productivity, incomes, and wealth – that the principle became explicit.
That such bounty could coincide with a deterioration in the well-being of so many, presaged an enlightenment in thinking that assigned to the state the responsibility of ensuring everyone is provided with the same opportunity to prosper.
“When there is an income tax, the just man will pay more and the unjust less on the same amount of income.” – Plato
The moral foundation of progressive taxation is well lost in the reductionism of modern economics that emphasises instead reducing hurdles to earning higher after-tax income. Progressive tax rates, in our contemporary literature, are seen as such hurdles, rather than being valued for their moral justification.
The idea that in principle individuals have inalienable rights, including the right to receive resources from the rest of the community in order to live a dignified life, has been embedded in public policy in much of the Western world (as indicated by a UN Declaration in 1948). But as we’ll soon see, that original inalienable right has become subverted by a post-Thatcher conviction that the right to receive redistributed resources is highly conditional.
Adam Smith initially thought that an unfettered capitalist system would lead to a narrowing of income gaps over time, because the supply of capital would rise relative to labour, and profits would fall relative to wages:
“The increase in stock [capital], which raises wages, tends to lower profit. When the stocks of rich merchants are turned into the same trade, their mutual competition naturally tends to lower its profit; and when there is a like increase of stock in all the different trades carried on in the same society, the same competition must product the same effect in them all.”
For this reason, he concluded that the capitalist system – where everyone pursued their own self-interest freely trading in a market environment – was the best possible system of economic organisation.
Sound familiar? There’s little need to remind the reader that it’s this perspective that seized the mindset of politicians and political parties during the era of Thatcherism-Reaganism.
That was the theory.
But in practice, Smith observed an ever-widening gap in wealth and income. This led him to change his mind: from believing that the best form of capitalism was the unfettered variety, he came to acknowledge the reality that markets didn’t always stay perfect and that’s when problems arose.
“Is this improvement in the circumstances of the lower ranks of the people to be regarded as advantage or as an inconvenience to the society? The answer seems at first sight abundantly plain. Servants, labourers and workmen of different kinds, make up the far greater part of every great political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged.”
Smith decided that when wealth became concentrated in the hands of a few, they gained political power and economic privileges which interfered with the free operation of markets.
Smith blamed the widening gap in income and wealth on collusion amongst the owners of the capital.
John Stuart Mill believed that individuals were the best judges of their own interests and, left to experiment with different lifestyles and activities, would arrange for their own self-fulfilment far better than anyone could arrange it for them. So to promote the greatest happiness for the greatest number (this is often called the “utility principle”), society ought to maximise the liberty of its citizens.
Society’s institutions and laws could and should be changed to produce a better society.
Mill believed that the state should only be active when it was necessary, and in his mind this included providing protection and security for citizens and providing them with opportunities to fulfil their potential. Protecting citizens meant providing some economic security, and he believed institutions and laws should be aimed at achieving these goals. Later in his career, he came to support women’s rights, extending the voting franchise beyond property owners, and was in favour of labour unions and farm cooperatives.
Today, it has become deeply engrained in our thinking about transfer payments that they should only be extended to those who would work for income if they could.
Paid work, that is, is the goal toward which any self-respecting individual should strive. Fulfilling your individual potential is nowadays seen as synonymous with earning cash recompense. This ignores the value of unpaid work, and the preference of some to contribute to society in ways that don’t necessarily result in remuneration.
It’s the distinctly modern reductionism of what makes the model citizen, what constitutes a life that is regarded by others as “worthless” that is the natural consequence of our pathological materialism.
The Marginalist Revolution.
In the last few decades of 19th century and the early 20th century, there was a revolution in philosophy. The analysis of economies left the homely comfort of moral philosophy and entered the clinical precincts of mathematics.
There was a revolution in the way economic systems were analysed – it became known as the “marginalist revolution”, because “economists” began to focus on small changes, utilising the concepts of the branch of mathematics known as calculus.
It’s not about transfer handouts for those who meet strict eligibility criteria: that reductionist model of modern welfarism ignores the whole point of an equitable and just society as envisaged by Smith and Mill.
An effect of the marginalist revolution was to remove any moral context for setting economic policies.
Not all economists lost sight of the fact that ultimately economics cannot be separated from values and principles.
In 1966, John Kenneth Galbraith sought to describe “the good society”:
“The good society does not seek equality in economic return; that is neither a realizable nor a socially desirable goal. There are those for whom income and wealth and their public manifestation or private contemplation are the ultimate goal and satisfaction; there are others for whom they are not. The Wall Street operative measures the quality of life by his or her income; the poet, actual or aspiring, does not. It is the essence of liberty that these differences in motivation and reward be accepted…” “The good society does not seek equality in the distribution of income. Equality is not consistent with either human nature or the character and motivation of the modern economic system. As all know, people differ radically in their commitment to making money and also in their competence in doing so…”
The 1948 UN Declaration of Human Rights
The Declaration of Human Rights adopted by the UN General Assembly on 10 December 1948 explicitly embedded the idea that individuals have a universal entitlement to resources:
Article 22. Everyone, as a member of society, has the right to social security and is entitled to realization, …in accordance with the organization and resources of each State, of the economic, social and cultural rights indispensable for his dignity and the free development of his personality.
Article 25. Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing and medical care and necessary social services, and the right to security in the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in circumstances beyond his control.
Gareth Morgan. from his book: The Big Kahuna, Turning Tax and Welfare in New Zealand in its head.