November 29, 2022
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Balbien: Let economic theory guide tax reform


Joel Balbien

By Joel Balbien

In an ideal world, governments operate under balanced budgets and taxes on the private sector and individuals are structured to minimize adverse changes in economic behavior.

Good public policy funds government services demanded by voters and paid for by taxpayers while sustaining competitive levels of private sector production, sale of goods of services, and investment and hiring decisions by employers that minimize the costs of production.

To maximize welfare, most economists recommend taxes that do not alter the relative prices of most privately supplied goods and services or the relative cost of labor, capital and technology. Unfortunately, most contemporary tax regimes violate this ratio principal.

For example, state and local entities typically impose sales taxes exclusively on manufactured goods and restaurant meals while exempting some of the fastest-growing segments of the economy including health care, pharmaceuticals, ride-sharing, shipping, aviation, housing, utilities and food products.

This shifts relative prices and economic decisions in a material and sometimes adverse way, and it forces sales tax rates ever higher on a narrowing tax base.

One exception to the relative price rule is higher taxes levied on goods and services with significant uncompensated social costs. These include tobacco products, recreational drugs, alcohol, junk food and other products with a large pollution and public health burden.

For instance, if carbon emissions from the burning of fossil fuels cause climate change that results in uncompensated economic losses due to drought and storm-related damage, rising sea levels and destruction of natural habitats, economists would advocate revenue neutral carbon taxes on polluters. Preferably, they would be offset by reductions in other taxes or investments in third-party emission reductions.

Most economists have always favored decriminalization and, ultimately, taxation of some recreational drugs, such as cannabis, because the resulting tax levies can be used to cover the social cost of rehabilitation, education and damage to public health while reducing the heavy cost burden on law enforcement and the criminal justice system.

Sometimes, governments use tax policy to address income and wealth inequality created by technological change and competitive market outcomes that only value efficiency and productivity.

One such tool is the progressive income tax system whereby higher marginal tax rates are applied to higher incremental earnings.

However, in competitive labor markets, higher compensation is usually associated with higher productivity, so progressive tax systems may encourage the most productive and creative employees to choose more leisure over heavily taxed labor.

Furthermore, individuals and pass-through businesses may favor tax-driven investment in less productive tax shelters and other tax-avoidance schemes that reduce economic growth and consumer welfare.

Ultimately, higher tax rates on labor earnings and higher minimum wages raise market-clearing wage rates, leading to substitution of automation, robotics and machine intelligence for human labor.

Futurists believe that by 2030, advancing machine intelligence may reach equality with the average adult human, potentially displacing between 15 and 30 percent of the human labor force, including 20 million manufacturing jobs and between 40 million and 160 million clerical workers worldwide.

Unfortunately, machine-learning algorithms and robots pay neither regressive payroll taxes nor progressive income taxes, and the value they create is taxed primarily under an ineffective and territorial corporate income tax system.

Therefore, in the future, workers will need to upgrade their skill and education levels to better compete and cooperate with machines.

And governments may need to reengineer the entire tax system to reduce the burden on labor services, more heavily tax electricity that feeds the emerging robotic and machine-learning workforce, and implement other reforms that level the playing field between machines and humans.

• Joel Balbien is an adjunct professor in the California Lutheran University School of Management.