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What Every Debater Should Know About Economics

#8 Taxation and regulation discourage production and destroy wealth.

How hard we are willing to work depends on how much we are offered in pay. Incentives matter. Taxes lower our incentive to work just like a reduction in pay, since that is exactly what they are. If allowed to keep only half of every dollar we earn, alternatives to working for money begin to look more attractive. Some people will work less overtime and enjoy more leisure, some will find non-taxable work in the home (and stop paying daycare and cleaning people), some will retire earlier, etc. Businesses whose income is heavily taxed may withhold undertaking new ventures since the share of the profits they are allowed to keep doesn't justify the risks. Investors, too, find alternatives to putting their money to work in a high-tax environment: they invest in countries where the tax rates are lower or they simply consume more of their surplus income. All these choices illustrate that high taxation discourages productive activity, and thereby reduces the wealth that is created in society.

Equally important for the general welfare is the fact that taxation diverts enormous amounts of time and resources into non-productive activities. Businesses and individuals spend billions of worker-hours each year (in America, 5.5 billion, to be exact¹²) just completing taxation paperwork. This includes the wasted talent and labor when lawyers and accountants are hired to find legal and not-so-legal ways of sheltering income from the tax collector. These jobs in the tax industry create no wealth for society as a whole, rather they deprive us all of the valuable services these individuals could be producing for the market. The higher the tax rate, though, the more people hire such experts to help them.

Tax cuts reduce the percentage of income government collects, but because of the stronger incentives to produce they also increase the tax base (the total amount of taxable income generated in the economy). This means that cutting tax rates doesn't necessarily reduce the revenue government takes in. When taxes are very high, tax cuts have even increased total tax revenue, thanks to the economic growth produced. This is not "voodoo economics" -it is just common sense. Consider that if we were taxed at a rate of 100%, government revenue would be almost zero since few people would bother working for money knowing they would receive no take-home pay. Tax cuts from that level and from levels substantially lower would obviously increase income-producing activity, and tax revenue along with it. Significant tax cuts during the Kennedy and Reagan administrations were attended by increased tax revenues in the years that followed, just as this theory would predict.

For debaters this means that raising taxes is a questionable option for funding plan mandates! For everyone, the economic reasoning provides a framework to assess conflicting claims about taxes within the media.

A fascinating side-effect of technology for protecting the privacy of economic transactions is that it may vastly reduce government capacity to tax and regulate these transactions. In a society where a large proportion of goods and services are bought and sold over the internet, shielded from view by strong encryption technology, how will income or sales taxes be enforced? Some economists have argued that the expansion of consumer privacy on the internet via encryption will result in a radically freer economy and a smaller, less powerful government. If so, the potential for people to produce wealth through production and exchange could be significantly increased. Critics fear that criminal activities, too, might be more easily hidden from view, making economic plunder a more successful strategy, but technology may provide protection against this form of predation as well as from excessive taxation and regulation.¹³

¹² James Gwartney and Richard Stroup, What Everyone Should Know About Economics and Prosperity, 1993, p. 76

¹³ See an online version of economist David Friedman's intriguing article, "A World of Strong Privacy: Promises and Perils of Encryption" at http://www.best.com/~ddfr/Academic/Strong_Privacy/Strong_Privacy.html#Crypto-anarchy