We were happy to sign the Australian Institute letter on taxation cuts in the Sydney Morning Herald (12/04/2016).We now would like to set out the general philosophy that lay behind our support.
We have always argued that taxes have two main functions: first, the relative structure of taxation types and rates should reflect philosophical views on equity as between different groups in society. Secondly, the total tax take should impact on the need to achieve high levels of employment and activity, after taking into account the other main sources of overall demand at any moment of time — expected expenditures on consumption and investment, current and capital government expenditures, and net exports. Meeting these two criteria implies that sometimes the government will be in deficit, sometimes in surplus, so that neither achieving a deficit or a surplus or a balance at a moment in time or over time should be the criterion of fiscal policy, but the residual outcome of attempting to achieve these other fundamental aims.
The corollaries of this view are, first, that hypothecation — matching particular expenditures with particular sources of finance — is a fallacy. Secondly, that achieving high levels of activity also usually implies agreeable rates of growth over time. This in turn means that even if sustained deficits result in rising debt-to-income ratios, these will not blow out for ever but will usually approach liveable-with debt-to-income ratios. That the budget be required to balance ‘over the cycle’ implies that the economy is a stationary state, i.e., on average the economy neither grows nor declines.
Thirdly, implicit in this approach is that the total amount of capital expenditure by the government should reflect the longer-term needs of the society, especially the creation of green-friendly infrastructure, and that only in very special circumstances should government capital formation be used to achieve high levels of activity — usually it should be the second function of taxation noted above that should do this. May we add that government expenditure on the disabled, schools and teaching generally, and hospitals and medical care may be viewed as investments which result both in a more agreeable society and a more productive one?
Finally, a distinction should be made between domestic debt raised in our economy, and overseas debt. Domestic debt requires a transfer between bond holders and taxpayers (of course, they can be overlapping sets) so that the impact on the economy is a secondary one, depending on whether there are great differences at the margin between the saving and consumption behaviour of interest recipients and taxpayers.
There is a real burden associated with overseas debt — exports will have to be that much higher than they otherwise would have been in order to allow interest and loan repayments to be met. Nevertheless, if the borrowed funds are used wisely to finance productivity-enhancing expenditures, the level of activity would be higher than otherwise would have been the case, so that even after meeting the real burden, society will be better off than it would have been otherwise.
All these important considerations have been forgotten in the political and other debates over taxation and spending in the last decades.