Thursday, March 5, 2009

The Price Elasticity of Politics

The Green Party wants to put a 1c tax on texts. The Labour Party wants to remove tax breaks from landlords. Some politicians have clearly never heard of incentive effects. Generally if you make something more/less expensive to do then people will do less/more of it. Like increasing the vat rate in December (the biggest month of the year in retailing) ... and seeing vat revenues fall in January and February.

Politicians are supposed to have superhuman powers of empathy (all those chats in their clinics every weekend must surely demand it) and yet they cannot put themselves in the shoes of the people they want to tax and ask themselves 'what would I do if it got more expensive/less rewarding to do something because of this tax'? But they're going to have to extend their empathy to taxpayers pretty soon because the gap between government spending and taxes is yawning widely - as illustrated in the chart from a recent post on The Irish Economy blog by Patrick Honohan.

The message from the chart if you are a taxpayer is pretty clear: you've got to cut expenditure. The message the government seems to be taking from it is that it must increase taxes. The problem is that the government's taxation options are extremely limited:
  • the folks who want to introduce higher income tax rates for incomes over, say, €70,000 have failed to notice the surge in married women's participation in the workforce which has raised many two-income households' incomes to this and higher levels: good luck to the politicians who want to raise taxes on the earnings of Ireland's working wives.
  • the generous increases in social welfare payments during the good times means that the introduction of income taxes on those previously outside the tax net will leave many low earners wondering why they're bothering to work at all.
  • reducing tax allowances on pension contributions (already down to a ceiling of €150,000) will stem money going into Irish pension funds (and therefore Irish equities) just as they're already scraping along at 1996 price levels (by the way: a company director contributing the maximum possible under the existing tax allowance regime would still come nowhere near to enjoying the pension entitlement of any moderately senior civil servant upon retirement).
  • the Levy-Kalecki formula means that the remaining affluent consumers may 'go on strike' and save even more/spend even less if the uncertainties created by a shifting tax regime leave them even more worried about the future.
So what spending should be cut? The answer is: I don't know. Nor does the Minister for Finance, the Green Party or any one individual for that matter. The people who know - the managers of sections, divisions and organisations within the public sector (including the health services) - are the ones who can identify where cuts could be made to maximum effect. They should be empowered to do just that: give them a budget and tell them to 'do what you need to meet it'. Including pay cuts and redundancies as a last resort (though I'm guessing more efficient work practices, less sick leave and less overtime might be the main gains).

Any government that thinks it can simply increase taxes without consumers, workers, employers and mobile phone users responding negatively in the current climate is delusional. I sincerely hope they're not.


  1. This comment has been removed by the author.

  2. I have to disagree with the introduction to the last post, if Ireland was being run by teenagers a text tax would never have been suggested! It is worrying that the figures proposed for the revenue generated by this 'plan' to tax texts were almost 20 fold (1.4 billion) of what it would generate (a max of around 80 million). And clearly there will be incentive effects, especially as many texts are currently free under certain tariffs.

    If the Greens want to extract cash from youngsters (or their parents) they would be better off suggesting some Michael O'Learyesque manoeuvres, like a pay-to-pee plan for school toilets. It may not take them long to learn an unsavory lesson in incentive effects in this case.

  3. It may not take long for O'Leary to learn some unsavoury lessons either!


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