How can governments justify taking income tax on earnings, and then taking more tax on spending? [closed]

Question

I have always had an issue with the concept of governments taking a percentage of an individual's earnings, and then when the individual tries to spend the remaining money, governments take a percentage of that.

Can someone explain to me how this is justified by governments? (Besides the reason of just being greedy and wanting more money. That reason I always understand.)

Answer 1

Assume that taxes in general are justified. Some people question that, I don't.

Assume that taxes are allowed to encourage or discourage some completely legal behaviour in the taxpayer. Mortgage tax credits to encourage home ownership, deductions for charitable donations, the list goes on.

Consider that each taxpayer pays a total tax burden in direct and indirect taxes each year, and that the total amount depends on his or her earnings, other actions, and other conditions. This total amount is what really matters, the rest is administrative detail.

So if a government wants to encourage people to drink fruit juice without additional sugar or sweeteners instead of booze, they could give a tax credit on anyone who submits receipts for fruit juice purchases, or they slap an extra tax on booze sales. I know which one is easier to handle ...

They don't want to go to a pure expenses-based system because they believe that income should be one of the major factors how total taxes on the individual are calculated. Just not the only one.

Answer 2

The language of "greed" is not really appropriate. The government spends money on Education, social services, roads, defence, the health system and so on. There is no "magic money tree", money for these services comes from tax.

Most taxes are on financial transactions. For example, the income tax that we pay could be seen as a tax on my money, or it could be seen as a tax on my company (that has to pay more to give me the same take-home pay). Similarly, sales taxes, like VAT can be seen both as a tax on my spending or as a tax on the retail company.

Rather than thinking of these as taxes on persons or companies, it is better to think of them as taxes on transactions. The matter then just becomes, how to structure that tax on transactions in a way that gets sufficient money to pay for education, health care etc, and is reasonably fair. It would be possible to structure the tax system so that there was no sales tax, it would mean that the tax on wage transactions would be much higher. You would have cheaper products, but less take-home pay. Some would win and some would lose. It would certainly not be obviously more fair.

One problem that governments have is getting tax from multinational companies. Taxing the profit of a company is difficult if the company is registered overseas. The most effective way to tax companies is to tax the transactions that they do inside the country. There are two main transactions that companies make: selling stuff and paying wages. It is no surprise that both these transactions attract tax.

Answer 3

TLDR summary:

• There's an argument that taxing consumption rather than income increases incentives to work.
• There's a counter-argument that taxing consumption can increase inequality, particularly by flat-rate consumption tax. (In general, the progressive or regressive nature of the entire tax mix needs to be considered.)
• Both previous arguments (bullets) seem affected (weakened) by what else is done, e.g. how much of the tax money is spent on welfare programs.

The above are economics arguments that are discussed often enough to be considered mainstream. As for pure ideological positions, some the right-wing and/or libertarians in the US attack a consumption tax as a "wealth tax". I'm not sure if anyone has bothered to refute this (poorly framed, IMO) ideological argument. No wealth is taxed through a consumption tax unless it is actually consumed.

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This question seems to apply squarely to EU countries, which have both income tax and a fairly high VAT. Actually,

The spread of Value Added Tax (also called Goods and Services Tax – GST) has been the most important development in taxation over the last half-century. Limited to less than ten countries in the late 1960s it has now been implemented by about 136 countries; and in these countries (including OECD member countries) it typically accounts for one-fifth of total tax revenue. The recognised capacity of VAT to raise revenue in a neutral and transparent manner drew all OECD member countries (except the United States) to adopt this broad based consumption tax. Its neutrality of principle towards international trade also made it the preferred alternative to customs duties in the context of trade liberalisation.

As for the theoretical arguments for a consumption tax, from the large body of economics papers on this:

The debate on possible consequences of a tax shift from income towards consumption centers around two issues. First, according to standard economic theory, such a tax shift might be favorable with respect to employment as a consequence of lower marginal tax rates on labor income, implying higher incentives to take up work. Second, higher consumption taxes are often associated with lower tax progressivity and higher levels of inequality. However, employment increases from a tax shift may outweigh adverse distributional impacts. The degree to which there exists a trade-off between equity and efficiency in this context is an empirical question.

But do note the immediate counter argument on potential inequality increase (that's what regressive tax means). Frankly, if one considers the EU with its typically higher unemployment than the US, I'm not this theoretical argument of consumption tax encouraging work holds much water in practice... Nevertheless, it's actually part of the official EU thinking:

In the recent years, some new aspects of the EU tax policies have emerged. The Commission invites to increase “quality of taxation” which means that tax system should generate a proper amount of public revenue and cause minimal harm to economic growth (EU Commission, 2011abc). One of the aspects of taxation system quality issue is a modification of tax structure. That means optimal and efficient allocation of tax burden across various tax subjects. The Commission invites to improve taxation through “more growth-friendly tax structure”, which means shifting tax burden from “labor to consumption” (European Commission (EU Commission, 2011c, p.4-5)

A Canadian parliament website provides a fairly similar argument:

One benefit of most consumption taxes is their limited adverse impact on economic growth. When the income of individuals and businesses exceeds the amount of their consumption, the difference can be invested. For example, investments can be made in the construction of productive assets, which can increase future production and economic growth. A consumption tax encourages individuals and firms to consume less, which means that they are able to invest more, all other factors remaining the same.

A fixed VAT is recognized as a regressive tax, but its success is owed to how easy it is to have it guarantee income for the government.

a VAT is relatively easy to administer and more economically efficient than an income tax. It’s true that a VAT is regressive but this problem can be addressed by making other, more progressive, changes to taxes or spending.

Supposedly the VAT can and is made progressive in some EU countries by having a lower VAT on foodstuff etc. compared to high-end goods. There are methodological issues in coming with this latter conclusion, so it's not universally accepted.. The aforementioned Canadian website also says:

In Canada, the regressive effects of the GST/HST are mitigated somewhat by the zero-rating or exemption of some products, such as basic groceries, and by the refundable GST/HST tax credit that can be claimed by low-income Canadian taxpayers.

An IMF staff note is also mostly on the same key (but they seem to disagree on the regresiveness issue)

Broad-based consumption taxes, and particularly the VAT, have the advantage of not discouraging saving and investment decisions. At the other end of the spectrum, income taxes and social contributions are thought to have the most adverse effects on growth as they interfere directly with economic decisions (e.g., labor force participation). Within income taxes, corporate taxes are typically seen as the most harmful to growth, primarily because they discourage capital accumulation and productivity improvements, while introducing a bias toward the use of debt finance. Shifting the composition of the tax system from direct to indirect taxes may have positive effects on growth, but this may come at the expense of equity. For instance, the VAT is generally regressive in advanced economies—at least when assessed against current income rather than current consumption.

In any case, what you are asking about is called designing the tax structure or mix of direct and indirect taxes. There have been lots and lots of studies what is the best way to do this. What ultimately matters from a redistribution perspective is the overall mix:

The theoretical controversy over the optimal tax mix is also mirrored by the diverging solutions adopted in various OECD countries. Cross-country comparisons reveal striking differences in the tax structure especially when considering effective tax rates. For example, during the period 1970–2001, the ratio of the effective labour to consumption tax rate was as high as 1.89 in the United States and as low as 0.77 in Ireland and 0.78 in Portugal. A similar picture emerges for the effective labour to capital tax ratio. Even among European countries, this ratio ranged from 2.31 in Germany to 0.78 in the United Kingdom. The same holds for the effective consumption to capital tax ratio, which ranged from 2.04 in Finland to 0.52 in the United States. These tax mix differences imply that any cross-country comparison of the inequality effects of effective taxation should be seen in the context of relative tax rates, rather than in relation to single tax rates since the use of the latter will only provide a partial assessment.

There's little doubt however that EU countries (which have VAT) gather more overall taxes relative to their GDP compared to the USA. But also note that Australia has a VAT-equivalent called the GST, and its overall taxes are not far from the US ones.

Here's a part of that graph with indirect taxes also added. The US is in the last place among these (has local/state sales taxes):

I can't find the page where I read this right now but I recall Stiglitz saying he was not particularly worried about the regressive nature of the VAT in Europe because those countries with a high VAT also have more welfare programs. (Which probably also negates the idea that consumption tax alone can lead to more uptake of work. But conversely, one can argue that in state with high welfare, lower consumption taxes would encourage even more people to give up work.) Anyway a newer paper (not by Stiglitz) reiterates roughly the same point:

Clearly, arguments made for both points of view can be valid: a strong reliance on the VAT is relatively regressive, if the alternative is to have a well-functioning progressive income tax. On the other hand, if the VAT indeed serves as a money machine and provides the government with more revenues, these revenues can also be used for financing transfers and the provision of (public) goods that can reduce inequality. The overall impacts of the VAT on inequality are, therefore, ambiguous in theory.

This latter paper also finds that in practice the effects of VAT on inequality have been "benign".

Answer 4

When governments raise taxes, they affect behavior. When cigarettes get taxed, people smoke less. When wages get taxed, people work less. These are not only theories, but actually proven beyond reasonable doubt using empirical evidence.

Therefore, when governments set up their tax schedules, they have to think about how they affect behavior. Other answers have emphasized that some taxes are set in particular to change some behavior (e.g. smoking). This answer emphasizes the other part: Governments don't want to change behavior they don't deem bad.

Spreading incidence of taxes is good

You seem to be under the impression that being taxed on several margins (income, expenditure) is bad. I'll argue the opposite. Governments want to reach a certain level of income (money they take via taxes), and the question is what is the best way to do so. If you only tax income, you'll have to set a high earnings tax. A high earnings tax means that people reduce working a lot. If you only tax consumption, it means makes consumption very expensive. People will start saving more, spending less (which can be bad for the economy), or participate in black markets (and you'll also forego the tax income).

This motives a general rule of tax theory, which is that spreading the incidence of taxes is good. You want to tax people on many places a little bit, rather than taxing them at a single place a lot.

Answer 5

Stealing a good first point from o.m.’s answer:

Assume that taxes in general are justified. Some people question that, I don’t.

Now to my individual response.

You are concentrating on the perception of the individual person. When they receive money as income, it is taxed by income. When they spend money, a portion of it is determined to be tax. From the point of view of the individual person, they may claim they have been taxed twice.

I wish to take a different view: that of the moving money. When you receive your income, money moves from your employer to you and the state declares that during this movement a certain amount should be transferred to it as a (legitimate) tax. Now you go to a shop and buy a product. Again, you are moving money, this time it lands in the hand of the retail business. The state again decides that a certain amount of this money should be transferred to it as a (legitimate) tax.

The second transaction can also be looked at from the perspective of the shop: when you buy the product, you are generating the shop’s income, and as your income is taxed, so is the shop’s.

A follow-up question might be: But what about taxes like a tobacco tax? Surely that is an additional, potentially unwarranted tax? Well, selling a tobacco product is a certain type of income that you can classify differently from, e.g., selling bread. As the income is slightly different, it can be taxed differently. The same can be said for an individual’s income: earnings from the stock market may, for example, be taxed at a different rate from salaries. Landlords receiving rent can have that rent be taxed differently from their daytime job as an accountant. and the list goes on.

If you are interested, you can follow the path of the money further from the retail shop to the wholesale to the company that produced the good to the companies that supplied the raw materials. At each individual step, a transaction is performed, money changes hands and that process can be taxed.

One might counter at this point that ‘obviously’ it is not the shop paying VAT/GST/whatever it is called in your jurisdiction but that it is added on top of the price the consumer has to pay. On the other hand, you can view the price of a good as a result of the calculations the shop has to make so it can make a living. It needs to pay for its building, interior, electricity, employees, the product it wants to sell and it wants to make a profit. Just add the VAT/GST/etc. as another cost to that general equation and suddenly it is not so different from the consumer being charged for more expensive raw material or others.

Also, one might want to argue that the shop is taxed once when it sells the goods (VAT/GST/etc) and once at the end of the year when it reports its profits. But if you look at it in a different way, that is basically just an immediate tax to be paid on part of the income and then at the end of the year a big balance sheet with deductions/additional taxes as if the shop were an individual. Only the names of the taxes/deductions and the look of the final balances are inherently different.

Consider as part of this that there is only a certain amount of money (at least that was the idea of currency in the pre-electronic era). It’s not like the company generates money out of nowhere when it pays a salary, it is taking money it has received elsewhere and is moving it on. Suddenly that single transaction does seem special enough to warrant being the only taxable one.

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There are two exceptions to this general idea of each movement of money being taxed: when the government receives money (taxes) and when it spends money. In each case, the recipient of the tax is involved in the transaction so giving part of the money to itself would make no sense.

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Some taxes do not fit this general idea, e.g. a property tax or a wealth tax. Those must be argued for differently and indeed in these cases the double taxation claim is much stronger as the money is not going anywhere.