In our last post, we discussed that tax defines the national currency, and saw how this makes the economy stable. But this is not the only good thing that we get from tax.
Taxes define Australian dollars as the national currency. But that’s not all they do.
Fairness
At their most basic level, taxes can make our society fairer. An Australian dollar is a unit of purchasing power. If one person has too many dollars, they can have too much purchasing power. This means they can take possession of too many things, leaving too few things for the rest of us to buy.
Taxes are a a simple way to reduce someone’s purchasing power. Basically, by taking money off some people (but not all people), we rearrange the relative purchasing power. If we tax wealthier people, we reduce the amount they can buy and thereby increase the amount available for everyone else.
Inflation
Inflation is in the news lately. Inflation is what happens to prices when demand and supply are not in sync: basically, when demand is greater than supply, prices will tend to rise.
There are two ways in which demand and supply can go ‘out of sync.’ The first is where demand rises. The second is where supply falls. In either case, prices will rise unless something happens to bring demand and supply closer together.
Taxes are a way to reduce demand for things. Taxes do this by simply removing money from the economy. This has to reduce the amount that can be spent – another way of describing the reduction of demand.
Many economists assume that interest rate rises do the same thing. But interest rate rises do not take money out of the economy. Instead, they simply move money from borrowers to lenders. The money is still there for the lenders to spend, and so interest rate rises have a limited effect on demand. They are also unfair in that they move money from borrowers to lenders. Borrowers tend to be poorer than lenders (explaining why they need to be borrowers in the first place). So, interest rate rises move money from poorer people to richer people. The only way this can reduce demand is if the richer people decide not to spend it. So, interest rate rises work by taking money from people who need it and giving it to people who don’t.
Taxes are much fairer. They can be imposed on everyone (think of the GST) or they can be targeted towards richer people (think progressive income tax, where the higher your income, the greater percentage of your income that you pay in tax). In this way, they have a much more direct and predictable impact on demand than interest rate rises.
Influencing Behaviour
If you smoke legal cigarettes, you will be interested to know that more than half of the cost of your cigarettes is tax. Governments impose tax on things like cigarettes to try to discourage people from smoking.
At the other end of the spectrum, if you make a donation to a registered charity, you can usually claim a tax deduction for the donation.
Both of these are examples of Governments using tax to encourage or discourage certain behaviours.