Tuesday 22 November 2022

Taxes are fungible, so you can't really direct where your individual taxes are spent

Last month, there was an article in The Conversation by Jean-Paul Gagnon (University of Canberra) and co-authors, proposing a way of 'democratising taxation'. I meant to comment on it at the time, but was busy with teaching and assessment, and have only come back to it now. Anyway, here's what Gagnon et al. proposed:

Most of us accept tax, if grudgingly. But many aren’t happy with how it is spent.

Enter TaxTrack – our hypothetical proposal for democratising taxation, details of which are to be published in the Australasian Parliamentary Review.

Our idea is that Australians who want a greater say in where their taxes go could be given a TaxTrack number, which would trace those dollars and direct them only to places they wanted them to go.

If they wanted, they could view the invoices their contributions had helped pay, and they could specify which invoices their contributions should not pay – perhaps by prohibiting the spending of their money on things such as military ammunition, or specifying that a certain proportion was directed to healthcare.

Governments would have to work with those instructions, cutting spending in areas that lacked support and boosting it in areas for which there was overwhelming support.

On the surface, that proposal sounds interesting, perhaps attractive. However, there is a fundamental problem with the proposal, which means that it simply won't achieve what Gagnon et al. propose. That problem is that tax payments are fungible. That means that a dollar of tax paid by any taxpayer is exactly the same as a dollar of tax paid by any other taxpayer. Even if the government earmarked some individual taxpayers' tax payment for a particular purpose (or purposes), the government could simply reallocate other taxpayers' tax payments to the remaining purposes, leaving the overall effect unchanged.

A numerical example may suffice. Say that there are four taxpayers: (1) Taxpayer A pays $10,000 in tax; (2) Taxpayer B pays $20,000 in tax; (3) Taxpayer C pays $30,000 in tax; and (4) Taxpayer D pays $100,000 in tax. The total tax received by the government is $100,000, which goes into a big pool that the government uses to finance its spending. And say that there are two ways for the government to spend those tax receipts: (1) Social services (like health, education, and welfare), which receives a budget allocation of $50,000; and (2) Administration costs, which receives a budget allocation of $50,000. Total government spending is $100,000, and the budget is balanced (tax receipts is equal to government spending). Since all the spending is paid out of the pool, it doesn't matter which taxpayer contributed to exactly which spending.

Now, say that Taxpayer B decides that they don't want any of their tax payment to go towards administration costs. They only want to fund social services with their $20,000 tax payment. This is what Gagnon et al. are proposing. What does the government do? They make sure that Taxpayer B's $20,000 goes towards social services. They then take the remaining $80,000 of tax receipts, and allocate $30,000 to social services, and $50,000 to administration costs. The overall effect is no change in spending allocation, because total spending on each category of spending is the same as before. The only difference is that Taxpayer B can think to themselves, 'at least my tax payment isn't funding those worthless administration costs'. There is no other effect at all.

However, TaxTrack could have an impact on government spending, but only if a large proportion of taxpayers sign up for TaxTrack. Continuing with the example above, if both Taxpayer B and Taxpayer D decide that they only want their tax payments to go to social services, then the government would have to direct $60,000 towards social services. What does the government do in that case? Do they cut back on administration costs, spending only $40,000 in that area? Or do they continue to spend the budgeted $50,000 on administration costs, and run a deficit? TaxTrack doesn't provide an answer to that question.

And it should be a real concern. If every taxpayer wants their tax to be spent on sexy causes like climate change mitigation, or saving endangered frogs, or pre-school education, or large subsidies for tourism operators, how will the government fund courts, or police, or parliamentary services, or all of the other unsexy but necessary things that governments have to spend taxes on? They either have to increase the deficit, or cut that spending. Neither is likely to be an optimal solution.

Fortunately, I think TaxTrack would have the opposite problem. Instead of forcing the government into suboptimal allocations of spending, I think that not enough people would sign up for it for TaxTrack to make any difference at all to what the government does. I mean, how many people even engage in effective budgeting for their own household, let alone would be willing to allocate their tax dollars to various specific funding streams?

If taxpayers want to hold the government to account for its spending plans, the way to do that is through the political process. Adding another bureaucratic tool that would serve no purpose other than making a small proportion of taxpayers feel better about where their tax dollars were being spent is not going to achieve that. Arguably, it might even make taxpayers less likely to want to hold the government to account. Currently, if a taxpayer doesn't like the allocation of government spending, they can complain, or try to vote out the incumbent politicians at the next election. But, if the taxpayer feels like their tax dollars are being used in the way they intended, they are less likely to apply the same level of accountability to the government's overall spending allocation.

TaxTrack should be a non-starter for Australia. Thankfully, it hasn't been proposed for use in New Zealand.

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