BACK TO BENEFIT-BASED TAXATION: Giving taxpayers value for what they pay

Economists need to get back to the historically prominent and commonsensical principle that taxes should be based – at least in part – on how much taxpayers benefit from what the government does with its funding. That is the conclusion of a study by Matthew Weinzierl, published in the July 2018 issue of the Economic Journal. Drawing on the views of thinkers and politicians from Adam Smith to Barack Obama, he writes:

‘Politicians and the public already think about taxes in terms of the value they provide, so it is time for us to catch up.’

‘If we do so, we will stand a much better chance of making sure that future governments receive higher marks for customer satisfaction.’

The research begins by noting that a government, like a company, must deliver value to those who pay it if it hopes to succeed. Put another way, taxpayers will demand value for what they pay to a government just as customers demand it for what they pay to a company.

That simple idea is called ‘classical benefit-based taxation’ – and in an era when governments are facing widespread customer dissatisfaction, it may be time to revisit its wisdom.

Adam Smith gave benefit-based taxation the most prominent place possible: as his first maxim of taxation. He wrote in Wealth of Nations: ‘The subjects of every state ought to contribute toward the support of the government, as near as possible, in proportion to their respective abilities; that is in proportion to the revenue which they respectively enjoy under the protection of the state.’

Nearly 250 years later, Barack Obama said much the same thing: ‘Everybody pays, but the wealthier have borne a little more. This is not because we begrudge those who've done well – we rightly celebrate their success. Instead, it's a basic reflection of our belief that those who've benefited most from our way of life can afford to give back a little bit more.’

Despite the wide gap of time and place between them, Smith and Obama shared the realisation that taxes are not just a way to raise money for the government. They are a way to tie the people to the work of their government and to ensure that both are getting a good deal.

In sharp contrast, most tax experts whose models and theories diagnose the problems with our current tax systems and suggest reforms have abandoned the idea of benefit-based taxation. In its place they have elevated the principle that tax policy should be used to maximise overall wellbeing.

That principle is perfectly reasonable, and likely a wise one, but the new study argues that it should be used in combination with the classical benefit-based principle. By combining these two objectives, we would design a tax policy that was delivering more value to taxpayers and thus was more supportive of a healthy relationship between the government and the governed.

Consider the following example: when most of us talk about tax policy, we usually talk about the tax rates that people pay rather than the amounts of money that people end up with after taxes. But wellbeing depends only on the latter, so a tax policy designed to maximise wellbeing will intentionally ignore the rates of tax that people pay.

In contrast, our debates over tax policy strongly suggest that we care about how much people at different incomes pay. Usually, we want people with higher incomes to pay higher percentages of their income. In other words, most of us think more like Obama and Smith than like modern tax theorists.

It’s no surprise that politicians are more in tune with the public than are economists, but it matters. Economists generate the analyses that inform public debate over tax policy. They educate future leaders in their classrooms and textbooks. And they set the intellectual agenda for the future, determining what we study and therefore learn about as a society.

The new study revisits the classical benefit-based view of taxation and argues that it can be – and should be – incorporated into modern tax theory. The author shows formally how we can model benefit from the government’s activities, following Smith’s lead, and suggests ways in which we might measure it.

The author then calculates resulting tax policies and shows that a wide range can be consistent with benefit-based taxation, so that the idea’s appeal cuts across partisan lines. In brief: if tax theorists want to reincorporate benefit-based thinking into how they evaluate tax policy, this study tries to show them how.

Revisiting the Classical View of Benefit-Based Taxation’ by Matthew Weinzierl is published in the July 2018 issue of the Economic Journal.