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To Tax or To Cut?

By   /   July 4, 2012  /   No Comments

The debate has long been raging – in times of need, should governments cut spending or increase taxes?

Of course, there is no easy answer. Invariably, both should be attempted to some extent if the government is attempting to address a budget deficit. Such a scenario is omnipresent across European nations at the moment, and the US, too, has an enormous national debt to consider tackling.

Tax raises are usually the easier option. By targeting a minority demographic, the government can usually allow sharp repercussions in the polls. Spending cuts tend to be more hotly disputed, as the government, by definition, spends on ‘essential’ services such as healthcare, education and infrastructure. Even in times of desperation, sharp cuts in national healthcare are political suicide.

Such has been the thinking of the incumbent French government. The Socialist Party swept into power two months ago under Mr. Francois Hollande’s leadership. Much of the election focused on the party’s radical tax plans, which, as was suggested above, targeted a particular demographic, and one which has arguably provided a scapegoat for a variety of problems ever since the financial crisis hit back in 2008 – the rich.

By implementing a 75% marginal tax rate on earnings over €1m, Mr. Hollande hopes to reduce the French budget deficit without needing to cut in key spending areas.

The economic theory is largely sound, but it is outdated.

Many economic domains that used to be the government’s sole prerogative are now able to be privatised. If the last decade has shown us anything, it is that private markets are immeasurably more efficient that public enterprises.

London has demonstrated that it can fund the concerns of its council residents by taxing roads, formerly a public good, via the congestion charge. Toll roads built by private companies enjoyed a boom in Spain in the post-math of the turn of the millennium. Even public transport has hugely improved since it was privatised by Thatcher in the 1980s.

There are numerous examples where technological advances have opened up previously public markets to the private sector. With the current Western model based upon the assumption that spending more boosts chances of re-election, to the detriment of the nation’s finances in the long term, it is time for a change.

The French deficit is a perfect case in point. Successive French governments have failed to balance the government’s budget for nearly 40 years now, and faces a €33bn hole in its public finances next year. That Mr. Hollande intends to raise corporation tax to tackle this problem is misguided.

France should be doing everything it can to stimulate innovation. This would allow many industries which are currently the responsibility of the government to be transferred to the private domain, for the benefit of the private companies, which make a profit where the government frequently makes a loss, for consumers, who receive lower prices due to competition (hopefully) and for entrepreneurs, who ought to be incentivised by low corporation taxes, not high ones.

There are no easy fixes for governments looking to tackle their national debts, but by reducing the size of the state, they might be able to reduce spending without appearing to do so.

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