GST is Better than Income Tax
In my last article I argued that a flat and broad-based income tax is much the same as a broad-based GST, so we have little reason to hate the concept of income tax more than the concept of GST. I argued this by setting out an imaginary scenario with five citizens, one business, and no government.
But there is an inherent difference between income tax and GST that makes GST better. I will argue this by adding an additional year to the imaginary scenario, and by honing in on three of the citizens – the three employees.
Year 1
In year 1 each employee earns a salary of $100,000, enough to buy 100,000 products at $1 each.
One employee is short-sighted and borrows $100,000 from another employee, who we will call the long-sighted employee. So in year 1 the short-sighted employee buys 200,000 products while the long-sighted employee buys nothing.
Year 1 with no government
To extract the money it demands, the government imposes an income tax rate of 19.8 per cent.
Year 2
In year 2 each salary is $104,030, but this amount now buys only 101,000 products because the product price has risen from $1 to $1.03.
The salary of the short-sighted employee is transferred to the long-sighted employee to pay off the previous year’s debt. As such, the long-sighted employee buys 202,000 products in year 2, while the short-sighted employee buys nothing.
Year 2 with no government
Bring Out The Government
Now imagine instead a scenario where there is a government, and let us assume the government’s taxation does not discourage the citizens from producing as much as in the absence of government.
In year 1 the government demands enough money from the three employees to buy 60,000 products. The government could get the money via a 20 per cent income tax on the salaries of the employees.
Year 1 with income tax
In year 2, the government ups its demand, and now seeks enough money from the three employees to buy 60,600 products.
If the government gets the money via income tax, it ends up taking more from savers compared to the amount taken from borrowers, and compared to the amount taken from those who neither save nor borrow.
Consider the long-sighted employee, who lent $80,000 to the short-sighted employee in year 1, and who receives $83,452 from the short-sighted employee in year 2.
Year 2 with income tax
The pre-tax income of the long-sighted employee in year 2 is $104,030 of salary plus $3,452 of interest, summing to $107,482. So the long-sighted employee has higher pre-tax income than the other employees, simply because of a deal struck between peers.
There is an inherent difference between income tax and GST that makes GST better.
To extract the money it demands, the government imposes an income tax rate of 19.8 per cent. The rate is lower than in year 1 because the government has dreamt up more income to tax than just salary income.
The long-sighted employee pays more tax in year 2 than any other citizen ($21,261 compared to $20,578). The long-sighted employee ends up purchasing less than double what the take-it-as-it comes employee purchases, despite the long-sighted employee having gone without all purchases in year 1.
This intrusion into the deal struck between the long-sighted employee and the short-sighted employee is how income tax punishes saving.
Even if the long-sighted and short-sighted employees respond to the imposition of income tax by negotiating a change in the interest payment involved in their arrangement, this would just mean they share the punishment of deal-making meted out by income tax, a punishment that the take-it-as-it-comes employee avoids.
As income tax penalises deal-making between savers and borrowers, while GST does not, income is inherently inferior to GST.
