By Guillaume Bullier.
On the occasion of the Great National Debate, many proposals have been made to reform our tax system. Yet we are often unaware of the real effects that these reforms would have on the economy.
The levies are not neutral and it is important to study how their structure affects economic development, and therefore the enrichment of each. The bases and rates of these various taxes are important incentives that influence our choices and our behaviors.
To know these effects is necessary to be able to judge the good or bad character of a reform. Some levies (and not the least) have a very negative effect on the trade and the specialization of the economy.
Why do we exchange?
Let's start by clarifying the interest of economic exchanges for the creation of wealth. When we agree to transfer a good, a service or a quantity of money in exchange for another good or service, we consider that it brings us more utility than the first.
What you earn is more valuable than what you give away. Étienne Bonnot de Condillac explains, in Trade and government (1776), that an exchange is always mutually beneficial, and that both parties are always winners. A freely agreed exchange is therefore always a fair exchange.
From this natural principle follows the specialization and division of labor. Rather than producing all the answers to our needs ourselves, we use people who can produce them relatively cheaply. We buy their products and services through the sale of the fruit of our own work. In the same way, we specialized in an activity so that it costs less for some to buy our work than to do it themselves. The division of labor and commerce make it possible to provide the whole population at a lower cost.
In The Wealth of NationsAdam Smith illustrates this principle by the example of a pin factory, demonstrating how the division of tasks between specialized individuals allows a much better performance than that of a single individual who is not used to this work.
Specialization and trade are penalized
Imagine now that you are told that when you buy or sell a good or service, the price paid by the consumer will be double the price received by the producer. In the event that the utility you derive from the property will not be twice the cost to the producer, you give up this exchange.
In other words, if you are able to produce yourself this good or service for less than double the cost for a specialized producer, you will give up the use of it, even if this specialized producer could do it for less that you. You end up doing tasks for which you are relatively less productive.
This situation that has just been described exists today in France and in many countries. Indeed, large mandatory deductions have a correlated amount (proportionately or progressively) to the amount of your income, and therefore to the value that you have created and exchanged. These levies have the effect of distorting market prices by artificially inflating them, reducing incentives to trade and create value.
Employer and employee social security contributions, the generalized social contribution (CSG), income tax and value-added tax (VAT) are among them. The more you work and produce wealth for others, the higher the amount that will be taken from you.
High marginal rates on value creation
It is important to consider the marginal rate, that is to say the amount taken from the last euro won. This rate easily exceeds 50% for income from work (depending on the VAT rate, it can be around 65% for an employee in the SMIC), which means that for additional work, your income would be halved compared to price paid by the consumer.
The chart below shows the marginal disposable income corresponding to a 1 euro increase in the price of labor for the consumer. The two particular cases illustrated are fairly widespread and representative. Nevertheless, different methods or certain mechanisms make it possible to reduce the amount of these deductions (VAT at reduced rate, self-entrepreneurship, etc.).
Figure 1: Marginal deduction rate and increase in the disposable income of the worker, for an additional euro paid by the consumer (calculations based on data from the URSSAF)
The analysis presented in this chart is not complete and does not take into account all the factors. Fortunately, INSEE has carried out a very thorough study of the Marginal Effective Levy Levy (TMEP) for people in employment in France in 2014. This rate takes into account the levies, but also the reductions in benefits resulting from an increase in income. . It shows that the median TMEP in France in 2014 was 57%, not counting VAT, and that it strikes as low as the high income. For an additional euro earned by an employee in the SMIC, it averages only 38 cents.
This is shown in the graph below, which shows the decomposition of TMEP from lowest to highest income. This little-known indicator of our politicians is the main measure of the disincentive effect of our tax and social system on work and trade.
Figure 2: Decomposition of average METRs by type of transfer, from lowest to highest income (in the sense of labor cost) (INSEE study)
As explained above, such high marginal rates have a very negative effect on economic development. The Laffer Curve describes the paradoxical phenomenon that when tax rates rise too much, tax revenues decline because of the decline in economic activity. (An empirical study of the Laffer effect in France during the 1980s, Philippe Lacoude)
Which tax system more incentive?
The relationship between the amount of the levies and the person's income is at the root of these negative consequences for the economy. It is therefore important, when choosing tax measures, to favor those that reduce the marginal tax rate.
The proportional income tax, commonly called flat tax and acclaimed by many authors or think tanks (Génération Libre, IREF …), certainly has the advantage of homogenizing this marginal rate, but it does not allow to reduce it. It therefore remains disincentive to specialization and trade, and therefore harmful to economic development.
The range of choices is broad to favor taxes that are not related to the value produced (property taxes, environmental taxation, etc.). It is also possible to set up utility billing, so that everyone contributes to the costs of the services or infrastructures according to their use. Finally, making optional state insurance like Social Security would make everyone free to use his income to make contributions. Thus, social contributions that are not necessarily linked to income would give impetus to economic dynamism.
We see that other tax models exist that can generate better incentives. By reforming our tax system, let's stop penalizing work and creating value!