Will Developed Countries Learn to Tax?

In 1963, Nicholas Kaldor published a paper in Foreign Affairs about the ongoing fiscal problems of poor countries, entitled “Will Underdeveloped Countries Learn to Tax?“   It turns out Kaldor should have aimed this advice at his own country, as the rich world, confident in its fiscal advice to the poor throughout the 60s through the 90s, was busy eroding its own ability to finance the needs of the prosperous state and now must take its own medicine, to no one’s liking.

As Kaldor stated it:

… [t]he importance of public revenue to the underdeveloped countries can hardly be exaggerated if they are to achieve their hopes of accelerated economic progress. Whatever the prevailing ideology or political color of a particular government, it must steadily expand a whole host of non-revenue- yielding services-education, health, communication systems and so on-as a prerequisite for the country’s economic and cultural development. These services must be financed out of government revenue. Besides meeting these needs, taxes and other compulsory levies provide the most appropriate instruments for increasing savings for capital formation out of domestic sources. By providing a surplus over recurrent expenditure, they make it possible to devote a higher proportion of resources to building up capital assets.

In a paper recently posted on NBER, Swiss economist Charles Wyplozs contemplates the chronic undertaxation self-imposed in rich countries, and comes to the same conclusion as Kaldor: Countries need revenues to build up a state that fosters economic growth and not catastrophic ruin.  They fail in this miserably because of political malfunction — every special interest group vies for favors and every politician vies for reelection by granting them.  This leads to what Wyplozs called a deficit bias.  Of course, we in the tax world know this problem and even have a poem for it, sometimes attributed to Senator Long:

Don’t tax you, don’t tax me, tax the fella behind the tree.

We also all know that there is no fella behind the tree, so of course Wyplozs is right, every democracy will gravitate to an undertaxation situation because every democratic legislature has a K street and an upcoming election.  The difficulty of course is that there is no reasoning with special interest groups or politicians, and even as the deficit bias rears its ugly head and threatens to topple the whole structure, we still hear the ancient mating call for tax cuts and incentives to boost the competitiveness of insert-your-constituency-name-here and a loving response from Congress.

So, will developed countries learn to tax?  Wyplozs seems to think there is potential if societies can figure out how to get a combination of good rules and good institutions in place to help governments reject “all favors, carrying out spending and transfers purely on the basis of welfare principles exactly as the mythical benevolent dictator would do.”   As a lawyer, I like the idea of a system of rules and institutions that carry out this public service in a way that incorporates the ideas of human freedom and representation in government.  As a realist, I know that such a system is a mythical creature, something like a “confidence fairy.”  Some might call it the “rule of law” fairy.  But perhaps, unlike the confidence fairy, the rule of law fairy is worth chasing.  With few alternatives, we can do little but continue to express our belief in it in hopes that somewhere, it can come to life and do good things.