And neutrality?

We consider necessary to present some brief and synthetic considerations on some tax issues that sometimes are not taken into account in economic policy decisions. This is because some policymakers consider taxes as something isolated and independent, which only provide resources to the State.

Although the collection is a task of significant importance, it is clear that taxes, or tax policy, also constitutes one of the instruments that the economic policy use to achieve its objectives. This means that the design of taxes adopted by the tax policy should use technical structures suitable to the goals or objectives pursued.

We refer, among others, to two basic functions of taxes:

a)    Raise resources from the economic system to finance the public spending, and

b)    Influences the behavior of the economic agents given that:

i)             They affect the available income and therefore influence the demand based on income elasticity.

ii)            They affect the available income and therefore influence the demand based on income elasticity.

This is why the supply and demand variations in the market usually derive from variations at the level of income or prices.

Consequently, a chain effect begins with the creation or modification of one or several taxes, which alters the goods and services flow of income and prices; this affects the expectations and decisions of economic agents, which has an impact on the market forces (supply and demand), and finally affects the behavior of the economy. It is therefore obvious that taxes stimulate the economy and therefore constitute one of its instruments.

If this is so, a question arises: would it be possible in some cases to use “neutral” taxes that avoid affecting the economic chain?

First, before answering this question, we need to agree on what we mean by “neutral” taxes. In our view, a tax is neutral when it meets the following characteristics: i) it does not modify the decisions of economic agents in the application of the production factors. ii) It does not create an effect of replacement or alteration in the production factors, and iii) these aspects indicate that its purpose is to “collect” resources. (The above, obviously does not include the “economic neutrality” that a tax could have for the taxpayer by law).

By contrast, “Non-neutral” taxes produce: i) alterations in the expectations and decisions of economic agents, ii) they generate therefore a substitution effect by altering the use of factors of production and iii) besides collection, their goals usually have a “finalist” character and therefore affects the market mechanisms guiding the supply and demand.

The above shows us that when a tax is designed to achieve “fairness”, it necessarily veers away from neutrality. Therefore, neutrality and equity are not compatible.

Certainly, it is difficult to conceive a “neutral” tax, and starting from the opposite hypothesis would be an error of importance considering the negative consequences that this could lead to economic policy. If we ignore the effects of tax policy (taxation) on economic policy, this will generate conflicts with the goals and objectives established by the latter. For this reason, one of the tasks of tax policy is to analyze the tax consequences on the economic process, after the stages of the selection of the tax technical structure, its design and the distribution of the tax burden.

Therefore, even though when we design taxes in specific situations we may bear in mind the concept of neutrality, we must be aware that neutrality can hardly be achieved. Consequently, we return to our starting point, stating that it is not possible to support the view that taxes have as sole purpose to collect resources for the State, and deny their importance in affecting the behavior of the economy and stimulate it.

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