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A Note on Taxation and Inflation*

Published online by Cambridge University Press:  07 November 2014

Benjamin Higgins
Benjamin Higgins*
Affiliation:
Indonesia
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Extract

The cold war has resulted in levels of government spending in advanced countries far bigger than the post-war deflationary gaps as estimated by the most pessimistic of the pessimists. Deflationary gaps have been over-filled, and the postwar situation in the advanced countries has been one of chronic inflation rather than chronic under-employment. The high level of demand in the advanced countries has also aggravated the chronic inflationary pressure in the less developed countries. It is natural, therefore, that the attention of economists and laymen alike should have turned from public spending policy to tax policy.

The general tax problem which seems to have aroused most interest is, “What are the limits to taxable capacity?” Among business men, trade union officials, government advisers, and even among professional economists, from Canada to Indonesia, one often hears today the statement that when tax rates reach a certain limit, further increases in tax rates will be inflationary rather than deflationary. It is the present writer's opinion that this statement is based upon a misunderstanding, and that its frequent repetition in high places calls for a restatement of home truths regarding the economic effects of taxation. What follows is certainly not original analysis; but sometimes a simple application of familiar but appropriate tools can help to clarify an economic policy issue. Such clarification is the purpose of this note.

Type
Research Article
Information
Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique , Volume 19 , Issue 3 , August 1953 , pp. 392 - 402
Copyright
Copyright © Canadian Political Science Association 1953

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Footnotes

*

Republished from Ekonomi dan Keuangen Indonesia by permission of the editors.

References

1 Clark, Colin, “Public Finance and Changes in the Value of Money,” Economic Journal, 12, 1945, 371–89.CrossRefGoogle Scholar

2 In this discussion “national income” means net national income at market prices, and not personal or disposable income. Consequently, the appropriate marginal propensity to consume to use in making an estimate of the budget surplus necessary to prevent inflationary effects from government spending should be the marginal propensity to consume out of national income, and not out of personal income or out of disposable income. For the less developed countries, a marginal propensity to consume out of national income of 4/5 may be fairly realistic. In advanced countries, however, a marginal propensity to consume closer to 3/4 or even 2/3 would probably be more realistic. In that case, a neutral budget would be one in which the budget surplus is equal to 1/4 or 1/3 of total tax revenues. In Canada at the present time, for example, “neutralizing” government expenditures of about $5 billion would probably require tax revenues of about $7.5 billions and a surplus of $2.5 billion.

3 See Higgins, B., “Postwar Tax Policy,” part II, Canadian Journal of Economics and Political Science, 11, 1943.CrossRefGoogle Scholar

4 P.Gv = (M + M′)V = 1 × 50 = (5 + 5) × 5.

5 P.Gv = (M + M′)V = 1.1 × 50 = (5 + 6) × 5.

6 Of course, a distinction must be made between taxes collected, and wages paid, per unit of effort expended, and taxes collected or wages paid on increments of effort expended.