The states of the rich world are becoming larger and less functional, and it is difficult to reverse the causes. Governments are providing higher pensions and benefits as a means of addressing wage disparity and caring for an aging population. In wealthy nations where data was available, social spending increased from 14% to 21% of GDP between 1980 and 2022.
Politicians, however, have frequently lowered taxes rather than raised them to keep up. As a result, borrowing has increased dramatically, and public services have been cut to cover the costs. Numerous government services are malfunctioning as a result. Children in certain places of Canada wait as long for nursery as they would in the actual nursery. Because it has not constructed enough prisons, Britain is releasing prisoners early; in Germany, less than two-thirds of the long-distance trains operate on schedule.
It has long been claimed by economists that retirement ages need to increase in line with life expectancy. However, because there are so many elderly people, the ratio of retirees to workers may still increase even with this approach. In any event, it is difficult to stop the elderly’s benefits from increasing due to their strong voting strength. Similarly, when pre-tax wage inequality increases, it is inevitable that progressive taxation and income top-ups for low-earners will result in more redistribution. Politicians will find it difficult to keep the welfare bill within bounds if they hope to be elected. They will have to raise taxes to finance a larger government if they hope to prevent the collapse of public services. One option which does not distort economic behavior is Value Added Tax.
Experience suggests that raising VAT is simpler than enacting other efficient taxes; in fact, the Republican Party in America has always opposed the tax, arguing that it makes it too simple to establish a welfare state. (Unusually, only state-level sales taxes are imposed in America.) Britain increased its VAT rate from 17.5% to 20% in 2011 with minimal opposition from the general public. Furthermore, the Nordic countries’ high VAT rates—which are among the highest in the wealthy world at 24 or 25%—have historically aided in the pairing of strong market economies with large governments. To finance additional defense, Estonia is increasing its taxes to comparable levels.
The poor spend a larger portion of their income than the rich do, hence the argument against VAT is that it is regressive. However, the benefits of improved public services and faster economic growth are disproportionately felt by the poor. Raising the tax would have an impact on wealthy retirees who spend their fortune and no longer pay labor taxes; in any event, the tax is less regressive when compared to lifetime income as opposed to yearly income. The claim that raising the VAT will result in price increases and increased measured inflation is another reason against doing so. However, inflation has drastically decreased. Increases could have tolerable consequences if they were introduced gradually.
Source: Economist
