The Sweet Spot for Taxes

A blogger called evilgenius has this graph of prices versus revenues for ebooks:

Sweet Spot Pricing
Price versus Revenue Showing Sweet Spot

In this graph, the sweet spot price point is between $3 and $4. Graphs like this are commonly shown to marketing students because these illustrate very clearly that as you increase the price of a commodity, after a certain price point your revenues will decrease instead of increase.

Now hold this graph in your mind as we shift the topic to tax collection.

In a free country such as Pinas, tax collection is enforced but punishment for non-payment does not necessarily lead to imprisonment. In most cases punishment can mean fines, and in extreme cases garnishment of wages. There are many ways for an individual to reduce the tax burden, and in a lot of cases even escape this responsibility altogether. Revenues from tax collection can depend on the aggressiveness by which tax collectors approach their job. However, the same can be said of the salesmen selling products to earn revenues on behalf of their organizations.

In my view, there’s not much difference between government revenues and corporate revenues in terms of marketing versus collection. In a very major sense, the government is selling a “product”, much like marketers. What is the product? It is intangible, in the way that “insurance protection” is intangible. The term I have heard or read as the “product” of government is “legitimacy” or simply “being legal”. In the most negative sense, this kind of product is very much akin to any protection racket perpetrated by a gang on some locality: “we will not bother your store as long as you pay us only one-hundred pesos a month”. The difference is that we ourselves have pre-ordained that the government protect us and the protection is meant to be real: we should be protected even from the government itself.

And so, if you agree that “legitimacy” is just a form of product or service that we pay for by way of taxes (laying aside the caveat that this “product” is very different from those we ordinarily regard as products), it should be not much stretch of the imagination to relate the price/revenue curve to the price of legitimacy and tax revenue. Raising the price of legitimacy raises revenue, but only up to a certain point. Raising the price beyond the sweet spot LOWERS revenue instead of increasing it.

This is now a truism that many countries have applied the price/revenue curve in the calculation of taxes. In practically every case, whenever the tax rates were lowered, revenues went up. In modern economies like the U.S., there are those that still argue for higher taxes to increase revenues, but most economists can readily concede that there is a sweet spot for tax rates. It works in modern economies because, by lowering tax rates, what the government has done is simply allow both individuals and corporations to decide what to do with the extra money not paid to taxes. That part of the nation’s wealth freed from the tax collector will eventually contribute to the economy, no matter what the individuals or corporations decide to do with it. This increases business activity (more hiring, more products produced, more products sold) and thereby increases government revenue. It is not intuitive, and some politicians still hark to the “loss” from revenues due to lowering of taxes, but the graph above illustrates the phenomenon really well: by lowering prices, you increase your sales, thereby increasing revenue.

In backward economies like in Pinas, the effect of lowering of taxes can be even more pronounced, and the sweet spot is skewed to the left. Why so? Let’s examine a hypothetical case. If I want my sale transactions to be legitimate, I would pay the 12% EVAT tax for each such transaction. But I can choose otherwise, opening myself up to the risk of hefty fines over and above the EVAT tax. For my line of work, which is selling my software services to medical clinics, this is too much risk compared to the price, so let’s say I choose to pay 12%. I tell my clients that my price includes the EVAT tax. Most of them would try to negotiate the 12% away; but I’m the one taking the risk. I would insist that 12% be added to my price to pay for EVAT, unless I can make a deal with some tax collector. I can agree to carry the price of legitimacy if I can find a Bureau of Internal Revenue (BIR) officer who can help me get legitimacy for 6% instead of 12%. Most likely I can find such BIR officer, and most likely he would pocket the 6% instead of reporting it as revenue.

Now let’s imagine that, by some stupendous luck, our lawmaking body somehow decides to lower the EVAT to say, 8%. At this tax rate, I would not hesitate to pay for it, and I can even afford to insist on my clients that it is not negotiable. Most other small businesses would probably do the same, and for all of us that do, think of what would happen: the government is now earning 8% of our transactions instead of earning zero revenues when the tax collector took 6% for himself. Not all small businessmen would do the same, of course, by force of habit, but sooner or later they too will see that the price of “high-quality” legitimacy at 8% is really better than the price of dubious legitimacy at 6% (the price paid to the corrupt tax collector).

Now some smart politicians are suggesting that we RAISE the EVAT to 14%. At this price, I would definitely look for that BIR officer who “understands” the plight of small businessmen like me. Raising the EVAT to 14% would most certainly make a lot of BIR officers rich, at the expense of government.

About these ads

About ctapang

I am a Software Design Engineer. I live in Wenatchee, Washington, a city in Eastern Washington which I call the Bitcoin Mining Capital of the world. Aside from my work on crypto-coin mining, I am also involved in a movement (http://correctphilippines.org) to correct our constitution. It's an ambitious undertaking in itself, and there's no guarantee that improving our constitution will improve things. However, one thing is certain: if we don't establish a rational constitution, we will continue on our path of self-destruction. What kind of government is best? For me the best government is that which governs the least. We need the government not because it can provide for us but because it keeps us from running into each other. The proper function of government is that of a traffic light: it prevents us from bumping each other, but it does not tell us where to go.
This entry was posted in News and politics. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s