Tax increases are not the solution, they are the problem.
Not long ago, Mattias Muckenhuber of the Momentum Institute called for capital and labor income to be taxed equally in an article for Die Presse. Therein, he claims that rich people pay too little tax – and that capital income should therefore be taxed more heavily to achieve equal treatment of income. There are a few things to say in response to this article.
Yes, capital and labor income should be taxed equally. There is little to argue against this from an economic point of view. However, much is to be said against raising the tax burden on capital income.
First of all, it must be clear: Money withdrawn from the private sector is no longer available to the people in the private sector. Therefore, the relevant economic question in taxes is: Can the public sector manage funds better than the private sector? The answer is a twofold no: first, one at the theoretical level, and second, one at the practical level.
On a theoretical level, the public sector lacks a suitable feedback mechanism that could lead it to use its funds as well as possible in terms of the needs of its citizens. Such feedback mechanisms are found everywhere, and in a free market economy, they tend to ensure that the selfishness of individuals serves to increase the prosperity of all. If an entrepreneur does not sufficiently satisfy his customers, he will lose his customers. If an employee does not adequately help his employer, he will lose his job.
The situation is different when the public sector intervenes and unilaterally prescribes monetary payments or “offers” services with compulsory consumption. These feedback mechanisms then no longer function because consensus is usually lacking. In a transaction without agreement as a precondition, it is unclear whether the individuals involved expect their situation to improve. That invalidates precisely the mechanism that leads to the best possible use of resources without public sector intervention.
At the practical level, recent decades show that rising public sector tax and expenditure ratios are not accompanied by increased wealth creation – quite the opposite, as a cross-country comparison shows. The most recent example: the 40 billion euros mentioned in his article as a “decisive response” did not lead Austria’s economy “quickly out of the crisis,” as claimed. Austria ranks 24th among the 27 EU countries in terms of projected economic growth between 2020 and 2023, with only Italy, Portugal, and Spain showing lower growth figures.
Finally, three comments: Even a flat tax ensures that higher earners nominally pay significantly more taxes than average citizens. However, they do not claim benefits in the same proportion. For example, someone who earns ten times as much as the average citizen and thus has to pay ten times as much in taxes under a flat tax does not (usually) claim 10 times as much in public benefits. In fact, in some cases, wealthy people receive fewer public benefits than average citizens. Therefore, those who argue for fairness should think about how it is fair to tax such people disproportionately high through a progressive tax system.
Furthermore, every capital investment is fundamentally associated with the risk of a total loss of the capital invested. In comparison, an employment relationship is generally associated with significantly less risk. The sufficient willingness to take high risks is an essential prerequisite for the further development of an economy, so taking risk into account for tax purposes is not just a question of fairness.
And lastly, from a pragmatic point of view, a higher capital tax would lead to capital not being invested in Austria or moving away. That, in turn, would have a dampening effect on future economic growth. In the extreme case, this could minimize the tax base – meaning high tax rates that no one pays, and therefore lower public revenues than before with lower tax rates. The shot in the knee would thus become a shot in the head.
Therefore: Do not raise the capital tax but lower the income tax. Unless one decides to lock people up to repair the state finances. However, I am sure that no one in Austria intends to build a wall.
Martin Gundinger is a Senior Research Fellow at both the Austrian Economics Center and Friedrich A. v. Hayek Institute.