If you cut taxes and this causes an economic boom, is that proof that low taxes are good for the economic health of an economy?
A company could cut all investment in product development and see bigger profits in the short term. They could cut down on maintenance of equipment and see even more profits in the short term.
A country works much the same. Many of the expenses of a country have significant long term effects. A country could slice taxes considerably by stop spending money on roads, schools, health care, unemployment benefits etc. It is quite possible for this to cause an economic boom as people suddenly have a lot more money to spend. To add to the effect one could run big deficits.
Of course in the long term such behavior would stunt the growth of a company as well as a country. Without investment in product development, the competition will eventually outcompete and outsell you. Without maintenance equipment will break down and need expensive replacements.
Likewise a country will eventually suffer economically from crumbling infrastructure as business will get increased transport costs and poorer access to customers. Without schools churning out an educated population, companies will struggle to hire the people they need and youth will struggle to find a job.
Hence any economic boom experienced from low taxes risks happening at the expense of short term economic growth.
Getting It Just Right
The conclusion should of course not be that higher taxes means, higher long term growth. Again we can compare with a company. One might invest so much in product development that the company goes bankrupt. Moore’s law is an illustration of this idea. It was never really a law to predict how much better microchips intel could make, but rather a prediction of what was a sensible pace of development from an economic point of view.
While there was often a possibility to improve chips more that Moore’s law predicted, that would have created chips too expensive to sell in the market. The trick is hence to get the rate of improvement just right.
And so it is with taxes. It is about getting the tax rate just right. But this is not a single number for all eternity. The number will always be affected by changes in technology and market preferences.
The Inevitable Increase In Taxation
Most countries have e.g. determined, that there must be a major government component to health care, education and retirement. That means if demand or relative cost of these services go up, taxes must necessarily follow.
We are able to improve efficiency of production of smart phones, furniture, cars, fridges, toys etc fast because such production can be automated in factories. Health care, education and retirement services does not see similar types of dramatic efficiency gains over time. The number of teachers needed to teach a group of people has not really dropped since the inception of public education. While technology has certainly aided us, it has not translated into a need for a smaller educator workforce, the same way as the number of steel workers or auto workers have been reduced.
There is also the problem that you can give a human a tool to perform his work 100 times faster, but you can’t provide a human a tool which allows him to learn new things 100 times faster. The speed of learning is hard to improve significantly. We are not able to change the workings of the human brain.
Thus we have a difference in potential for efficiency gains in different sectors of the economy. Those services which do not easily afford automation will see a relative price increase.
Often these are the very services we tend to demand more of as we get richer. People who are materially well off care less for eating more food, having more smart phones, flat screen TVs or cars. Rather they want better health care and education for themselves and their family.
That means a relative increase in expenses on these services. If these services were offered in a free market, you would spend an increasing share of your income on buying these services.
However most countries have deemed tax financed solutions to these services most cost effective. Consequently in most rich countries citizens will experience a increase in taxation level to cover the increased demand for health care, education, retirement benefits etc.