Is there a direct correlation between the amount of state expenditures and the rate of economic growth? The answer is a definite “yes,” according to the conclusion drawn by the Institute of Economic Affairs (IEA) of Great Britain after sixty years of observing how those two indicators fluctuate in twenty-four countries. Every one-percentage increase in state expenditure against the Gross Domestic Product (GDP) slows down economic growth by 0.1 percent on average. In other words, the more a state spends, the slower the economy grows. And vice versa – the less a state takes money away from the economy, the higher the income per capita growth.
Taking into account that the IEA study was mainly conducted in developed economies, it is easy to surmise that the economic growth rate in Georgia would be much higher per each one-percentage decrease of public expenditure against the GDP.
Several years ago, Georgia started implementing changes in the tax structure, along with other reforms. The country at that time significantly reduced not only the number of different taxes, but also the rates of those taxes remaining in force. The changes produced tangible results: Within seven years or so after these changes were implemented, the country’s economy trebled from GEL 8 billion to GEL 24 billion. Public revenues increased as well – from GEL 800 million to GEL 8 billion. Those are not figures extrapolated from a study conducted somewhere else by someone else. That is what we have seen happen before our very eyes in the past seven to eight years.
The reason why decreasing public expenditures contributes to economic growth is easy to explain: When we pay fewer taxes as citizens, we have more money to spend as consumers. We enjoy broader freedom to choose among a wider variety of products and services and to buy more of the products and services we want. Through a complex market pricing system, we send signals about what commodities we want in greater amounts, which of them meet our current demands, which suit our tastes. Those signals tell producers what commodities to produce and in what amounts. If we decide to save some of our earned income, the increase in bank deposits means that the value of money (interest rate) offered by banks will go down. That, in turn, enables businesses to start new projects they would not otherwise be able to implement because of the high value of money. With a lower interest rate, more citizens will be able to take out consumer or mortgage loans. That way and only that way the economy grows.
Paying high taxes restricts our freedom. With less money, we have fewer choices and can buy fewer products. The choice of how to spend our money is not left up to us; instead the choice is made on our behalf by bureaucrats who spend our money in accordance with their own priorities. That is where the problem arises. When we spend our own money, we are focused on obtaining the product we want of the quality we like. When a bureaucrat spends someone else’s money, the bureaucrat is simply not driven by such interests. How can a public servant identify what we want? Given that values and interests differ from individual to individual and change on a daily basis, it is impossible for any group of bureaucrats to identify our specific demands at a specific moment of time. Only the free market can do that.
When the government several years ago decreased the number of taxes and their rates, the government made a pledge that it would further decrease the income tax rate. It was supposed to decrease eventually to fifteen percent. Delivery of that promise was postponed because of the August 2008 war and the world financial crisis. We thought the delay would be only temporary. On 22 May 2012, however, we learned that we must abandon altogether any hope of seeing a decrease in the income tax rate.
A new initiative of the government, which was approved by the Parliament on its first reading, establishes a supposedly “voluntary” tax scheme beginning this year. Taxpayers will have the option of paying eighteen percent of the twenty-percent income tax to the state budget and transferring the remaining two percent into their individual savings accounts. If a taxpayer decides not to exercise that option, that “extra” two-percent of the income tax will end up going to the state, not to the taxpayer. To manage amounts accumulated on individual savings accounts, the government plans to set up special assets-management private companies, which will use our money in a way that will profit them and accrue some profit for us too. But what is most interesting is that this new initiative has been marketed by the government as a way of giving taxpayers the freedom of choice.
Why is the tax initiative problematic?
The main problem with the new initiative is that it signifies an unpredictable tax environment. We promised investors long ago that we would reduce income taxes. Today, we apparently no longer have any desire to do so. Such inconsistency of action creates uncertainty and the fear that tomorrow we may do worse. Investors, whose capital inflows fuel economic activity as well as the rate of employment, make estimations, often over many years. If they are told to expect that taxes will decrease, they have the right to expect that will happen. Otherwise, trust in our economic environment will diminish, resulting in less investment and lower economic growth.
The proposed system is not voluntary. Citizens have two alternatives, neither of which gives them the right to take home that ostensible two-percent tax reduction. Citizens are not given any ownership right for at least fifteen years (if they transfer the money to individual savings accounts) or ever (if the state keeps it). Naturally, the majority of citizens will direct that two percent toward individual savings accounts. But that is not a matter of choice; it is a matter of the state leaving them with no other choice. State bureaucrats paternalistically tell us: “You do not know how to spend that two percent and, therefore, we will take it, let it accumulate and give it to those who know how to profit from that money.”
If the aim of the initiative is to ensure that we are not left indigent in our old age, then it is inefficient and unfair. It is not the business of the state to tell us that we are better off waiting to receive income in our old age. Were we allowed to use that two percent at our discretion now, we could better prepare for the future ourselves. We could transfer that money to a private insurance company or invest it in real estate which we could rent in our old age. We could even use it to finance our children’s education in the hope that they will become financially secure and maintain us in our old age. It is far less credible to proffer that state bureaucrats are more concerned about our old age than we are.
It is incomprehensible why we should entrust our money to artificially established private entities. Financial institutions already exist and, if interest rates on deposits offered by those banks prove attractive to citizens, they can deposit their own money anyway.
When citizens voluntarily entrust their money to financial institutions that means they deem that to be an advantageous alternative. When citizens are forced by the state to entrust money to some artificially created joint stock company, that means that citizens with other priorities have no way left but to act contrary to their own best interests. And why should anyone believe that newly established structures are better able to handle our money than, say, existing banks? What happens if they go bankrupt? What will happen then? If some people end up getting arrested for, say, bank robbery, will anyone return their money?
If these new private entities are only now being planned, that has to mean there is simply no demand for such a service. What guarantee will there be that these entities established to manage our money (approximately GEL 160 million, considering 2012 budget parameters and assuming that every citizen will opt to transfer two percent of their incomes to individual savings accounts) will not be the result of a corrupt deal? Acquiring more money through the use of money is a business. And that business must be undertaken by private entrepreneurs with their own money, not by a private entrepreneur selected by a few bureaucrats to handle our money.
This new initiative is detrimental to the national economy and to us individually. We should have decreased the income tax rate to fifteen percent, as promised. That would have left more money to the private sector (our pockets) and would have supported faster economic growth. It also would have reassured investors that we deliver on our promise. It is the fulfillment of promises upon which Western civilization rests.
This article first appeared in
Tabula Georgian Issue # 102,
published 28 May 2012.