How governments can (and why they should) ensure right use of taxes

I don’t like paying taxes

I have a confession to make: I don’t really like paying taxes. And I’m certain I’m not the only one. Each month, when my pay check arrives, I notice the difference between my gross and net salary. Living in Belgium, known for its elevated taxes, should have made me aware of and used to this. It did, but it also made me very aware of the use that is being made of the money I don’t get to spend.

Governments should create an equitable social environment

So, let’s return to why don’t I like paying taxes. Does it imply I believe in the “everyone for themselves” philosophy I see returning in force in certain countries? On the contrary. It is one of my most deeply held beliefs that as human beings, we have a responsibility to support the creation of an environment in which each of us has both the liberty and the ability to develop ourselves to the optimum of our abilities. I’m convinced that such a optimization will benefit all of us. I’m also aware that such an optimization is anything but simple. But I think that a just and correct contribution by each of us, to the extend of our capacity, to a set of common needs and finalities can be a mechanism to bring that optimum one step closer. And the best system we currently have to make this happen is taxation and redistribution according to certain policies and rules.

Two types of intervention

But how do we currently go about taxation and redistribution? When governments assist in creating an environment, any kind of environment which is different from the current environment, they redistribute their potential income which they receive under the form of taxes. They can do so by direct or indirect intervention.

  • Direct intervention entails allocating budgetary means – their actual income in the form of collected taxpayers’ money – to a certain end. Usually, money flows to a person or organisation with a certain end in mind, in order to do something, and the money is given under specific conditions. This direct intervention, which requires specific government activities, is often called a subsidy.
  • Indirect intervention occurs when government decides to forego tax income in order to stimulate behaviour. It does not redirect means it has already collected, but it decides not to collect taxes on certain potentially taxable activities in order to stimulate those activities, in effect creating tax exemptions. Money does not pass directly through the government but its decision to exempt a specific use from taxes creates a certain – ideally desired – effect.

Interventions aimed at redistribution should be both effective and efficient

As a tax payer, I want a reasonable assurance such a redistribution occurs in the most effective and efficient way possible. In this context, effective redistribution is redistribution that reaches the right people at the right moment and allows them to use it for the right purpose. Efficient redistribution ensures that entire mechanism works at optimal cost, balancing cost of managing the system with required functionalities of such a system.

The main structures that manage such a redistribution are, in the case of Belgium and most of Europe, our (multiple layers of) government. And what I am looking for, as a tax payer and concerned citizen, are adequate assurances that the taxes I pay are at least put to the right use.

Types of redistribution

Governments have tested many different ways of redistributing wealth in order to create an environment in which each of us has the liberty and the ability to develop ourselves.

  • The most traditional way of redistribution has been redistribution in kind. This has been going on since before the Middle Ages. If the ruler wanted to keep his people alive in order for them to keep giving him (part of) what they produced, he had to feed his people, which often meant he had to redistribute food. While it appeared to function for a long time, there are significant problems with this mechanism, problems we see reoccurring time and again today when we are looking at disaster relief challenges. In addition to risk of theft and fraudulent use, the cost of the entire logistical chain in a more complex environment is prohibitive. Hence, while this approach may be effective, it is far from efficient.
  • A redistribution mechanism that is currently gaining a lot of attention is the direct redistribution of cash. While the logistical challenges are of course significantly less, right use can often no longer be guaranteed. Cash can easily be repurposed for other ends than the intended one, with little or no trace. While this approach may be efficient, it is far from effective. Must reads about direct cash redistribution in the context of development aid are studies that measure the effects of distribution of cash to husbands or wives in a household. Enlightening to say the least.

But to return to the subject at hand, we’re looking for a mechanism that allows for the correct distribution of the correct levels of support to the correct people while ensuring correct use. You may note I’m already compromising here: I’m not asking for best possible use. But “best possible” is a matter of opinion. The best possible use according to me is likely to be different than the best possible use according to you. But we can agree, or at least create a set of specific legal frameworks around what we want taxes to be used for. As a tax payer, at least I want to know that the intention, the distribution and the follow-up of results has been assured with respect to the use of my money.

Just redistribution requirements

But how can we assure such a effective and efficient redistribution? How can we achieve that so called “right use”, redistribution of the right amounts to the right people for right use, at an optimal cost? These systems exist, and they are called voucher systems. Let’s examine the stated goals and how these systems respond in a bit more detail:

  1. Redistribution of the right amounts: as vouchers have standard face values, ensuring every entitled person gets what she or he has a right to becomes a lot easier than in a redistribution in kind scenario. As long as the redistribution criteria are well established, and the information about potential beneficiaries is accessible (in a GDPR compliant manner) a voucher system can automatically allocate the right amounts based on the available profiles.
  2. Redistribution to the right people: the redistribution needs to reach the right people. If key information about the potential beneficiaries can be consulted (even through a simple yes/no check of a certain status in an otherwise well protected database of personal information), the redistribution can go to all the right people and only the right people. By putting this in a system and not making it dependent on the decision of people, and subject to the correct definition of the redistribution rules in a legal and a systems framework (rules engine) we can eliminate as many type 1 (false positives) and type 2 (false negatives) errors as possible.
  3. Redistribution for the right use: But even getting the right amounts to the right people does not ensure right use. This is were vouchers and voucher networks come in: by limiting use of the vouchers to a certain subset of utilisations (for example limitation of merchants where vouchers can be used) and even limit use with these merchants to certain products, we can ensure that the redistribution of income will be used for its intended purpose, and we can start tracking the effectiveness of a redistribution measure.

Vouchers are – with a few exceptions – no longer the paper, unwieldy things of the past. A largely dematerialized tool, such a system allows for a flexible allocation of advantages to specific people, even up to the individual level.

The UK, for example, has a voucher system underlying its support to asylum seekers in which the profile of the asylum seeker determines her or his available support which can be accessed through a card system. Depending on the profile, some of them have the right to a cash advance, some of them do not. They can go and shop, but they cannot necessarily purchase everything which such a shop may offer with the non-cashable part of their allowance.

Actors in the redistribution activity

Let’s examine a simple subsidy system. There are in essence four actors: the parties contributing to the budget, the government redistributing the budget, the beneficiaries and the party managing the transaction. Let’s examine the objectives of each, in case they would act as rational actors.

The contributing parties, the tax payers, would like their taxation to be the lowest possible. Ideally, they have a secondary objective, which is appropriate use of the taxes, but that in itself is a tax minimization objective: the better taxes are used, the less of them are required, the lower the taxation can be. A few of the tax payers will want to avoid taxation altogether, by either tax avoidance or tax fraud.

The beneficiaries, on the other hand, would like their benefit to be as high as possible. They want as much as possible of the available budgets, in order to more easily achieve their objectives. A few of the beneficiaries may want to use the subsidies received for edge purposes, which do not entirely enter within the initial scope of the subsidy.

The government consists of two entities: the political level and the administration. The political level has differing objectives, depending on the constituency the politicians serve. They may even have multiple conflicting objectives. They want to keep taxes as low as possible while serving as many beneficiaries as possible while keeping the administration happy. The administration should mainly be focused on developing long term thinking as to their scope … but as social employment is another, sometimes not explicitly stated objective, they want to ensure people working for the administration have work to do as well.

Before we discuss the issuer objectives, let’s take stock for a minute. Tax payers want to pay as little taxes as possible. Beneficiaries want to receive as many benefits as possible. The government wants to support everyone, including their own workers. Within this system, the balance depends entirely on the not necessarily stable balance of power between these actors. In addition, there is no sure system of objective accountability which is beyond reproach.

The added value of the issuer

So let’s look at the issuer’s objectives. As the provider of the subsidy management and clearance system, an issuer is compensated in principle on a per transaction or per voucher basis. As a rational actor, his optimization is an optimization in which the system runs for the lowest possible cost. At the same time, he is being held accountable by the three other actors, each pulling in their direction with contrary objectives, to make the system work in the best possible manner. In other words, for the issuer the optimal point is an optimization aimed at both effectiveness and efficiency. In addition, as the issuer has no other agenda than to make the system work (because if it works there are few incidents and hence the additional costs are lowest), he is the sole party that, supported by good business intelligence systems, could provide objective insights on the overall effectiveness of the subsidies. As such, an issuer can provide the necessary accountability.

As to oversight on the issuer, I’ve mentioned it exists on multiple levels:

  • Beneficiaries often know their rights very well, and are attentive to any subsidy amounts not accurately received on time;
  • As an outsourced activity by government, government usually executes detailed oversight;
  • Government also often imposes service level agreements it could not necessarily impose on own personnel;
  • Finally, tax payers are likely to consider known issues at the level of the issuer as a waste of tax payers’ money, and would react quickly.

Alignment with the broader philisophical dimension

And overall, using dematerialized voucher systems to calibrate a social environment in which we as a society can thrive makes sense from a philosophical standpoint as well. As Dirk Verhofstadt states in his excellent treatise “Bases of liberal thought” (Grondslagen van het liberalisme) (translation to English by me, al translation faults are mine)

“Freedom is an empty concept if one does not have access to the means and the structures to make this freedom effective.”

That line clearly charges an actor, any actor, with ensuring that both means and structures exist to support freedom. This aligns with the obligation to create an equitable environment which I referred to above. Further, Verhofstadt states:

“A society which cannot guarantee a baseline level of these rights and liberties to all of its citizens, fails those citizens and is not an entirely just society.”

Hence the actor that should make sure this happens, is society as a whole. But who is to act on behalf of society? Verhofstadt explains this a few pages later with:

“At the economic level, liberalism pleads for free initiative, personal ownership, free trade and free competition. Social and economic freedom end however where they impede the freedom and the development of another (…) Essential to liberalism is the just functioning of democracy and market economy and the correction of its harshest effects, if need be by government intervention.”

Which could be interpreted as a clear role for the government in the development of this just society. And it is indeed government that employs the redistribution of taxes, directly or indirectly, as a tool to mitigate these “harshest effects”. But should government do all the work? Not quite, because Verhofstadt follows with:

“The government should not itself become an economic actor, with the exception of establishing and maintaining those state structures that, while they contribute in the best possible way in a positive manner to the most just society, are of such nature that the benefits will never outweigh the costs they represent for one or a few people en which cannot be expected to be established or maintained by one person or a small group of people.”

Hence, the only situation in which a subsidy system should be internalized by the government is when it can be maintained in an as effective and efficient manner it would be maintained by a private actor at a lower cost than the private actor could ever provide.

In conclusion

As a tax payer, I hold the government accountable for the right use of my taxes paid. I want my taxes to be used effectively and efficiently, and I have a right to accountability about that use. I also want my government to use those taxes in the best possible way to enhance our society. Part of that enhancement is redistribution to create an environment that supports rights and opportunities for all citizens. But that responsibility also needs to happen in both an efficient and effective manner. When government allocates part of its resources received or foregoes those resources in order to get a specific result, I want accountability as to that result. Dematerialized voucher systems are an effective and efficient means to that end.