When income taxation works and does not work

The flagship of taxation is income tax. Many modern countries obtain quite an important part of their budget from it. It is a very costly form of taxation, however. That is probably why it was only introduced in the 20th century. It requires:

  • a population registry, recording births and deaths
  • a population address registry, recording every house move of the tax subjects
  • a postal office capable of delivering tax returns to every tax subject
  • an enormous administration collecting and following up on delinquent payments

Few countries, even rich ones, are able to maintain an accurate population address registry.

In practice, income tax only works if a large proportion of the population is employed by a relatively small number of employers who collect income taxes at the source. Before paying their employees, employers withhold an estimated amount of income tax out of their wages.

In a subsistence farming economy, most people are self-employed. In such case, there is no employer who can withhold income taxes before the subsistence farmer receives his income. Collecting after the fact is hard and generally leads to delinquency on income tax. That is why income tax did not exist in the farming economy that existed before the 20th century in rich countries.

In rich countries, the industrial economy with its large employers employing the majority of the population, is gone now. In other words, the true taxation basis for income tax has largely disappeared.

In developing countries, the vast majority of the population are not employees. With the industrial economy gone even in rich countries, they will probably never be. In other words, there may never be a taxation basis for income tax in developing countries.

Industrial production gave rise to large production facilities with a large number of workers. Due to automation, most of these workers are gone now. In non-industrial production, there are usually no good reasons for large employers to emerge. In fact, large employers tend to be uncompetitive if only because they get pushed into the role of tax collectors.

The trend for new companies, such as Uber, is rather to hire self-employed contractors instead of employees. This means that the taxation basis for income tax has an undeniable propensity to implode. Furthermore, it is not possible to artificially create large employers just to keep taxation going. It is technology that dictates what kind of companies will emerge in the future. Politics may defeat the market, but technology always defeats politics.

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