The Wedge

What are taxes, anyway?

Governments have to collect taxes to pay for their services. They also collect taxes to encourage or discourage various activities. For example, the mortgage interest deduction and homestead property tax exemption are designed to encourage people to own their own homes. Our governments have tax policies that affect our actions.

But taxes also act as a wedge between economic actors, distorting prices and changing behavior in unforeseen ways. For example, a tax on luxury goods has the effect of increasing the price to the consumer (depressing demand) while decreasing the price received by the producer (depressing supply). With lower demand and lower supply, the price stays the same, but less is sold. So governments never get as much in tax revenue as they expect.

When you look for them, there are tax wedges everywhere. Social security taxes are a wedge between workers and their employers. Income taxes create a wedge between the value of someone’s labor and what she receives. Capital gain and dividend taxes are a wedge between what investors earn and how much an investment returns.

The larger the rate, the bigger the wedge. That’s why many see that having a broad tax base and low tax rates as the most effective way to raise money for the government. A lower rate distorts the economy less and provides less drag.

Which raises a question: can you think of a tax that’s not a wedge? I can. I don’t like it. But it may just be the best way to go.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2014-09-05T13:29:54+00:00 October 16th, 2009|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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