Tax and spend: in the balance?

11 Mar 14
Ian Ball

There have been suggestions that the power to tax could be ‘offset’ against negative net assets on a government's balance sheet. But this would only be appropriate if future obligations to spend were similarly viewed as a ‘liability’

In the words of Jean Baptiste Colbert, the French minister of finance in the 17th Century, the art of taxation ‘consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing’.

This quote came to mind recently when I heard a finance official explain that the negative net assets on his government’s balance sheet should be understood in the context that the power to tax was not reported as an asset. The implication was that if the power to tax were put on the balance sheet, all would be well.

So should the power to tax be seen as an offset to negative net worth on a government’s balance sheet? Most countries, when first moving to report on an accrual basis, have negative net worth. Most also remain in this position, even, perhaps surprisingly, those that do not include their public service pension obligations as a liability.

Implicit in the analogy of plucking geese are two things. First, that the aim of a government is to extract as much tax as it is able to – that it will not voluntarily tax at a rate markedly lower than it is able to sustain. Second, that the rate of extraction has some limits – the hissing.  In other words, there are both political and economic constraints on a government’s capacity to raise tax.

Political constraints also apply on the expenditure side of the equation – to meeting the government’s policy obligations. Governments can reduce spending only to a certain point without also inducing an unacceptable volume of hissing. So, in any given year, a government raises taxes to fund its policy obligations, but must operate within its tolerance for hissing from both taxpayers and recipients of government services.

What we have seen over recent years (and decades for some countries) is that the hissing from taxpayers will not allow the policy obligations to be met without borrowing, ie the government runs a deficit. Assuming that a government would prefer to at least break even, a string of deficits, especially ones creating debt obligations in excess of the Maastricht limit, implies that the limits of tax-raising powers have been reached, at least within the health and safety limits that apply to the volume of hissing.

So, while the power to tax may not be on the balance sheet, neither are the obligations to spend. If one were to include both, what would be the result?

On the basis that the recent past is the best indicator of the future, we would include on the balance sheet the present value of future tax revenues as an asset, and the present value of the (generally larger) expenditure obligations as a liability.

If both these flows are capitalised, and brought onto the balance sheet, the net result would be a large increase in the negative net worth number for countries habitually running a deficit. And if the ageing populations in many developed countries, with generous pension schemes, were also taken account, the negative number would be even larger.

So to see the power to tax as an asset that in some way counteracts negative net worth on a government’s balance sheet is to see only half the picture. View the whole picture and it is no comfort at all, quite the contrary.

  • Ian Ball
    Ian Ball

    Professor of Public Financial Management at Victoria University of Wellington and emeritus chair of CIPFA International

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