Taxes, Comparative Advantages and the Division of Labor – A Ricardian Case Against Taxation

1. Taxes, Comparative Advantages and the Division of Labor –A Ricardian Case Against Taxation by Richard C. B. Johnsson Ph.D. Contact: richard.johnsson@ratio.se The Ratio Institute, Stockholm, Sweden www.ratio.se Personal website: http://home.tiscali.se/amagi/

2. Major ills of the modern welfare state – some facts • Example: Sweden, the welfare state of welfare states • 25 percent of adults don’t work • Home labor hours equal market labor hours • Sizable black market • GDP growth has deteriorated since 1950’s • No jobs has been added to the private sector since 1950 • No company since 1970 has grown big • Prices 30 % above EU average • Tax pressure almost 52% of GDP • whereof 65% from labor taxes, 26% from consumption taxes and 9% capital taxes

3. The Division of labor • Why divide labor? Answer: because time is scarce. • Dividing labor: • raises labor productivity • allows for more knowledge • and machinery • etc • And is the single most important explanation for our standard of living today, as well as for comparisons to the past or less developed countries

4. How labor is divided • But why should people want to specialize in the first place? According to what principle is this made? • Common answer: according to our skills • Correct answer: according to our skills relative to others • This is known as Ricardo’s law of comparative advantages. • It is a well-known principle but for some reason only applied to international trade. As Mises points out, it applies to all levels of society.

5. Ricardo’s principle revisited Table 1 – Time requirements in minutes Table 2 – Relative output

6. Direct implications • Anna fixes more bugs in terms of finished ads than Emma, as 1.125>0,833, while Emma makes more ads in terms of fixed bugs than Anna, as 1,200>0,889. Both persons benefits from trading with each other! • If they fixed 2 bugs and made 2 ads in 390 minutes, by trading they could fix 2,125 bugs and make 2,200 ads if both worked the same amount of time. Labor productivity and overall output would increase! • Despite the absolute disadvatages of low productivity, there is room for everybody in the competition!

7. The division of labor condition For a monetary society, money being a prerequisite for advanced division of labor, Ricardo’s principle boils down to this condition: • Thus, for the division of labor to occur, • the relative income must exceed the relative productivity, • or, equivalently, • the alternative cost of performing a task oneself exceeds the price offered by the other part

8. The Glue of Society The division of labor condition is a condition that explains why people bother dividing labor, at all levels of society. All of us rely on our comparative advantages, and a society cannot exist without an advanced division of labor – it is the glue of society. This in turn makes it immensely important that the condition is fulfilled. If not, we can expect a number of major ills at all levels of society. Let’s focus on labor and consumption taxes and the labor tax wedges.

9. Tax effects on our DOL condition The Tax Factor X tells us how many times more money you have to earn to afford to pay for a service. For example, with a marginal income tax of 55%, value added tax of 25% and a pay-roll tax of 35%, the Tax Factor=3.75. To pay a price of 1 000 kronor, you’d have to earn 3 750 kronor. With such a high Tax Factor, people will find it hard to afford dividing labor. The alternatives seem to be unemployment, home labor, exchange in natura or no production at all.

10. Tax effects on the cost of living The Earnings Requirement tells us how many times more money the buyer needs to earn on a gross basis to be able to pay what the seller requires on a net basis. For example, if both seller and buyer face a marginal income tax of 30%, value added tax of 25% and a pay-roll tax of 35%, the Earnings Requirement=5,81. This is normal in Sweden today. If both face a marginal income tax of 55%, value added tax of 25% and a pay-roll tax of 35%, the Earnings Requirement=14.06 (!!!).

11. Wasting Time • Example with Anna and Emma and : • Absent taxes: • Anna has to work 38 minutes to hire Emma an hour • Emma has to work 1 hour and 36 minutes to hire Anna an hour • Average taxes in the Swedish Welfare state: • Anna has to work 2 hour and 16 minutes minutes to hire Emma an hour • Emma has to work 9 hour and 18 minutes to hire Anna an hour • This explains not only why the dentist can’t afford to hire a carpenter, but also why the carpenter can’t afford going to the dentist. Once again, the alternatives seem to be unemployment, home labor, exchange in natura or no production at all.

12. Restoring the DOL condition In case the condition is not fulfilled, five factors could help restoring it:  (1) The productivity of the less productive individual ↑ (2) The productivity of the more productive individual ↓ (3) The Tax factor ↓ (4) Hourly money income for the more productive ↑ (5) Hourly money income for the less productive ↓ However,  (1) hard for the less productive to increase own productivity by much, especially in manual labor facing the risk of unemployment. (2) the more productive tends to be even more productive in the occupation of the less productive as DOL deteriorates. (3) raising taxes to pay for unemployment or imposing minimum wage laws worsen things, while cutting taxes will help restore the DOL condition (4) somehow raising the income of the more productive not likely. (5) leaving people free to underbid other in terms of money income, only likely way to restore the DOL condition.

13. Concluding remarks • Indeed, the welfare state causes many of the major ills of today! • Cutting taxes would make it possible for more and more people to find and use their comparative advantage, this being especially important for the less productive. It would lead to a higher degree of division of labor and thus raise the productivity of labor. This would make people having more time available for work and leisure. That would involve the great outcome of being able to work less and still produce more. • A simple, generally accepted idea about Ricardian comparative advantages as an argument against taxation, fully compatible and implicit in Austrian thought