Sunday, October 09, 2005

Costs of Taxation

The Adam Smith Institute blog had an entry this past week entitled, "Adam Smith and Taxes." The author made a good observation, noting that, "When work is taxed, people work less. They take fewer risks, because the risk/reward balance deteriorates – which means less innovation for the society. And they learn less, because we learn by doing things, so society's knowledge advances more slowly too."

People often forget that taxation discourages work and innovation. Of course people will still be productive to some extent; however, it will not be to the same extent that they would have been otherwise.

I generally consider myself a 'risk-neutral' person. I take risks when I feel my expected return (the return that takes into account risk) is greater than it would be in comparison to my available alternatives. Let's suppose I have an invention which I believe may benefit mankind immensely, and benefit my bank account immensely as well. Without taxes, I estimate my return at $100 million. With taxes, I might estimate my return to be $70 million. However, my risk has not changed from the $100 million estimate to the $70 million estimate. Although my invention may benefit mankind, I am less likely to undertake it when the expected return is lower. I may choose to enjoy my leisure time or to invest elsewhere instead of deciding to develop my great invention.

Taxation may pay for services that we consider to be in our interest, but they do so at the expense of goods and services that might have existed in their absence. These costs remain unseen to both the politician and the taxpayer.

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