Taxes, Comparative Advantages and the Division of Labor

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

• by Richard C. B. Johnsson
• Ph.D.
• Contact
• richard.johnsson_at_ratio.se
• The Ratio Institute, Stockholm, Sweden
• www.ratio.se
• Personal website http//home.tiscali.se/amagi/

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Major ills of the modern welfare state some
facts

• Example Sweden, the welfare state of welfare
  states
• 25 percent of adults dont work
• Home labor hours equal market labor hours
• Sizable black market
• GDP growth has deteriorated since 1950s
• 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

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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

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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 Ricardos 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.

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Ricardos principle revisited
Table 1 Time requirements in minutes
Anna Emma
Consulting (1 bug) takes 90 minutes 100 minutes
Marketing (1 ad) takes 80 minutes 120 minutes
Table 2 Relative output
Anna Emma
Consulting (1 bug) equals 0,125 ads 0,833 ads
Marketing (1 ad) equals 0,889 bugs 1,200 bugs
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Direct implications

• Anna fixes more bugs in terms of finished ads
  than Emma, as 1.125gt0,833, while Emma makes more
  ads in terms of fixed bugs than Anna, as
  1,200gt0,889. 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!

 
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The division of labor condition
For a monetary society, money being a
prerequisite for advanced division of labor,
Ricardos 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

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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. Lets focus
on labor and consumption taxes and the labor tax
wedges.
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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 Factor3.75. To pay a price of 1
000 kronor, youd 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.
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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 Requirement5,81. 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 Requirement14.06 (!!!).
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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 cant
  afford to hire a carpenter, but also why the
  carpenter cant afford going to the dentist. Once
  again, the alternatives seem to be unemployment,
  home labor, exchange in natura or no production
  at all.

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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.
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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