In our discussion we will take premiums as part of taxes in so far as it is economically relevant to do so. This may need some clarification.
Premiums for old age, sickness, disability, unemployment and the like are often regarded as insurances, and studied separately. In the practical situation of empirical economies these provisions are often indeed administered by separate institutions called ‘insurance companies’. And there indeed exists the possibility to apply the mathematics and economics of insurance to these topics. However, that these provisions are called ‘insurance’ should not cause us to regard them as only such. Part of these so-called insurances are provisions for the efficiency of the labour market.
To understand this, let us take the case of a low wage labourer. Suppose that he would have to pay such an amount of premiums, for only a limited package of insurance, that his net wage would make him eligible for benefits, or his gross wage would make him unemployed so that he also gets a benefit. Once he relies on benefits, the mentioned insurances are provided for him for free.
This thus shows the structural identity of the problem of exemption in ‘insurance’ with the problem of exemption in taxation. Hence, on economic grounds, insurances here are lumped together with taxes, in so far as they are provisions for the well functioning of the labour market.
Note too that governments would be wise to follow a ‘basic insurance policy’ which holds that workers can be insured up to a basic level but without payment of premiums. This reminds of the ‘basic income argument’, but only applies to the mentioned premiums. Similarly poor people exempt from taxation receive public goods, without paying for them.
Common structure
Most developed nations have nonproportional taxes, i.e. tax codes with an exemption at the threshold and then a (rising) statutory marginal rate. The latter parameters in fact concern the intercept and the slope of the tax function. There is also a remarkable similarity in the policy regarding these two parameters (or sets of parameters), see OECD (1986):
· The policy feature concerning the intercept or exemption.
Exemption generally is low, also with respect to social insurance.
Tax parameters, and notably exemption, are generally indexed on inflation. Since incomes tend to grow faster than inflation, exemption lags behind incomes. There is a deliberate tax creep - measured by the ‘macroeconomic progression factor’.
· The policy feature concerning the slope or the statutory marginal rate.
Both in theory and public discussion there is a consideration that high marginal rates have disincentive effects. This has resulted in the policy objective to reduce marginal rates. One way to reduce marginal rates has been the switch from income tax to VAT.
Given the common notion of budget neutrality, these two features in policy tend to complement each other. Budget neutrality requires that the revenue loss due to slope reduction is compensated for by other proceeds. These other proceeds will often come from the tax creep and the reduction of exemption. At least, it is often thought that the reduction of exemption generates additional revenue. This, however, turns out to be a wrong assumption.