This blog post examines why efficiency becomes an issue when the government pursues economic equity, weighs the balance between these two values amid debates over taxation, redistribution, and tax cuts, and summarizes their economic implications.
The Economic Implications of Government Policy
The market economy system is fundamentally an economic system capable of achieving a significant level of efficiency even without government intervention. However, market economies do not always achieve efficiency, and when efficiency is hindered, government intervention is necessary to compensate. Therefore, even in a market economy, the government must play a crucial role across the entire economy. Furthermore, achieving economic equity alongside efficiency, and managing to prevent inequality from becoming excessively severe, is also one of the core roles the government must undertake.
This chapter places the government at the center of the economy and examines the functions and roles it performs. Through this, we will explore taxes and inequality, along with several key economic policy issues. These issues are closely tied to the long-standing debate between efficiency and equity, and readers should bear in mind that interpretations may vary significantly depending on individual values or beliefs.
Do we really have to pay taxes?
In modern society, the roles performed by the government are vast. However, from an economic perspective, the government’s functions can be broadly categorized into two main areas: efficiency and equity. Through appropriate policy implementation, the government can enhance efficiency on one hand and improve equity on the other. However, to fulfill these roles, the government requires financial resources, and taxes are the core source of these funds.
How can efficiency be improved?
Efficiency can be understood as raising the aggregate economic standard of living for citizens. Quantitatively, this means increasing the Gross Domestic Product (GDP). The market economy system, which forms the backbone of the modern economy, freely trades and distributes goods and services through the market. The market economy, where transactions occur based on prices formed by the meeting of supply and demand, has been sufficiently proven to generate very high efficiency both theoretically and historically.
However, for the market economy to fully realize efficiency, several crucial prerequisites must be met. If these conditions are not satisfied, the market economy itself suffers efficiency losses. The efficiency of the market economy is maximized in perfectly competitive markets, which are possible when numerous small firms compete. Yet, due to the nature of modern industry, monopolistic structures are increasingly prevalent, and it is becoming ever more difficult to find industries that meet the strict conditions of perfect competition.
Furthermore, market efficiency is not achieved when the production, consumption, or distribution of goods and services causes harm or benefits to third parties not directly involved in the process. Economics refers to this as an external effect. While profits and losses arising from transactions between producers and consumers are reflected in prices and transaction volumes, satisfying efficiency, external effects are not reflected in these transactions, leading to inefficiency. Environmental pollution is a prime example.
Such problems that the market economy cannot solve on its own lead to what is called market failure. In these situations, government intervention is necessary. The government can mitigate or solve problems by prohibiting or supervising certain activities, or by imposing taxes or providing subsidies for others. Of course, there are also cases where government intervention actually worsens the problem. However, simply leaving everything to the market and standing by is also not a desirable choice.
How can we enhance equity?
Equity is directly linked to the issue of distribution. Perceptions of equity inevitably vary from person to person. Many people believe it is fair for those who work harder and achieve better results to receive greater rewards, and feel that distributing everything equally among all citizens is actually unfair.
However, the accumulation of wealth cannot be explained by individual effort alone. Various factors interact, such as family background—including parental ability and wealth—and unexpected luck. One might gain significant wealth through a sudden surge in the value of held stocks or virtual assets, or face severe job shortages due to an economic downturn despite diligent job-seeking efforts. Recent research indicates that grit—the perseverance to sustain effort toward goals—is also significantly influenced by one’s parents. Furthermore, the market economy inherently favors those who already possess substantial assets, granting them greater access to opportunities and purchasing power. Without government intervention, these characteristics inevitably lead to deepening inequality.
Furthermore, as the market economy is itself an economic system, it can be sustained or collapse depending on people’s choices. If resentment toward the market economy spreads, the system itself becomes difficult to maintain. While the level of inequality and the resulting discomfort each individual can tolerate varies, if inequality becomes excessively severe, society becomes unstable and the system inevitably shakes.
Recently, even some far-right politicians have made statements denying the fundamental principles of the market economy, transcending traditional ideological divides. This can be interpreted as a sign of the market economy’s collapse. Indeed, many economists also point out that deepening inequality could lead to a crisis of capitalism. For a nation to develop stably, and for the current market economic system to maintain its persuasive power, equity is a value that must be pursued.
For the government to enhance efficiency, it requires policies designed with economic sophistication. Equity, however, is a far more challenging issue. This is because increasing equity generally requires sacrificing some degree of efficiency. The problem lies in the fact that people differ in their views on the appropriate level of this sacrifice.
Let’s illustrate this with a simple example. The most representative method for reducing economic inequality and securing equity is redistribution through taxation. This approach provides basic rights and opportunities to the poor while imposing higher tax burdens on those with greater economic means. This protects the poor and mitigates the deepening of inequality.
However, this method requires sacrificing some efficiency. One of the core pillars supporting market economies and capitalism is private property. The motivation of individuals striving to achieve higher consumption levels forms a crucial foundation for maintaining the market economy. When taxes are levied on personal income, the incentive to strive for greater earnings can weaken.
However, the existence of taxes does not negate the private property system. In fact, the share of the government sector is significantly larger in many countries than in ours. While the share of the government sector relative to GDP in our country falls short of 40 percent, a majority of OECD member nations maintain levels significantly exceeding 40 percent. For the government sector’s share to increase, tax rates above a certain level become unavoidable.
Regarding equity, several points are relatively clear. Dividing the pie completely equally is unfair, and excessive deepening of inequality is also socially undesirable. Equity is clearly a value worth pursuing, but achieving it requires sacrificing some efficiency. However, opinions differ on how far equity should be pursued, and this is heavily influenced by individual values and beliefs. Consequently, reaching social consensus is extremely difficult.
There is no absolute right answer on whether efficiency or equity is more important. However, I believe the government should intervene more actively to enhance equity. This is because deepening inequality can lead to the collapse of the market economy and social unrest. Furthermore, since gaps in income and assets are not formed purely by individual ability, it is justified for the state to redistribute a portion of the gains derived from these gaps back to socially vulnerable groups.
Beyond this, the government must perform numerous functions, including national defense and maintaining public order, and taxes are essential for this. Ultimately, taxes must be collected more heavily from those with greater economic capacity. While it is true that taxes can somewhat weaken individual effort and motivation, taxes themselves do not destroy private property, as long as the state does not control or confiscate personal income.
The Risks of Tax Cuts
Taxes play a crucial role in enabling the government to function properly. They directly improve equity and provide the necessary resources for the government to perform its key functions, including enhancing efficiency.
However, taxes also have the potential to stifle economic activity in the private sector. Corporate taxes, in particular, are highly likely to negatively impact corporate investment decisions. Therefore, discussions surrounding tax cuts must always consider their degree and balance. This is because the social costs the state must bear may outweigh the benefits gained from tax cuts.
Proponents of tax cuts argue that lowering tax rates stimulates the economy, ultimately increasing government revenue. However, the prevailing view among most economists is that the short-term impact of taxes on the economic activities of businesses and individuals is limited. Realistically, it is difficult to achieve the high economic growth necessary for government revenue to increase significantly in the short term through low tax rates alone. For this reason, the concept of the Laffer Curve faces considerable criticism within the current economics community.
Furthermore, the strategy of attracting global companies through tax cuts has clear limitations. If one country attracts companies by cutting taxes, other countries are highly likely to respond with tax cuts as well. If all countries competitively lower tax rates, corporations benefit, but governments face severe difficulties in financing their budgets. Efforts by multiple countries to introduce a global minimum corporate tax rate are part of the attempt to mitigate this problem.
Meanwhile, tax and fiscal policies also significantly impact the broader macroeconomy. During economic downturns, governments expand fiscal spending to prop up the economy. This process may involve reducing taxes or increasing government expenditure. However, when inflation risks outweigh recessionary pressures, such policies may actually exacerbate price increases, necessitating a cautious approach. The 2022 case of UK Prime Minister Liz Truss, who resigned after her large-scale tax cut policy triggered financial market turmoil, illustrates this point well.
Governments face a higher likelihood of persistent inefficiencies due to relatively low competitive pressure. Continuous internal efforts to reduce these inefficiencies are essential. However, just as corporate restructuring problems arise when implemented solely as a predetermined headcount reduction, governments also face adverse effects when attempting rapid spending cuts solely to achieve tax reduction targets. In this process, safety management and welfare-related projects, which have less direct link to performance metrics, are most likely to be cut first.
The same problem arises when the government targets tax cuts. If tax cuts are decided first and budget reductions are then demanded from each ministry, there is a high risk that areas playing crucial long-term roles will be cut first. Therefore, to secure fiscal soundness, we must abandon haste and instead systematically review and adjust unnecessary expenditures.
The solutions to the myriad problems facing modern society and the economy ultimately depend on the role and functions of government. To enhance efficiency, pursue equity, improve citizens’ quality of life, prepare for population decline and aging, and protect citizens from various risks, the government must fulfill its responsibilities. And as repeatedly emphasized, taxes are indispensable for the government to perform these roles.
If taxes are evaded or a blind pursuit of small government is advocated simply because the government cannot be trusted, the resulting harm ultimately falls upon society as a whole. Just as the role of the market economy is crucial, the role of government within that market economy is equally vital. While a large government does not automatically equate to a good government, this is precisely why a small government cannot be a good government either.
