Chapter 4--Binary Intervention: Taxation
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1.
Introduction: Government Revenues and Expenditures
An interventionary agency, such as the government, must spend funds; in
the monetary economy, this means spending money. This money can be
derived only from revenues (or income). The bulk of the revenue (and
the reason the agency is called interventionary) must come from two
sources: in the case of the government, taxation and inflation.
Taxation is a coerced levy that the government extracts from the
populace; inflation is the basically fraudulent issue of pseudo
warehouse-receipts for money, or new money. Inflation, which poses
special problems of its own, has been dealt with elsewhere.
This chapter focuses on
taxation.
We are discussing the government for the most part, since empirically
it is the prime organization for coercive intervention. However, our
analysis will actually apply to all coercive organizations. If
governments budget their revenues and expenditures, so must criminals;
where a government levies taxes, criminals extract their own brand of
coerced levies; where a government issues fraudulent or fiat money,
criminals may counterfeit. It should be understood that,
praxeologically, there is no difference between the nature and effects
of taxation and inflation on the one hand, and of robberies and
counterfeiting on the other. Both intervene coercively in the market,
to benefit one set of people at the expense of another set. But the
government imposes its jurisdiction over a wide area and usually
operates unmolested. Criminals, on the contrary, usually impose their
jurisdiction on a narrow area only and generally eke out a precarious
existence. Even this distinction does not always hold true, however. In
many parts of many countries, bandit groups win the passive consent of
the majority in a particular area and establish what amounts to
effective governments, or States, within the area. The difference
between a government and a criminal band, then, is a matter of degree
rather than kind, and the two often shade into each other. Thus, a
defeated government in a civil war may often take on the status of a
bandit group, clinging to a small area of the country. And there is no
praxeological difference between the two.
Some writers maintain that only government expenditures,
not revenues, constitute a burden on the rest of
society. But the government cannot spend money until it obtains it as
revenue—whether that revenue comes from taxation, inflation,
or borrowing from the public. On the other hand, all revenue is spent.
Revenue can differ from expenditure only in the rare case of deflation
of part of the government funds (or government hoarding, if the
standard is purely specie). In that case, as we shall see below,
revenues are not a full burden, but government expenditures are more
burdensome than their monetary amount would indicate, because the real
proportion of government expenditures to the national income will have
increased.
For the rest of this chapter, we shall assume that there is no such
fiscal deflation and, therefore, that every increase in taxes is
matched by an increase in government expenditures.
2.
The Burdens and Benefits of Taxation and Expenditures
As Calhoun brilliantly pointed out (see chapter 2 above), there are two
groups of individuals in society: the taxpayers and the tax
consumers—those who are burdened by taxes and those who
benefit. Who is burdened by taxation? The direct or immediate answer
is: those who pay taxes. We shall postpone the questions of the
shifting of tax burdens to a later section.
Who benefits from taxation? It is clear that the primary beneficiaries
are those who live full-time off the proceeds, e.g., the politicians
and the bureaucracy. These are the full-time rulers. It should be clear
that regardless of legal forms, the bureaucrats pay no taxes; they
consume taxes.
Additional beneficiaries
of government revenue are those in society subsidized by the
government; these are the part-time rulers. Generally, a State cannot
win the passive support of a majority unless it supplements its
full-time employees, i.e., its members, with subsidized adherents. The
hiring of bureaucrats and the subsidizing of others are essential in
order to win active support from a large group of the populace. Once a
State can cement a large group of active adherents to its cause, it can
count on the ignorance and apathy of the remainder of the public to win
passive adherence from a majority and to reduce any active opposition
to a bare minimum.
The problem of the diffusion of expenditures and benefits is, however,
more complicated when the government spends money for its various
activities and enterprises. In this case, it acts always as a consumer
of resources (e.g., military expenditures, public works, etc.), and it
puts tax money into circulation by spending it on factors of
production. Suppose, to make the illustration clearer, the government
taxes the codfish industry and uses the proceeds of this tax to spend
money on armaments. The first receiver of the money is the armament
manufacturer, who pays it out to his suppliers and the owners of
original factors, etc. In the meantime, the codfish industry, stripped
of capital, reduces its demand for factors. In both cases, the burdens
and benefits diffuse themselves throughout the economy.
“Consumer” demand, by virtue of State coercion, has
shifted from codfish to armaments. The result imposes short-run losses
on the codfish industry and those who supply it, and short-run gains on
the armaments industry and those who supply it. As the ripples of
expenditure are pushed further and further back, the impact dies out,
having been strongest at the points of first contact, i.e., the codfish
and the armament industries. In the long run, however, all firms and
all industries earn a uniform return, and any gains or losses are
imputed back to original factors. The nonspecific or convertible
factors will tend to shift out of the codfish and into the armaments
industry.
The purely specific or
nonconvertible original factors will remain to bear the full burden of
the loss and to reap the gain respectively. Even the nonspecific
factors will bear losses and reap gains, though to a lesser degree. The
major effect of the change, however, will eventually be felt by the
owners of the specific original factors, largely the landowners of the
two industries. Taxes are compatible with equilibrium, and therefore we
may trace the long-run effects of a tax and expenditure in this manner.
In the short run, of
course, entrepreneurs suffer losses and earn profits because of the
shift in demand.
All government expenditure for resources is a form of consumption
expenditure, in the sense that the money is spent on various items
because the government officials so decree. The purchases may therefore
be called the consumption expenditure of government officials. It is
true that the officials do not consume the product directly, but
their wish has altered the production pattern to make these
goods, and therefore they may be called its
“consumers.”
As will be seen further
below, all talk of government “investment” is
fallacious.
Taxation always has a two-fold effect: (1) it distorts the allocation
of resources in the society, so that consumers can no longer most
efficiently satisfy their wants; and (2) for the first time, it severs
“distribution” from production. It brings the
“problem of distribution” into being.
The first point is clear; government coerces consumers into giving up
part of their income to the State, which then bids away resources from
these same consumers. Hence, the consumers are burdened, their standard
of living is lowered, and the allocation of resources is distorted away
from consumer satisfaction toward the satisfaction of the ends of the
government. More detailed analysis of the distorting effects of
different types of taxes will be presented below. The essential point
is that the object of many economists’ quest, a
neutral tax, i.e., a tax that will leave the market exactly
the same as it was without taxation, must always be a chimera. No tax
can be truly neutral; every one will cause distortion. Neutrality can
be achieved only on a purely free market, where governmental revenues
are obtained by voluntary purchase only.
It is often stated that “capitalism has solved the problem of
production,” and that the State must now intervene to
“solve the problem of distribution.” A more clearly
erroneous formulation would be difficult to conceive. For the
“problem of production” will never be solved until
we are all in the Garden of Eden. Furthermore, there is no
“problem of distribution” on the free market. In
fact, there is no “distribution” at all.
On the free market, a
man’s monetary assets have been acquired precisely because
his or his predecessors’ services have been purchased by
others. There is no distributional process apart from the production
and exchange of the market; hence, the very concept of
“distribution” as something separate becomes
meaningless. Since the free-market process benefits all participants on
the market and increases social utility, it follows directly that the
“distributional” results of the free
market—the pattern of income and wealth—also
increases social utility and, in fact, maximizes it
at any given time. When the government takes from Peter and gives to
Paul, it then creates a separate distribution
process and a “problem” of distribution. No longer
do income and wealth flow purely from service rendered on the market;
they now flow from special privilege created by the coercion of the
State. Wealth is now distributed to
“exploiters” at the expense of the
“exploited.”
The crucial point is that the extent of the distortion of resources,
and of the State’s plunder of producers, is in direct
proportion to the level of taxation and government expenditures in the
economy, as compared with the level of private income and wealth. It is
a major contention of our analysis—in contrast to many other
discussions of the subject—that by far the most important
impact of taxation results not so much from the type of tax as from its
amount. It is the total level of taxation, of
government income compared with the income of the private sector, that
is the most important consideration. Far too much significance has been
attached in the literature to the type of
tax—to whether it is an income tax, progressive or
proportional, sales tax, spending tax, etc. Though important, this is
subordinate to the significance of the total level of taxation.
3.
The Incidence and Effects of Taxation
Part I:
Taxes on Incomes
A.
The General Sales Tax and the Laws of Incidence
One of the oldest problems connected with taxation is: Who
pays the tax? It would seem that the answer is clear-cut,
since the government knows on whom it levies a tax. The problem,
however, is not who pays the tax immediately, but
who pays it in the long run, i.e., whether or not the tax can be
“shifted” from the immediate taxpayer to somebody
else. Shifting occurs if the immediate taxpayer is able to raise his
selling price to cover the tax, thus “shifting” the
tax to the buyer, or if he is able to lower the buying price of
something he buys, thus “shifting” the tax to some
other seller.
In addition to this problem of the incidence of
taxation, there is the problem of analyzing other economic effects of
various types and amounts of taxes.
The first law of incidence can be laid down immediately, and it is a
rather radical one: No tax can be shifted forward.
In other words, no tax can be shifted from seller to buyer and on to
the ultimate consumer. Below, we shall see how this applies
specifically to excise and sales taxes, which are commonly thought to
be shifted forward. It is generally considered that any tax on
production or sales increases the cost of production and therefore is
passed on as an increase in price to the consumer. Prices, however, are
never determined by costs of production, but rather the reverse is
true. The price of a good is determined by its total stock in existence
and the demand schedule for it on the market. But the demand schedule
is not affected at all by the tax. The selling price is set by any firm
at the maximum net revenue point, and any higher price, given the
demand schedule, will simply decrease net revenue. A tax, therefore, cannot
be passed on to the consumer.
It is true that a tax can be shifted forward, in a
sense, if the tax causes the supply of the good to decrease, and
therefore the price to rise on the market. This can hardly be called
shifting per se, however, for shifting implies that
the tax is passed on with little or no trouble to the producer. If some
producers must go out of business in order for the tax to be
“shifted,” it is hardly shifting in the proper
sense but should be placed in the category of other effects
of taxation.
A general sales tax is the classic
example of a tax on producers that is believed to be shifted forward.
The government, let us say, imposes a 20-percent tax on all sales at
retail. We shall assume that the tax can be equally well enforced in
all branches of sales.
To most people, it seems
obvious that the business will simply add 20 percent to their selling
prices and merely serve as unpaid collection agencies for the
government. The problem is hardly that simple, however. In fact, as we
have seen, there is no reason whatever to believe that prices can be
raised at all. Prices are already at the point of maximum net revenue,
the stock has not been decreased, and demand schedules have not
changed. Therefore, prices cannot be increased. Furthermore, if we look
at the general array of prices, these are determined by the supply of
and the demand for money. For the array of prices to rise, there must
be an increase in the supply of money, a decrease in the schedule of
the demand for money, or both. Yet neither of these alternatives has
occurred. The demand for money to hold has not decreased, the supply of
goods available for money has not declined, and the supply of money has
remained constant. There is no possible way that a general price
increase can be obtained.
It should be quite evident that if businesses were able to pass tax
increases along to the consumer in the form of higher prices, they
would have raised these prices already without waiting for the spur of
a tax increase. Businesses do not deliberately peg along at the lowest
selling prices they can find. If the state of demand had permitted
higher prices, firms would have taken advantage of this fact long
before. It might be objected that a sales tax increase is general
and therefore that all the firms together can shift the tax. Each firm,
however, follows the state of the demand curve for its own
product, and none of these demand curves has changed. A tax increase
does nothing to make higher prices more profitable.
The myth that a sales tax can be shifted forward is comparable to the
myth that a general union-imposed wage increase can be shifted forward
to higher prices, thereby “causing inflation.”
There is no way that the general array of prices can rise, and the only
result of such a wage increase will be mass unemployment.
Many people are misled by the fact that the price the consumer pays
must necessarily include the tax. When someone goes
to a movie and sees prominently posted the information that the $1.00
admission covers a “price” of 85cents and a tax of
15 cents, he tends to conclude that the tax has simply been added on to
the “price.” But $1.00 is the price, not 85cents,
the latter sum being the income accruing to the firm after taxes. This
income might well have been reduced to allow for
payment of taxes.
In fact, this is precisely the effect of a general sales tax. Its
immediate impact lowers the gross revenue of firms by the amount of the
tax. In the long run, of course, firms cannot pay the tax, for their
loss in gross revenue is imputed back to interest income by capitalists
and to wages and rents earned by original factors—labor and
ground land. A decrease in the gross revenue of retail firms is
reflected back to a decreased demand for the products of all the
higher-order firms. All the firms, however, earn, in the long run, a
pure uniform interest return.
Here a difference arises between a general sales tax and, say, a
corporate income tax. There has been no change in time-preference
schedules or other components of the interest rate. While an income tax
compels a lower percent interest return, a sales tax can and will be
shifted completely from investment and back to the original factors.
The result of a general sales tax is a general reduction in the net
revenue accruing to original factors: to all wages and ground rents.
The sales tax has been shifted backwards to
original factor returns. No longer does every original factor of
production earn its discounted marginal value product. Now, original
factors earn less than their DMVPs, the reduction
consisting of the sales tax paid to the government.
It is necessary now to integrate this analysis of the incidence of a
general sales tax with our previous general analysis of the benefits
and burdens of taxation. This is accomplished by remembering that the
proceeds of taxation are, in turn, spent by the government.
Whether the government
spends the money for resources for its own activities or simply
transfers the money to people it subsidizes, the result is to shift
consumption and investment demand from private hands to the government
or to government-supported individuals, by the amount of the tax
revenue. In this case, the tax has been ultimately levied on the incomes
of original factors, and the money transferred from their hands to the
government. The income of the government and/or those it subsidizes has
been increased at the expense of those taxed, and therefore consumption
and investment demands on the market have been shifted from the latter
to the former by the amount of the tax. As a consequence, the value of
the money unit will remain unchanged (barring a difference in demands
for money between the taxpayers and the tax consumers), but the array
of prices will shift in accordance with the shift in demands. Thus, if
the market has been spending heavily on clothing, and the government
uses the revenue mostly for the purchase of arms, there will be a fall
in the price of clothes, a rise in the price of arms, and a tendency
for nonspecific factors to shift out of clothing and into the
production of armaments.
As a result, there will not be, as might be assumed, a proportional
20-percent fall in the incomes of all original factors as a result of a
20-percent general sales tax. Specific factors in industries that have
lost business as a result of the shift from private to governmental
demand will lose proportionately more in income. Specific factors in
industries gaining in demand will lose proportionately less, and some
may gain so much as to gain absolutely as a result of the change.
Nonspecific factors will not be affected as much proportionately, but
they too will lose and gain according to the difference that the
concrete shift in demand makes in their marginal value productivity.
The knowledge that taxes can never be shifted forward is a consequence
of adhering to the “Austrian” analysis of value,
i.e., that prices are determined by ultimate demands for stock, and not
in any sense by the “cost of production.”
Unhappily, all previous discussions of the incidence of taxation have
been marred by hangovers of classical
“cost-of-production” theory and the failure to
adopt a consistent “Austrian” approach. The
Austrian economists themselves never really applied their doctrines to
the theory of tax incidence, so that this discussion breaks new ground.
The shifting-forward doctrine has actually been carried to its logical,
and absurd, conclusion that producers shift taxes to consumers, and
consumers, in turn, can shift them to their employers, and so on ad
infinitum, with no one really paying any
tax at all.
It should be carefully noted that the general sales tax is a
conspicuous example of failure to tax consumption.
It is commonly supposed that a sales tax penalizes consumption rather
than income or capital. But we find that the sales tax reduces, not
just consumption, but the incomes of original
factors. The general sales tax is an income tax,
albeit a rather haphazard one, since there is no way that its impact on
income classes can be made uniform. Many
“right-wing” economists have advocated general
sales taxation, as opposed to income taxation, on the ground that the
former taxes consumption but not savings- investment; many
“left-wing” economists have opposed sales taxation
for the same reason. Both are mistaken; the sales tax is an income tax,
though of more haphazard and uncertain incidence. The major effect of
the general sales tax will be that of the income tax: to reduce the
consumption and the savings-investment of the
taxpayers.
In fact, since, as we
shall see, the income tax by its nature falls more heavily on
savings-investment than on consumption, we reach the paradoxical and
important conclusion that a tax on consumption will
also fall more heavily on savings-investment, in
its ultimate incidence.
B.
Partial Excise Taxes; Other Production Taxes
The partial excise tax is a sales tax levied on some,
rather than all, commodities. The chief distinction between this and
the general sales tax is that the latter does not, in itself,
distort productive allocations on the market, since a tax is levied
proportionately on the sale of all final products. A partial excise, on
the other hand, penalizes certain lines of production. The general
sales tax, of course, distorts market allocations insofar as government
expenditures from the proceeds differ in structure from private demands
in the absence of the tax. The excise tax has this effect, too, and, in
addition, penalizes the particular industry taxed. The tax
cannot be shifted forward, but tends to be shifted backward to the
factors working in the industry. Now, however, the tax exerts pressure
on nonspecific factors and entrepreneurs to leave the taxed industry
and enter other, nontaxed industries. During the transition
period, the tax may well be added to cost. As the price,
however, cannot be directly increased, the marginal
firms in this industry will be driven out of business and will seek
better opportunities elsewhere. The exodus of nonspecific factors, and
perhaps firms, from the taxed industry reduces the stock of
the good that will be produced. This reduction in stock, or
supply, will raise the market price of the good, given the
consumers’ demand schedule. Thus, there is a sort of
“indirect shifting” in the sense that the price of
the good to consumers will ultimately increase. However, as we have
stated, it is not appropriate to call this
“shifting,” a term better reserved for an
effortless, direct passing on of a tax in the price.
Everyone in the market suffers as a result of an excise tax.
Nonspecific factors must shift to fields of lower income; since the
discounted marginal value product is lower there, specific factors are
hit particularly hard, and consumers suffer as the allocations of
factors and the price structure are distorted in comparison with what
would have satisfied their desires. The supply of factors in the taxed
industries becomes excessively low, and the selling price in these
industries too high; while the supply of factors in other industries
becomes excessively large, and their product prices too low.
In addition to those specific effects, the excise tax also has the same
general effect as all other taxes, viz., that the
pattern of market demands is distorted from private to government or
government-subsidized wants by the amount of the tax intake.
Far too much has been written on the elasticity of
demand in relation to the effect of taxation. We know that the demand
schedule for one firm is always elastic above the
free-market price. And the cost of production is not something fixed,
but is in itself determined by the selling price.
Most important, since the demand curve for a good is always falling,
any decrease in the stock will raise the market price, and any increase
in the stock will lower the price, regardless of the elasticity of
demand for the product. Elasticity of demand is a topic that warrants
only a relatively minor role in economic theory.
In sum, an excise tax (a) injures consumers in the
same way that all taxes do, by shifting resources and demands from
private consumers to the State; and (b) injures
consumers and producers in its own particular way by distorting market
allocations, prices, and factor revenues; but (c)
cannot be considered a tax on consumption in the
sense that the tax is shifted to consumers. The excise tax is also a
tax on incomes, except that in this case the effect
is not general because the impact falls most heavily on the factors
specific to the taxed industry.
Any partial tax on production will have effects similar to an excise
tax. A license tax imposed on an industry, for example, granting a
monopolistic privilege to firms with a large amount of capital, will
restrict the supply of the product and raise the price. Factors and
pricing will be misallocated as in an excise tax. In contrast to the
latter, however, the indirect grant of monopolistic privilege will benefit
the specific, quasi-monopolized factors that are able to remain in the
industry.
C.
General Effects of Income Taxation
In the dynamic real economy, money income consists
of wages, ground rents, interest, and profits, counterbalanced by
losses. (Ground rents are also capitalized on the market, so that
income from rents is resolvable into interest and profit, minus
losses.) The income tax is designed to tax all such
net income. We have seen that sales and excise taxes are really taxes
on some original-factor incomes. This has been generally ignored, and
perhaps one reason is that people are accustomed to thinking of income
taxation as being uniformly levied on all incomes of the same amount.
Later, we shall see that the uniformity of such a levy has been widely
upheld as an important “canon of justice” for
taxation. Actually, no such uniformity does or need exist. Excise and
sales taxes, as we have seen, are not uniformly levied, but are imposed
on some income receivers and not others of the same income class. It
must be recognized that the official income tax,
the tax that is generally known as the “income
tax,” is by no means the only form in which income is, or can
be, taxed by the government.
An income tax cannot be shifted to anyone else. The taxpayer himself
bears the burden. He earns profits from entrepreneurial activity,
interest from time preference, and other income from marginal
productivity, and none can be increased to cover the tax. Income
taxation reduces every taxpayer’s money income and real
income, and hence his standard of living. His income from working is
more expensive, and leisure cheaper, so that he will tend to work less.
Everyone’s standard of living in the form of exchangeable
goods will decline. In rebuttal, much has been made of the fact that
every man’s marginal utility of money rises as his money
assets fall and, therefore, that there may be a rise in the marginal
utility of the reduced income obtainable from his current expenditure
of labor. It is true, in other words, that the same labor now earns
every man less money, but this very reduction in money income may also
raise the marginal utility of a unit of money to the extent that the
marginal utility of his total income will be raised,
and he will be induced to work harder as a result
of the income tax. This may very well be true in some cases, and there
is nothing mysterious or contrary to economic analysis in such an
event. However, it is hardly a blessing for the man or for society.
For, if more work is expended, leisure is lost, and people’s
standards of living are lower because of this coerced loss.
In the free market, in short, individuals are always balancing their
money income (or real income in exchangeable goods) against their real
income in the form of leisure activities. Both are basic components of
the standard of living. The greater their exchangeable-goods income, in
fact, the higher will be their marginal utility of a unit of leisure
time (nonexchangeable goods), and the more proportionately will they
“take” their income in the form of leisure. It is
not surprising, therefore, that a coerced lower income may force
individuals to work harder. Whichever the effect, the tax lowers the
standard of living of the taxpayers, either depriving them of leisure
or of exchangeable goods.
In addition to penalizing work relative to leisure, an income tax also
penalizes work for money as against work for a
return in kind. Obviously, a relative advantage is conferred on work
done for a nonmonetary reward. Working women are penalized as compared
with housewives; people will tend to work for their families rather
than enter into the labor market, etc.
“Do-it-yourself” activities are stimulated. In
short, the income tax tends to bring about a reduction in
specialization and a breakdown of the market, and hence a retrogression
in living standards.
Make the income tax high
enough, and the market will disintegrate altogether, and primitive
economic conditions will prevail.
The income tax confiscates a certain portion of a person’s
income, leaving him free to allocate the remainder between consumption
and investment. It might be thought that, since we may assume
time-preference schedules as given, the proportion of consumption to
savings-investment—and the pure interest rate—will
remain unaffected by the income tax. But this is not so. For the
taxpayer’s real income and the value of his monetary assets
have been lowered. The lower the level of a man’s real
monetary assets, the higher will his time-preference rate be
(given his time-preference schedule) and the higher the proportion of
his consumption to investment spending. The taxpayer’s
position may be seen in the diagram in Figure 4.
Figure 4 is a portrayal of an individual
taxpayer’s time-preference schedule, related to his monetary
assets. Let us say that the taxpayer’s initial position is a
stock of 0M; tt is his
time-preference curve. His effective time-preference rate,
determining the ratio of his consumption to his savings-investment is t1.
Now the government levies an income tax, reducing his initial monetary
assets at the start of his spending period to 0M1.
His effective time-preference rate is now higher, at t2.
We have seen that an individual’s real as
well as nominal money assets must decline in order for this result to
take place; if there is deflation, the value of the monetary unit will
increase roughly in proportion, and, in the long run, time-preference
ratios, ceteris paribus, will not be changed. In
the case of income taxation, however, there will be no change in the
value of the monetary unit, since the government will spend the
proceeds of taxation. As a result, the taxpayer’s real
as well as nominal money assets decline, and decline to the same extent.
It might be objected that the government officials or those subsidized
receive additional money, and the fall in their time-preference ratios
may well offset, or balance, the rise in the rate from the
taxpayers’ side. It could not be concluded, then, that the
social rate of time-preference will rise, and savings-investment
particularly decrease. Government expenditures, however, constitute
diversion of resources from private to government purposes. Since the
government, by definition, desires this diversion, this is a consumption
expenditure by the government.
The reduction in income
(and therefore in consumption and
savings-investment) imposed on the taxpayers will therefore be
counterbalanced by government consumption-expenditure. As for the transfer
expenditures made by the government (including the salaries of
bureaucrats and subsidies to privileged groups), it is true that some
of this will be saved and invested. These investments, however, will
not represent the voluntary desires of consumers, but rather
investments in fields of production not desired by
the producing consumers. They represent the
desires, not of the producing consumers on the free
market, but of exploiting consumers fed by the unilateral coercion of
the State. Once let the tax be eliminated, and the producers are free
to earn and consume again. The new investments called forth by the
demands of the specially privileged will turn out to be malinvestments.
At any rate, the amount consumed by the government insures that the
effect of income taxation will be to raise time-preference ratios and
to reduce saving and investment.
Some economists maintain that income taxation reduces saving and
investment in the society in a third way. They assert that income
taxation, by its very nature, imposes a “double”
tax on savings-investment as against consumption.
The reasoning runs as
follows: Saving and consumption are not really symmetrical. All saving
is directed toward enjoying more consumption in the future. Otherwise,
there would be no point at all in saving. Saving is abstaining from
possible present consumption in return for the expectation of increased
consumption at some time in the future. No one wants capital goods for
their own sake.
They are only the
embodiment of an increased consumption in the future.
Savings-investment is Crusoe’s building a stick to obtain
more apples at a future date; it fructifies in increased consumption
later. Hence, the imposition of an income tax excessively penalizes
savings-investment as against consumption.
This line of reasoning is correct in its explanation of the
investment-consumption process. It suffers, however, from one grave
defect: it is irrelevant to problems of taxation. It is true that
saving is a fructifying agent. But the point is that everyone knows
this; that is precisely why people save. Yet, even though they know
that saving is a fructifying agent, they do not save all
their income. Why? Because of their time preference for present
consumption. Every individual, given his current income and value
scales, allocates that income in the most desired proportion among
consumption, investment, and addition to his cash balance. Any other
allocation would satisfy his desires to a lesser extent and lower his
position on his value scale. There is therefore no reason here to say
that an income tax especially penalizes savings-investment; it
penalizes the individual’s entire standard of living,
encompassing present consumption, future consumption, and his cash
balance. It does not per se penalize saving any
more than it does the other avenues of income allocation.
There is another way, however, in which an income
tax does, in fact, levy a particular burden on saving. For the interest
return on savings-investment, like all other earnings, is subject to
the income tax. The net interest rate received, therefore, is lower
than the free-market rate. The return is not consonant with free-market
time preferences; instead, the imposed lower return induces people to
bring their savings-investment into line with the reduced return; in
short, the marginal savings and investments, now not profitable at the
lower rate, will not be made.
The above Fisher-Mill argument is an example of a curious tendency
among economists generally devoted to the free market to be unwilling
to consider its ratio of consumption to investment allocations as
optimal. The economic case for the free market is that market
allocations tend at all points to be optimal with respect to consumer
desires. The economists who favor the free market recognize this in
most areas of the economy but for some reason show a predilection for
and special tenderness toward savings-investment, as against
consumption. They tend to feel that a tax on saving is far more of an
invasion of the free market than a tax on consumption. It is true that
saving embodies future consumption. But people voluntarily choose
between present and future consumption in accordance with their time
preferences, and this voluntary choice is their optimal choice. Any
tax levied particularly on their consumption, therefore, is just as
much a distortion and invasion of the free market as a tax on their
savings. There is nothing, after all, especially sacred about
savings; they are simply the road to future consumption. But they are no
more important than present consumption, the allocation
between the two being determined by the time preferences of all
individuals. The economist who shows more concern for free-market
savings than he does for free-market consumption is implicitly
advocating statist interference and a coerced distortion of resource
allocation in favor of greater investment and lower consumption. The
free-market advocate should oppose with equal fervor coerced distortion
of the ratio of consumption to investment in either
direction.
As a matter of fact, we have seen that income taxation, by other
routes, tends to distort the allocation of resources into more
consumption and less savings-investment, and we have seen above that attempts
to tax consumption in the form of sales or production taxation must
fail and end as levies on incomes instead.
D.
Particular Forms of Income Taxation
(1) Taxes on Wages
A tax on wages is an income tax that cannot be shifted away
from the wage earner. There is no one to shift it to, especially not
the employer, who always tends to earn a uniform interest rate. In
fact, there are indirect taxes on wages that are shifted to the wage
earner in the form of lower wage incomes. An example is that part of
social security, or of unemployment compensation premiums, levied on
the employer. Most employees believe that they completely escape this
part of the tax, which the employer pays. They are wholly mistaken. The
employer, as we have seen, cannot shift the tax forward to the
consumer. In fact, since the tax is levied in proportion to wages paid,
the tax is shifted backward wholly on the wage earners themselves. The
employer’s part is simply a collected tax levied at the
expense of a reduction of the net wages of the employees.
(2) Corporate Income Taxation
Taxation of corporate net income imposes a “double”
tax on the owners of corporations: once on the official
“corporate” income and once on the remaining
distributed net income of the owners themselves. The extra tax cannot
be shifted forward onto the consumer. Since it is levied on net income
itself, it can hardly be shifted backward. It has the effect of
penalizing corporate income as opposed to income from other market
forms (single ownership, partnerships, etc.), thereby penalizing
efficient forms of enterprise and encouraging the inefficient.
Resources shift from the former to the latter until the expected rate
of net return is equalized throughout the economy—at a lower
level than originally. Since interest return is forcibly lower than
before, the tax penalizes savings and investment as well as an
efficient market form.
The penalty, or “double-taxation,” feature of
corporate income taxes could be eliminated only by abolishing the tax
and treating any net incomes accruing to a corporation as pro
rata income to its stockholder-owners. In other words, a
corporation would be treated as a partnership, and not according to the
absurd fiction that it is some sort of separate real entity functioning
apart from the actions of its actual owners. Income accruing to the
corporation obviously accrues pro rata to the owners. Some writers have
objected that the stockholders do not really receive the income on
which they would be taxed. Thus, suppose that the Star Corporation
earns a net income of $100,000 in a certain period, and that it has
three stockholders—Jones, with 40 percent of the stock;
Smith, holding 35 percent of the stock; and Robinson, owning 25
percent. The majority stockholders, or their management
representatives, decide to retain $60,000 as
“undistributed” earnings “in the
firm,” while paying only $40,000 as dividends. Under present
law, Jones’ net income from the Star Corporation is
considered as $16,000, Smith’s as $14,000, and
Robinson’s as $10,000; the
“corporation’s” is listed at $100,000.
Each of these entities is then taxed on these amounts. Yet, since there
is no real corporate entity separate from its owners, the incomes would
be more properly recorded as follows: Jones, $40,000; Smith, $35,000;
Robinson, $25,000. The fact that these stockholders do not actually receive
the money is no objection; for what happens is the equivalent of
someone’s earning money yet keeping it on account without
bothering to draw it out and use it. Interest that piles up in
someone’s savings bank account is considered as income and
taxed accordingly, and there is no reason why
“undistributed” earnings should not be considered
individual income as well.
The fact that total corporate income is first taxed and then
“distributed” as dividend income to be taxed again,
encourages a further distortion of market investment and organization.
For this practice encourages stockholders to leave a greater proportion
of their earnings undistributed than they would have done in a free
market. Earnings are “frozen in” and either held or
invested in an uneconomic fashion in relation to the satisfaction of
consumer wants. To the reply that this at least fosters investment,
there are two rejoinders: (1) that a distortion in favor of investment
is as much a distortion of optimum market allocations as anything else;
and (2) that not “investment” is encouraged, but
rather frozen investment by owners back into their
original firms at the expense of mobile investment. This distorts and
renders inefficient the pattern and allocation of investment funds and
tends to freeze them in the original firms, discouraging the diffusion
of funds to different concerns. Dividends, after all, are not
necessarily consumed: they may be reinvested in other firms and other
investment opportunities. The corporate income tax greatly hampers the
adjustment of the economy to dynamic changes in conditions.
(3) “Excess” Profit Taxation
This tax is generally levied on that part of business net income,
dubbed “excess,” which is greater than a base
income in a previous period of time. A penalty tax on
“excess” business income directly penalizes
efficient adjustment of the economy. The profit drive by entrepreneurs
is the motive power that adjusts, estimates, and coordinates the
economic system so as to maximize producer income in the service of
maximizing consumer satisfactions. It is the process by which
malinvestments are kept to a minimum, and good forecasts encouraged, so
as to arrange advance production to be in close harmony with consumer
desires at the date when the final product appears on the market.
Attacking profits “doubly” disrupts and hampers the
whole market-adjustment process. Such a tax penalizes efficient
entrepreneurship. Furthermore, it helps to freeze market patterns and
entrepreneurial positions as they were in some previous time period,
thus distorting the economy more and more as time passes. No economic
justification can be found for attempting to freeze market patterns in
the mould of some previous period. The greater the changes in economic
data that have occurred, the more important it is not to tax
“excess” profits, or any form of
“excess” revenue for that matter; otherwise,
adaptation to the new conditions will be blocked just when rapid
adjustment is particularly required. It is difficult to find a tax more
indefensible from more points of view than this one.
See Man, Economy, and
State, pp. 989–1023.
The striking title of Mr.
Chodorov’s pamphlet is, therefore, praxeologically, accurate:
see Frank Chodorov, Taxation is Robbery
(Chicago: Human Events Associates, 1947), reprinted in Chodorov, Out
of Step (New York: Devin-Adair, 1962), pp. 216–39.
As Chodorov says:
A
historical study of taxation leads inevitably to loot, tribute,
ransom—the economic purpose of conquest. The barons who put
up toll-gates along the Rhine were tax-gatherers. So were the gangs who
“protected,” for a forced fee, the caravans going
to market. The Danes who regularly invited themselves into England, and
remained as unwanted guests until paid off, called it Dannegeld; for a
long time that remained the basis of English property taxes. The
conquering Romans introduced the idea that what they collected from
subject peoples was merely just payment for maintaining law and order.
For a long time the Norman conquerors collected catch-as-catch-can
tribute from the English, but when by natural processes an amalgam of
the two peoples resulted in a nation, the collections were regularized
in custom and law and were called taxes. (Ibid., p.
218)
If a bureaucrat receives a salary
of $5,000 a year and pays $1,000 in “taxes” to the
government, it is quite obvious that he is simply receiving a salary of
$4,000 and pays no taxes at all. The heads of the government have
simply chosen a complex and misleading accounting device to make it
appear that he pays taxes in the same way as any other men making the
same income. The UN’s arrangement, whereby all its employees
are exempt from any income taxation, is far more candid.
The shift will not necessarily, or
even probably, be from the codfish to the armament industry directly.
Rather, factors will shift from the codfish to other, related
industries and to the armament industry from its related lines.
The diffusion effect of inflation
differs from that of taxation in two ways: (a) it is
not compatible with a long-run equilibrium, and (b)
the new money always benefits the first half of the money receivers and
penalizes the last half. Taxation-diffusion has the same effect at
first, but shifting alters incidence in the final reckoning.
On the other hand, since the
officials do not usually consume the products directly, they often believe
that they are acting on behalf of the consumers. Hence, their choices
are liable to an enormous degree of error. Alec Nove has pointed out
that if these choices were simply the consumer preferences of the
government planners themselves, they would not, as they do now, realize
that they can and do make grievous errors. Thus,
the choices made by government officials do not even possess the virtue
of satisfying their own consumption preferences.
Alec Nove, “Planners’ Preferences, Priorities, and
Reforms,” Economic Journal, June, 1966,
pp. 267–77.
Two other types of revenue are
consonant with neutrality and a purely free market: fines
on criminals, and the sale of products of
prison labor. Both are methods for making the criminals pay
the cost of their own apprehension.
See above and
Rothbard, “Toward a Reconstruction of Utility and Welfare
Economics,” pp. 250–51.
It might be objected that, while
bureaucrats are solely exploiters and not producers, other subsidized
groups may also be producers as well. Their exploitation extends,
however, to the degree that they are net tax consumers rather than
taxpayers. Their other productive activities are beside the point.
Usually, of course, it cannot, and
the result will be equivalent to a specific excise tax on some branches
of sales, but not on others.
Whereas a partial excise tax will
eventually cause a drop in supply and therefore a rise in the price of
the product, there is no way by which resources can escape a general
tax except into idleness. Since, as we shall see, a sales tax is a tax
on incomes, the rise in the opportunity cost of leisure may push some
workers into idleness, and thereby lower the quantity of goods
produced. To this tenuous extent, prices will rise.
See the pioneering article by Harry Gunnison Brown,
“The Incidence of a General Sales Tax,” reprinted
in R.A. Musgrave and C.S. Shoup, eds., Readings in the
Economics of Taxation (Homewood, Ill.: Richard D. Irwin,
1959), pp. 330–39. This was the first modern attack on the
fallacy that sales taxes are shifted forward, but Brown unfortunately
weakened the implications of this thesis toward the end of his article.
Of course, if the money supply is
increased and credit expanded, prices can be raised so that money wages
are no longer above their discounted marginal value products.
If the government does not spend
all of its revenue, then deflation is added to the impact of taxation.
See below.
For example, see
E.R.A. Seligman, The Shifting and Incidence of Taxation
(2nd ed.; New York: Macmillan & Co., 1899), pp.
122–33.
Mr. Frank Chodorov, in his The
Income Tax—Root of All Evil (New York: Devin-Adair,
1954), fails to indicate what other type of tax would be
“better” from a free-market point of view than the
income tax. It will be clear from our discussion that there are few
taxes indeed that will not be as bad as the income tax from the
viewpoint of an advocate of the free market. Certainly, sales or excise
taxation will not fill the bill.
Chodorov, furthermore, is surely wrong when he terms income and
inheritance taxes unique denials of the right of
individual property. Any tax whatever infringes on property rights, and
there is nothing in an “indirect tax” which makes
that infringement any less clear. It is true that an income tax forces
the subject to keep records and disclose his personal dealings, thus
imposing a further loss in his utility. The sales tax, however, also
forces record-keeping; the difference again is one of degree rather
than of kind, for here the extent of directness covers only retail
storekeepers instead of the bulk of the population.
Perhaps the reason for the
undeserved popularity of the elasticity concept is that economists need
to employ it in their vain search for quantitative laws and
measurements in economics.
Even the official tax is hardly
uniform, being interlarded with extra burdens and exemptions. See below
for further discussion of uniformity of taxation.
See C.
Lowell Harriss, “Public Finance” in Bernard F.
Haley, ed., A Survey of Contemporary Economics
(Homewood, Ill.: Richard D. Irwin, 1952), II, 264. For a practical
example, see P.T. Bauer, “The Economic
Development of Nigeria,” Journal of Political
Economy, October, 1955, pp. 400ff.
These expenditures are commanded
by the government, and not by the free action of individuals. They
therefore may satisfy the utility (or are expected to satisfy the
utility) only of the government officials, and we cannot be sure that
anyone else’s is satisfied.
The Keynesians, on the contrary, classify all government resource-using
expenditure as “investment,” on the ground that
these, like investment expenditures, are
“independent,” and not passively tied to income by
means of a psychological “function.” Thus, see
Irving and Herbert W. Fisher, Constructive Income Taxation
(New York: Harper & Bros., 1942). “Double”
is used in the sense of two instances, not
arithmetically twice.
Thus, see
Irving and Herbert W. Fisher, Constructive Income Taxation
(New York: Harper & Bros., 1942). “Double”
is used in the sense of two instances, not
arithmetically twice.
Although there is much merit in
Professor Due’s critique of this general position, he is
incorrect in believing that people may own capital for its own sake. If
people, because of the uncertainty of the future, wish to hold wealth
for its service in relieving risk, they will hold wealth in its most
marketable form—cash balances. Capital is far less marketable
and is desired only for its fructification in consumers’
goods and earnings from the sale of these goods. John F. Due, Government
Finance (Homewood, Ill.: Richard D. Irwin, 1954), pp.
123–25, 368ff.
These economists generally go on
to advocate taxation of consumption alone as the only
“real” income. For further discussion of such a
consumption tax, see below.
Thus, one of the standard
conservative arguments against progressive income
taxation (see below) is that savings would be taxed in greater
proportion than consumption; many of these writers leave the reader
with the inference that if (present) consumption were taxed more
heavily, everything would be all right. Yet what is so worthy about future,
as against present, consumption, and what principle
do these economists adopt that permits them to alter by force the
voluntary time-preference ratios between present and future?
Some writers have pointed out that
the penalty lowers future consumption from what it would have been,
reducing the supply of goods and raising prices to consumers. This can
hardly be called “shifting,” however, but is rather
a manifestation of the ultimate effect of the tax in reducing consumer
standards of living from the free-market level.
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