The Truth About Taxes

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This article,
a response to Alan
Greenspan’s call for a consumption tax
, originally appeared
in the Review of Austrian Economics, 1994, Volume 7, No.
2, pp. 75–90, as The Consumption Tax: A Critique.

The Alleged
Superiority of the Income Tax

Orthodox
neoclassical economics has long maintained that, from the point
of view of the taxed themselves, an income tax is “better than”
an excise tax on a particular form of consumption, since, in addition
to the total revenue extracted, which is assumed to be the same
in both cases, the excise tax weights the levy heavily against
a particular consumer good. In addition to the total amount levied,
therefore, an excise tax skews and distorts spending and resources
away from the consumers’ preferred consumption patterns. Indifference
curves are trotted out with a flourish to lend the scientific
patina of geometry to this demonstration.

As in many
other cases when economists rush to judge various courses of action
as “good,” “superior,” or “optimal,” however, the ceteris paribus
assumptions underlying such judgments – in this case, for
example, that total revenue remains the same – do not always
hold up in real life. Thus, it is certainly possible, for political
or other reasons, that one particular form of tax is not likely
to result in the same total revenue as another. The nature of
a particular tax might lead to less or more revenue than another
tax. Suppose, for example, that all present taxes are abolished
and that the same total is to be raised from a new capitation,
or head, tax, which requires that every inhabitant of the United
States pay an equal amount to the support of federal, state, and
local government. This would mean that the existing total government
revenue of the United States, which we estimate at 1 trillion,
380 million dollars – and here exact figures are not important
– would have to be divided between an approximate total of
243 million people. Which would mean that every man, woman, and
child in America would be required to pay to government each and
every year, $5,680. Somehow, I don’t believe that anything like
this large a sum could be collectible by the authorities, no matter
how many enforcement powers are granted the IRS. A clear example
where the ceteris paribus assumption flagrantly breaks down.

But a more
important, if less dramatic, example is nearer at hand. Before
World War II, Internal Revenue collected the full amount, in one
lump sum, from every taxpayer, on March 15 of each year. (A month’s
extension was later granted to the long-suffering taxpayers.)
During World War II, in order to permit an easier and far smoother
collection of the far higher tax rates for financing the war effort,
the federal government instituted a plan conceived by the ubiquitous
Beardsley Ruml of R.H. Macy & Co., and technically implemented
by a bright young economist at the Treasury Department, Milton
Friedman
. This plan, as all of us know only too well, coerced
every employer into the unpaid labor of withholding the tax each
month from the employee’s paycheck and delivering it to the Treasury.
As a result, there was no longer a need for the taxpayer to cough
up the total amount in a lump sum each year. We were assured by
one and all, at the time, that this new withholding tax
was strictly limited to the wartime emergency, and would disappear
at the arrival of peace. The rest, alas, is history. But the point
is that no one can seriously maintain that an income tax deprived
of withholding power, could be collected at its present high levels.

One reason,
therefore, that an economist cannot claim that the income tax,
or any other tax, is better from the point of view of the taxed
person, is that total revenue collected is often a function of
the type of tax imposed. And it would seem that, from the point
of view of the taxed person, the less extracted from him the better.
Even indifference-curve analysis would have to confirm that conclusion.
If someone wishes to claim that a taxed person is disappointed
at how little tax he is asked to pay, that person is
always free to make up the alleged deficiency by making a voluntary
gift to the bewildered but happy taxing authorities.[1]

A second
insuperable problem with an economist’s recommending any form
of tax from the alleged point of view of the taxee, is that the
taxpayer may well have particular subjective evaluations of the
form of tax, apart from the total amount levied. Even if the total
revenue extracted from him is the same for tax A and tax B, he
may have very different subjective evaluations of the two taxing
processes. Let us return, for example, to our case of the income
as compared to an excise tax. Income taxes are collected in the
course of a coercive and even brutal examination of virtually
every aspect of every taxpayer’s life by the all-seeing, all-powerful
Internal Revenue Service. Each taxpayer, furthermore, is obliged
by law to keep accurate records of his income and deductions,
and then, painstakingly and truthfully, to fill out and submit
the very forms that will tend to incriminate him into tax liability.
An excise tax, say on whiskey or on movie admissions, will intrude
directly on no one’s life and income, but only into the sales
of the movie theater or liquor store. I venture to judge that,
in evaluating the “superiority” or “inferiority” of different
modes of taxation, even the most determined imbiber or moviegoer
would cheerfully pay far higher prices for whiskey or movies than
neoclassical economists contemplate, in order to avoid the long
arm of the IRS.[2]

The Forms
of Consumption Tax

In recent
years, the old idea of a consumption tax in contrast to an income
tax has been put forward by many economists, particularly by allegedly
pro-free-market conservatives. Before turning to a critique of
the consumption tax as a substitute for the income tax, it should
be noted that current proposals for a consumption tax would deprive
taxpayers of the psychic joy of eradicating the IRS. For while
the discussion is often couched in either-or terms, the various
proposals really amount to adding a new consumption tax
on top of the current massive armamentarium of taxing power. In
short, seeing that income tax levels may have reached their political
limits for the time being, our tax consultants and theoreticians
are suggesting a shining new tax weapon for the government to
wield. Or, in the immortal words of that exemplary economic czar
and servant of absolutism, Jean-Baptiste Colbert, the task of
the taxing authorities is to “so pluck the goose as to obtain
the largest amount of feathers with the least amount of hissing.”
We the taxpayers, of course, are the geese.

But let us
put the best face on the consumption-tax proposal, and deal with
it as a complete replacement of the income tax by a consumption
tax, with total revenue remaining the same. Our first point is
that one venerable form of consumption tax not only retains existing
IRS despotism but makes it even worse. This is the consumption
tax first prominently proposed by Irving Fisher.[3]
The Fisher tax would retain the IRS, as well as the requirement
that everyone keep detailed and faithful records and truthfully
estimate his own taxes. But it would add something else. In
addition to reporting one’s income and deductions, everyone
would be required to report his additions to or subtractions from
capital assets (including cash) over the year. Then, everyone
would pay the designated tax rate on his income minus his addition
to capital assets, or net consumption. Or, contrarily, if he spent
more than he earned over the year, he would pay a tax on his income
plus his reduction of capital assets, again equaling his net consumption.
Whatever the other merits or demerits of the Fisherine tax, it
would add to IRS power over every individual, since the
state of his capital assets, including his stock of cash, would
now be examined with the same care as his income.

A second
proposed consumption tax, the VAT, or value-added tax, imposes
a curious hierarchical tax on the “value added” by each firm and
business. Here, instead of every individual, every business firm
would be subjected to intense bureaucratic scrutiny, for each
firm would be obliged to report its income and its expenditures,
paying a designated tax on the net income. This would tend to
distort the structure of business. For one thing, there would
be an incentive for uneconomic vertical integration, since the
fewer the number of times a sale takes place, the fewer the imposed
taxes. Also, as has been happening in European countries with
experience of the VAT, a flourishing industry may arise in issuing
phony vouchers, so that businesses can overinflate their alleged
expenditures, and reduce their reported value added. Surely a
sales tax, other things being equal, is manifestly both simpler,
less distorting of resources, and enormously less bureaucratic
and despotic than the VAT. Indeed the VAT seems to have no clear
advantage over the sales tax, except of course, if multiplying
bureaucracy and bureaucratic power is considered a benefit.

The third
type of consumption tax is the familiar percentage tax on retail
sales. Of the various forms of consumption tax, the sales tax
surely has the great advantage, for most of us, of eliminating
the despotic power of the government over the life of every individual,
as in the income tax, or over each business firm, as in the VAT.
It would not distort the production structure as would the VAT,
and it would not skew individual preferences as would specific
excise taxes.

Let us now
consider the merits or demerits of a consumption as against an
income tax, setting aside the question of bureaucratic power.
It should first be noted that the consumption tax and the income
tax each carry distinct philosophical implications. The income
tax rests necessarily on the ability-to-pay principle, namely
the principle that if a goose has more feathers it is more ripe
for the plucking. The ability-to-pay principle is precisely the
creed of the highwayman, of taking where the taking is good, of
extracting as much as the victims can bear. The ability-to-pay
principle is the philosophical embodiment of the memorable answer
of Willie Sutton when he was asked, perhaps by a psychological
social worker, why he robbed banks. “Because,” answered Willie,
“that’s where the money is.”

The consumption
tax, on the other hand, can only be regarded as a payment for
permission-to-live. It implies that a man will not be allowed
to advance or even sustain his own life unless he pays, off the
top, a fee to the State for permission to do so. The consumption
tax does not strike me, in its philosophical implications, as
one whit more noble, or less presumptuous, than the income tax.

Proportionality
and Progressivity: Who? Whom?

One of the
suggested virtues of the consumption tax advanced by conservatives
is that, while the income tax can be and generally is progressive,
the consumption tax is virtually automatically proportional. It
is also claimed that progressive taxation is tantamount to theft,
with the poor robbing the rich, whereas proportionality is the
fair and ideal tax. In the first place, however, the Fisher-type
consumption tax could well be every bit as progressive as the
income tax. Even the sales tax is scarcely free from progressivity.
For most sales taxes in practice exempt such products as food,
exemptions that distort individual market preferences and also
introduce progressivity of taxation.

But is progressivity
really the problem? Let us take two individuals, one who makes
$10,000 a year and another who makes $100,000. Let us posit two
alternative tax systems: one proportional, the other steeply progressive.
In the progressive tax system, income tax rates range from 1 percent
for the $10,000-a-year man, to 15 percent for the man with the
higher income. In the succeeding proportional system, let us assume,
everyone, regardless of income, pays the same 30 percent of his
income. In the progressive system, the low-income man pays $100
a year in taxes, and the wealthier pays $15,000, whereas in the
allegedly fairer proportional system, the poorer man pays $3000
instead of $100, while the wealthier pays $30,000 instead of $15,000.
It is, however, small consolation to the higher-income person
that the poorer man is paying the same percentage of income in
tax as he, for the wealthier person is being mulcted far more
than before. It is unconvincing, therefore, to the richer man
to be told that he is now no longer being “robbed” by the poor,
since he is losing far more than before. If it is objected that
the total level of taxation is far higher under our posited
proportional than progressive system, we reply that that is precisely
the point. For what the higher-income person is really objecting
to is not the mythical robbery inflicted upon him by “the poor”;
his problem is the very real amount being extracted from him by
the State. The wealthier man’s real complaint, then,
is not how badly he is being treated relative to someone else,
but how much money is being extracted from his own hard-earned
assets. We submit that progressivity of taxes is a red herring;
that the real problem and proper focus should be on the amount
that any given individual is obliged to surrender to the State.[4]

The State,
of course, spends the money it receives on various groups, and
those who claim that progressive taxation mulcts the rich on behalf
of the poor argue by comparing the income status of the taxpayers
with those on the receiving end of the State’s largess. Similarly,
the Chicago School claims that the tax system is a process by
which the middle class exploits both the rich and the poor, while
the New Left insists that taxes are a process by which the rich
exploit the poor. All of these attempts misfire by unjustifiably
bracketing as one class the payers to, and recipients from, the
State. Those who pay taxes to the State, be they wealthy, middle
class or poor, are certainly on net, a different set
of people than those wealthy, middle-class, or poor, who receive
money from State coffers, which notably includes politicians and
bureaucrats as well as those who receive favors from these members
of the State apparatus. It makes no sense to lump these groups
together. It makes far more sense to realize that the process
of tax and expenditures creates two and only two separate, distinct,
antagonistic social classes, what Calhoun brilliantly identified
as the (net) taxpayers and the (net) tax consumers, those who
pay taxes and those who live off them. I submit that, looked at
in this perspective, it also becomes particularly important to
minimize the burdens which the State and its privileged tax consumers
place on the productivity of the taxpayers.[5]

The Problem
of Taxing Savings

The major
argument for replacing an income by a consumption tax is that
savings would no longer be taxed. A consumption tax, its advocates
assert, would tax consumption and not savings. The fact that this
argument is generally advanced by free-market economists, in our
day mainly by the supply-siders, strikes one immediately as rather
peculiar. For individuals on the free market, after all, each
decide their own allocation of income to consumption or to savings.
This proportion of consumption to savings, as Austrian economics
teaches us, is determined by each individual’s rate of time preference,
the degree by which he prefers present to future goods. For each
person is continually allocating his income between consumption
now, as against saving to invest in goods that will bring an income
in the future. And each person decides the allocation on the basis
of his time preference. To say, therefore, that only consumption
should be taxed and not savings is to challenge the voluntary
preferences and choices of individuals on the free market, and
to say that they are saving far too little and consuming too much,
and therefore that taxes on savings should be removed and all
the burdens placed on present as compared to future consumption.
But to do that is to challenge free-market expressions of time
preference, and to advocate government coercion to forcibly alter
the expression of those preferences, so as to coerce a higher
saving-to-consumption ratio than desired by free individuals.

We must,
then, ask, By what standards do the supply-siders and other advocates
of consumption taxes decide why and to what extent savings are
too low and consumption too high? What are their criteria of “too
low” or “too much,” on which they base their proposed coercion
over individual choice? And what is more, by what right do they
call themselves advocates of the “free market” when they propose
to dictate choices in such a vital realm as the proportion between
present and future consumption?

Supply-siders
consider themselves heirs of Adam Smith, and in one sense they
are right. For Smith, too, driven in his case by a deep-seated
Calvinist hostility to luxurious consumption, sought to use government
to raise the social proportion of investment to consumption beyond
the desires of the free market. One method he advocated was high
taxes on luxurious consumption; another was usury laws, to drive
interest rates below the free-market level, and thereby coercively
channel or ration savings and credit into the hands of sober,
industrious prime business borrowers, and out of the hands of
“projectors” and “prodigal” consumers who would be willing to
pay high interest charges. Indeed, through the device of the ghostly
Impartial Spectator, who, in contrast to real human beings, is
indifferent to the time at which he will receive goods, Smith
virtually held a zero rate of time preference to be the ideal.[6]

The only
coherent argument offered by advocates of consumption against
income taxation is that of Irving Fisher, based on suggestions
in John Stuart Mill.[7]
Fisher argued that, since the goal of all production is consumption,
and since all capital goods are only way stations on the way to
consumption, the only genuine income is consumption spending.
The conclusion is quickly drawn that therefore only consumption
income, not what is generally called “income,” should be subject
to tax.

More specifically,
savings and consumption, it is alleged, are not really symmetrical.
All saving is directed toward enjoying more consumption in the
future. Potential present consumption is foregone in return for
an expected increase in future consumption. The argument concludes
that therefore any return on investment can only be considered
a “double counting” of income, in the same way that a repeated
counting of the gross sales of, say, a case of Wheaties from manufacturer
to jobber to wholesaler to retailer as part of net income or product
would be a multiple counting of the same good.

This reasoning
is correct as far as it goes in explaining the consumption-savings
process, and is quite helpful in leveling a critique of conventional
national income or product statistics. For these statistics carefully
leave out all double or multiple counting in order to arrive at
total net product, yet they arbitrarily include in total net income,
investment in all capital goods lasting longer than one year
– a clear example itself of double counting. Thus, the
current practice absurdly excludes from net income a merchant’s
investment in inventory lasting 11 months before sale, but includes
in net income investment in inventory lasting for 13 months. The
cogent conclusion is that an estimate of social or national income
should include only consumer spending.[8]

Despite the
many virtues of the Fisher analysis, however, it is impermissible
to leap to the conclusion that only consumption should be taxed
rather than income. It is true that savings leads to a greater
supply of consumer goods in the future. But this fact is known
to all persons; that is precisely why people save. The
market, in short, knows all about the productive power of savings
for the future, and allocates its expenditures accordingly. Yet
even though people know that savings will yield them more future
consumption, why don’t they save all their current income? Clearly,
because of their time preferences for present as against future
consumption. These time preferences govern people’s allocation
between present and future. Every individual, given his money
“income” – defined in conventional terms – and his value
scales, will allocate that income in the most desired proportion
between consumption and investment. Any other allocation
of such income, any different proportions, would therefore satisfy
his wants and desires to a lesser extent and lower his position
on his value scale. It is therefore incorrect to say that an income
tax levies an extra burden on savings and investment; it penalizes
an individual’s entire standard of living, present and future.
An income tax does not penalize saving per se any more than it
penalizes consumption.

Hence, the
Fisher analysis, for all its sophistication, simply shares the
other consumption-tax advocates’ prejudices against the voluntary
free-market allocations between consumption and investment. The
argument places greater weight on savings and investment than
the market does. A consumption tax is just as disruptive of voluntary
time preferences and market allocations as is a tax on savings.
In most or all other areas of the market, free-market economists
understand that allocations on the market tend always to be optimal
with respect to satisfying consumers’ desires. Why then do they
all too often make an exception of consumption-savings allocations,
refusing to respect time-preference rates on the market?

Perhaps the
answer is that economists are subject to the same temptations
as anyone else. One of these temptations is to call loudly for
you, him, and the other guy to work harder, and save and invest
more, thereby increasing one’s own present and future standards
of living. A follow-up temptation is to call for the gendarmes
to enforce that desire. Whatever we may call this temptation,
economic science has nothing to do with it.

The Impossibility
of Taxing Only Consumption

Having challenged
the merits of the goal of taxing only consumption and freeing
savings from taxation, we now proceed to deny the very possibility
of achieving that goal, i.e., we maintain that a consumption tax
will devolve, willy-nilly, into a tax on income and therefore
on savings as well. In short, that even if, for the sake of argument,
we should want to tax only consumption and not income,
we should not be able to do so.

Let us take,
first, the Fisher plan, which, seemingly straightforward, would
exempt saving and tax only consumption. Let us take Mr. Jones,
who earns an annual income of $100,000. His time preferences lead
him to spend 90 percent of his income on consumption, and save
and invest the other 10 percent. On this assumption, he will spend
$90,000 a year on consumption, and save-and-invest the other $10,000.
Let us assume now that the government levies a 20 percent tax
on Jones’s income, and that his time-preference schedule remains
the same. The ratio of his consumption to savings will still be
90:10, and so, after-tax income now being $80,000, his consumption
spending will be $72,000 and his saving-investment $8,000 per
year.[9]

Suppose now
that instead of an income tax, the government follows the Irving
Fisher scheme, and levies a 20 percent annual tax on Jones’s consumption.
Fisher maintained that such a tax would fall only on consumption,
and not on Jones’s savings. But this claim is incorrect, since
Jones’s entire savings-investment is based solely on the possibility
of his future consumption, which will be taxed equally.
Since future consumption will be taxed, we assume, at the same
rate as consumption at present, we cannot conclude that savings
in the long run receives any tax exemption or special encouragement.
There will therefore be no shift by Jones in favor of savings-and-investment
due to a consumption tax.[10]
In sum, any payment of taxes to the government, whether they be
consumption or income, necessarily reduces Jones’s net income.
Since his time-preference schedule remains the same, Jones will
therefore reduce his consumption and his savings proportionately.
The consumption tax will be shifted by Jones until it becomes
equivalent to a lower rate of tax on his own income. If Jones
still spends 90 percent of his net income on consumption, and
10 percent on savings-investment, his net income will be reduced
by $15,000, instead of $20,000, and his consumption will now total
$76,000, and his savings-investment $9,000. In other words, Jones’s
20 percent consumption tax will become equivalent to a 15 percent
tax on his income, and he will arrange his consumption-savings
proportions accordingly.[11]

We
saw at the beginning of this paper that an excise tax skewing
resources away from more desirable goods does not necessarily
mean we can recommend an alternative, such as an income tax. But
how about a general sales tax, assuming that one can be levied
politically with no exemptions of goods or services? Wouldn’t
such a tax burden be only on consumption and not income?

In the first
place, a sales tax would be subject to the same problems as the
Fisher consumption tax. Since future and present consumption would
be taxed equally, there would again be shifting by each individual
so that future as well as present consumption would be reduced.
But, furthermore, the sales tax is subject to an extra complication:
the general assumption that a sales tax can be readily shifted
forward to the consumer is totally fallacious. In fact, the sales
tax cannot be shifted forward at all!

Consider:
all prices are determined by the interaction of supply, the stock
of goods available to be sold, and by the demand schedule for
that good. If the government levies a general 20 percent tax on
all retail sales, it is true that retailers will now incur an
additional 20 percent cost on all sales. But how can they raise
prices to cover these costs? Prices, at all times, tend to be
set at the maximum net revenue point for each seller. If the sellers
can simply pass the 20 percent increase in costs onto the consumers,
why did they have to wait until a sales tax to raise prices? Prices
are already at highest net income levels for each firm.
Any increase in cost, therefore, will have to be absorbed by the
firm; it cannot be passed forward to the consumers. Put another
way, the levy of a sales tax has not changed the stock already
available to the consumers; that stock has already been produced.
Demand curves have not changed, and there is no reason for them
to do so. Since supply and demand have not changed, neither will
price. Or, looking at the situation from the point of the demand
and supply of money, which help determine general price levels,
the supply of money has remained as given, and there is also no
reason to assume a change in the demand for cash balances either.
Hence, prices will remain the same.

It might
be objected that, even though shifting forward to higher prices
cannot occur immediately, it can do so in the longer run, when
factor and resources owners will have a chance to lower their
supply at a later point in time. It is true that a partial excise
can be shifted forward in this way, in the long run, by resources
leaving, let us say, the liquor industry and shifting into other
untaxed industries. After a while, then, the price of liquor can
be raised by a liquor tax, but only by reducing the future supply,
the stock of liquor available for sale at a future date. But such
“shifting” is not a painless and prompt passing on of a higher
price to consumers; it can only be accomplished in a longer run
by a reduction in the supply of a good.

The burden
of a sales tax cannot be shifted forward in the same
way, however. For resources cannot escape a sales tax as they
can an excise tax – by leaving the liquor industry and moving
to another. We are assuming that the sales tax is general and
uniform; it cannot therefore, be escaped by resources except by
fleeing into idleness. Hence, we cannot maintain that the sales
tax will be shifted forward in the long run by all supplies
of goods falling by something like 20 percent (depending on elasticities).
General supplies of goods will fall, and hence prices rise, only
to the relatively modest extent that labor, seeing a rise in the
opportunity cost of leisure because of a drop in wage incomes,
will leave the labor force and become voluntarily idle (or more
generally will lower the number of hours worked).[12]

In the long
run, of course, and that run is not very long, the retail
firms will not be able to absorb a sales tax; they are not unlimited
pools of wealth ready to be confiscated. As the retail firms suffer
losses, their demand curves for all intermediate goods, and then
for all factors of production, will shift sharply downward, and
these declines in demand schedules will be rapidly transmitted
to all the ultimate factors of production: labor, land, and interest
income. And since all firms tend to earn a uniform interest return
determined by social time preference, the incidence of the fall
in demand curves will rest rather quickly on the two ultimate
factors of production: land and labor.

Hence, the
seemingly common-sense view that a retail sales tax will readily
be shifted forward to the consumer is totally incorrect. In contrast,
the initial impact of the tax will be on the net incomes of retail
firms. Their severe losses will lead to a rapid downward shift
in demand curves, backward to land and labor, i.e., to
wage rates and ground rents. Hence, instead of the retail sales
tax being quickly and painlessly shifted forward, it will, in
a longer run, be painfully shifted backward to the incomes of
labor and landowners. Once again, an alleged tax on consumption,
has been transmuted by the processes of the market into a tax
on incomes.

The general
stress on forward shifting, and neglect of backward shifting,
in economics is due to the disregard of the Austrian theory of
value, and its insight that market price is determined only
by the interaction of an already-produced stock, with the subjective
utilities and demand schedules of consumers for that stock. The
market supply curve, therefore, should be vertical in the usual
supply-demand diagram. The standard Marshallian forward-sloping
supply curve illegitimately incorporates a time dimension within
it, and it therefore cannot interact with an instantaneous, or
freeze-frame, market-demand curve. The Marshallian curve sustains
the illusion that higher cost can directly raise prices, and not
only indirectly by reducing supply. And while we may arrive at
the same conclusion as Marshallian supply-curve analysis for a
particular excise tax, where partial equilibrium can be used,
this standard method breaks down for general sales taxation.

Conclusion:
The Amount vs. the Form of Taxation

We conclude
with the observation that there has been far too much concentration
on the form, the type of taxation, and not enough on
its total amount. The result has been endless tinkering with kinds
of taxes, coupled with neglect of a far more critical question:
how much of the social product should be siphoned away
from the producers? Or, how much income should be retained by
the producers and how much income and resources coercively diverted
for the benefit of nonproducers?

It is particularly
odd that economists who proudly refer to themselves as advocates
of the free market have in recent years led the way in this mistaken
path. It was allegedly free-market economists for example who
pioneered in and propagandized for the alleged Tax Reform Act
of 1986. This massive change was supposed to bring us “simplification”
of our income taxes. The result, of course, was so simple that
even the IRS, let alone the fleet of tax lawyers and tax accountants,
has had great difficulty in understanding the new dispensation.
Peculiarly, moreover, in all the maneuverings that led to the
Tax Reform Act, the standard held up by these economists, a standard
apparently so self-evident as to need no justification, was that
the sum of tax changes be “revenue neutral.” But they never told
us what is so great about revenue neutrality. And of course, by
cleaving to such a standard, the crucial question of total revenue
was deliberately precluded from the discussion.

Even more
egregious was an early doctrine of another group of supposed free-market
advocates, the supply-siders. In their original Laffer-curve manifestation,
now happily consigned to the dustbin of history, the supply-siders
maintained that the tax rate that maximizes tax revenue is the
“voluntary” rate, and a rate that should be diligently pursued.
It was never pointed out in what sense such a tax rate is “voluntary,”
or what in the world the concept of “voluntary” has to do with
taxation in the first place. Much less did the supply-siders in
their Lafferite form ever instruct us why we must all uphold maximizing
government revenue as our beau idéal. Surely, for free-market
proponents, one might think that minimizing government
depredation of the private product would be a bit more appealing.

It is with
relief that one turns for a realistic as well as a genuine free-market
approach to Jean-Baptiste
Say
, who contributed considerably more to economics than Say’s
law
. Say was under no illusion that taxation is voluntary
nor that government spending contributes productive services to
the economy. Say pointed out that, in taxation,

The government
exacts from a taxpayer the payment of a given tax in the shape
of money. To meet this demand, the taxpayer exchanges part of
the products at his disposal for coin, which he pays to the
tax-gatherers.

Eventually,
the government spends the money on its own needs, so that

in the
end … this value is consumed; and then the portion of wealth,
which passes from the hands of the taxpayer into those of the
tax-gatherer, is destroyed and annihilated.

Note that,
as in the case of the later Calhoun, Say sees that taxation creates
two conflicting classes, the taxpayers and the tax gatherers.
Were it not for taxes, the taxpayer would have spent his money
on his own consumption. As it is, “The state … enjoys the satisfaction
resulting from that consumption.”

Say proceeds
to denounce the

prevalent
notion, that the values, paid by the community for the public
service, return it again … that what government and its agents
receive, is refunded again by their expenditures.

Say angrily
comments that this “gross fallacy … has been productive of infinite
mischief, inasmuch as it has been the pretext for a great deal
of shameless waste and dilapidation.”

On the contrary,
Say declares, “the value paid to government by the taxpayer is
given without equivalent or return; it is expended by the government
in the purchase of personal service, of objects of consumption.”

Say goes
on to denounce the “false and dangerous conclusion” of economic
writers that government consumption increases wealth. Say noted
bitterly that “if such principles were to be found only in books,
and had never crept into practice one might suffer them without
care or regret to swell the monstrous heap of printed absurdity.”

But unfortunately,
he noted, these notions have been put into “practice by the agents
of public authority, who can enforce error and absurdity at the
point of a bayonet or mouth of the cannon.”[13]
Taxation, then, for Say is

the transfer
of a portion of the national products from the hands of individuals
to those of the government, for the purpose of meeting the public
consumption of expenditure…. It is virtually a burthen imposed
upon individuals, either in a separate or corporate character,
by the ruling power … for the purpose of supplying the consumption
it may think proper to make at their expense.[14]

But taxation,
for Say, is not merely a zero-sum game. By levying a burden on
the producers, he points out, taxes, over time, cripple production
itself. Writes Say,

Taxation
deprives the producer of a product, which he would otherwise
have the option of deriving a personal gratification from, if
consumed … or of turning to profit, if he preferred to devote
it to an useful employment…. [T]herefore, the subtraction
of a product must needs diminish, instead of augmenting, productive
power.

J.B. Say’s
policy recommendation was crystal clear and consistent with his
analysis and that of the present paper. “The best scheme of [public]
finance is, to spend as little as possible; and the best tax is
always the lightest.”

Notes

[1]
In 1619, Father Pedro Fernandez Navarrete, “Canonist Chaplain
and Secretary of his High Majesty,” published a book of advice
to the Spanish monarch. Sternly advising a drastic cut in taxation
and government spending, Father Navarrete recommended that, in
the case of sudden emergencies, the king rely soley on soliciting
voluntary donations. Alejandro Antonio Chafuen, Christians
for Freedom: Late Scholastic Economics
(San Francisco:
Ignatius Press, 1986), p. 68.

[2]
It is particularly poignant, on or near any April 15, to contemplate
the dictum of Father Navarrete, that “the only agreeable country
is the one where no one is afraid of tax collectors,” Chafuen,
Christians for Freedom, p. 73. Also see Murray N. Rothbard,
“Review of A. Chafuen, Christians
for Freedom: Late Scholastic Economics
,” International
Philosophical Quarterly 28 (March 1988): 112–14.

[3]
See, for example, Irving and Herbert N. Fisher, Constructive
Income Taxation
(New York: Harper, 1942).

[4]
For a fuller treatment, and a discussion of who is being robbed
by whom, see Murray N. Rothbard, Power
and Market: Government and the Economy
, 2nd ed. (Kansas
City: Sheed Andrews & McMeel, 1977), pp. 120–21.

[5]
See Murray N. Rothbard, Man,
Economy, and State: A Treatise on Economic Principles
.

[6]
See the illuminating article by Roger W. Garrision, “West’s
‘Cantillon and Adam Smith’: A Comment
,” Journal of Libertarian
Studies 7 (Fall 1985): 291–92.

[7]
See Rothbard, Power and Market, pp. 98–100.

[8]
We omit here the fascinating question of how government’s activities
should be treated in national income statistics. See Rothbard,
Man, Economy, and State, 2, pp. 815–20; idem, Power
and Market, pp. 199–201; idem, America’s
Great Depression
, 4th ed. (New York: Richardson &
Snyder, 1983), pp. 296–304; Robert Batemarco, “GNP,
PPR, and the Standard of Living,”
Review of Austrian Economics
1 (1987): 181–86.

[9]
We set aside the fact that, at the lower amount of money assets
left to him, Jones’s time-preference rate, given his time-preference
schedule, will be higher, so that his consumption will be higher,
and his savings lower, than we have assumed.

[10]
In fact, per note 9, supra,
there will be a shift in favor of consumption because a diminished
amount of money will shift the taxpayer’s time preference rate
in the direction of consumption. Hence, paradoxically, a pure
tax on consumption will and up taxing savings more than consumption!
See Rothbard, Power and Market, pp. 108–11.

[11]
If net income is defined as gross income minus amount paid in
taxes, and for Jones, consumption is 90 percent of net income,
a 20 percent consumption tax on $100,000 income will be tantamount
to a 15 percent tax on this income. Rothbard, Power and Market,
pp. 108–11. The basic formula is that net income,

where G=gross
income, t=the tax rate on consumption, and c, consumption as percent
of net income, are givens of the problem, and N = G – T by
definition, where T is the amount paid in consumption tax.

[12]
Rothbard, Power and Market, pp. 88-93. Also see the notable
article by Harry Gunnison Brown, “The Incidence of a General Sales
Tax,” in Readings
in the Economics of Taxation
, R. Musgrave and C. Shoup,
eds. (Homewood, Ill: Irwin, 1959), pp. 330–39.

[13]
Jean-Baptiste Say, A
Treatise on Political Economy
, 6th ed. (Philadelphia:
Claxton, Remsen & Heffelfinger, 1880), pp. 412–15. Also
see Murray N. Rothbard, “The Myth of Neutral Taxation,” Cato
Journal 1 (Fall 1981): 551–54.

[14]
Say, Treatise, p. 446.

Murray
N. Rothbard

(1926–1995) was dean of the Austrian School, founder of modern
libertarianism, and chief academic officer of the Mises
Institute
. He was also editor – with Lew Rockwell –
of The
Rothbard-Rockwell Report
,
and appointed Lew as his executor. See
Murray’s books.

Copyright
2013 by the Ludwig von Mises Institute.
Permission to reprint in whole or in part is hereby granted, provided
full credit is given.

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