The Ultimate Tax Cut

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Since it is presidential campaign season, we will inevitably be treated to the usual discourse about tax cuts. Some candidates will call for tax cuts, undoubtedly as a way to bribe voters into voting for them. Others will resist the call, undoubtedly in fear that their favorite government program might not receive desired funding. In actuality, all the tax-cut talk will be rather meaningless, especially for advocates of liberty.

From the founding of the United States through the early part of the 20th century, with a few exceptions (e.g., the Civil War), Americans lived without income taxation, the federal government being funded primarily by tariffs and excise taxes. Americans were free to keep everything they earned and decide what to do with their money. There was no IRS and no one had to file income-tax returns.

When the idea of an income-tax-free society is posed to a modern-day American, oftentimes the reaction to such a radical idea is shock. “Why, that would be anarchy!” the American sometimes responds. But that notion would have come as a surprise to our American ancestors, who lived in a society with a fully functioning federal government and no income taxation for more than 100 years.

Why did our American ancestors oppose income taxation? Because they had discovered an important point: People cannot be free in a society in which the government has the power to levy taxes on income. To put it another way, people are free only when they have the ability to keep everything they earn and decide for themselves what to do with their own money.

With the advent of income taxation in America, the relationship between citizen and government was inverted. Prior to the income tax, the citizen was sovereign by virtue of the fact that he was free to earn unlimited amounts of money and there was nothing the government could do about it. Like it or not, it was his money, to do with as he pleased.

With the adoption of income taxation, all that changed. In effect, the income tax nationalized income. While many people would undoubtedly prefer not to think about it in this way, under the federal income tax everyone’s income belongs to the government or, if you prefer, to “society.” The power to set the tax rate is essentially the power to decide how much of their income people are going to be permitted to keep.

Thus, the income tax has converted the relationship between government and citizen into one akin to parent and child. The portion of their income that the citizenry are permitted to retain has effectively become an allowance. Sometimes the government is good to the citizenry and lets them keep more of their income. Sometimes the government is not so nice and lets the citizenry keep less of their income. But what’s important here, in terms of freedom, is not the percentage that is being levied but rather the fact that it is the government making the determination. That’s obviously a far cry from a society in which there is no income taxation at all.

Taxes and spending

There is another factor to consider here, a practical one. Those candidates who call for tax cuts are doing more than throwing a bone to beleaguered taxpayers. They are also perpetrating a fraud, because they know that since government expenditures today far exceed government revenues, people are going to have to pay for the deficit somehow.

Permit me to digress a bit here. One of my biggest personal revelations when I discovered libertarianism many years ago was that the federal government acquired its resources differently than people in the private sector. I had envisioned the government as just being part of a huge collection of enterprises, producing its own wealth and deciding what to do with it. That was one reason I could not understand why anyone would object to the government’s helping the poor with welfare. I thought, Why shouldn’t the government be as “free” as everyone else to decide how to spend its money, and why shouldn’t it spend its money on helping the poor?

And then I discovered that the federal government acquired its money differently than everyone else. Its money comes from taxes, which are forcible exactions imposed on people. That is obviously very different from how people in the private sector get their money. Microsoft, for example, depends on offering products that induce people to voluntarily trade their money for a particular piece of software. If people decide to hold on to their money instead of buying the software, there is nothing that Microsoft can do about it. That is, Microsoft cannot force anyone to hand over his money.

It’s different with the government. Its revenues do depend on force. If someone doesn’t like a particular service that the government is providing (e.g., waging the drug war, providing people with welfare, torturing detainees, or killing people in Iraq), he can’t do what he does with Microsoft. He must pay his income taxes anyway, on pain of fine and imprisonment or even death upon steadfast refusal to do so.

Now, back to the tax-cut bone that presidential candidates love to offer voters during campaign season. As Milton Friedman pointed out, the true level of taxation is not what is being collected in taxes but rather the level of government expenses. Why is this so? Because if the government is spending more than it is receiving in tax revenues, it is doing it in one of two ways — borrowing or printing the money.

If it’s borrowing the money to finance its expenditures, those debts must ultimately be paid back. That’s why a tax-cut bone that presidential candidates offer voters is a fraud. They know that one way or another, ultimately the government is going to have to repay those debts. And the only way it can get the money to repay those debts is to tax the citizenry.

Inflation plunder

Another way — historically a popular one — that the government finances its excess expenditures is by simply printing the money to pay for expenditures, a practice known as inflation. When the government inflates the currency to pay its excess bills, the result is a lower-valued currency. As with any other product, increasing the supply of money lowers its value. And the lower value of a currency is reflected in a rise in the prices of the things that money buys — such as groceries, automobiles, gasoline, clothing, and school supplies.

The advantage of paying for government expenses through inflation, as compared to income taxation, should be obvious: Most people don’t have any idea that this is the way that government is paying its bills. They think that inflation is some sort of mysterious monetary infection that just seems to strike nations randomly and unexpectedly. In fact, even mainstream “educated” journalists often use the term “inflation” to describe rising prices in society rather than using it in its true sense — an artificial increase in the supply of money that is reflected in the rising prices in society.

The point of all this is to show another reason that the tax-cut bone that presidential candidates offer the electorate is a fraud. Since people are going to have to pay for the excess government expenditures through the reduced purchasing power of their income, what practical difference does a tax cut make to them? Moreover, even if a tax cut increases government revenues, as some people claim, government expenditures inevitably rise proportionately.

Suppose that government spends $100 million a year and collects income taxes of $100 million. The following year, the government decides to engage in an overseas military adventure that doubles government expenditures to $200 million. The president, however, vows not to raise taxes. To pay the extra $100 million in new expenses, the government simply prints the money, which because of rising prices reduces the purchasing power of everyone’s income, a reduction, say, equal to a doubling of the income tax.

Are people any better off because the government has financed its expenditures through inflation? Of course not. While it’s true that some taxpayers might benefit more and others lose more, the fact is that either way, the government has sucked $200 million out of the pockets of the citizenry.

Let’s assume that during this process, a power-lusting presidential candidate comes along and calls for a tax cut. “I’ll lower your taxes if you elect me!” exclaims the politician. Would people be better off with such a tax cut? Of course not, because what is gained with the tax cut will be lost in the reduced purchasing power of their income, given that the excess expenditures are being financed with inflation.

Ultimately, the issue of income taxation cannot be divorced from the things on which the federal government is spending its money. As we have seen, the money that government is spending must be collected, either directly through taxes, through borrowing (which must be repaid through taxes or inflation), or inflation. The burden of government expenditures must ultimately be borne by the citizenry.

Alternative taxes

Thus, while the abolition of the income tax and the IRS are necessary prerequisites to a free society, if the financial burden of other taxes is equal to the same amount that the income taxes were collecting, how much better off are people financially if they’re having to pay the same amount of money through an alternative tax that they were previously paying though the income tax? Let’s assume, for example, that a family is earning $60,000 a year and paying $20,000 in income taxes. Suppose the income tax is abolished and replaced with a national sales tax, which ultimately collects $20,000 from our hypothetical family. While it’s true that the individual will be freer in the sense that he no longer has to file income tax returns and deal with the abusiveness and intrusiveness of the IRS, the federal government is still determining the family’s “allowance,” albeit indirectly.

That’s why, ultimately, the only protection that people have is a constitutional prohibition on all taxation (the ideal) or, alternatively, a constitutional limitation on the overall level of indirect taxation.

The former would mean that government would have to depend on voluntary support from the citizenry, just as churches, museums, and other charitable organizations operate. Of course, the standard response to such a suggestion is, “Well, that’s ridiculous. The American people don’t believe in government and, therefore, have to be forced to support it.”

Yet, if most Americans didn’t believe government is important, why wouldn’t they have abolished it a long time ago? The fact is that most Americans do believe that government is important and essential and would be as willing to support it as they do other organizations.

In an imperfect world of indirect taxation to fund the federal government, people would still be better off with a constitutional ceiling on the rate of tax collected; for example: “The federal government shall collect its revenues only through tariffs, which shall never exceed 2 percent.”

Obviously, there would have to be a simultaneous moral and intellectual revolution with respect to government programs because government revenues will most likely be quite small, especially in comparison to what they are today. That means that in order to restore a free society, Americans must ask themselves a fundamentally important question: What should be the role of government in a free society? Should its role include taking money from one group of people by force (i.e., taxation) in order to give it to another group of people (i.e., provide welfare)? Should its role include the maintenance of an enormous military-industrial empire that serves as an international policeman and welfare-provider for the world?

The reason that such questions are so important is that if people maintain their allegiance to either a welfare state or a warfare state, they need to recognize that the restoration of a free society becomes impossible because of the massive amount of tax revenues needed to fund such states. In fact, as one hopes that modern-day Americans have learned, once they delegate to the government the role of providing socialist or imperialist programs, its expenditures inevitably soar exponentially.

Finally, there is a critically important economic angle to all this. The key to higher standards of living lies in the accumulation of private savings, which tends toward investment in tools and equipment, which makes workers more productive, and that tends toward higher incomes. Thus, the more income and savings that government is confiscating, the lower the standard of living of the citizenry.

Thus, a moral and intellectual revolution against income taxation must be accompanied by a moral and intellectual revolution against socialism and empire. By limiting the role of government to its traditionally legitimate functions of police, defense, and courts, the amount of voluntary money needed to fund such operations becomes relatively minuscule. The citizenry would have the freedom to keep everything they earn in the marketplace, accumulate unlimited amounts of wealth, and decide for themselves how to dispose of it. Herein lies the key to a free, prosperous, and harmonious society.

Jacob Hornberger [send him mail] is founder and president of The Future of Freedom Foundation.

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