It Would Take Just 3 Short Laws

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Let us assume that at some point in the future, Congress will pass and the President will sign three bills. These three laws would strip power from the United States government on a scale inconceivable even to the Tea Party’s hard core members. They would be very short laws.

The United States Government hereby abolishes the Federal Reserve Act of 1913 and all subsequent laws relating to that Act.

The deadline for filing all Federal income taxes will shift in the next fiscal year from April 15 to the first Monday of November.

Withholding for all Federal taxes is hereby abolished.

Think of what this would mean. First, the central bank of the United States would become just one more over-leveraged bank – the most over-leveraged bank in the country. It would no longer possess a grant of privilege from the United States government. Members of the Board of Governors would no longer be paid by the U.S. government, nor would any other employees of the Board. The Board would have to abandon its Web address: www.federalreserve.gov. No more “.gov.”

Second, the voters would be reminded in every Congressional election year just how much money the government is costing them. They would no longer have from mid-April to early November to forget.

If all Federal income taxes were due on the same day, this day would become the most feared and hated day of the year, assuming that it isn’t already. I ask: Why not have this day fall on the day before Federal elections?

Personal income tax forms must be mailed by April 15. Think about this date. Before they vote in November, taxpayers have almost seven months to forget about tax misery day the previous April, and their next form-filing day will not come for almost six months. Out of sight, out of mind.

I say, let every citizen recall his previous day’s tax filing and check-writing experience when he steps into the polling booth to cast his vote. Let democracy speak!

Third, taxpayers would have to adopt a program of personal voluntary thrift in order to set aside the money they owe to the government. Every payday, they would have to take steps to prepare for the Day of Reckoning. No longer would the government get the use of the public’s money interest-free for a year. No longer would the government be able to position itself as a provider of nice refunds: “free money!” No longer would the government force people to reveal their whereabouts in order to get their refunds.

WITHHOLDING TAXES

The withholding tax program makes it easier for governments to collect taxes. The system was invented by Rockefeller agent Beardsley Ruml. When, in 1942, he came up with a plan to sell Congress on the idea of income tax withholding, he understood exactly what this would do for revenues actually collected: multiply them.

Here was the government’s problem in 1942: only about five million out of the 34 million Americans subject to the income tax were saving to pay it on March 15, 1943. This presented a big problem for tax collectors, now that wartime taxes had been hiked dramatically. Ruml, formerly the director of the Laura Spelman Rockefeller Foundation, in 1942 was chairman of the New York Federal Reserve Bank. He was also the treasurer of R. H. Macy & Co., the department store. As Macy’s treasurer, he well understood that most people resist saving for known expenditures. He asked: Why not get employers to deduct their employees’ income tax liabilities? He recommended this to Congress in 1942, and Congress in 1943 passed a tax collection bill that included Ruml’s withholding provision: the Current Tax Payment Act.

The Treasury Department went to work defending this program. It used staff economist Milton Friedman to do much of the research.

Did the scheme work? Beyond the politicians’ wildest expectations. In 1942, the U.S. government collected $3.2 billion from income taxes. It 1943, before the law was fully operational, it collected $6.5 billion from income taxes. In 1944, it collected $20 billion. (“Historical Statistics of the United States,” Pt. 2 [1975], p. 1105.)

The withholding tax was passed as a wartime measure. Naturally, it was not repealed in 1945.

The withholding tax system is popular with the Federal government for four reasons. First, the government deliberately over-withholds. This forces taxpayers to file their forms to get their refunds. They must identify where they live. Second, it creates a “free money from the government” emotional response when the refund check arrives. Third, the government gets to use this money, interest-free, during the taxable year. Fourth, it makes income taxes and Social Security taxes less painful and therefore more acceptable.

If withholding were abolished, the decline in revenues would be both immediate, permanent, and spectacular. Then, on the second Monday of November, there would be desperation across the land. Hardly anyone would have saved all of the money owed during the year. Where would they get the money to pay? They wouldn’t. So, many would not file. There would be no way that the Internal Revenue Service could follow up on all the non-filing residents.

As soon as the taxpayers realized that there are too many people to convict, they would understand the enormous power they possess. Congress could do nothing. It would have to cut taxes to such a degree that people will set aside money to pay. It would have to issue high-interest tax prepayment bonds.

The government would have to default on its other debts.

I mention this just as a reminder: the entire system of Federal power rests on three laws, two of which are essentially technical, namely, the date for tax filing and tax withholding. These two technical laws are the foundation of the modern welfare-warfare-nanny state. Remove these two pillars, and the whole Federal system will come down.

WHY DEFAULT IS INEVITABLE

There is no school of academic opinion except for Austrian School economics that seriously suggests that the Federal debt should ever return to zero, as it was for just one year: 1836. The idea of debt-free civil government is universally regarded as utopian.

Some members of the Tea Party say that the government’s debt is too large, but no one will gather Tea Party votes by calling for permanent budget surpluses sufficient to reduce the debt to zero over the next 20 or 30 years. That would require spending cuts that voters today will not tolerate: Social Security, Medicare, and Medicaid.

All three of these programs will eventually be cut, either by piecemeal cuts, or by hyperinflation, or by an outright default by the government. But today’s politicians deny this, so most voters imagine that, somehow, these promises will not be broken by long-term fiscal crises in the future. It is not that a sucker is born every minute. On the contrary, voters who will someday demand that Congress default are born every minute. In contrast, suckers retire every minute. They are the sure losers.

“We owe it to ourselves” is a popular slogan of the defenders of the Federal debt. It has been ever since the New Deal of the 1930s. It is a nutty idea. Specific borrowers owe specific amounts to specific creditors for a specific time period. Nobody assumes that, under private debt, we owe it to ourselves, yet the idea is taken seriously by a large percentage of the voting the public when they think of government debt.

As the debt builds up relentlessly, and because nothing is done to stop this, the statistical probability of default increases. A statistician can see what is coming. A politician can too, but he is not going to admit this in public. An older voter should see it, but he has a built-in preference for not seeing it. He thinks, “I have paid so much money into the system. I deserve to be repaid.” This is the “just deserts” theory of politics. It leads to ever-greater Federal debt based on ever-more preposterous denials.

It is not a question of default vs. no default. It is a question of which kind of default and when. It is a question of whose ox will get gored.

FEDERAL DEBT, INFLATION, AND DEFLATION

Most of the Federal Reserve’s debt holdings is Federal debt, either Treasury bonds or IOU’s from Fannie Mae and Freddy Mac. Because of the way that the Federal Reserve operates, this on the surface seems to create a theoretical problem for those few economists who favor budget surpluses to reduce the Federal debt to zero. Here’s why. If Federal debt is the legal foundation of the monetary base, and if the FED’s monetary base is the legal basis of the commercial banking system’s issue of loans and therefore its creation of money (M1), then any attempt to pay off the debt to zero seems to require one of two things: (1) force the Federal Reserve to deflate, or (2) force the Federal Reserve to substitute other debt for the repaid Federal debt.

As I will show, this dilemma need not exist, but it has been raised in the financial media. Here is the argument. “If the FED is ever forced to deflate by selling its IOUs from the government back to the government, there would be price deflation on a scale undreamed of. Prices would fall by 50% or more – probably more like 90%.”

Is this true? Prices have not risen to match the increase in the FED’s monetary base since 2008. This is because commercial banks have increased their holdings of excess reserves at the FED.

Let us consider scenario #1: the FED loses its status as a government-connected agency. Its excess reserves would be withdrawn. The FED would then go bankrupt, thereby wiping out commercial banks’ holdings of excess reserves.

If the independent FED somehow could meet these obligations, commercial banks would buy Treasury debt or other forms of debt. There would be mass inflation, then hyperinflation: way over 20% per annum. Commercial banks would put to use its legal reserves created by the FED in 2008 and 2010.

The FED could buy Treasury debt only if other holders of Treasury debt would accept its newly created money. But why would anyone accept payment from an over-leveraged private bank that no longer has any connection with the U.S. government?

Let us consider scenario #2: the government lets the FED remain as the central bank. The government then starts to pay off its debt. The ultimate result would be for the central bank and the commercial banks to hold no Federal debt. That would mean a shift of the asset base from IOU’s issued by the government to IOU’s issued by others: maybe foreign governments or maybe corporations.

There is a myth that the U.S. government would create mass deflation if it ever began to pay off its debt. This is because the FED holds Treasury debt. But for every bond purchased by the government and retired, there need be no deflation. It depends on the reaction by the public. If depositors think the banks’ assets are liquid and safe, they will not make a run on the banks. Neither will other agents who extend credit to banks. The bank can buy other IOU’s to replace the Treasury’s.

The FED can buy U.S. bonds from any holder. It would take decades for the Federal government to buy back all of its on-budget bonds that are held by the public. There would be time for all banks to replace Treasury bonds with IOU’s issued by other agencies.

In a fractional reserve banking system, debt undergirds the issuing of money. But it is a matter of historical precedent that government debt has be used by the central bank as its asset base. There is nothing in theory that requires this.

The standard economic textbook accounts of central banking indicate that central banks buy government IOU’s with newly created money. The question is never raised in the textbooks about how the government could ever reduce its debt to zero without creating mass deflation. This is because textbooks rarely discuss the feasibility of debt-free government. Such a vision is presented as utopian if it is even mentioned.

So, the argument that debt-free government would produce mass deflation is limited to non-economists, most likely Greenbackers who call for the issuing of fiat money by Congress. They are opposed to government debt and fractional reserve banking, but they favor fiat money issued by Congress. They used to be associated with the far Left, but these days, they are associated with the far Right. They are inflationists and defenders of the welfare State. I have been writing against them for 45 years.

There is no theoretical reason for the reduction of Federal debt to zero to mandate monetary deflation or price deflation. Fractional reserve banking will at some point deflate, but only because governments can no longer raise enough money to bail out the banking system.

The central bank can cease buying Treasury debt for this reason: to keep buying it means hyperinflation. That would end the automatic purchase of Federal debt. That would in turn raise interest rates and produce Great Depression II.

Alternatively, the central bank can keep buying Federal debt and produce hyperinflation, which will lead to a post-inflation deflation, when zeroes are knocked off the currency.

In either case, the cause of the deflation is not the paying off of the Federal debt. On the contrary, the cause is the ever-greater increase in Federal debt.

CONCLUSION

Liberty is possible. I do not think it is likely in the near future. It will take three laws: (1) the abolition of central banking; (2) the temporal connection between tax day and voting day; (3) the abolition of withholding taxes. If and when we get all three, the government will shrink back below the definition of tyranny provided in the Bible governments that tax at 10% or higher (I Samuel 8:14, 17)

Alvin Rabushka, the pre-eminent student of taxation in colonial America, has pointed to the history of American taxation after the Federal Reserve but before the New Deal and withholding taxes. Most people are unaware of this. Nevertheless, reflecting its colonial antecedents, the scope of the federal government remained small, consuming only 3 percent of the national income as recently as 1929. The states remained the principal source of taxing and spending, consuming 7 percent of national income in 1929. It took the legislative measures enacted during the Great Depression to change the compact between the American people and their government, raising the share of taxes levied at all levels of government from a tenth to a third of the national income in peacetime, higher during wartime. The colonial roots of American taxation were lost in the transformation that took place in the twentieth century.

I would settle for going back to 1912. Wouldn’t you?

Of course, 1775 would be much better: closer to 1% of national income going to Great Britain in taxes.

Maybe we can get a new Declaration of Independence to return us to the “tyranny” of 1775. “When in the course of human events, it becomes necessary,” etc., etc.

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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