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.
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.
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.
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.
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.
(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.
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.
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.