Chapter 4--Binary Intervention: Taxation (continued)
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Chapter 4—Binary
Intervention: Taxation (continued)
(4) The Capital Gains Problem
Much discussion has raged over the question: Are capital gains income?
It seems evident that they are; indeed, capital gain is one of the
leading forms of income. In fact, capital gain is the same as profit.
Those who desire uniformity of income-pattern taxation would therefore
have to include capital gains if all forms of monetary profit are to be
brought into the category of taxable income.
Using as an example the
Star Corporation described above, let us consider Time1
to be the period just after the corporation has earned $100,000 net
income and just before it decides where to allocate this income. In
short, it is at a decision point in time. It has earned a profit of
$100,000.
At Time1,
its capital value has therefore increased by $100,000. The stockholders
have, in the aggregate, earned a capital gain of $100,000, but this is
the same as their aggregate profit. Now the Star Corporation keeps
$60,000 and distributes $40,000 in dividends, and for the sake of
simplicity we shall assume that the stockholders consume this amount.
What is the situation at Time2,
after this allocation has taken place? In comparison with the situation
prevailing originally, say at Time0,
we find that the capital value of the Star Corporation has increased by
$60,000. This is unquestionably part of the income of the stockholders;
yet, if uniform income taxation is desired, there is no need to levy a
tax on it, for it was already included in the $100,000 income of the
stockholders subject to tax.
The stock market always tends toward an accurate reflection of the
capital value of a firm; one might think, therefore, that the quoted
value of the firm’s shares would increase, in the aggregate,
by $60,000. In the dynamic world, however, the stock market reflects
anticipations of future profit, and therefore its values will diverge
from the relatively ex post accounting of the
firm’s balance sheet. Furthermore, entrepreneurship, in
addition to profits and losses, will be reflected in the valuations of
the stock market as well as in business enterprises directly. A firm
may be making slim profits now, but a farseeing entrepreneur will
purchase stock from more shortsighted ones. A rise in price will net
him a capital gain, and this is a reflection of his entrepreneurial
wisdom in directing capital. Since it would be impossible
administratively to identify the profits of the firm, it would be
better from the point of view of uniform income taxation not
to tax the business income of corporate stockholders at all, but to tax
a stockholder’s capital gains instead. Whatever gains the
owners reap will be reflected in capital gains on their stock anyway,
so that taxation of the business income itself becomes unnecessary. On
the other hand, taxation of business income while exempting capital
gains would exclude from “income” the
entrepreneurial gains reaped on the stock market. In the case
of partnerships and single enterprises that are not owned in shares of
stock, the business income of the owners would, of course, be taxed
directly. Taxation of both business income (i.e., profits accruing to
stockholders) and capital gains on stock would
impose a double tax on efficient entrepreneurs. A genuinely uniform
income tax, then, would not tax a stockholder’s pro rata
business income at all, but rather the capital gain from his shares of
stock.
If business profits (or capital gains) are income subject to tax, then,
of course, business losses or capital losses are a negative income,
deductible from other income earned by any particular individual.
What of the problem of land and housing? Here, the same situation
obtains. Landlords earn income annually, and this may be included in
their net income as business profits. However, real estate, while not
given to stock ownership, also has a flourishing capital market. Land
is capitalized, and capital values increase or dwindle on the capital
market. It is clear that, once again, the government has an alternative
if it desires to impose uniform personal income taxes: either it can
impose the tax on net profits from real estate, or it can forgo this
and impose a tax on increases in the capital values of real estate. If
it does the former, it will omit the entrepreneurial gains and losses
made on the capital market, the regulator and anticipator of investment
and demand; if it does both, it imposes a double tax on this form of
business. The best solution (once again within the context of a uniform
income tax) is to impose a tax on the capital gain minus the capital
loss on the land values.
It must be emphasized that a capital gains tax is truly an income tax
only when it is levied on accrued, rather than on realized,
capital gains or losses. In other words, if a man’s capital
assets have increased during a certain period, from 300 ounces of gold
to 400 ounces, his income is 100 ounces, whether or not he has sold the
asset to “take” the profit. In any period, his
earnings consist not simply in what he may use for spending. The
situation is analogous to that of a corporation’s
undistributed profits, which as we have seen, must be included in each
stockholder’s accumulation of income. Taxing realized
gains and losses introduces great distortions into the economy; it then
becomes highly advantageous to investors never to sell their stock, but
to hand it down to future generations. Any sale would require the old
owner to pay the capital gains levy accumulated for an entire period.
The effect is to “freeze” an investment in the
hands of one person, and particularly of one family, for generations.
The result is rigidity in the economy and failure of the hampered
market to meet flexibly the continual changes in data that always take
place. As time goes on, the distortive effects of the economic rigidity
grow worse and worse.
Another serious hampering of the capital market results from the fact
that, once the capital gain is “taken” or realized,
the income tax on this particular gain is actually far higher and not
uniform. For the capital gains accrue over a long stretch of time, and
not simply at the point of sale. But the income tax is based only on
each year’s realized income. In other words, a man who
realizes his gain in a certain year must pay a far bigger tax in that
year than would be “justified” by a tax on his
actually acquired income during the year. Suppose, for example, that a
man buys a capital asset at 50 and its market value increases by 10
each year, until he finally sells it for 90 in four years’
time. For three years, his income of 10 goes untaxed, while in the
fourth year he is taxed on an income of 40 when his income was only 10.
The final tax, therefore, largely becomes one on accumulated
capital rather than on income.
The incentive for keeping
investment rigid, therefore, becomes even greater.
There are, of course, grave difficulties in any such tax on accrued
capital gains, but, as we shall see, there are many insuperable
obstacles to any attempt to impose uniform income
taxes. Estimates of market value would pose the greatest problem.
Appraisals are always simply conjectures, and there would be no way of
knowing that the assessed value was the correct one.
Another insuperable difficulty arises from changes in the purchasing
power of the monetary unit. If the purchasing power has fallen in half,
then a change in capital value of an asset from 50 to 100 does not
represent a real capital gain; it simply reflects the maintenance
of real capital as nominal values double. Clearly, a constant
nominal value of capital when other prices and values double would
reflect a high capital loss—a halving of
real capital value. To reflect gains or losses in income, then, a
person’s capital gain or loss would have to be corrected for
changes in the purchasing power of money. Thus, a fall in purchasing
power tends to result in the overstatement of business income and hence
leads to a consumption of capital. But if a man’s capital
gains or losses must be corrected for changes in the purchasing power
of money in order to state his true income for a certain period, what
standards can be used for such a correction? For changes in purchasing
power cannot be measured. Any
“index” used would be purely arbitrary. Whichever
method is adopted, therefore, uniformity in income taxation cannot be
achieved, because an accurate measurement of income cannot be attained.
Thus, to the controversial question, “Are capital gains
income?” the answer is emphatically yes, provided that (1) a
correction is made for changes in the purchasing power of the monetary
unit, and (2) the accrued rather than the realized
capital gain is considered. In fact, whenever businesses are owned by
stockholders (and bondholders), the gains on these stocks and bonds
will provide a fuller guide to income earned than the actual net income
of the firm. If it is desired to tax incomes uniformly, then taxes
would have to be levied on the former only; to tax
both would be to level a “double” tax on the same
income.
Professor Groves, while agreeing that capital gains are income, lists
several reasons for giving capital gains preferential treatment.
Almost all of them apply,
however, to taxation on realized, rather than on accrued,
capital gains. The only relevant case is the familiar one that
“capital gains and losses are not regularly recurrent, as are
most other incomes.” But no income is
“regularly recurrent.” Profits and losses, of
course, are volatile, being based on speculative entrepreneurship and
adjustments to changing conditions. Yet no one contends that profits
are not income. All other income is flexible as well. No one has a
guaranteed income on the free market. Everyone’s resources
are subject to change as conditions and the data of the market change.
That the division between income and capital gains is illusory is
demonstrated by the confusion over the classification of
authors’ incomes. Is the income in one year resulting from
five years’ writing of a book “income” or
an increase in the “capital worth” of the author?
It should be evident that this entire distinction is valueless.
Capital gains are profits. And the real
value of aggregate capital gains in society will equal total aggregate
profits. A profit increases the capital worth of the owner, whereas a
loss decreases it. Moreover, there are no other sources from which real
capital gains can come. What of the savings of individuals? Individual
savings, to the extent that they do not add to cash balances, go into
investments. These purchases of capital lead to capital gains for
stockholders. Aggregate savings lead to aggregate capital gains. But it
is also true that profits can exist in the aggregate only when there is
aggregate net saving in the economy. Thus, aggregate pure
profits, aggregate capital gains, and aggregate net
savings all go hand in hand in the economy. Net dissavings
lead to aggregate pure losses and aggregate capital losses.
To sum up, if it is desired to tax uniformly (this
goal will be analyzed critically below), the correct procedure would be
to consider capital gains as equivalent to income when
corrected for changes in the purchasing power of the monetary
unit, and to consider capital losses as negative income. Some critics
charge that it would be discriminatory to correct capital for changes
in prices without doing the same for income, but this objection misses
the point. If the desire is to tax income rather
than accumulated capital, it is necessary to correct for changes in the
purchasing power of money. For example, capital rather than pure income
is being taxed during an inflation.
(5)
Is a Tax on Consumption Possible?
We have seen that attempts to tax consumption via sales and excise
taxes are vain and that they inexorably result in a tax on incomes.
Irving Fisher has suggested an ingenious plan for a
consumption tax—a direct tax on the individual akin to the
income tax, requiring annual returns, etc. The base for the
individual’s tax, however, would be his income, minus net
additions to his capital or cash balance, plus net subtractions from
that capital for the period—i.e., his consumption spending.
The individual’s consumption spending would then be taxed in
the same way as his income is now.
We have seen the fallacy
in the Fisher argument that only a tax on consumption would be a true
income tax and that the ordinary income tax constitutes a double tax on
savings. This argument places greater weight on savings than the market
does, since the market knows all about the fructifying power of saving
and allocates its expenditures accordingly. The problem we have to face
here is this: Would such a tax as Fisher proposes actually have the
intended effect—would it tax consumption only?
Let us consider a Mr. Jones, with a yearly income of 100 gold ounces.
During the year, he spends 90 percent, or 90 ounces, on consumption and
saves 10 percent, or 10 ounces. If the government imposes a 20-percent
income tax upon him, he must pay 20 ounces at the end of the year.
Assuming that his time-preference schedule remains the same (and
setting aside the fact that there will be an increased proportion spent
on consumption because an individual with fewer money assets has a
higher time-preference rate), the ratio of his
consumption to investment will still be 90:10. Jones will now spend 72
ounces on consumption and eight on investment.
Now, suppose that instead of an income tax, the
government levies a 20-percent annual tax on consumption. Fisher
maintained that such a tax would be levied only on consumption. But
this is incorrect, since savings-investment is based solely on the
possibility of future consumption. Since future consumption will also
be taxed, in equilibrium, at the same rate as present consumption, it
is evident that saving does not receive any special encouragement.
Even if it were desirable
for the government to encourage saving at the expense of consumption,
taxing consumption would not do so. Since future and present
consumption will be taxed equally, there will be no shift in favor of
savings. In fact, there will be a shift in favor of
consumption to the extent that a diminished amount of money
causes an increase in the rate of preference for present goods. Setting
aside this shift, his loss of funds will cause him to reallocate and
reduce his savings as well as his consumption. Any payment of funds to
the government necessarily reduces the net income remaining to him,
and, since his time preference remains the same, he reduces his savings
and his consumption proportionately.
It will help to see how this works arithmetically. We may use the
following simple equation to sum up Jones’ position:
With Gross Income equal to 100, and solving for these three equations,
we get this result: Net Income = 85, Tax = 15, Consumption = 76.
We may now sum up in the following tabulation what happened to Jones
under an income tax and under a consumption tax:
We
thus see this important truth: A consumption tax is always
shifted so as to become an income tax, though at a lower rate. In fact,
the 20-percent consumption tax becomes equivalent to a 15-percent
income tax. This is a very important argument against the plan.
Fisher’s attempt to tax consumption alone must fail; the tax
is shifted by the individual until it becomes an income tax, albeit at
a lower rate than the equivalent income tax.
Thus, the rather startling conclusion is reached in our analysis that there
can be no tax on consumption alone; all consumption taxes
resolve themselves in one way or another into taxes on incomes. Of
course, as is true of the direct consumption tax, the effect of the
rate is discounted. And here perhaps lies a clue to
the relative predilection that free-market economists have shown toward
consumption taxes. Their charm, in the final analysis, consists in the
discounting—in the fact that the same rate in a consumption
tax has the effect of a lower rate of income tax.
The tax burden on society and the market is lower.
This reduction of the tax
burden may be a very commendable objective, but it should be stated as
such, and it should be realized that the problem lies not so much in
the type of tax levied as in the over-all burden of
taxes on individuals in the society.
We must now modify our conclusions by admitting the case of dishoarding
or dissaving, which we had ruled out of the
discussion. To the extent that dishoarding occurs, consumption
is tapped rather than income, for the dissaver consumes out
of previously accumulated wealth, and not out of current income. The
Fisher tax would thus tap spending out of accumulated wealth, which
would remain untaxed by ordinary income taxation.
4.
The Incidence and Effects of Taxation
Part II:
Taxes on Accumulated Capital
In a sense, all taxes are taxes on capital. In
order to pay a tax, a man must save the money. This is a universal
rule. If the saving took place in advance, then the tax reduces the
capital invested in the society. If the saving did not take place in
advance, then we may say that the tax reduced potential
saving. Potential saving is hardly the same as accumulated capital,
however, and we may therefore consider a tax on current income as
separate from a tax on capital. Even if the individual were forced to
save to pay the tax, the saving is current just as the income is
current, and therefore we may make the distinction between taxes on current
saving and current incomes, and taxes on accumulated
capital from past periods. In fact, since there can be no consumption
taxes, except where there is dissaving, almost all taxes resolve
themselves into income taxes or taxes on
accumulated capital. We have already analyzed the effect of an income
tax. We come now to taxes on accumulated capital.
Here we encounter a genuine case of “double
taxation.” When current savings are
taxed, the charge of double taxation is a dubious one, since people are
allocating their newly produced current income. Accumulated capital, on
the contrary, is our heritage from the past; it is the accumulation of
tools and equipment and resources from which our present and future
standard of living derive. To tax this capital is to reduce the stock
of capital, especially to discourage replacements as well as new
accumulations, and to impoverish society in the future. It may well
happen that time preferences on the market will dictate voluntary
capital consumption. In that case, people will deliberately choose to
impoverish themselves in the future so as to live better in the
present. But when the government compels such a result, the distortion
of market choices is particularly severe. For the standard of living of
everyone in the society will be absolutely lowered, and this includes
perhaps some of the tax consumers—the government officials
and the other recipients of tax privilege. Instead of living off
present productive income, the government and its favorites are now
dipping into the accumulated capital of society, thereby killing the
goose that lays the golden egg.
Taxation of capital, therefore, differs considerably from income
taxation; here the type matters as well as the
level. A 20-percent tax on accumulated capital will have a far more
devastating, distorting, and impoverishing effect than a 20-percent tax
on income.
A.
Taxation on Gratuitous Transfers: Bequests and Gifts
The receipt of gifts has often been considered simple income. It should
be obvious, however, that the recipient produced nothing in exchange
for the money received; in fact, it is not an income from current
production at all, but a transfer of ownership of accumulated capital.
Any tax on the receipt of gifts, then, is a tax on capital. This is
particularly true of inheritances, where the
aggregation of capital is shifted to an heir, and the gift clearly does
not come from current income. An inheritance tax,
therefore, is a pure tax on capital. Its impact is particularly
devastating because (a) large sums will be involved,
since at some point within a few generations every piece
of property must pass to heirs, and (b) the prospect
of an inheritance tax destroys the incentive and the power to save and
build up a family competence. The inheritance tax is perhaps the most
devastating example of a pure tax on capital.
A tax on gifts and bequests has the further effect of penalizing
charity and the preservation of family ties. It is ironic that some of
those most ardent in advocating taxation of gifts and bequests are the
first to assert that there would never be “enough”
charity were the free market left to its own devices.
B.
Property Taxation
A property tax is a tax levied on the value of property and hence on
accumulated capital. There are many problems peculiar to property
taxation. In the first place, the tax depends on an assessment
of the value of property, and the rate of tax is applied to this
assessed value. But since an actual sale of
property has usually not taken place, there is no way for assessments
to be made accurately. Since all assessments are arbitrary, the road is
open for favoritism, collusion, and bribery in making them.
Another weakness of current property taxation is that it taxes doubly
both “real” and “intangible”
property. The property tax adds
“real” and “intangible”
property assessments together; thus, the bondholders’ equity
in property is added to the amount of the
debtors’ liability. Property under debt is therefore doubly
taxed as against other property. If A and B each own a piece of
property worth $10,000, but C also holds a bond worth $6,000 on
B’s property, the latter is assessed at a total of $16,000
and taxed accordingly.
Thus, the use of the
credit system is penalized, and the rate of interest paid to creditors
must be raised to allow for the extra penalty.
One peculiarity of the property tax is that it attaches to the property
itself rather than to the person who owns it. As a
result, the tax is shifted on the market in a special way known as tax
capitalization. Suppose, for example, that the social
time-preference rate, or pure rate of interest, is 5 percent. Five
percent is earned on all investments in equilibrium, and the rate tends
to 5 percent as equilibrium is reached. Suppose a property tax is
levied on one particular property or set of
properties, e.g., on a house worth $10,000. Before this tax was
imposed, the owner earned $500 annually on the property. An annual tax
of 1 percent is now levied, forcing the owner to pay $100 per year to
the government. What will happen now? As it stands, the owner will earn
$400 per year on his investment. The net return on the investment will
now be 4 percent. Clearly, no one will continue to invest at 4 percent
in this property when he can earn 5 percent elsewhere. What will
happen? The owner will not be able to shift his tax
forward by raising the rental value of the property. The
property’s earnings are determined by its discounted marginal
value productivity, and the tax on the property does not increase its
merits or earning power. In fact, the reverse occurs: the tax lowers
the capital value of the property to enable owners to earn a 5-percent
return. The market drive toward uniformity of interest return pushes
the capital value of the property down to enable a return on
investment. The capital value of the property will fall to $8,333, so
that future returns will be 5 percent.
In the long run, this process of reducing capital value is imputed
backward, falling mainly on the owners of ground land. Suppose a
property tax is levied on a capital good or a set of capital goods.
Income to a capital good is resolvable into wages, interest, profit,
and rental to ground land. A lower capital value of capital goods would
shift resources elsewhere; workers, confronted with lower wages in
producing this particular good, would shift to a better-paying job;
capitalists would invest in a more remunerative field; and so forth. As
a result, workers and entrepreneurs would largely be able to slough off
the burden of the property tax, the former suffering to the extent that
their original DMVP was higher here than in the next-highest-paying
occupations. Consumers would, of course, suffer from a coerced
misallocation of resources. The man bearing the major burden, then, is
the owner of ground land; therefore, the process of tax capitalization
applies most fully to a property tax upon ground land. The incidence
falls on the owner of the “original” ground land,
i.e., the owner at the time the tax is first imposed. For not only does
the landlord pay the annual tax (a tax he cannot shift) so long as he
is the owner, but he also suffers a loss in capital value. If Mr. Smith
is the owner of the above property, not only does he pay $83 per year
in taxes, but the capital value of his property also falls from $10,000
to $8,333. Smith openly absorbs the loss when he sells the property.
What, however, of the succeeding owners? They buy the property at
$8,333 and earn a steady 5-percent interest, although they continue to
pay $83 a year to the government. The expectation of the tax payment
attached to the property, therefore, has been capitalized
by the market and taken into account in arriving at its capital value.
As a result, the future owners are able to shift the entire incidence
of the property tax to the original owner; they do not really
“pay” the tax in the sense that they bear its
burden.
Tax capitalization is an instance of a process by which the market
adjusts to burdens placed upon it. Those whom the government wanted to
pay the burden can avoid doing so because of the market’s
resilience in adjusting to new impositions. The original owners of
ground land, however, are especially burdened by a property tax.
Some writers argue that, where tax capitalization has taken place, it
would be unjust for the government to lower or remove the tax because
such an action would grant a “free gift” to the
current owners of property, who will receive a counterbalancing
increase in its capital value. This is a curious argument. It rests on
a fallacious identification of the removal of a burden
with a subsidy. The former, however, is a move
toward free-market conditions, whereas the latter is a move away
from such conditions. Furthermore, the property tax, while not
burdening future owners, depresses the capital value of the property
below what it would be on the free market, and therefore discourages
the employment of resources in this property. Removal of the property
tax would reallocate resources to the advantage of the consumers.
Tax capitalization and its incidence on owners of ground land occur
only where the property tax is partial rather than
universal—on some pieces of property rather than all. A truly
general property tax will reduce the rate of income earned from all
investments and thereby reduce the rate of interest instead of the
capital value. In that case, the interest return of both the original
owner and later owners is reduced equally, and there is no extra burden
on the original owner.
A general, uniform property tax on all property values, then, will,
like an income tax, reduce the interest return throughout the economy.
This will penalize saving, thereby reducing capital investment below
what it would have been and depressing real wage rates further below
their free-market level.
Finally, a property tax necessarily distorts the allocation of
resources in production. It penalizes those lines of production in
which capital equipment per sales dollar is large and causes resources
to shift from these to less “capitalistic” fields.
Thus, investment in higher-order productive processes is discouraged,
and the standard of living lowered. Individuals will invest less in
housing, which bears a relatively heavy property tax burden, and shift
instead to less durable consumers’ goods, thus distorting
production and injuring consumer satisfaction. In practice, the
property tax tends to be uneven from one line and location to another.
Of course, geographic differences in property taxation, in impelling
resources to escape heavy tax rates,
will distort the location
of production by driving it from those areas that would maximize
consumer satisfaction.
C.
A Tax on Individual Wealth
Although a tax on individual wealth has not been tried in practice, it
offers an interesting topic for analysis. Such a tax would be imposed
on individuals instead of on their property and would levy a certain
percentage of their total net wealth, excluding liabilities. In its
directness, it would be similar to the income tax and to
Fisher’s proposed consumption tax. A tax of this kind would
constitute a pure tax on capital, and would include in its grasp cash
balances, which escape property taxation. It would avoid many
difficulties of a property tax, such as double taxation of real and
tangible property and the inclusion of debts as property. However, it
would still face the impossibility of accurately assessing property
values.
A tax on individual wealth could not be capitalized, since the tax
would not be attached to a property, where it could be discounted by
the market. Like an individual income tax, it could not be shifted,
although it would have important effects. Since the
tax would be paid out of regular income, it would have the effect of an
income tax in reducing private funds and penalizing savings-investment;
but it would also have the further effect of taxing
accumulated capital.
How much accumulated capital would be taken by the tax depends on the
concrete data and the valuations of the specific individuals. Let us
postulate, for example, two individuals: Smith and Robinson. Each has
an accumulated wealth of $100,000. Smith, however, also earns $50,000 a
year, and Robinson (because of retirement or other reasons) earns only
$1,000 a year. Suppose the government levies a 10-percent annual tax on
an individual’s wealth. Smith might be able to pay the
$10,000 a year out of his regular income, without reducing his
accumulated wealth, although it seems clear that, since his tax
liability is reduced thereby, he will want to reduce his wealth as much
as possible. Robinson, on the other hand, must pay
the tax by selling his assets, thereby reducing his accumulated wealth.
It is clear that the wealth tax levies a heavy penalty on accumulated
wealth and that therefore the effect of the tax will be to slash
accumulated capital. No quicker route could be found to promote capital
consumption and general impoverishment than to penalize the
accumulation of capital. Only our heritage of accumulated capital
differentiates our civilization and living standards from those of
primitive man, and a tax on wealth would speedily work to eliminate
this difference. The fact that a wealth tax could not be capitalized
means that the market could not, as in the case of the property tax,
reduce and cushion its effect after the impact of the initial blow.
5.
The Incidence and Effects of Taxation
Part III:
The Progressive Tax
Of all the patterns of tax distribution, the progressive
tax has generated the most controversy. In the case of the progressive
tax, the conservative economists who oppose it have taken the
offensive, for even its advocates must grudgingly admit that the
progressive tax lowers incentives and productivity. Hence, the most
ardent champions of the progressive tax on “equity”
grounds admit that the degree and intensity of progression must be
limited by considerations of productivity. The major criticisms that
have been leveled against progressive taxation are: (a)
it reduces the savings of the community; (b) it
reduces the incentive to work and earn; and (c) it
constitutes “robbery of the rich by the poor.”
To evaluate these criticisms, let us turn to an analysis of the effects
of the progression principle. The progressive tax imposes a higher rate
of taxation on a man earning more. In other words, it acts as a penalty
on service to the consumer, on merit in the market. Incomes in the
market are determined by service to the consumer in producing and
allocating factors of production and vary directly according to the
extent of such services. To impose penalties on the very people who
have served the consumers most is to injure not only them, but the
consumers as well. A progressive tax is therefore bound to cripple
incentives, impair mobility of occupation, and greatly hamper the
flexibility of the market in serving the consumers. It will
consequently lower the general standard of living.
The ultimate of progression—coercively equalized
incomes—will, as we have seen, cause a reversion to
barbarism. There is also no question that progressive income taxation
will reduce incentives to save, because people will not earn the return
on investment consonant with their time preferences; their earnings
will be taxed away. Since people will earn far less than their time
preferences would warrant, their savings will be depressed far below
what they would be on the free market.
Thus, conservatives’ charges that the progressive tax reduces
incentives to work and save are correct and, in fact, are usually
understated, because there is not sufficient realization that these
effects stem a priori from the very nature of
progression itself. It should not be forgotten, however, that proportional
taxation will induce many of the same effects as, in fact, will any tax
that goes beyond equality or the cost principle. For proportional
taxation also penalizes the able and the saver. It is true that
proportional taxation will not have many of the crippling effects of
progression, such as the progressive hampering of effort from one
income bracket to another. But proportional taxation also imposes
heavier burdens as the income brackets rise, and these also hamper
earning and saving.
A second argument against the progressive income tax, and one which is
perhaps the most widely used, is that, by taxing the incomes of the
wealthy, it reduces savings in particular, thus
injuring society as a whole. This argument is predicated on the usually
plausible assumption that the rich save more proportionately than the
poor. Yet, as we have indicated above, this is an extremely weak
argument, particularly for partisans of the free market. It is
legitimate to criticize a measure for forcing deviations from
free-market allocations to arbitrary ones; but it can hardly be
legitimate simply to criticize a measure for reducing savings per
se. For why does consumption possess less merit than saving?
Allocation between them on the market is simply a matter of time
preference. This means that any coerced deviation
from the market ratio of saving to consumption imposes a loss in
utility, and this is true whichever direction the
deviation takes. A government measure that might induce more saving and
less consumption is then no less subject to criticism than one that
would lead to more consumption and less saving. To say differently is
to criticize free-market choices and implicitly to advocate
governmental measures to force more savings upon the public. If they
were consistent, therefore, these conservative economists would have to
advocate taxation of the poor to subsidize the rich, for in that case
savings would presumably increase and consumption diminish.
The third objection is a political-ethical one—that
“the poor rob the rich.” The implication is that
the poor man who pays 1 percent of his income in taxes is
“robbing” the rich man who pays 80 percent. Without
judging the merits or demerits of robbery, we may say that this is
invalid. Both citizens are being
robbed—by the State. That one is robbed in greater proportion
does not eliminate the fact that both are being injured. It may be
objected that the poor receive a net subsidy out of the tax proceeds
because the government spends money to serve the poor. Yet this is not
a valid argument. For the actual act of robbery is
committed by the State, and not by the poor. Secondly, the State may
spend its money, as we shall see below, on many different projects. It
may consume products; it may subsidize some or all of the rich; it may
subsidize some or all of the poor. The fact of progressive income
taxation does not itself imply that “the
poor” en masse will be subsidized. If some
of the poor are subsidized, others may not be, and these latter will
still be net taxpayers rather than tax-consumers and will be
“robbed” along with the rich. The extent of this
deprivation will be less for a poor taxpayer than for a rich one; and
yet, since usually there are far more poor than rich, the poor en masse
may very well bear the greatest burden of the tax
“robbery.” In contrast, the State bureaucracy, as
we have seen, actually pays no taxes at all.
This misconception of the incidence of “robbery,”
and the defective argument on savings, among other reasons, have led
most conservative economists and writers to overemphasize greatly the
importance of the progressiveness of taxation.
Actually, the level of taxation is far more
important than its progressiveness in determining the distance that a
society has traveled from a free market. An example will clarify the
relative importance of the two. Let us contrast two people and see how
they fare under two different tax systems. Smith makes $1,000 a year,
and Jones makes $20,000 a year. In Society A taxation is proportionate
for all at 50 percent. In Society B taxation is very steeply
progressive: rates are ½ percent for $1,000 income, 20
percent for $20,000 income. The following tabulation shows how much
money each will pay in taxes in the different societies:
Now, we may ask both the rich and the poor taxpayers: Under
which system of taxation are you better off? Both
the rich man and the poor man will unhesitatingly pick Society B, where
the rate structure is far more progressive, but where the level of
taxation for every man is lower. Some may object that the total amount
of tax levied is far greater in Society A. But this is precisely the
point! The point is that what the rich man objects to is not the progressiveness
of the rates, but the high level of the rates
imposed upon him, and he will prefer progressiveness when rates are
lower. This demonstrates that it is not the poor who
“rob” the rich through the progressive
principle of taxation; it is the State that
“robs” both through all taxation. And it indicates
that what the conservative economists are actually objecting to,
whether they fully realize it or not, is not progression, but high
levels of taxation, and that their real objection to progression is
that it opens the sluice gates for high levels of
taxation of the rich. Yet this prospect will not always be realized.
For it is certainly possible and has often occurred that a rate
structure is very progressive and yet lower all around, on the high
brackets and on the low, than a less progressive structure. As a
practical matter, however, progressiveness is necessary for high tax
rates, because the multitude of lower-income citizens might revolt
against very steep tax rates if they were imposed on all equally. On
the other hand, many people may accept a high tax burden if they are
secure in the knowledge or belief that the rich pay a still higher rate.
We have seen that coerced egalitarianism will cause a reversion to
barbarism and that steps in that direction will result in dislocations
of the market and a lowering of living standards. Many
economists—notably the members of the “Chicago
School”—believe that they champion the
“free market,” and yet they do not consider
taxation as connected with the market or as an intervention in the
market process. These writers strongly believe that, on the market,
every individual should earn the profits and marginal value
productivity that the consumers wish to pay, in order to achieve a
satisfactory allocation of productive factors. Nevertheless, they see
no inconsistency in then advocating drastic taxation and subsidies.
They believe that these can alter the
“distribution” of incomes without lowering the
efficiency of productive allocations. In this way they rely on an
equivalent of Keynesian “money
illusion”—a tax illusion, a
belief that individuals will arrange their activities according to
their gross rather than net
(after-tax) income. This is a palpable error. There is no reason why
people should not be tax-conscious and allocate their resources and
energies accordingly. Altering relative rewards by taxation will
disrupt all the allocations of the market—the movement of
labor, the alertness of entrepreneurship, etc. The market is a vast
nexus, with all strands interconnected, and it must be analyzed as
such. The prevailing fashion in economics of chopping up the market
into isolated compartments—“the firm,” a
few “macroscopic” holistic aggregates, market
exchanges, taxation, etc.—distorts the discussion of each one
of these compartments and fails to present a true picture of the
interrelations of the market.
It must not be
inferred that the present author is an advocate of uniform taxation.
Uniformity, in fact, will be sharply criticized below as an ideal impossible
of attainment. (An ethical goal absolutely impossible of attain ment is
an absurd goal; to this extent we may engage, not in ethical
exhortation, but in praxeological criticism of the possibility of
realizing certain ethical goals.) However, it is analytically more
convenient to treat various types of income taxation in relation to
uniform treatment of all income.
For the sake of
convenience, we are assuming that this income is pure profit, and that
interest income has already been disposed of. Only pure profit
increases capital value, for in the evenly rotating economy there will
be no net savings, and the interest income will
just pay for maintaining the capital income structure intact.
For a discussion of taxation on
accumulated capital, see below.
See Due,
Government Finance, p. 146.
Another problem in levying a tax
on accrued capital gains is that the income is not realized in money
directly. Uniform taxation of income in kind, as well as of psychic
income, faces insuperable problems, as will be seen below. Just as
there may be taxes on the imputed monetary equivalents of income in
kind, however, there may also be taxes on accrued capital gains.
Harold M. Groves, Financing
Government (New York: Henry Holt, 1939), p. 181.
Irregular income poses the same
problem as irregular realized capital gain. The difficulty can be met
in both cases by the suggested solution of averaging income over
several years and paying taxes annually on the average.
Fisher and Fisher, Constructive
Income Taxation, passim.
Neither does hoarding
receive any special encouragement, since hoarding must finally
eventuate in consumption. It is true that keeping cash balances itself
yields a benefit, but the basis for such balances
is always the prospect of future consumption.
In the same way, the charm of the
sales tax lies in the fact that it cannot be progressive, thus reducing
the burden of income taxation on the upper groups.
See Groves,
Financing Government, p. 64.
The final capital value is
not $8,000, since the property tax is levied at 1 percent of the final
value. The tax does not remain at 1 percent of the original capital
value of $10,000. The capital value will fall to $8,333. Property tax
payment will be $83, net annual return will be $417, and an annual rate
of return of 5 percent on the capital of $8,333.
The
algebraic formula for arriving at this result is as follows: If C
is the capital value to be determined, i is the
rate of interest, and R the annual rent from the
property, then, when no tax enters into the picture:
iC = R
When
a property tax is levied, then the net return is the rent minus the
annual tax liability, T, or:
iC = R
– T
In
this property tax, we postulate a fixed rate on the value of the
property, so that:
iC = R
– tC,
where t equals the tax rate on the value of the
property.
Transposing,
C
= R / i + t;
the new capital value equals the annual rent divided by the interest
rate plus the tax rate. Consequently, the capital value is driven down
below its original sum, the higher are (a) the
interest rate and (b) the tax rate.
On tax-capitalization, see
Seligman, Shifting and Incidence of Taxation, pp.
181–85, 261–64. See also Due, Government
Financing, pp. 382–86.
This distortion of location would
result from all other forms of taxes as well. Thus, a higher income-tax
rate in region A than in region B would induce workers to shift from A
to B, in order to equalize net wage rates after taxes. The location of
production is distorted as compared with the free market.
On the extent to which the
lower-income classes actually pay taxes in present-day America, see
Gabriel Kolko, Wealth and Power in America (New
York: Frederick A. Praeger, 1962), chap. 2.
Cf., Bertrand de Jouvenel, The
Ethics of Redistribution (Cambridge: Cambridge University
Press, 1952).
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