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2. The Burdens and Benefits of Taxation and 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.3 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.4 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.5 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.”6 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.7
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.8 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.”9
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.
- 3. 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.
- 4. 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.
- 5. 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.
- 6. 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.
- 7. 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.
- 8. See above and Rothbard, “Toward a Reconstruction of Utility and Welfare Economics,” pp. 250–51.
- 9. 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.