Dr. Sennholz heads the Department of Economics at Grove City College and is a noted writer and lecturer for freedom.
Political scientists tell us that the Federal government may incur a deficit of 10 to 12 billion dollars in fiscal year 1971. If the proposed welfare reform measure known as the Family Assistance Plan is enacted, and if the current business recession persists or deepens, even greater Federal deficits may be expected in the years ahead.
When government spending outpaces revenues by such magnitudes we must brace ourselves for higher taxes, new debt, and more inflation. For the Federal government has only three sources of revenue that provide the funds for its spending.
It may borrow the necessary funds in the loan market. In competition with business it may compete for the savings that accrue in the economy. Indeed, government can outbid business for new funds, and thus deprive business of capital needed for operation, expansion, and modernization. Interest rates will then soar and business decline. An economic depression would be the inevitable consequence of such deficit financing.
Inflation, i.e. the creation of new money, is a much more convenient method of government financing. The new debt is simply monetized, that is, either purchased directly by the central bank—the Federal Reserve System—or purchased by commercial banks which in turn are supplied with the necessary reserves by the Federal Reserve System. The Federal government thus uses newly created purchasing power.
But such spending tends to raise goods prices and thereby deprives all money holders of some purchasing power. In fact, inflation is a Federal tax on all dollar holders. It also alters all existing debt relations as it enriches all debtors at the expense of creditors. Inflation thus shifts huge amounts of real wealth from the pockets of savers and investors to those of debtors among which the U.S. Government is the biggest. It is a cruel tax as it gradually destroys the financial substance of many people, especially the old and weak. And it is a highly inefficient tax as its unearned revenues accrue not only to the Federal government that is levying it, but also to all other debtors who now discharge their obligations with cheaper money and less purchasing power.
But inflation as a source of revenue is rather popular with many politicians and bureaucrats as some of its painful effects become visible only much later. And finally, inflation is not so easily understood by its victims. The government that inflates may blame businessmen and other minorities for the inflation evils. In fact, it may even broaden its powers over the people through price, wage, and rent controls in order "to fight the inflation."
Thus, in view of the staggering Federal deficits that are on the fiscal horizon we must brace ourselves for rampant inflation.
A less popular source of new revenue is higher taxation. New taxes may be invented or the rates of old taxes may be raised. We must expect both in times of huge Federal deficits. It is true, Federal tax revenues are expected to drop $2.3 billion in fiscal 1970. And further tax cuts have been written into Federal law for the years ahead, mainly benefiting people in lower income tax brackets. This is why one may expect the new taxes to be directed at American business and businessmen in higher tax brackets.
But few taxpayers are likely to enjoy lower tax burdens. State and local taxes are shooting up rapidly despite a taxpayers’ revolt that has blocked many tax boosts across the country. In 1970, states and localities are expected to collect $89.5 billion, some 10 per cent more than in 1969. Altogether, taxpayers are estimated to turn in about $282 billion in 1970, which is $5.9 billion more than in 1969. In the years ahead when the Federal demand for funds will soar, sharp annual boosts in combined tax burdens may be expected.
Rising Taxes Raise Prices
Most students of fiscal matters are aware that Federal government deficits are inflationary whenever they entail currency and credit expansion. But they frequently overlook the fact that rising taxes, too, may cause prices to rise.
Taxes are an integral factor of cost in economic production, like labor, capital, land, electric power, materials, and other resources. Whenever production costs rise, goods prices tend to follow. But rising costs are not simply added to prices, as is commonly assumed. The economic "law of cost" teaches that production costs exert their influence on prices only through the interaction of supply. That is, rising costs tend to reduce business income and thus deprive marginal enterprises of the needed revenue to carry on production. Output is curtailed and supply declines, which then causes goods prices to rise.
Taxing Peter to pay Paul has become a respectable way of life with countless pressure groups and their spokesmen in Congress. Taxation is one of the most potent instruments of political and economic radicalism. It is the political tool that can change the political and economic system, redistribute the fruits of all our labors, and inflict oppression on some or all people. In the often quoted words of Justice Marshall, "The power to tax is the power to destroy." And, in the words of Edmund Burke: "Taxing is an easy business. Any projector can contrive new impositions; any bungler can add to the old; but is it altogether wise to have no other bounds to your imaginations than the patience of those who are to bear them?"
Government’s concern for the poor is laudable indeed. But the tax programs that are so popular today would only aggravate the plight of the poor. After all, taxes like the corporate income tax and many other business taxes imposed on the rich are taxes on economic production. Such taxes consume the very capital that creates jobs through investments, improves production and working conditions, and thereby raises wage rates. To advocate higher taxes on the rich, most of whom are highly productive businessmen and investors, is to expropriate the very means of capital investment that afford jobs and better living conditions for the poor. It is in the vital interest of the poor that there be wealthy promoters and investors who do not consume all their income, but build factories and stores, shops and other business establishments—all of which provide jobs and income.
How Taxes Affect Our Lives
The impact of taxation on every aspect of economic life is frequently underrated. Taxes on production, like wages and interest, are boosting goods prices in accordance with the "law of cost." But also those taxes that are leveled primarily at consumption, such as the income taxes paid by workers, make their way into prices. The $2,000 income tax withheld from the steelworker’s annual pay is a real cost to the steel mill like the wages paid directly to the worker. As such the very amount of tax withheld is reflected in steel prices. A boost in his income tax reduces the worker’s take-home pay, but does not reduce the steel production costs, and therefore does not lower steel prices. A boost of those labor taxes that directly raise production costs such as payroll taxes, employment taxes, and social security taxes, does affect profit margins and consequently output, supply, and ultimately also prices.
The price of an automobile thus embodies all its costs of material, of capital and labor including all income taxes withheld from the paychecks of everyone participating in its production, from the chairman of the board to the night janitor, in addition to all business taxes levied directly upon its production. A steelworker who finally purchases the automobile must cover all these costs in the purchase price, including ironically his own income taxes that were withheld from his paycheck when he produced the steel for the car. In short, his income taxes reduce his take-home pay, and with this take-home pay thus reduced he can buy the product at a price that contains his total labor costs including his own income taxes. He pays income taxes and then pays for them in the price of the product.
Even the taxes levied on the owners of the steel mill or automobile plant may affect the prices of their final products. New taxes on capital income not only prevent formation of new capital through saving and investing, but also may induce the owners to withdraw their liquid capital from production. An investment made sub marginal by corporate and capital income taxes tends to be liquidated whenever possible. The withdrawal of capital from production, or merely the lack of new capital for expansion and modernization, causes economic stagnation or even decline. In fact, a heavy tax newly levied on capital income must generate a serious depression with heavy unemployment. Withdrawal and consumption of capital then raise the marginal productivity of capital, i.e., the productivity of capital relative to labor, which in turn tends to raise interest rates. Thus again, the taxes newly imposed work their way into prices either through higher prices or lower wages.
Taxes and Prices Rise the Remedy is Higher Taxes
The total impact of taxation on our daily lives is probably beyond anyone’s comprehension. Government statistics readily confess to a share of 35 per cent of total production as the money costs of government in the U.S. The effects of such a burden on prices are obviously incalculable. But next to labor costs they are undoubtedly the most significant factor of cost and price in economic production today.
And yet, politicians and their academic propagandists like to prescribe yet higher taxes as a remedy for rising prices. They are warning us again and again that taxes will have to be raised if the inflationary pressures do not soon subside. When the issue of new paper money by our monetary authorities lifts prices or when new taxes stifle production and then raise prices, the Federal government proposes to levy new taxes on the people.
Thus, rising prices caused by government are the occasion for yet higher taxes by government. And in particular, rising taxes that cause prices to rise are to be alleviated by even higher taxes. It is difficult to imagine where this spiral of taxation must ultimately end.
The fact that it has become so difficult to accumulate even a comparatively small fortune must have the most profound effect on the organization of business; and it is by no means clear to me that these results are in the social interest. Must not the inevitable consequence of all this be that it will become more and more difficult for innovation to develop save within the ambit of established corporate enterprise, and that more and more of what accumulation takes place will take place within the large concerns which—largely as a result of individual enterprise in the past—managed to get started before the ice age descended?
LIONEL ROBBINS, "Notes on Public Finance," Lloyds Bank Review, October, 1955