Tax Policy

Dr. Sennholz heads the Department of Eco­nomics at Grove City College in Pennsylvania.

An important pillar of our re­publican form of government is the people’s control over govern­ment spending. Representative government means budgetary con­trol. The people, through their representatives, consent to certain taxation in order to facilitate pub­lic policies. They determine the task of the Administration and its expenditures. No penny must be spent without the consent of Congress.

Senator Monroney of Oklahoma, Chairman of the Joint Committee on Organization of Congress, briefly described this pillar as fol­lows: “The primary function of the Congress is still the exercise of the power of the purse… If we use this power well, we can and will be able to control the size of government, its activities, and the number of people who find their way on or off the payroll. This is the major responsibility given to the Congress by the Con­stitution. We dare not fail in this assignment.” But how has the Congress actually discharged this duty during the 1960′s?

Since 1960 the Federal govern­ment has grown rapidly in size and expense. Administrative Bud­get expenditures alone have risen from $76.5 billion in 1960 to an estimated $153.9 billion in the fiscal year ending June 30, 1970. (Cf. The Budget of the United States Government for 1970, p. 524.)

But this is not the only Federal budget. The 130 Federal trust funds, among which the Old-Age and Survivors’ Insurance (Social Security) and the Hospital Insurance Trust Fund (Medicare) are the largest, receive taxes and dis­burse funds without Congressional appropriations. Their expenditures have grown even more signifi­cantly than Administrative spend­ing. From 1960 to 1970 they are expected to rise from $21.2 billion to $48.3 billion, or 128 per cent.

And finally, there are some 85 Federal enterprises and govern­ment-sponsored enterprises that are scheduled to spend another $31 billion. Altogether, the Federal government plans to spend $232 billion in the coming fiscal year. When compared with 1960, this constitutes an increase of nearly $120 billion.

The Burden Grows

Since 1960 the Federal govern­ment has more than doubled its taxing and spending and, at the given rate of growth, must be expected to double again in less than 10 years. The growth rate of Federal Trust Funds, which cover more than two-thirds of the total Federal expenditures on health, education, and welfare, will prob­ably exceed all others. In the 1970 Budget, Trust Fund receipts are estimated at $50.9 billion, or 35 per cent of total administrative receipts of $147.8 billion. Nor does there appear in sight any end to the expansion of the Social Secur­ity and Medicare programs.

In terms of total personal in­come of $800 billion, which is the government’s favorite measure of progress and prosperity, the 1970 Federal tax take of $198.6 billion amounts to approximately one-fourth. But personal income is a gross estimate that includes per­sonal taxes of more than $105 bil­lion. If we deduct this amount and base our calculations on disposable personal income of only $700 bil­lion, the $198.6 billion of Federal spending amounts to 29 per cent. But how is this possible if most people pay Federal income tax rates below 29 per cent? Many in­dividuals, in fact, pay much higher rates. Highly productive business­men pay various corporation taxes in excess of 50 per cent plus in­dividual income taxes of 50 per cent or more on the remainder, which comes to 75 per cent or more of their earned incomes.

The tax burden of government that is frequently overlooked is hidden in the costs of all goods and services we consume. All goods bear taxes that account for varying shares of the purchase price. This is how every citizen, even the poorest member of soci­ety, must bear the growing bur­den of his government. Taxes are the largest single item in our cost of living; nothing else can com­pare with the cost of government. For instance, Americans spend less than $100 billion on food per year and more than twice this amount to finance the Federal gov­ernment.

To Change the Economy

We often forget that taxation aims not only at raising the de­sired revenue but also at other purposes. Today, taxes are a fa­vorite tool of government policy and control. In the past, regula­tion through taxation was limited, by and large, to protective tariffs which restricted the supply of goods in order to benefit certain producers. Modern regulatory ob­jectives are much wider and more far-reaching. Some taxes aim at influencing certain consumption. Some are designed to affect cer­tain sectors of production and trade. Others are to change busi­ness customs and conduct. Still others aim at controlling or chang­ing our economic system. The rev­enue accruing to the government treasury may be a desirable but not vital objective of taxation.

Taxation may even aim at changing our economic system. All taxes that attack the substance of private property, destroy indi­vidual incentive, and prevent capi­tal formation, are gnawing at the foundation of a free economy. Confiscatory income taxes and business taxes diminish the in­centive to work. Many professional people whose services are urgently needed by society are induced to work less and retire earlier than they otherwise would. Young men may be tempted not to enter busi­ness and become founders and pro­moters of successful enterprises, but to seek security and prestige in government offices and appoint­ments.

Confiscatory taxes that aim at the roots of our individual enter­prise system, spend and consume what generations have built and accumulated. Heavy death duties and highly progressive business and income taxes tend to consume productive capital. It is true, such taxes do not destroy the real capi­tal—factories and equipment—but they consume the liquid cash the heirs must raise in order to satisfy tax claims. In expectation of his demise, a successful busi­nessman may sell out to his com­petitors in order to prepare his estate with readily marketable securities, such as U.S. Treasury bonds. The confiscatory death tax thus eliminates many independent enterprises and promotes growth of giant corporations.

To Equalize Incomes

Our present tax structure open­ly aims at greater equalization of income and wealth through tax rate progression. However, this must not be understood to mean that the system relieves the lowest income brackets from a propor­tional share of the tax burden. On the contrary, it has been proven by a number of able writers that even the poorest people pay a higher percentage of their income in indirect taxes than does the class with the greatest number of taxpayers.

F. A. Hayek, eminent Austrian economist, found that “it was not the poorest but the most numer­ous and therefore politically most powerful classes which were left off relatively lightly, while not only those above them but also those below them were burdened more heavily—approximately in proportion to their smaller polit­ical strength.”

Taxation is no simple govern­ment matter. It presents problems of shifting, diffusion, and inci­dence, the difficulties of which challenge even the ablest econo­mist. Every tax sets into opera­tion a chain of reactions that af­fect industrial production, wages, income, employment, standard of living, mode of living, and so on. Most legislators probably are un­aware of the numerous economic effects of the taxes imposed.

They may be unaware that the steep graduation of the income tax accomplishes the very opposite of what it was meant to do. It per­petuates economic and social in­equalities and thereby creates a rigid class structure that divides society. The expropriation of high incomes effectively prevents for­mation of capital and wealth that facilitate individual improvement. How can an able newcomer from the wrong side of town rise to economic and social eminence if his “excess income” is expropri­ated at every turn of success? How can he challenge the business es­tablishment with its hereditary wealth and position if he is pre­vented from accumulating the necessary capital?

On the other hand, old business­es can relax, turn inefficient and bureaucratic because newcomers with excess profits are prevented by confiscatory taxation from ever challenging the establishment. It is true, the tax progression pre­vents the rich from growing rich­er; but it also protects them from the threats of competition by am­bitious and able newcomers. Thus the rich stay rich, and the poor stay poor, which gives birth to economic and social classes. In­stead of individual effort and pro­ductivity, the coincidence of birth and inheritance becomes the main economic determinant for most individuals.

To Fight Inflation

The tax objective that has been very much in the news throughout the 1960′s is the cure of infla­tion. Taxes are raised or reduced depending on the rate of inflation. Surtaxes are imposed and tax credits for equipment purchases are repealed because inflation is said to require the tax boost.

The rationale of this taxation is based on the popular, although erroneous, notion of inflation. Ac­cording to this view, rising prices are inflation. Prices are pushed up by profit-seeking businessmen and labor unions seeking unreasonable wage increases. In order to reduce their purchasing power, which is reflected in an ever-rising demand for production equipment by busi­ness and for consumers’ goods by labor, the Federal government aims to check this demand through higher taxes.

Unfortunately, such tax levies cannot alleviate inflation, but may actually make matters worse, be­cause they do not attack the root of the inflation problem. The fu­tility of taxation as an inflation remedy becomes apparent as soon as we accurately define inflation. If we bear in mind that inflation actually is the creation of new money by government, we clearly perceive the futility of trying to cure inflation by new tax levies which merely shift more purchas­ing power from the people to the government. Taxes do not halt the printing presses; only the Presi­dent and his monetary authorities can halt them.

If the monetary authorities con­tinue to print money or create credit, no tax, no matter how high, can prevent the effects of inflation, such as rising prices and wages. It is true, rising taxes may cause havoc and ruin for taxpay­ers, but they do not necessarily slow down the government money presses. It is even conceivable that profits and interest might be com­pletely expropriated—which, of course, would precipitate economic stagnation and chaos—and yet in­flation could continue to ravage the country. After all, one does not preclude the other. In fact, the policies complement one an­other as they extract income and wealth from the people.

Taxation and Inflation Twins

Taxation and inflation are twin burdens imposed by government. A given administration may resort to inflation because taxation is unpopular; and the next admini­stration may choose to tax because inflation is unpopular. But both measures further reduce the peo­ple’s income and wealth. Inflation reduces the people’s real income through higher prices. Fixed in­come receivers and owners of money or claims to money have their real purchasing power re­duced in proportion as the government gains through money cre­ation and deficit spending. Though the following administration may resort to higher taxation, it does not thereby reduce the money sup­ply created by its predecessor. So, prices stay high even though the money presses may be silent for a while. The new tax levies on busi­ness tend to reduce capital invest­ment and economic output. And this lower output in turn raises prices even higher. Both inflation and taxation thus raise prices and reduce disposable real income while boosting government rev­enue.

It is true, if the surtax revenue were applied toward reduction of the money supply, prices would tend to decline. The inflation would be followed by a deflation with all its disastrous conse­quences. But the burdensomeness of government would not be re­duced by the shift in policy. The people, instead, would face three blows of government finance: in­flation, taxation, and deflation. Can a free economy survive such an assault?

Inflation—the creation of new money—can be halted without delay. Its inevitable effects gradu­ally spread throughout the system and run their course. Prices may continue to rise many months after the new money was first created. After all, economic adjustments take time. During this period of readjustment which pre­sents great difficulties to business, a wise administration would re­duce its tax burden rather than raise it.

Taxes Should be Neutral

In a free society the cost of government should be small com­pared with national income. Nev­ertheless, government must resort to taxation in order to cover its expenditures. But this taxation should not intentionally divert the economy from production chosen and directed by millions of con­sumers. Taxes should be neutral. A neutral tax would merely take a part of every citizen’s income for public expenditure without aiming at regulating or changing the economic actions of people. In particular, it would not hamper economic freedom and would not promote government enterprises with taxpayers’ money. In fact, government would terminate its ownership or operation of busi­ness-type activities for which there is no specific constitutional authorization, returning such properties through competitive bidding to individuals and private business organizations.

Such a withdrawal of the Fed­eral government from activities that by tradition and constitution created. After all, economic ad- were left to the individual would instantly reduce the need for tax revenues. For instance the Fed­eral government owns 32.3 per cent of the total land and water area of the United States. More than 700 Federal departments, agencies, and sub agencies carry on business-type activities, such as loans, grants, research, propa­ganda, news and advisory serv­ices, transportation, communica­tions, construction, management of land and other resources, gen­eration and transmission and dis­tribution of power, and so on. If all this bureaucratic activity were liquidated and the vast assets sold to the people, a great many tax problems would vanish. In the hands of taxpayers this property not only would yield tax revenues instead of consuming them but also would be made productive in the service of human needs and wants.

Such a fiscal reform would re­vitalize the ideals and principles that made this nation great; it would permit reduction of many taxes and the abolition of those most damaging to the economy.

Welfare Through Tax Reductions

Substantial reduction of estate and income taxation would give new life to private charity and voluntary social action. There can be no doubt that many contem­porary evils, such as persistent poverty, chronic unemployment, lack of education and training, slums and crime, have grown to such frightening proportions be­cause confiscatory taxes have crip­pled private charity and voluntary social action. The Federal govern­ment now faces intolerable condi­tions and loud demands for their solution because it has nearly pre­empted social welfare through its tax policy. When almost 40 per cent of personal and corporate in­come is consumed by various levels of government, there is little left for private charity and voluntary social action.

The Federal government alone cannot solve the burning economic and social problems of our time, but it could help to revitalize private effort by removing or lib­eralizing its limits on the deducti­bility of charitable contributions. To encourage independent action toward desirable social objectives, the Federal government must, above all, cease to discriminate against the very individuals it aims to benefit. The aged, for instance, whose well-being is a primary concern of contemporary government, now lose their Social Security benefits if they should continue to earn certain wages. Why not halt this discrimination and permit them to work freely for their own support and better­ment? If retired workers contribute their efforts and talents to charitable endeavors, why shouldn’t such contributions be treated as “gifts” by the tax code?

Economic development is said to be an important objective of the Federal government. Yet, such development by individuals—what­ever is built and created—is im­mediately subjected to taxation by all levels of government. A wiser tax policy would seek to reward individual effort rather than pen­alize it. Tax credits might help to spark business development in de­pressed areas. To provide employ­ment for educationally and cultur­ally handicapped workers, the minimum wage legislation could be revised in ways that would per­mit employers to hire and train them.

If education is seriously consid­ered a governmental responsibil­ity, why not adopt tax policies that would encourage rather than discourage private efforts to that end?

If slum clearance and urban renewal are desirable, why not encourage private enterprise to help, through tax incentives rather than penalties?

A wise tax policy need not im­pose ever higher taxes but might, instead, give recognition to indi­vidual effort and achievement toward the realization of welfare objectives. Above all, care should be taken not to cause the very evils the intervention is meant to alleviate.

Of course, such tax policy would not be neutral. It would still re­flect government planning and di­recting along welfare state lines. But it might be a hopeful initial step on the road back toward self-reliance and universally lower tax­ation.

 

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Proportional Taxation

Straight proportional taxation is the only practical and definite arithmetic principle of direct taxation that there is between the principles of (a) everybody paying the same amount of tax and (b) income equalization, that is, taxation, coupled with subsidy, which results in everyone having the same income after the tax and subsidy.

BRADFORD B. SMITH, Liberty and Taxes