Taxation Theory

Dr. Curtiss is Executive Secretary of the Foundation for Economic Education.

Tax experts long have theorized about the raising of money for various units and functions of government.

Should taxes be for revenue only, or as a means of social con­trol, or both?

Should taxes be levied on cit­izens equally, or should “ability to pay” be a major consideration?

Where practicable, should the “benefit principle” be followed? That is, if government performs a service for specific individuals and not for all, should those who directly benefit be charged for the service? For example, should high­way users be required to pay for them through specific taxes on motor fuels and motor vehicles and direct tolls? And, if such taxes are intended for highway use, are safeguards against diver­sion desirable?

How pay for government schools at all levels? Studies show the tremendous economic advantages of high school and college educa­tion. Most parents urgently want education for their children. Should the cost of government schooling be charged on a “bene­fit” basis, either to the parents, or against the enhanced future earnings of the students?

Changed Circumstances

In the early days of our coun­try, tariffs were an important source of revenue for the Federal government. And there was much debate among tax theorists as to the revenue-raising versus the pro­tectionist and discriminatory as­pects of tariffs. But “tariffs for revenue only” becomes an aca­demic issue when the national government requires one quarter or more of people’s earnings.

Seeking the ideal taxation formula is of course praiseworthy, but conditions of the search have changed! The taxation experts of 100 years ago were talking about nine cents out of each personal income dollar. Today, nearly 40 cents of every dollar of personal income goes to support national, state, and local units of govern­ment. This calls forth new the­ories of taxation. Collecting the billions of dollars now spent by various units of government is no longer a question of “soaking the rich” but of how to extract 40 cents of each personal income dollar without stirring up a tax­payer revolt.

Taxation has become a tool of monetary and fiscal management. The experts speak of “fine-tuning” the economy so that employment will be high and productivity will expand.

There doubtless are those who look upon taxation as a means of redistributing wealth, in the be­lief that some have too much in­come and some too little. The pro­gressive income tax is an expres­sion of this belief, as are current discussions of a guaranteed an­nual income for all.

So, in view of the growing tax burden and the increasing use of taxes as a tool for social and fiscal control, let us further review the new theories and modern prob­lems of taxation.

Hidden Taxes

The tendency of taxpayers to revolt against high taxes causes tax collectors to try to hide the tax burden so that the taxpayer will hardly be aware of what is happening to him. If this process takes place at a time of rapid growth in the economy, levels of living may rise at the same time that taxes are increasing. With­out an understanding of what might have been, people can truth­fully proclaim: “We never had it so good!”

An effective method of hiding taxes is the withholding of Fed­eral, state, and local income taxes by employers from the wages of employees. Most workers are in­clined to think only of their take-home pay and give little thought to the tax they are paying.

The social security tax not only is hidden through withholding, as is the income tax, but is other­wise disguised as well. If he thinks of it at all, the employee is likely to consider only his share of the tax, not realizing that the em­ployer pays an equal amount on his behalf. Further, many who pay in the name of social security view it not as a tax but as saving for their old age.

A real estate tax is rarely thought of as a hidden tax, but when I asked a neighbor how much his school taxes were, he replied: “I haven’t the slightest idea; I pay them monthly along with my mortgage, interest, and insurance bill.”

Perhaps the most cleverly hid­den tax is inflation. When the na­tional government fails to cover its expenditures through taxes, it must borrow the difference, either from individuals or the central bank. If the latter, a multiple of that debt is likely to be added to the money supply, which is infla­tion. Inflation usually is accom­panied by rising prices and ero­sion of the purchasing power of the dollar. Since 1939, the dollar has lost about half of its purchas­ing power. This is a tax upon sav­ings, as truly a tax as any of the many other ways of raising rev­enue. From a political standpoint it has the advantage of being hid­den. Also, it is possible to make people believe that the cause of inflation is the raising of prices by greedy businessmen or of wages by labor unions.

Taxes are hidden in other ways, too. Many are incorporated in the prices of things we buy and we rarely realize that a tax has been added. Taxes on liquor, cigarettes, automobiles, and gasoline are ex­amples.

Voluntary Taxes

With compulsory taxes absorb­ing so high a proportion of in­come, it may appear paradoxical to speak of voluntary taxes. But what is a government lottery, if not a voluntary tax? Certainly, a person may avoid the tax by not participating in the lottery.

The state of New York spends millions of dollars each year to try to prevent illegal gambling. One might conclude that the law­makers believe gambling is an evil which should be suppressed. But no; we find the state permitting and even encouraging certain types of gambling. Bingo is permitted under certain conditions and bet­ting at race tracks where the state gets a heavy “cut” is encouraged. And now, the state-wide lottery to raise money for “education”! The state felt it needed more gen­eral revenue than it could raise through its many tax sources. So, why not try a “voluntary” tax like a lottery, and call it “educa­tion”? This might remove the onus for some who think gambling is a little bit evil and who do not realize that this is just another way of swelling the general rev­enues of the state.

Regardless of how one may ap­praise the moral aspects of gamb­ling, there seems little doubt that a state lottery operates as a re­gressive tax, taking heavily from the poor, even though voluntarily. Historically, governments that have resorted to lotteries have had in common a tendency toward dec­adence. The state lottery feeds the idea of “something-for-noth­ing” already far advanced in this country. From the standpoint of the lawmakers, it is a “last re­sort,” desperation effort to fill the coffers of a profligate state.

Diverted Taxes and Highways to the Moon

Taxes sometimes are levied for an alleged purpose and diverted to another. The gasoline tax often brings this comment: “I wouldn’t mind paying the gas tax if I could be sure the money was spent to improve highways.”

The diversion of taxes collected from highway users has brought sufficient protest that 28 states have adopted antidiversion amend­ments to their constitutions. But, in most instances, such antidiver­sion measures have little effect on the over-all pattern of government spending.

True, in some states, more rev­enue is raised from highway users than the total spent on highways. For example, in New Jersey where there was no state income tax, more than 40 per cent of all state revenue in 1966 was from motor vehicle, fuel, and license taxes; and about 40 per cent of that was used for nonhighway purposes. In contrast, some states spend more on highways than they collect in highway taxes. For the country as a whole, disbursements for high­ways by all units of government are about equal to the receipts from highway taxes by all units of government.

One may be certain that tax in­come from lotteries in New York and New Hampshire will be watched like a hawk to see that it is not diverted from educational purposes. But this fear will be un­founded; the huge amounts bud­geted for education will more than absorb all such lottery funds. Whether the lotteries will make available additional funds for edu­cation or simply release general funds for other purposes would be difficult to determine.

The point is that when 40 per cent of personal income is taken for taxes, the diversion argument is hardly important. Ways will be sought to raise this money as pain­lessly as possible. Motorists ap­parently will tolerate a tax equal to half the price of their gasoline. Liquor and cigarette users will submit to a very heavy tax on those products, no matter to what purpose such funds are diverted. How would government finance an excursion to the moon except by diversion?

Are social security funds di­verted? It all depends upon one’s point of view. In the early days, when social security taxes collected far exceeded benefit payments, was there diversion? If one assumes that social security taxes are in­tended for the general welfare, then there is, of course, no diver­sion. If future benefits are con­sidered a contractual obligation, then past and current social secur­ity taxes fall far short of needs, and diversion is a term without meaning.

From an administrative stand­point, with governments involved in so many activities and at such tremendous cost, it becomes prac­tically meaningless to try to ear­mark funds at their source for specific expenditures. The attempt is made in the Postal Service, but with what success? Deficit after deficit! People will say: “Let those who want mail service pay for it,” or “Let those who want to go to the moon pay for it,” or “Let those who want to fight in Vietnam pay for it.” But do they really mean they’re ready to vote the government out of that par­ticular business and leave it to competitive private enterprise?

In many instances, special tax­ing districts are set up to provide specific services such as schools, fire protection, police protection, water, or sewerage. Diversion of such special district taxes for other purposes is reduced to a minimum under such arrange­ments, though such districts often require extra funds from other tax sources.

Not many years ago, public ele­mentary and secondary schools were financed almost entirely from local real estate taxes. But the trend has been increasingly toward state and Federal aid for the fi­nancing of more and more elabor­ate schools and school programs.

Conclusion

So, we see that tax policy is more complicated than it once was. What one’s theory of taxation fi­nally amounts to is his theory of government, because taxing is an integral part of the governmental process. And there are really but two basic and fundamentally op­posed theories of government. One theory, the one upon which the United States of America was launched, held that government ought to defend the peaceful in­dividual and his property.

The alternative theory of gov­ernment, increasingly popular among Americans, would plunder the property of individuals for the supposed benefit of others. This is socialism. And the tax policy of socialism is to confiscate all private property.

The use of tax policy for social control — for leveling wealth — is not a new development. The U.S. official who said recently he would take property from those who had more than they need and give it to those who don’t have enough was merely expressing the major tenet of socialism.

More important than taxation theories is the question of the proper function of government.’ Rather than debate whether 10 per cent should be added to in­come taxes or raised through further inflationary deficits, a more basic question should be raised: Will this money be used to finance a proper function of government?

Even though there will be minor differences in details, a clear un­derstanding of the proper place of government in an advanced free and open society will largely elim­inate the need for complicated tax­ation theory. With government re­duced to reasonable size, the fi­nancing of it becomes relatively simple.

—FOOTNOTES—

¹ For a discussion of the proper func­tion of government see Government: An Ideal Concept, by Leonard E. Read. Foundation for Economic Education, Inc.