Understanding Government: Taxes

Government needs money to fund its activities. It obtains this money through taxation.

Taxation is the act of the government taking money or other goods by force. It is possible because of the government's near monopoly on force. Taxation, and the activities funded by it, necessarily depend on coercion. Taxation is theft, but unlike private theft, it is legal.

Taxation is a form of monopoly. Resources owned by a person can be used in an almost infinite number of ways. Taxation is a declaration by government that a given resource can only be used in one way. Proponents of taxation imply that the way that government will use this resource is better than all its other possible uses.

While this is possible, it is very unlikely. If this judgment is wrong, then society is poorer by the difference between the value of what the resource would have been used for and what the government used it for. Due to the difference in who bears responsibility for their actions, the government consistently uses resources less efficiently than private citizens. Thus taxation systematically makes a nation poorer.

The impact of taxes doesn't end there. Taxes also create incentives that change people's behavior. Taxation penalizes whatever behavior it is applied to, and so reduces its frequency. Thus income taxes decrease the production of income. Sales taxes decrease the sale of taxable goods. Property taxes decrease the ownership of taxable property. Capital gains taxes decrease investment. Inflation discourages holding money.

Thus taxes discourage all the very behaviors that create wealth: work, trade, property ownership, investment, and use of money. Thus taxes promote poverty again. In this way, the impact of taxes is far greater than the amount collected. A 100% tax would generate no revenue, but that doesn't mean that it would have no impact.

Because taxes discourage productive behavior, increasing taxes can actually reduce the amount of revenue collected. At some point, the government loses more by discouraging production than it gains through higher taxes on the remaining production. Conversely, at certain levels of taxation, cutting taxes will actually bring in more revenue through increased production.

Politicians who wish to generate revenue face incentives of their own. There are many potential forms of taxation, from sending government agents to beat people and take their wallets to withholding income from their paychecks. Some are more intrusive than others. Since taxpayers dislike paying taxes, the stealthiest methods of taxation will tend to predominate.

Thus income taxes are collected through withholding, since people are less upset by the government taking their money if it never gets to them. Some taxes, such as corporate income taxes, may be collected from a small number of people directly, but will silently increase prices for all consumers. Regulations also constitute a form of tax that increase prices.

One particularly stealthy type of tax is inflation. Inflation is increasing the money supply, which reduces the value of the money already in existence. This is a tax. It is akin to counterfeiting. Inflation causes a general increase in prices. Increasing the money supply fast enough causes hyperinflation, which can quickly bankrupt a country. Thankfully, due to the efforts of economist Milton Friedman and others, there is enough recognition that inflation is a monetary phenomenon that only a low level of inflation is politically safe.

Because so many taxes are hidden, the true level of taxation is typically much higher than most people realize.

So why do so many taxes exist, and why are they so high? The most obvious reason is that government needs lots of money to fund its many programs and activities. However, there are other reasons.

Government can use the tax code to redistribute money to politically favored constituencies from politically disfavored constituencies. It can create incentives that encourage some behaviors and discourage other behaviors. Manipulating the tax code helps politicians to generate campaign contributions.

Finally, taxes make people poorer and hence more dependent on government. This increases government power. As the old saying says, the power to tax is the power to destroy. This may explain the desire of some politicians to continue raising taxes even when this will bring in less revenue, not more.

Given that some government programs are essential, there must be some taxes to pay for them. However, taxes for any other programs waste money and so make society poorer. Taxes create incentives that discourage creating wealth and so make people poorer still. Taxes increase the power of government over citizens. Thus taxes should be no higher than absolutely necessary.