6. The Theory of Distribution
Adam Smith's theory of distribution was fully as disastrous as his theory of value. Though
he was aware of the functions performed by the capitalist, his only venture in explaining
the rate of long-run profit was to opine that the greater the amount of stock, the lower
Over the Rate of Profit
He arrived at this highly dubious conclusion from his perfectly valid observation that
capitalists tend to move out of low-profit and into high-profit industries, their competition
tending to equalize the rates of profit throughout the economy.
But more production, lowering selling price and raising costs in a particular industry,
Is scarcely the same causal claim as more capital throughout the economy lowering profit rates.
Indeed, the rate of interest, or long-run rate of profit, is related not to the quantity
of accumulated capital, but to the amount of annual saving, and moreover, falling profit
rates are not caused by increasing saving.
On the contrary, as the Austrians would point out, both are the results of lower rates of
time preference in the society.
It is perfectly possible for a highly capitalized economy to experience rising rates of time
preference, which in turn would bring about higher rates of interest.
Smith saw correctly that increasing capital means an increase in the demand for labor,
and therefore higher wages, so that an advancing society necessarily means a secular increase
in wage rates.
Unfortunately, Smith's mechanistic view of the profit rate as being inversely proportional
to the total amount of capital led him to believe that wages and profits are always
moving inversely to the other, an adumbration of an allegedly inherent class struggle which
which Ricardo would do much to aggravate.
Moreover, if the supply of labor increases to absorb the increase in demand, wage rates will then fall.
At this point, Adam Smith provided the Malthusian hook, for, as we shall see further, the Reverend Malthus was a devoted follower of Adam Smith.
Smith, indeed, was picking up a theme common in the 18th century,
that the population of a species tends to press on the means of its subsistence.
As Smith put it, every species of animals naturally multiplies in proportion to the means of its subsistence.
So that Smith saw the secular trend of the economy as capital increasing, wages rising,
and the rise in wages calling forth an increase in population.
The liberal reward of labor, by enabling them to provide better for their children and consequently
to bring up their number, naturally tends to widen and extend those limits, the means
of subsistence.
If this demand for labor is continually increasing, the reward of labor must necessarily encourage
in such a manner the marriage and multiplication of laborers, as may enable them to supply
Why that Continually Increasing Demand by a Continually Increasing Population
In this way, wages tend to settle at the minimum subsistence level for the existing population.
A fall in wages below subsistence will forcibly reduce the population, and hence the supply
of labor, raising wages to the subsistence rate.
And if wages should rise above subsistence, the excessive multiplication of workers would
soon lower it to this necessary rate.
One of the many problems of this Malthusian approach is that it assumes that human beings
will not be able to act on their own to limit population growth in order to preserve a newly
achieved standard of living.
In addition to Smith's erroneous Malthusian view that long-run wage rates are at the means
of subsistence, he also introduced into economics the unfortunate fallacy that wages, at least
in the shorter run, are determined by the relative bargaining power of employers and
workers.
It was a simple leap from that position to the view that employers have greater bargaining
In his view of rent, Smith characteristically held several unintegrated views running side-by-side.
On the one hand, as we have seen, rent is demanded by landlords who reap where they
Why are they able to collect such a rent?
Because, now that land has become private property,
the laborer must pay for the license to cultivate the land,
and must give to the landlord a portion of what his labor either collects or produces.
Smith concludes that the rent of land, therefore, is naturally a monopoly price,
and Rice, since he regards private property in land in the same category as monopolization.
Surely, socialist and Henry Georgite calls for land nationalization found here their fundamental inspiration.
Smith also sensibly points out that rent will vary according to superior fertility and location of the land.
Furthermore, as we have indicated, he attributes rent to the powers of nature, which supposedly earns an extra return in agriculture as compared to other occupations.
Smith is also inconsistent on whether land rent is included in cost. At various points he includes land rent in cost and therefore as an alleged determinant of long run price.
On the other hand, he also asserts that high or low rents are the effect of high or low product prices,
and that since the supply of land is fixed, the full incidence of taxes upon rent will fall on land, rather than being shifted.
All these inconsistencies can be cleared up if we regard all costs as determined by expected future selling prices,
and individual costs to be the opportunity for GON to contribute to expected productive revenue elsewhere.
More specifically, while costs do not determine price directly, they do limit supply,
and in this sense, every expenditure, whether on rent or elsewhere, is definitely a part of cost.
But, as we have seen, the greatest of the many defects in Smith's theory was his totally
discarding Cartillon's and Turgot's brilliant analysis of the entrepreneur.
It was as if these great eighteenth-century Frenchmen had never written.
Smith's analysis rested solely on the capitalist investing stock, and on his labor of management
and inspection.
The very idea of the entrepreneur as a risk-bearer and forecaster was thrown away, and again
classical economics was launched into another lengthy blind alley.
If of course one persists in fixing one's vision on the never-never land of long-run
equilibrium, where all profits are low and equal and there are no losses, there is no
No point in talking about entrepreneurship at all.
The political implications of this omission were also not lost on 19th century socialists.
For if there is no role for entrepreneurial profits in a market economy, then any existing
profits must be exploitative, far more so than the low uniform rate existing in long-run
equilibrium.
The perceptive Scottish historian of economics, Alexander Gray, wrote of Smith's Theory of
Wages that he presented several theories not wholly consistent with each other, which lie
together in somewhat uneasy juxtaposition.
Gray then slyly added that it is a tribute to the greatness of Smith that all schools
of thought may trace to him their origin and inspiration.
Other words for such inchoate confusion, for what Gray referred to aptly as a vast chaos, come more readily to mind.
7. The Theory of Money
We have seen that David Hume's famous elucidation of the price-specie-flow mechanism in international
All monetary relations, though attractively written, was itself a deterioration from
the pioneering and highly sophisticated analysis of Richard Cantillon.
It was, however, better than nothing.
Yet, as Jacob Weiner put it, one of the mysteries of the history of economic thought is that
Adam Smith, though a close friend of Hume for many years, included none of the Humean
analysis in his Wealth of Nations. Instead, Smith propounded the primitive and erroneous
view that every country will have as much specie as it allegedly needs to circulate
trade, the surplus overflowing channels of circulation to seek that profitable employment
which it cannot find at home. Gone is any reference whatever to the causal nexus between
and the Quantity of Money, Price Levels and Balances of Trade.
The mystery deepens when we realize that the wealth of nations is a grave deterioration
even from Smith's own lectures of over a dozen years earlier.
For in those lectures, unpublished in Smith's own day, we find a clear presentation and
summary of the Humean analysis.
Thus in his lectures, Smith had written that Hume proves that whenever money is accumulated beyond the proportion of commodities in any country, the price of goods will necessarily rise, that this country will be undersold in the foreign market, and consequently the money must depart into other nations, but on the contrary, whenever the quantity of money falls below the proportion of goods,
Even Smith's modern admirers despair of his confused and scattered, as well as hopelessly inadequate, theory of money and theory of international monetary relations.
Professor Petrella tries to explain Smith's later rejection of Hume's species flow price mechanism as a reaction to Hume's giving hostage to the alleged employment benefits of mercantilistic increases in the quantity of money, benefits which Smith was anxious to deny.
Petrella cites in support a sentence critical of Hume following the passage from the lectures just quoted.
Mr. Hume's reasoning is exceedingly ingenious. He seems, however, to have gone a little into the notion that public opulence consists in money.
But here, Petrella attempts to prove too much. For why couldn't Smith simply continue to adopt the specie-flow price mechanism and then repeat or elaborate on his criticisms of Hume's position, demonstrating the latter's inconsistency?
It seems clear in contrast that the mystery of Smith's abandonment of the price-specie-flow mechanism can be solved if we realize that this particular deterioration in his economic analysis was not unique.
Indeed, we have noted a similar fatal deterioration in his value theory from the time of the lectures to the wealth of nations.
It seems plausible that the cause of the decay in each case was the same. Smith's shift of concentration from the real world of market prices to the exclusive vision of long-run natural equilibrium, the shift from the real world of market process to focusing on equilibrium states, made Smith impatient with the process analysis that was the hallmark and the merit of the process.
of the Specie Flow approach.
Instead, Smith treats only a world of pure specie money and assumes that all countries
are always in equilibrium.
Moreover, any departures from world-wide monetary equilibrium are eradicated swiftly,
leaving the world in a virtually perpetual equilibrium state.
Smith's focus on the long run, in fact, led him to apply his general labor cost of production theory of value to the value of money.
The value of money, that is, the value of the metal commodity gold or silver, then becomes the embodiment of the labor cost of producing it.
In that way, Smith attempted to integrate the values of money and other goods by assimilating all of them into a labor cost theory.
Thus Smith wrote in The Wealth of Nations,
Gold and silver, however, like every other commodity, vary in their value, are sometimes cheaper and sometimes dearer.
The quantity of labor which any particular quantity of them can purchase or command, or the quantity of other goods which it will exchange for, depends always upon the fertility or barrenness of the mines.
The discovery of the abundant mines of America reduced in the 16th century the value of gold and silver in Europe to about a third of what it had been before.
As it cost less labor to bring those metals from the mine to the market, so when they were brought thither, they could purchase or command less labor.
Even those few economists who laud Adam Smith as really adopting the humane price-specie flow mechanism concede that he dropped this approach when considering a mixed monetary system, including banknotes or paper money.
Indeed, even though Smith occasionally adhered to the quantity theory of specie money and its effects on prices, he here throws it over altogether, and asserts that convertible banknotes are always equal in value to gold, and hence their quantity will always remain the same.
Any increase of banknotes beyond the total of specie will overflow the
channel of circulation and therefore return to the banks in what was later
called a reflux in exchange for specie which immediately flows out of the
country. Smith therefore explicitly denies that an increase in banknotes
can raise the prices of commodities. But why did Smith abandon the quantity
The Theory completely here in exchange for such nonsense, plausibly because of Smith's
need to integrate all-value theory on the basis of the labor cost of production.
If he ever conceded that an increase in the quantity of paper money could affect values,
even temporarily, then Smith would have had to admit an enormous hole in his labor cost
For the labor cost involved in printing paper money obviously bears no relation whatever to the exchange value of that money.
Therefore paper money, including bank paper, had to be assimilated tightly to the value of specie.
Adam Smith wrote in an 18th century Britain where virtually all his predecessors had denounced the new institution of fractional reserve banking.
Reserve Banking as Inflationary and Illegitimate. His friend, David Hume, 1752, had called for the radical repudiation of this institution on behalf of 100% Specie Reserve Banking.
Other important writers had taken the same position, including Jacob Vanderlint, died 1740, in his Money Answers All Things, 1734,
and Joseph Harris, 1702 to 1764, Master of the Royal Mint, in his An Essay upon Money and Coins, 1757 and 1758.
Harris had stated that banks were convenient so long as they issued no bills without an equivalent in real treasure,
If Smith had continued in his predecessor's footsteps, his commanding authority and prestige
might have been able to bring about a fundamental reform of the fractional reserve banking system.
But unfortunately, Smith, in his need to meld all monetary theory into a long-run labor-cost-of-production
approach, abandoned the quantity theory and the speciflow price mechanism in his discussion
of paper money.
He thus set economic theory once again on an erroneous and fateful road by embracing
the institution of fractional reserve credit.
No longer holding such credit to be inflationary, Smith went on to adumbrate one of the major
defenses of paper money still held to this day.
That gold and silver are mere dead stock, accomplishing nothing.
The banks, by substituting their paper notes for specie, enable the country to convert
a great deal of this dead stock into active and productive stock.
Indeed, so far did Adam Smith rhapsodize about paper money that he likened its accomplishments to providing a sort of highway through the air.
The gold and silver money which circulates in any country may very properly be compared to a highway, which, while it circulates and carries to market all the grass and corn of the country, produces itself not a single pile of either.
The judicious operations of banking, by providing a sort of wagon way through the air, enable the country to convert, as it were, a great part of its highways into good pastures and cornfields, and thereby to increase considerably the annual produce of its land and labor.
Adam Smith failed to realize that the stock of gold and silver was far from dead.
On the contrary, it performed the vital function of being a money commodity, among other functions providing to every member of society an insurance against paper money inflation, whether launched by government or banks.
The stock of gold, in short, performs a store of value service, which Smith totally overlooks.
Smith's critique of specie as dead stock also stems from his belief that money is not a commodity serving as a medium of exchange, but a claim, a sign, a voucher to purchase.
The French economist Charles Reist is justly highly critical of the dead stock approach and its influence on later generations.
This idea was seized upon with extraordinary alacrity and found high favor.
It dominated the thought of English writers in the 19th century.
The belief that the use of metallic money is a retrograde and costly system to be discouraged
by all possible means is firmly fixed in British thought on currency and banking.
The use of the check and the banknote was, for a long time, regarded only from this point of view.
These two instruments were considered merely as means of economizing money.
The idea was taken as the guide to the country's currency policy,
and the most disastrous conclusions were drawn from it.
8. The Myth of Laissez-Faire
If, then, Adam Smith contributed nothing of value to economic thought, if, in fact, he
introduced numerous fallacies, including the labor theory of value, and thereby caused
a significant deterioration of economic thought from previous French and British economists
of the 18th century, did he make any positive contribution to economics?
A common answer is that the significance of the wealth of nations was political rather
than analytic, that his great achievement was to initiate and take the lead in the advocacy
of free trade, free markets and laissez-faire.
It is true that Smith articulated the political-economic sentiments of his day.
As Joseph Schumpeter wrote, those who extolled Adam Smith's work as an epoch-making, original
Achievement were of course thinking primarily of the policies, he advocated.
Smith's views, Schumpeter added, were not unpopular, they were in fashion.
In addition, Schumpeter shrewdly noted that Smith was very much a judiciously deluded
Rousseauian in his 18th century egalitarianism.
Human beings seemed to him to be much alike by nature, all reacting in the same simple
are all ways to very simple stimuli, differences being due mainly to different training and
different environments.
But while Schumpeter's explanation of Smith's vast popularity, that he was a plotter in
tune with the zeitgeist, holds part of the truth, it still scarcely accounts for the way
in which Smith swept the board, blotting out general knowledge of all previous and contemporary
for the Economists.
This puzzle will be examined further in the next chapter.
For the mystery of Smith's total triumph deepens when we realize that he scarcely originated
laissez-faire thought.
As we have seen, he was merely in an eighteenth century tradition, flourishing in Scotland
and especially in France.
Why then were these preceding economists analytically far superior to Smith, and also in the laissez-faire
Smith's greatest achievement has generally been supposed to be the enunciation of the
way in which the free market guides its participants to pursue the good of the consumers by following
their own self-interest.
As Smith wrote in perhaps his most famous passage, a man will be more likely to prevail
Well if he can interest their self-love in his favor, and show that it is for their own
advantage to do for him what he requires of them.
It is not from the benevolence of the butcher, the brewer or the baker that we expect our
dinner, but from their regard to their own interest.
We address ourselves not to their humanity, but to their self-love, and never talk to
to them of our own necessities but of their advantages, and in an equally famous passage
bringing out the general principles of this point, as every individual therefore endeavors
as much as he can both to employ his capital in the support of industry and so to direct
that industry that its produce may be of the greatest value, every individual necessarily
Murray labors to render the annual revenue of the society as great as he can.
He generally, indeed, neither intends to promote the public interest, nor knows how much he
is promoting it.
By directing that industry in such a manner as its produce may be of the greatest value,
he intends only his own gain.
And he is, in this, as in many other cases, led by an invisible hand to promote an end
which was no part of his intention.
Smith goes on to caution wisely against alleged aims to promote the public good directly.
Nor is it always the worse for the society that it was no part of it.
By pursuing his own interest, he frequently promotes that of the society more effectually
Hostile critics of laissez-faire have latched on to Smith's terminology of the invisible hand to indict him for ostensibly beginning his analysis with a mystical, and therefore flagrantly unscientific, a priori assumption that providence manipulates people for everyone's good.
Manipulates People for Everyone's Good by an Invisible Hand
are alive to the pernicious consequences of government's creation of monopolies and its conferring privileges on special interest groups.
Smith, a religious man, was simply expressing his quite justified wonderment at the harmonizing influence of the free market,
and his buy-an-invisible hand was a metaphor which contained an implicit as-if before his use of the phrase.
Despite the undoubted importance of these passages, however, Adam Smith's championing of laissez-faire was scarcely consistent.
In the first place, Smith retreated from the absolutist natural law position that he had set forth in his ethical work, The Theory of Moral Sentiments, 1757.
In this book, free interaction of individuals creates a harmonious natural order, which
government interference can only cripple and distort.
In wealth of nations, on the other hand, laissez-faire becomes only a qualified presumption rather
than a hard and fast rule, and the natural order becomes imperfect and to be followed
only in most cases.
Indeed, it is this deterioration of the case for laissez-faire that German scholars were to label Das Adam Smith Problem.
Indeed, the list of exceptions Smith makes to laissez-faire is surprisingly long.
His devotion to the militarism of the nation-state, for example, induced him to take the lead in the pernicious modern view
and the view of excusing any government intervention that might plausibly be labeled for the national defense.
On that basis, Smith supported the Navigation Acts, that bulwark of British mercantilism and systemic subsidy for British shipping.
One of Smith's reservations about the division of labor, indeed, is that it leads to a decay of the martial spirit,
And Smith goes on at length about the decay of the martial spirit in modern times and about the great importance of restoring and sustaining it.
The security of every society must always depend, more or less, upon the martial spirit of the great body of the people.
It was an anxiety to see government foster such a spirit that led Smith into another important deviation from laissez-faire principle.
Principle, His Call for Government-Run Education, It is also important, opined Smith, to have
governmental education in order to inculcate obedience to it among the populace, scarcely
a libertarian or laissez-faire doctrine.
Wrote Smith, An instructed and intelligent people, besides, are always more decent and
orderly than an ignorant and stupid one.
They feel themselves, each individually, more respectable and more likely to obtain the
respect of their lawful superiors, and they are therefore more disposed to respect those
superiors.
They are less apt to be misled into any wanton or unnecessary opposition to the measures
of government.
In addition to navigation acts and public education, Adam Smith advocated the following
Following Forms of Government Intervention in the Economy, Regulation of Bank Paper, including the outlawing of small denomination notes after allowing fractional reserve banking, Public Works, including highways, bridges and harbors, on the rationale that private enterprise would not have the incentive to maintain them properly,
Government Coinage, The Post Office, on the simple grounds, which will draw a bitter laugh from modern readers, that it is profitable,
compulsory building of firewalls, compulsory registration of mortgages, some restrictions on the export of corn, that is, wheat,
The outlawing of the practice of paying employees in kind, forcing all payment to be in money.
There is also a particularly lengthy list of taxes advocated by Adam Smith, each of
which interferes in the free market.
For one thing, Smith paved the way for Henry Georgism and the single tax by urging higher
Adam Smith's Calvinist Abhorrence of Luxury is also seen in his proposals to levy heavy
He called for heavy taxes on luxurious consumption.
Thus he called for heavier highway tolls on luxury carriages than on freight wagons, specifically
to tax the indolence and vanity of the rich.
His puritanical hostility to liquor also emerges in his call for a heavy tax on distilleries.
In order to crack down on hard liquor and induce people to drink instead, the wholesome
Adam Smith advocated the Soak the Rich Policy of Progressive Income Taxation.
Smith's most flagrant violation of laissez-faire was his strong advocacy of rigid usury laws,
a sharp contrast to the opposition to such laws by Catillon and Turgot.
Smith did not, indeed, wish to adhere to the medieval prohibition of all credit.
Instead, he urged an interest rate ceiling of 5 percent, slightly above the rate charged
to Prime Borrowers, a price which is commonly paid for the use of money by those who can
give the most undoubted security.
His reasoning followed his predilection, as we have already noted, for hostility to free
market time preferences between consumption and saving.
Driven by Calvinist hostility to luxurious consumption, Smith tried to skew the economy
Money in favor of more productive labor in capital investment and less in consumption.
By forcing interest rates below the free market level, Smith hoped to channel credit into
the sober hands of prime borrowers and away from credit into the hands of speculators
and of prodigal consumers.
As Professor West admits, Adam Smith condemned the demand for loans by prodigals and projectors
in which the prodigal dissipates in the maintenance of the idol what was destined for the support of the industrious.
In that way, the ceiling on interest rates, as West notes, would reallocate credit into the most productive hands.
Yet West, a free market adherent who is generally an uncritical admirer of Smith,
Then maintains that Smith was curiously inconsistent in not realizing in this one case that price controls would create a greater shortage of credit.
Here West echoes the brilliant essay, The Defense of Usury, by the Smithian Jeremy Bentham, in accusing the master of inconsistency in his usual advocacy of the free market.
But as Professor Garrison indicates in his comment on West, Smith knew only too well what he was doing.
In urging a reallocation of credit by the government into the most productive hands,
Adam Smith was precisely trying to create a shortage of credit for consumers and speculators,
and thereby to channel credit into the hands of sober, low-risk businessmen.
As Garrison points out, Smith was not interested in reducing the cost of borrowing with his credit controls.
He was trying to reduce the amount of funds borrowed for certain categories of loans.
And his anti-usury scheme was well suited for this.
Smith notes that money is lent to the government at 3% and to sound businessmen at 4 and 4 and a half.
Only prodigals and projectors, people who are most likely to waste and destroy capital, would be willing to borrow at 8 or 10 percent.
Smith, therefore, recommended an interest ceiling at 5 percent.
This policy was not aimed at allowing the prodigals and projectors to obtain funds more cheaply, but at preventing them from obtaining any funds at all.
These funds would be diverted then into the hands of those who are more future-oriented.
In short, Smith knew full well that a low-interest ceiling would not benefit marginal borrowers by providing them with cheap credit.
He knew that usury laws would dry up credit altogether for marginal borrowers, and he sought precisely that result.
For Smith virtually embraced the idea of zero-time preference as the ideal, the non-time preference of his mythical impartial spectator, and, concludes Garrison, it is not difficult to see how Smith's standard of zero-time preference, coupled with his awareness of sharply positive time preferences, could lead him to make the very policy recommendations that West found to be surprising.
He sought to reallocate resources away from the present and toward the future.
Perhaps most important of all, how do we square Smith's alleged role as champion of free trade and laissez-faire,
with his spending the last 12 years of his life as a commissioner of Scottish customs,
Cracking Down on Smugglers, Violating Britain's Extensive Mercantilist Laws and Evading Import Taxes
Did he treat the job as a sinecure? No.
Recent studies show that his role as a top enforcer of mercantilist laws and tariffs was active and hard working.
Was he driven by penury? Hardly.
Since, with his great reputation, he probably could have commanded an equivalent sum in a top academic post.
Did he suffer from qualms of conscience? Apparently not, since he not only approached his job with enthusiasm,
but was also particularly vigilant and hard-nosed in trying to enforce the onerous restrictions and tariffs to the hilt.
Edwin West, an inveterate admirer of Smith as an alleged devotee of laissez-faire, speculates that he entered the high customs bureaucracy as a practical free trader trying to remove or lighten the customs burden on the Scottish economy.
But, as Anderson and others reply, if Smith had been deeply concerned with reducing the
cost to the economy resulting from customs, the most effective strategy at the level of
his responsibilities would have been to reduce the efficiency of the enforcement apparatus.
But Smith did not do this.
On the contrary, Smith showed no appreciation whatever of the social and economic value
of the Underground Economy, or the Great British tradition of smuggling.
Instead, he tried his best to make enforcement of the mercantilist laws and burdens as efficient
as possible.
Neither did he use his high post to promote reforms in the direction of free trade.
On the contrary, his major reform proposal as commissioner was for compulsory automatic
warehousing of all imports, which would have made inspection and enforcement far easier
for the customs officials, at the expense of the smugglers, international trade, and
the nation's economy.
As Anderson and others note, Smith was proposing a reform that was likely to increase the costs
to the economy from customs duties.
And finally, Smith's correspondence as Commissioner shows no particular desire to cut tariffs
or restrictions.
In contrast, his dominant emotion seems to have been pride at cracking down on smugglers,
and thereby increasing government revenue.
In December 1785, he writes to a fellow customs official that, it may perhaps give the gentleman
It is my own pleasure to be informed that the net revenue arising from the customs in Scotland is at least four times greater than it was seven or eight years ago.
It has been increasing rapidly these four or five years past, and the revenue of this year has overleaped by at least one half the revenue of the greatest former year.
I flatter myself it is likely to increase still further.
Well, happy day! This, from an alleged champion of laissez-faire.
9. On Taxation
Over the centuries, economists have contributed little of interest or value on the subject
of taxation. In addition to describing forms of taxation, they have generally approached
the subject from the point of view of the state, as a kindly or not-so-kindly despot,
seeking to maximize its revenue while doing minimum harm to the economy.
There are variations among the different schools, but the general thrust is the same.
Thus, the Cameralists were frankly interested solely in maximizing state revenue, as were
the French absolutists.
The more liberal economists admonish the government to keep tax rates lower than had been customary.
The more liberal economists had tried to strictly demarcate functions which government should
and should not perform.
By ruling out various kinds of government intervention, the thrust, other things being
equal, is to reduce total government taxation and spending.
But they have offered us very few guidelines beyond that.
If for example, as in the case of Smith, the government is supposed to supply public works,
how many should it provide and how much should be spent?
There have been almost no preferred criteria then for total spending or for overall levels
of taxation.
There has been more discussion of the distribution of taxation.
That is, given from some arbitrary external dictate that the total level of taxation should
be a certain amount, T, there has been considerable discussion of how T should be distributed.
In short, the two main problems of taxation are how much should be levied and who should
pay, and there has been considerably more thought devoted to the latter question.
But none of this has been very satisfactory.
Again, the basic point of view seems to be that of a highwayman or slave master interested
in extracting the maximum from his charges while keeping their complaints as minimal
as possible.
In the discussion in 18th century France, there were two favorite tax proposals.
Proportional income or property taxation, or as in the case of Marshall Vauban and later
Under the Physiocrats, a single tax on land, revenue to a fixed and visible source of income
that seems fixed, unchanging and therefore easy for the state to get at.
Adam Smith's discussion of taxation in the wealth of nations became, like the rest of
his work, a classic, setting the central focus for economic thought from that point on.
Like the rest of the work, it was a confused mixture of the banal and the fallacious.
Thus, Smith set forth four canons of evident justice and utility in taxation, which were
to become famous from then on.
Of the four, three are banal, that the tax payment be made as convenient as possible
for the payer, that the cost of collection be kept to a minimum since the State does
does not even benefit from these levies on the taxpayer, and that the tax be certain
rather than arbitrary.
The substantive canon was Smith's first in the list, that tax be proportional to incomes.
Thus, the subjects of every state ought to contribute toward the support of the government
as nearly as possible in proportion to their respective abilities, that is, in proportion
and to the revenue which they respectively enjoy under the protection of the state.
The expense of government to the individuals of a great nation is like the expense of a
great estate, whoivided in proportion to respective interests to the estate.
In the first place, this passage is hopelessly confused in presenting, as if they were identical,
Two very different criteria for justice or propriety in taxation, the ability to pay
and the benefit principles.
Smith maintains that people's ability to pay taxes is proportionate to income and that
benefits derived from the state are proportional in the same way.
Yet he offers no justification for either of these dubious propositions.
On ability, it is by no means clear that people's ability to pay, however that be defined, is
proportionate to income.
What for example of the influence of a person's relative wealth as contrasted to income, his
medical or other expenses, etc.
And one thing is certain, Adam Smith presented no arguments for this bald assertion.
The idea that one's benefit derived from the state is proportional to one's income is
even shakier.
How precisely do the wealthy, by virtue of that wealth, benefit proportionately from
the state as compared to the poor?
That would only be true if the government were responsible for the wealth by means of
a subsidy, monopoly grant, or some form of special privilege.
If not from special privilege, then how do the rich benefit proportionately to their income?
Surely not from redistributive measures, by which the state takes money from the wealthy
and gives it to bureaucrats or the poor.
In that case, it is the latter group who benefit, and the rich who suffer from this redistribution.
So who then should pay for such benefits?
by the Bureaucrats and the Poor and Benefits from Police Protection or the Public Schools
but surely the wealthy could far more afford to pay for private provision of these services
and therefore the rich benefit less than the middle class or certainly than the poor from
such expenditures.
Neither would it save the theory to say that since A, for example, makes five times as
The Theory of Money and Credit
The reverse argument would be far more plausible, that the differential between A's and B's
incomes is due to A's superior productivity, and that society, if indeed it can be held
to be responsible for anything specific at all, can be held responsible for their equal
core incomes below that differential.
The implication of that point would be that both persons, and therefore all persons, should
pay an equal tax, that is, a tax equal in absolute numbers.
Finally, whatever society's claim to part of people's incomes may be, society, the
division of labor, the body of knowledge and culture, etc., is in no sense the state.
The State contributes no division of labor to the production process and does not transmit
knowledge or carry civilization forward.
Therefore, whatever each of us may owe to society, the State can hardly claim, any more
more than any other group in society to be surrogate for all social relations in the country.