8. Binary Intervention, Taxation
a. Income Taxation
Taxation as we have seen takes from producers and gives to others. Any increase in taxation
swells the resources, the incomes, and usually the numbers of those living off the producers,
while diminishing the production base from which these others are drawing their sustenance.
Clearly, this is eventually a self-defeating process.
There is a limit beyond which the top-heavy burden can no longer be carried by the diminishing stock of producers.
Narrower limits are also imposed by the disincentive effects of taxation.
The greater the amount of taxes imposed on the producers, the taxpayers, the lower the marginal utility of work will be, for the returns from work are forcibly diminished, and the greater the marginal utility of leisure foregone.
Not only that, the greater will be the incentive to shift from the ranks of the burdened taxpayers
to the ranks of the tax consumers, either as full-time bureaucrats or as those subsidized
by the government.
As a result, production will diminish even further as people retreat to leisure or scramble
harder to join the ranks of the privileged tax consumers.
In the less developed countries where a money economy is still emerging from barter, any
given amount of taxation will have a still more drastic effect, for it will make monetary
incomes much less worthwhile and will shift people's efforts from trying to make money
back to untaxed barter arrangements.
Taxation can therefore decisively retard development from a barter to a monetary economy, or even
These incomes will diminish.
The laborer, faced with a tax on his wages, has less incentive to work hard.
The capitalist, confronting a tax on his interest or profit return, has more incentive to consume,
rather than to save and invest.
The landlord, a tax being imposed on his rents, will have less of a spur to allocate land
sites efficiently.
It has been objected that since a man's marginal utility of money assets increases as he holds
less of a stock of money, lower money income will mean an increased marginal utility of
income.
As a result, a tax on money incomes creates both a substitution effect against work and
and in favor of leisure or against saving in favor of consumption and an income effect
working in the opposite direction.
This is true and in rare empirical cases the latter effect will predominate.
In plain language this means that when extra penalties are placed upon man's efforts he
will generally slacken them but in some cases he will work harder to try to offset the burdens.
In the latter cases, however, we must remember that he will lose the valuable consumption
good of leisure.
He will have less leisure now than he would have if his choices were still free.
Working harder under penalty is only a cause for rejoicing if we regard the matter exclusively
from the point of view of those living off the producers, who will thereby benefit from
the tax.
The standard of living of the workers, which must include leisure, has fallen.
The income tax, by taxing income from investments, cripples saving and investment, since it lowers
the return from investing below what free market time preferences would dictate.
The lower net interest return leads people to bring their savings investment into line
with the new realities.
In short, the marginal savings and investments at the higher return will now be valued below
consumption and will no longer be made.
There is another unheralded reason why an income tax will particularly penalize saving
and investment as against consumption.
It might be thought that since the income tax confiscates a certain portion of a man's
Income, and leaves him free to allocate the rest between consumption and investment, and
since time preference schedules remain given, the proportion of consumption to saving will
remain unchanged.
But this ignores the fact that the taxpayer's real income and the real value of his monetary
assets have been lowered by paying the tax.
We have seen in Chapter 6 that given a man's time preference schedule, the lower the level
of his real monetary assets, the higher his time preference rate will be, and therefore
the higher the proportion of his consumption to investment.
Under income taxation, he shifts to a higher proportion of consumption, and a lower proportion
of saving and investment.
For this shift to occur, the individual's real monetary assets must decline, not just
the nominal amount in terms of money.
If then, instead of this tax, there is deflation in the society, and the value of the monetary
unit increases roughly proportionately everywhere, then the nominal fall in each individual's
Money stock will not be a real fall, and hence effective time preference ratios will remain
unchanged.
In the case of income taxation, deflation will not occur, since the government will
spend the revenue rather than contract the money supply.
Even in the rare case where all the tax money is liquidated by the government, the individuals
Socials taxed will lose more than others and hence will lose some real monetary assets.
We have now seen two reasons why an income tax will shift the social proportion toward
more consumption and less saving and investment.
It might be objected that the time preference reason is invalid, since the government officials
People and the people they subsidize will receive the tax revenues and find that their
money stock has increased just as that of the taxpayers has declined.
We shall see, however, that no truly productive savings and investments can be made by government,
its employees, or the recipients of its subsidies.
Some economists maintain that income taxation reduces savings and investment in society
in yet a third way.
They assert that income taxation, by its very nature, imposes a double tax on savings investment
as against consumption.
Double is used in the sense of two instances, not arithmetically twice.
The reasoning runs as follows.
Saving and consumption are really not symmetrical.
All saving is directed toward enjoying more consumption in the future, otherwise there
would be no point at all to saving.
Saving is abstaining from possible present consumption in return for the expectation
of increased consumption at some time in the future.
No one wants capital goods for their own sake.
They are only the embodiment of increased consumption in the future.
Saving investment is Crusoe's building the stick to obtain more apples at a future date.
It fructifies in higher consumption later.
Hence, the imposition of an income tax is a double tax on consumption and excessively
penalizes saving and investment.
These economists generally conclude that not income but only consumption should be taxed
as the only real income.
This line of reasoning correctly explains the investment consumption process.
It suffers, however, from a grave defect.
It is irrelevant to problems of taxation.
It is true that saving is a fructifying agent.
But the point is that everyone knows this.
That is precisely why people save.
Yet even though they know that saving is a fructifying agent, they do not save all their
income.
Why?
Because of their time preferences for present consumption.
Every individual, given his current income and value scales, allocates that income in
in the most desirable proportions between consumption, investment and additions to his cash balance.
Any other allocation would satisfy his desires less well, and lower his position on his value
scale.
The fructifying power of saving is already taken into account when he makes his allocation.
There is, therefore, no reason to say that an income tax doubly penalizes saving investment.
It penalizes the individual's entire standard of living, encompassing present consumption,
future consumption, and his cash balance.
It does not, per se, penalize saving any more than the other avenues of income allocation.
This Irving Fisher argument reflects a curious tendency among economists devoted to the free
market to be far more concerned about governmental measures penalizing saving and investment
than they are about measures hobbling consumption.
Surely, an economist favoring the free market must grant that the market's voluntary consumption
and investment allocations are optimal and that any government interference in this proportion
from either direction is distortive of that market and of production to meet the wants
of the consumers.
There is nothing, after all, particularly sacred about savings.
They are simply the road to future consumption.
But they are, then, clearly no more important than present consumption.
The allocations between the two being determined by the time preferences of all individuals.
The economist who balks more at interference with free market savings than he does at infringement
on free market consumption is therefore implicitly advocating statist interference in the opposite
direction.
He is implicitly calling for a coerced distortion of resources to lower consumption and increase
and Investment.
The bias in favor of investment or growth as against present consumption is similar to
the conservationist attack on present consumption.
What is so worthy about future consumption and so unworthy about consuming in the present?
Perhaps what we have here is an illicit smuggling of the less rational aspects of the Protestant
Ethic into Economic Science, of the many problems involved we may mention one here.
What non-arbitrary quantitative standards for thrift can the economist establish once
the free market's decision is overridden?
B. Attempts at Neutral Taxation.
So far we have discussed the impact of a tax on an individual considered by himself.
Equally important is the distortion of the market's pattern of factor prices and incomes,
created by the way taxes bear down upon different people.
The free market determines an intricate, almost infinite array and structure of prices, rates
and incomes.
The imposition of different taxes disrupts these patterns and cripples the market's
work of allocating resources and output.
Thus, if Firm A pays $5,000 a year for a certain type of labor, and Firm B pays $3,000, laborers will tend to shift from B to A, and thereby more efficiently serve the wants of consumers.
But if the income earned at Firm A is taxed $2,000 per annum, while income at B is taxed
negligibly or not at all, the market inducement to move from B to A will totally or virtually
disappear, perpetuating a misallocation of productive resources and hampering the growth
and even the existence of Firm A.
We have seen that the quest for a neutral tax, a tax neutral to the market, leaving the market
roughly as it was before the tax was imposed, is a hopeless venture.
For there can be no uniformity in paying taxes, when some people in society are necessarily
taxpayers while others are privileged tax consumers.
But even if we disregard these objections and fail to consider the redistributionist effects
of government spending out of tax revenues, we cannot arrive at a system of neutral taxation.
This is true if we also disregard the grave conceptual difficulties of arriving at a
definition of income in accounting for the imputed monetary value of work done within
in a household, of averaging fluctuating incomes over various years, etc.
Many writers have maintained that uniformly proportional income taxes for all would yield
a neutral tax.
For then, the relative ratios of incomes in society would remain the same as before.
Thus, if A. received $6,000 a year, B. earned $3,000 and C. $2,000, a 10% tax on each man
would yield a distribution of A. $5,400, B. $2,700, C. $1,800, the same mutual ratios
as before.
This assumes, of course, no disincentive effects of the tax on the various individuals, or
rather, equi-proportional disincentive effects on each individual in the society, a most
unlikely occurrence.
But the trouble is that this solution misconceives the nature of what a neutral tax would have
to be.
For a tax truly neutral to the free market would not be one that left income patterns
the same as before.
It would be a tax which would affect the income pattern and all other aspects of the economy
in the same way as if the tax were really a free market price.
This is a very important correction, for we must surely realize that when a service is
is sold at a certain price on the free market.
This sale emphatically does not leave income distribution the same as before.
For normally, market prices are not proportional to each man's income or wealth, but are uniform
in the sense of equal to everyone, regardless of his income or wealth or even his eagerness
for the product.
A loaf of bread does not cost a multi-millionaire a thousand times as much as it costs the
average man.
If indeed the market really behaved in this way, there would soon be no market, for there
would be no advantage whatever in earning money.
The more money one earned, the more, peru-pasu, the price of every good would be raised to
him.
Therefore, the entire civilized money economy and the system of production and division of labor based upon it would break down.
Far from being neutral to the free market, then, a proportional income tax follows a principle which, if consistently applied, would eradicate the market economy and the entire monetary economy itself.
It is clear, then, that equal taxation of everyone, the so-called head tax or poll tax, would be a far closer approach to the goal of neutrality.
But even here, there are serious flaws in its neutrality, entirely apart from the ineluctable taxpayer-tax-consumer dichotomy.
For one thing, goods and services on the free market are purchased only by those freely
willing to obtain them at the market price.
Since a tax is a compulsory levy rather than a free purchase, it can never be assumed that
each and every member of society would, in a free market, pay this equal sum to the government.
In fact, the very compulsory nature of taxation implies that far less revenue would be paid
into the government were it conducted in a voluntary manner.
Rather than being neutral, therefore, the equal tax would distort market results by
imposing undue levies on at least three groups of citizens, the poor, the uninterested, and
Another grave problem in treating the equal tax as akin to a free market price is that
we do not know what services of government the people are supposed to be purchasing.
For example, if the government uses the tax to subsidize a certain favored group, it is
It is difficult to know what sort of service the payers of the head tax are reaping from this act of government.
But let us take a seemingly clear-cut case of pure service, police protection,
and let us assume that the head tax is being paid for this expenditure.
The free market rule is that equal prices are paid for equal services.
But what here is an equal service?
Surely the service of police protection is of far greater magnitude in an urban crime
center than it is in some sleepy backwater where crime is rare.
Police protection will certainly cost more in the crime-ridden area, hence if it were
supplied on the market, the price paid there would be higher than in the backwater.
Furthermore, a person under particular threat of crime and who might require greater surveillance
would have to pay a higher police fee. A uniform tax would be below market price in the dangerous
areas and above it in the peaceful areas. To approach neutrality then, a tax would have
to vary in accordance with the costs of services and not be uniform.
We are not here conceding that costs determine prices. The general array of final prices
Prices determines the general array of cost prices, but then the viability of firms is
determined by whether the price that people will pay for their particular products will
be enough to cover the costs which are determined throughout the market.
This is the neglected cost principle of taxation.
The cost principle, however, is hardly neutral either.
Apart from the inexorable taxpayer-tax-consumer problem, there is, again, the problem of how
a service is to be defined and isolated.
What is the service of redistribution from Peter to Paul, and what is the cost for which
Peter is to be assessed?
And even if we confine the discussion to such common services as police protection, there
are grave flaws.
In the first place, the costs of government, as we shall see further, are bound to be much
higher than those of the free market.
Secondly, the state cannot calculate well, and therefore cannot gauge its costs accurately.
Thirdly, costs are equal to prices only in equilibrium.
Since the economy is never in equilibrium, costs are never a precise estimate of what
the free market price would have been.
And finally, as in the equal tax, and in contrast to the free market, the taxpayer never demonstrates
his benefit from the governmental act.
It is simply and blithely assumed that he would have purchased the service voluntarily
at this price.
Still another attempt at neutral taxation is the benefit principle, which states that
a tax should be levied equal to the benefit which the individuals receive from the government
service.
It is not always realized what this principle would mean, for example, that recipients of
of Government Welfare Benefits
Like police protection, grave flaws still remain.
Let us again disregard the persistent taxpayer-tax-consumer dichotomy.
A fatal problem is that we cannot measure benefits or even know whether they exist.
As in the head tax and cost principles, there is here no free market where people can demonstrate
that they are receiving a benefit from the exchange greater than the value of the goods
they surrender.
In fact, since taxes are levied by coercion, it is clear that people's benefits from
government are considerably less than the amount that they are required to pay, since,
if left free, they would contribute less to government.
The benefit, then, is simply assumed arbitrarily by government officials.
Furthermore, even if the benefit were freely demonstrable, the benefit principle would
not approach the process of the free market.
For once again, individuals pay a uniform price for services on the free market, regardless
of the extent of their subjective benefits.
The man who would walk a mile for a camel pays no more ordinarily than the man who couldn't
care less.
To tax everyone in accordance with the benefit he receives, then, is diametrically opposed
to the market principle.
Finally, if everyone's benefit is taxed away, there would be no reason for him to make the
exchange or to receive the government service.
On the market, not all people, not even the marginal buyers, pay the full amount of their
benefit.
The supermarginal buyers obtain unmeasurable surplus benefit, and so do the marginal buyers,
for without such a surplus they would not buy the product.
Moreover, for such services as police protection, the benefit principle would require the poor
for the Poor and the Infirm to pay more than the rich and the able, since the former may
be said to benefit more from protection.
Finally, it should be noted that if each person's benefit from government is to be taxed away,
the bureaucrats who receive all their income from the government would have to return their
whole salary to the government, and so serve without pay.
Ever since Adam Smith, economists have tried fallaciously to use the benefit principle
to justify proportional and even progressive taxation, on the ground that people benefit
from society in proportion, or even more than in proportion, to their incomes.
But it is clear that the rich benefit less from such services as police protection, since
But it might be objected, can't we say that everyone derives proportional benefits to
To His Income from Society, Though Not from Government?
In the first place, this cannot be established.
In fact, the opposite argument would be more accurate.
For since both A and B participate in society and its benefits, any differential income
between A and B must be due to their own particular worths, rather than to society.
Certainly, equal benefits from society cannot be used to imply a proportional tax.
And furthermore, even if the argument were true, by what ledger domain can we say that
society is equivalent to the state?
If A, B, C, producers on the market, benefit from each other's existence as society,
How can G, the government, use this fact to establish its claim to their wealth?
We have thus seen that no principle of taxation can be neutral with respect to the free market.
Progressive taxation, where each man pays more than proportionately to his income, of
course makes no attempt at neutrality.
If the proportional tax embodies a principle destructive to the entire market economy and
the monetary economy itself, then the progressive tax does so still more.
For the progressive tax penalizes the able and efficient in even greater proportion than
their relative ability and efficiency.
Progressive rates are a particular disincentive against especially able work or entrepreneurship,
and since such ability is engaged in serving the consumer, a progressive tax levies a particular
burden on the consumers as well.
In addition to the two ways discussed by which income taxation penalizes saving, the progressive
of Tax imposes an added penalty, for empirically, in most cases, the wealthy save and invest
proportionately more of their incomes than the lower income groups.
There is, however, no apodictic, praxeological reason why this must always be so.
The rule would not hold, for example, in a country where the wealthy bought jewelry while
While the poor thriftily saved and invested, while the progressive principle is certainly
highly destructive of the market, most conservative pro-free market economists tend to overweigh
its effects and to underweigh the destructive effects of proportional taxation.
Proportional income taxation has many of the same consequences and therefore the level
of Income Taxation is generally more important for the market than the degree of progressivity.
Thus, Society A may have a proportional income tax requiring every man to pay 50% of his
income.
Society B may have a very steeply progressive tax requiring a poor man to pay ¼% and the
richest man 10% of his income.
The rich man will certainly prefer society be, even though the tax is progressive, demonstrating
that it is not so much the progressivity as the height of his tax that burdens the rich
man.
Incidentally, the poor producer, with a lower tax upon him, will also prefer society be.
This demonstrates the fallacy in the common conservative complaint against progressive
taxation that it is a means for the poor to rob the rich.
For both the poor man and the rich man have, in our example, chosen progression.
The reason is that the poor do not rob the rich under progressive taxation.
Instead, it is the state that robs both through taxation, whether proportional or progressive.
It may be objected that the poor benefit from the state's expenditures and subsidies from the tax
proceeds, and thus do their robbing indirectly. But this overlooks the fact that the state can
spend its money in many different ways. It may consume the products of specific industries.
It may subsidize some or all of the rich.
It may subsidize some or all of the poor.
The fact of progressivity does not in itself imply that the poor are being subsidized en
masse.
Indeed, if some of the poor are being subsidized, others will probably not be.
And so these latter net taxpayers will be robbed along with the rich.
In fact, since there are usually far more poor than rich, the poor en masse may very
well bear the greatest burden of even a progressive tax system.
Of all the possible types of taxes, the one most calculated to cripple and destroy the
workings of the market is the excess profits tax.
For of all productive incomes, profits are a relatively small sum with enormous significance
and impact.
They are the motor, the driving force of the entire market economy.
Profit and loss signals are the prompters of the entrepreneurs and capitalists who direct
and ever redirect the productive resources of society in the best possible ways and combinations
to satisfy the changing desires of consumers under changing conditions.
With the drive for profit crippled, profit and loss no longer serve as an effective incentive
or, therefore, as the means for economic calculation in the market economy.
It is curious that in wartime, precisely when it would seem most urgent to preserve an efficient
Productive System, the cry invariably goes up for taking the profits out of war.
This zeal never seems to apply so harshly to the clearly war-born profits of steel workers
in higher wages, only to the profits of entrepreneurs.
There is certainly no better way of crippling a war effort.
In addition, the excess concept requires some sort of norm above which the profit can be
taxed.
This norm may either be a certain rate of profit, which involves the numerous difficulties
of measuring profit and capital investment in every firm, or it may refer to profits
at a base period before the war started.
The latter, the general favorite because it specifically taps war profits, makes the economy
even more chaotic, for it means that while the government strains for more war production,
the excess profits tax creates every incentive toward lower and inefficient war production.
In short, the E.P.T. tends to freeze the process of production as of the peacetime base period,
and the longer the war lasts, the more obsolete, the more inefficient and absurd the base period
structure becomes.
C. Shifting and Incidence, Attacks on an Industry
No discussion of taxation, however brief, can overlook the famous problem of the shifting
and incidence of taxation.
In brief, who pays a tax?
The person on whom it is levied?
Or someone else, to whom the former is able to shift the tax?
There are still economists, incredibly, who hew to the old 19th century equal diffusion
and The Theory of Taxation, which simply closes the problem by proclaiming that all taxes
are shifted to everyone, so that there is no need to analyze each one in particular.
This obscurantist tendency is fostered by treating shifting in too broad a way.
Thus, if an income tax is levied on Jones at 80%, this will hurt not only Jones, but
but also, by decreasing Jones' incentives as well as capacities, other consumers, by
reducing Jones' work and savings.
It is therefore true that the effects of taxation diffuse outward from the center of the target.
But this is far from saying that Jones can simply shift the tax burden onto the shoulders
of others.
The concept of shifting will here be limited to the case where the payment of a tax can
be directly transferred from the original payer to someone else and will not be used
when others suffer in addition to the original taxpayer.
The latter may be called the indirect effects of the tax.
The first rule of shifting is that an income tax cannot be shifted.
This formerly accepted truth in economics is now countered with the popular assumption
that, for example, a tax on wages will spur unions to demand higher wages to compensate
for the tax, and that therefore the tax on wages is shifted forward onto the employer,
Who, in turn, shifts it again forward onto the body of consumers.
And yet, almost every step in this commonly proclaimed sequence is an egregious fallacy.
It is absurd in the first place to think that workers or unions wait quietly for a tax to
galvanize them into making demands.
Workers always want higher wages.
Unions always demand more.
The question is, will they get more?
There is no reason to think that they can.
A worker can get only the value of the discounted marginal productivity of his labor.
No clamor will raise that productivity, and therefore none can raise the wage he earns
from his employer.
Union demands for higher wages will be treated as usual.
is, they can be satisfied only at the cost of the unemployment of some of the workforce
in that industry.
But this is true whether or not there has been a tax on wages.
The tax will have nothing to do with the final wage set on the market.
The idea that the increased cost will be passed on to the consumer by the employer is an illustration
of Perhaps the Single Most Widespread Fallacy on Taxation that Businessmen can simply shift
their higher costs forward onto the consumers in the form of higher prices.
All the economic theory expounded in this book shows the error of this doctrine, for
the price of a given product is set by the demand schedules of the consumers.
There is nothing in higher costs or higher taxes which, per se, increases these schedules.
Hence, any change in selling prices, whether higher or lower, will decrease the revenues
of the business involved.
For each business on the market tends to be at all times at its maximum profit point in
relation to the consumers.
Those are already at their point of maximum return for the business, therefore higher
taxes or other costs imposed on the firm will reduce their net incomes rather than
be smoothly and easily passed on to consumers.
We thus arrive at this significant conclusion.
No tax, not just an income tax, can ever be shifted forward.
Notice that a particularly heavy tax of whatever type has been laid on a specific industry,
say the liquor industry.
What will be the effects?
As we have noted, the tax will not simply be passed on to the consumers.
Businessmen are particularly prone to this passing-on argument, obviously in an attempt
to Convince Consumers that they are really paying any tax on that industry.
Yet the argument is clearly belied by the very zeal of each industry to have its taxes
lowered and to fight against a tax increase.
If taxes could really be shifted so easily and businessmen were simply unpaid collection
agents for the government, they would never protest a tax on their industry.
Perhaps this is the reason why almost no businessmen have protested being collection agents for
withholding taxes on their workers.
Instead, the price of liquor will remain the same.
The net income of the firms will decline.
This will mean that returns will be lower to capital and enterprise in liquor than in
other industries of the economy.
All liquor firms will suffer losses and go out of business, and in general productive
resources of all types will flow out of liquor and into other industries.
The long-run effect, therefore, is to decrease the supply of liquor produced, and therefore
by the law of supply and demand to raise the price of liquor on the market.
However, as we have said before, this process, this diffusion of suffering over the economy,
is hardly shifting.
For the tax is not simply passed on, it only permeates to the consumers through hurting
the industry taxed.
The final result will be a distortion of the factors of production.
Your goods are now being produced than the consumers would prefer in the liquor industry,
and too many goods, relatively to liquor, are being produced in the other industry.
Taxes, in short, can more readily be shifted backward than forward.
Strictly the result is not shifting because it is not a painless process, but it is clear
Remember that the backward process, backward to the factors of production, happens more
quickly and directly than the effects on consumers, for losses or lowered profits to liquor firms
will immediately lower their demand for land, labor and capital factors of production.
This falling of demand schedules will lower wages and rents earned in the liquor industry,
These lower earnings will induce a shift of labor, land and capital out of liquor and
into other industries.
The rapid backward shifting is in harmony with the Austrian theory of consumption and
production developed in this volume, for prices of factors are determined by the selling prices
of the goods which they produce, and not vice versa, which would have to be the conclusion
Doctrine of the Naive Shifting Forward Doctrine
It should be noted that in some cases the industry itself can welcome a tax upon it,
for the sake of conferring an indirect but effective monopolistic privilege on the supermarginal
firms.
Thus, a flat license tax will confer a particular privilege on the more heavily capitalized
D. Shifting and Incidence, a General Sales Tax
The most popular example of a tax supposedly shifted forward is the general sales tax.
Surely, for example, if the government imposes a uniform 20% tax on all retail sales, and
And if we can make the simplifying assumption that the tax can be equally well enforced
everywhere, then business will simply pass on the 20% increase in all prices to consumers.
In fact, however, there is no way for prices to increase at all.
As in the case of one particular industry, prices were previously set, or approximately
So, at the points of maximum net revenue for the firms.
Stocks of goods or factors have not yet changed and neither have demand schedules.
How then could prices rise?
Moreover, if we look at the general array of prices, as is proper when dealing with
a general sales tax, these are determined by the supply of and the demand for money
from the goods and money sides.
For the general array of prices to rise, there must be either an increase in the supply of
money, a decrease in the demand schedule for money, or both.
Nothing in a general sales tax causes a change in either of these determinants.
It might be objected that the firms can pass along the sales tax because it is a general
Tax Increase for All Firms
Aside from the fact that no relevant general factor, supply, demand for money, has increased,
the individual firm is still concerned only with its individual demand, and this has not
shifted.
A tax increase has done nothing to make a higher price more profitable than it was before.
Furthermore, the long-run effects of a general sales tax on prices will be smaller than in the case of an equivalent partial excise tax.
A tax on a specific industry, such as liquor, will push resources out of this industry and into others, and therefore the relative price of the taxed commodity will eventually rise.
In a general, uniformly enforced sales tax, however, there is no room for such shifts of resources.
Resources can now shift only from work into idleness or into barter.
This, of course, may and probably will happen, since, as we shall see further, a sales tax is a tax on incomes.
The rise in opportunity cost of leisure may push some workers into idleness and thereby lower the quantity of goods produced.
To this extent prices will eventually rise, although hardly in the smooth, immediate, proportionate way of shifting.
The myth that a sales tax can be shifted forward is comparable to the myth that a general union-imposed wage increase can be shifted forward to higher prices for consumers, thereby causing inflation.
There is here no way that the general array of prices can rise, and the only possible result of such a wage increase is mass unemployment.
Of course, if the money supply is increased after a wage rise and credit expanded, prices
can be raised so that money wages are again not above their discounted marginal value
products.
In considering the general sales tax, many people are misled by the fact that the price
paid by the consumer necessarily includes the tax.
If someone goes to a movie and pays $1 admission, and if he sees prominently posted the information
that this covers a price of 85 cents and a tax of 15 cents, he tends to conclude that
the tax has simply been added on to the price.
But $1 is the price, not 85 cents, the latter sum simply being the revenue accruing to the
The Revenue to the Firm has, in effect, been reduced to allow for payment of taxes.
This is precisely the consequence of a general sales tax.
Its immediate impact lowers the gross revenue of firms by the amount of the tax.
In the long run, of course, firms cannot pay the tax.
The loss in gross revenue of firms being imputed backward to interest income by capitalists
and to wages and rents earned by owners of original factors, labor and ground land.
A decrease in gross revenue to retail firms is reflected back to a decreased demand for
the products of all the higher order firms.
The major result of a general sales tax is a general reduction in the net revenues accruing
to original factors.
The sales tax has been shifted backwards to original factor returns, to interest and to
all wages and ground rents.
No longer does every original factor of production earn its discounted marginal product.
General factors now earn less than their DMVPs, the reduction consisting of the sales tax
paid to the government.
Let us now integrate this analysis of the incidence of a general sales tax with our
previous general analysis of the benefits and burdens of taxation.
This is accomplished by remembering that the proceeds of taxation are, in turn, spent by
by the Government.
Whether or not the Government spends the money for resources for its own activities, or simply
transfers the money to people it subsidizes, the effect is to shift consumption and investment
demand from private hands to the Government, or to Government-supported individuals by
the amount of the tax revenue.
The tax has been ultimately levied on the incomes of original factors and the money transferred
from their hands to the government.
The income of the government and of those subsidized by the government has been increased
at the expense of the tax producers, and therefore consumption and investment demands on the
have been shifted from the producers to the expropriators by the amount of the tax.
As a consequence, the value of the monetary unit will remain unchanged,
barring a difference in demands for money between the taxpayers and the tax consumers.
But the array of prices will shift in accordance with the shift in demands.
Thus, if the market has been spending heavily on clothing, and the government uses the revenue
mostly for the purchase of arms, there will be a fall in the price of clothes and a rise
in the price of arms, and a tendency for non-specific factors to shift out of the production of
clothing and into the production of armaments.
As a result, there will not finally be, as might be assumed, a proportional 20% fall
in all original factor incomes as the result of a 20% general sales tax.
Specific factors in industries that have lost business from the shift from private to governmental
demand will lose proportionately more in income.
Non-specific factors in industries gaining in demand will lose proportionately less.
Some may gain so much as to gain absolutely from the change.
Non-specific factors will not be affected as much proportionately, but they too will
lose and gain according to the difference that the concrete shift in demand makes in
their marginal value productivity.
It should be carefully noted that the general sales tax is a conspicuous example of failure
to tax consumption.
The sales tax is commonly supposed to penalize consumption rather than income or capital.
Yet we find that the sales tax reduces not just consumption, but the incomes of original
factors.
The general sales tax is therefore an income tax, albeit a rather haphazard one.
Many right-wing economists have advocated general sales taxation as opposed to income taxation
on the grounds that the former taxes consumption but not savings investment.
Many left-wing economists have opposed sales taxation for the same reason.
Both are mistaken.
The sales tax is an income tax, though of a more haphazard and uncertain incidence.
The major effect of the general sales tax will be that of the income tax, to reduce
the consumption and the saving investment of the taxpayers.
Mr. Frank Chotirov in his The Income Tax, Root of All Evil, fails to indicate what other
Another type of tax would be better, from a free market point of view, than the income
tax.
It is clear from our discussion that there are few taxes indeed that will not be as bad
as the income tax from the viewpoint of the free market.
Certainly sales or excise taxation will not fill the bill.
Mr. Chaturov furthermore is surely wrong when he terms income and inheritance taxes unique
Denials of the Right of Individual Property
Any tax whatever infringes on property right, and there is nothing in an indirect tax which
makes the infringement any less clear. It is true that an income tax forces the subject to keep
records and disclose his personal dealings, thus imposing a further loss in his utility.
The sales tax, however, also forces record-keeping. The difference, again, is one of degree rather than of kind, since here the directness covers only retail storekeepers instead of the bulk of the population.
In fact, since, as we have seen, the income tax, by its nature, falls more heavily on savings investment than on consumption, we reach the paradoxical and important conclusion that a tax on consumption will fall more heavily on savings investment than on consumption in its ultimate incidence.
E. A Tax on Land Values
Wherever taxes fall, they blight, hamper and distort the productive activity of the market.
Clearly, a tax on wages will distort the allocation of labor effort.
A tax on profits will cripple the profit and loss motor of the economy.
A tax on interest will tend to consume capital, etc.
One commonly conceded exception to this rule is the doctrine of Henry George, that ground landowners perform no productive function, and that therefore the government may safely tax site value without reducing the supply of productive services on the market.
This is the economic, as distinguished from the moral, rationale for the famous single tax.
Unhappily, very few economists have challenged this basic assumption,
the single tax proposal being generally rejected on grounds purely pragmatic.
There is no way and practice of distinguishing sight from improvement value of land.
Or, conservative, too much has been invested in land to expropriate the landowners now.
Thus, even so eminent an economist as F. A. Hayek has recently written,
this scheme, the single tax, for the socialization of land, is, in its logic, probably the most seductive and plausible of all socialist schemes,
if the factual assumptions on which it is based were correct,
That is, if it were possible to distinguish clearly between the value of the permanent and indestructible powers of the soil and the value due to improvement, the argument for its adoption would be very strong.
Yet, this central Georgist contention is completely fallacious.
The owner of ground land performs a very important productive service.
He finds, brings into use, and then allocates land sites to the most value-productive bidders.
We must not be misled by the fact that the physical stock of land is fixed at any given
time.
In the case of land as of other material goods, it is not just the physical good that is being sold, but a whole bundle of services along with it, among which is the service of transferring ownership from seller to buyer, and doing so efficiently.
Ground land does not simply exist, it must be served to, the user, by the owner.
One man, of course, can perform both functions when the land is vertically integrated.
The land owner earns the highest ground rents by allocating land sites to their most value
productive uses, that is, to those uses most desired by consumers.
In particular, we must not overlook the importance of location and the productive service of
the site owner in assuring the most productive locations for each particular use.
The view that bringing sites into use and deciding upon their location is not really
productive is a vestige from the old classical view that a service which does not tangibly
create something physical is not really productive.
I do not know anyone who has brought out the productivity of landowners as clearly as Mr.
Spencer Heath, an ex-Georgist.
Heath comments on Henry George as follows, Wherever the services of landowners are concerned,
he is firm in his dictum that all values are physical, in the exchange services performed
by Landowners, their social distribution of sites and resources, no physical production
is involved.
Hence, he is unable to see that they are entitled to any share in the distribution of physical
things, and that the rent they receive is but recompense for their non-coercive distributive
or exchange services.
He rules out all creation of values by the services performed in land distribution by
free contract and exchange, which is the sole alternative to either a violent and disorderly
or an arbitrary and tyrannical distribution of land.
Actually, the function of bringing sites into use and deciding upon their location is just
In this necessarily hasty overview of the high spots of taxation theory, we have space
for only one more comment, a criticism of the very common view that, in a business boom,
The government should increase taxation in order to sop up excess purchasing power and
thereby halt the inflation and stabilize the economy.
We shall discuss the problems of inflation, stabilization and the business cycle later.
Here, let us note the oddity of assuming that a tax is somehow less of a social cost, less
of a burden than a price.
Thus suppose in a boom that Messers A, B and C, with the money they have on hand, would
spend a certain amount on some commodity, say pipes, at a certain market price, for
example, $10 per pipe.
The government decides that this is a most unfortunate situation, that the market price
The price is, by some arbitrary, undivulged standard, too high, and that therefore it must help its subjects by taxing their money away from them, and thus lowering prices.
Suppose, indeed, that A, B and C are taxed sufficiently to lower the pipe price to, say, $8.
In short, the tax price has gone up in order that the prices of other goods may decline.
Why is a voluntary price, paid willingly by buyers and accepted by sellers, somehow bad
or burdensome for the buyers, while at the same time a price levied compulsorily on the
same buyers for dubious governmental services for which they have not demonstrated a need,
is somehow good.
Why are high prices burdensome and high taxes not?