If We Must Pay Taxes, What is the Least Bad Way To Do That?

First Published: 2013-03-26

Original article at BurtFolsom.com and is reposted here with the kind permission of Dr. Folsom.

Ben Franklin once observed that nothing is as certain as death and taxes. He might have added that nothing is as certain to put readers to sleep as a lengthy discussion of taxes. Thus, I have only a short discussion of taxes to keep people alert as we near the month of April, when taxes are due.

First, Franklin was right; we must pay some of our earnings in taxes. Even Adam Smith admitted that national defense and administrative upkeep are legitimate functions of government. And that takes some revenue. But how should that revenue be raised?

Ever since FDR and the 1930s, we have been locked into the income tax (and corporate taxes) as the prime raisers of revenue. The Founders of our country did not agree with that approach, in part because it put the tax controls in the hands of politicians, not people. Politicians, under the income tax system, have incentives to raise taxes on the rich because the rich are few in number and large in income. That revenue from the rich can then be redistributed to voters in other income brackets in the form of government programs. The politicians thus win more votes than they lose, and some Americans gain federal tax dollars at the expense of the wealthy.

This redistribution also damages the development of new businesses. Entrepreneurs are restricted because they must spend so much time sheltering their wealth; and the whole system contradicts the American dedication to “life, liberty, and the pursuit of happiness” for all Americans.

After all, the Fourteenth Amendment promises that no state could “deny to any person within its jurisdiction the equal protection of the laws.” What’s good for states is also good for the nation: All Americans ought to have the same right to earn income and protect their property. If some can be denied that right, then all might be denied that right by politicians in the future.

What is the ideal system of taxation? Our Founders believed it was consumption taxes. Alexander Hamilton (in Federalist Paper #21) said that consumption taxes–levies on imports or on luxury goods–were the best way to raise revenue because “the amount to be contributed by each citizen will in a degree be at his own option, and can be regulated by an attention to his resources.” For example, Hamilton was thinking that people could choose to buy locally, or they could pay a tax to buy imported British clocks or French wine.

Hamilton added: “If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great. . . . This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them.” A 50 percent tariff, for example, on imported British shirts, instead of a 10 percent tax, might actually mean less revenue for the government because more Americans would buy cheaper American clothing. That, as Hamilton concluded, was “a complete barrier against any material oppresion” and a “natural limitaiton” on government. Consumption taxes, then, were a paradox. You could do two seemingly contradictiory things: raise revenue and protect liberty as well.

Under the current income tax system, liberty is always precarious. We do not choose what taxes we pay by what we consume; politicians choose what taxes we pay depending on political conditions at the moment. As a nation, we should think of returning to consumption taxes as the least of evils.

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