Do We Really Need Taxes?
Paradoxically, taxes are necessary for government but they are the bane of the citizen. To give a portion of your wealth to the mutual defense and common good is necessary, but it is not always fair.
For centuries, scholars have debated as to the best sort of tax, disputing the type, the amount, and the individual to affect. Few of the early economists agreed on the specifics regarding how to levy taxes, and there was particular disagreement by capitalist David Ricardo in On the Principles of Political Economy and Taxation with Adam Smith's idea that all taxes harm all people all the time by raising the cost of necessities.
Ricardo does not disagree with Smith in theory or principle, and he makes it clear that he opposed how taxes harm citizens by diminishing the value of their wages: “Taxes on wages will raise wages, and therefore will diminish the rate of the profits of stock. We have already seen that a tax on necessaries will raise their prices, and will be followed by a rise of wages. The only difference between a tax on necessaries, and a tax on wages is, that the former will necessarily be accompanied by a rise in the price of necessaries, but the latter will not”.
There are two responses to the levy of an income tax: either wages rise to provide a level of income that existed before the tax or the wages stay the same and are lowered by having to pay the tax. If wages are raised to accommodate the new tax, then goods must rise in an equal portion, which causes inflation.
If the wages do not rise, then it could cause great harm: “If the labourer's wages were before only adequate to supply the requisite population, they will, after the tax, be inadequate to that supply, for he will not have the same funds to expend on his family. Labour will, therefore, rise, because the demand continues, and it is only by raising the price, that the supply is not checked.”
Although some will argue that the taxes levied will make it back into the economy, they can never benefit the worker to the extent that a direct wage would benefit. This is the same for businesses in general.
Ricardo explains that there is no benefit to the labor market as a whole from government: “If the tax had been laid at once on the people of capital, their fund for the maintenance of labour would have been diminished in the very same degree that the fund of Government for that purpose had been increased; and therefore there would have been no rise in wages; for though there would be the same demand, there would not be the same competition.”
He then warns that any use of government funds abroad are a drain on the economy: “If when the tax were levied, Government at once exported the produce of it as a subsidy to a foreign State, and if therefore these funds were devoted to the maintenance of foreign, and not of English labourers... then, indeed, there would be a diminished demand for labour, and wages might not increase, although they were taxed; but the same thing would happen if the tax had been laid on consumable commodities, on the profits of stock, or if in any other manner the same sum had been raised to supply this subsidy: less labour could be employed at home.”
Even if a government cuts all foreign spending, redistributing taxes among businesses for the purpose of raising wages cannot increase the labor market: “In one case wages are prevented from rising, in the other they must absolutely fall. But suppose the amount of a tax on wages were, after being raised on the labourers, paid gratuitously to their employers, it would increase their money fund for the maintenance of labour, but it would not increase either commodities or labour. It would consequently increase the competition amongst the employers of labour, and the tax would be ultimately attended with no loss either to master or labourer. The master would pay an increased price for labour; the addition which the labourer received would be paid as a tax to government, and would be again returned to the masters.”
However, this neutral effect on the labor market can only be possible if the government is efficient in its spending, which is impossible: “It must, however, not be forgotten, that the produce of taxes is generally wastefully expended, they are always obtained at the expense of the people's comforts and enjoyments, and commonly either diminish capital or retard its accumulation. By diminishing capital they tend to diminish the real fund destined for the maintenance of labour; and therefore to diminish the real demand for it. Taxes then, generally, as far as they impair the real capital of the country, diminish the demand for labour, and therefore it is a probable, but not a necessary, nor a peculiar consequence of a tax on wages, that though wages would rise, they would not rise by a sum precisely equal to the tax.”
A tax on one particular type of laborer or industry would harm the industry, and there would be no way to escape the diminished value of their earning: “If taxes press unequally on the farmer, he will be enabled to raise the price of raw produce, to place himself on a level with those who carry on other trades; but a tax on wages, which would not affect him more than it would affect any other trade, could not be removed or compensated by a high price of raw produce; for the same reason which should induce him to raise the price of corn, namely, to remunerate himself for the tax, would induce the clothier to raise the price of cloth, the shoemaker, hatter, and upholsterer, to raise the price of shoes, hats, and furniture.”
All people would have to pay more for goods to compensate the rise of cost of one good, so all industries are affected by the rise of one. Taxation will always diminish the spending power of the people, and Ricardo argues, “There are no circumstances under which taxation does not abridge the enjoyments of those on whom the taxes ultimately fall, and no means by which those enjoyments can again be extended, but the accumulation of new revenue.”
Ricardo does allow for one form of taxation to diminish the economy to a lesser extent than others, but it has its own problems: “Taxes on luxuries have some advantage over taxes on necessaries. They are generally paid from income, and therefore do not diminish the productive capital of the country. If wine were much raised in price in consequence of taxation, it is probable that a man would rather forego the enjoyments of wine, than make any important encroachments on his capital, to be enabled to purchase it... A man intent on saving, will exempt himself from a tax on wine, by giving up the use of it. The income of the country may be undiminished, and yet the State may be unable to raise a shilling by the tax.”
Luxury taxes, especially “sin taxes,” will diminish the willingness for people to spend and are prohibitionary: “It is not because they cannot pay more, that they give up the use of wine and of horses, but because they will not pay more. Every man has some standard in his own mind by which he estimates the value of his enjoyments, but that standard is as various as the human character.”
Due to the nature of luxury taxes effectively limiting their ability to raise funds, governments who are eager to accumulate money will always turn to more harmful forms of taxation: “A country whose financial situation has become extremely artificial by the mischievous policy of accumulating a large national debt, and a consequently enormous taxation, is particularly exposed to the inconvenience attendant on this mode of raising taxes. After visiting with a tax the whole round of luxuries; after laying horses, carriages, wine, servants, and all the other enjoyments of the rich, under contribution; a minister is induced to have recourse to more direct taxes, such as income and property taxes, neglecting the golden maxim of M. Say, 'that the very best of all plans of finance is to spend little, and the best of all taxes is that which is the least in amount.'”
There is no good tax, and there are plenty of bad taxes. All taxes remove money from the market and they either hinder the ability of individuals to buy a necessity or discourage individuals from spending on a luxury. Although a tax on the “rich” or “corporations” may be more “fair,” they will either raise money through an increase in prices or seek to protect their assets from taxation as a whole.
Ultimately, the only proper solution is to limit government spending and reduce the potential for waste. Government is necessary for many things, including the raising and support of a military force, but it should not attempt to increase the wealth of laborers through wealth redistribution, public employment, welfare, or employment subsidies. No matter how effective and efficient government may be, it can never match the power of the natural market place.
Jeffrey Peters is an Annapolis, Md.-based writer and political consultant.