Front Page Titles (by Subject) Tax Capitalization - Cost and Choice: An Inquiry in Economic Theory, Vol. 6 of the Collected Works
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Tax Capitalization - James M. Buchanan, Cost and Choice: An Inquiry in Economic Theory, Vol. 6 of the Collected Works 
The Collected Works of James M. Buchanan, Foreword by Geoffrey Brennan, Hartmut Kliemt, and Robert D. Tollison, 20 vols. (Indianapolis: Liberty Fund, 1999-2002). Vol. 6 Cost and Choice: An Inquiry in Economic Theory.
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The Ricardian theorem is related to a separate fiscal-theory application that consistent cost theory may clarify. What, precisely, do fiscal theorists mean when they say that a tax may be fully capitalized under certain conditions? The arithmetic is straightforward: the present value of the asset subjected to a newly imposed tax is written down to reflect the weight of expected future taxes as charges against income. A purchaser of the asset, after the moment of capitalization, will not bear any part of the tax burden; this will rest exclusively on the owner of the asset at the time of imposition.
There is nothing wrong in this summary statement of the orthodox analysis provided that the conditions where capitalization can occur are carefully specified. The presumption is often made, however, that the “burden” of the tax is experienced, subjectively, only in the period when the asset’s capital value is written down and that no further sacrifice of utility is involved. This is based on elementary confusion. The moment of capitalization corresponds to the moment of choice in our earlier discussion of cost, and it may clarify the analysis to think of an asset owner’s making a choice which involves giving up, either in taxation or in some other form, a claim to a part of the asset’s future income stream. There will be a choice-influencing opportunity cost here, a purely subjective evaluation of the alternatives that must be foregone by the fact of the abandonment of future-period claims to income. However, just as with debt issue, this subjective cost arises only because of the expectation that, in future periods, some payment must be made from income, that some potential enjoyment from the use of income must be foregone. Once the choice is made and the tax or other claim against the asset’s income is imposed, consequences follow, and these include the contracted necessity of making the required payments. These become the choice-influenced costs of the decision taken earlier, and these can be measured objectively as well as evaluated subjectively. The owner of the asset experiences utility losses in such later periods. These cannot be eliminated by the process of capitalization since, in fact, the anticipation of these future-period utility losses is the only basis for the subjective costs experienced at the moment of choice or of capitalization.
There has been here some confusion between the transfer of burden among asset owners and the temporal location of this burden. Capitalization concentrates the tax burden on the owner of an asset at the moment of the initial levy. But “at the moment” refers to the ownership pattern, not to the tax burden. Even if the owner should sell the asset immediately after full capitalization, he will still experience the choice-influenced costs in subsequent time periods.
In tax capitalization, as in ordinary economic choice, there are two costs, not one, and it is necessary to keep these distinct. Fully analogous to the choice-influencing cost of any decision, there is the purely subjective realization that future income streams are reduced. This is experienced in the sensation of evaluating the future enjoyment of opportunities that have suddenly been foreclosed. Analogous to choice-influenced cost, there is the experienced utility loss that was anticipated and which has its objective equivalent in the payment obligations made. The asset owner cannot, therefore, fully capitalize future tax payments in the sense of suffering all real burden at the moment of imposition under any conditions. There is nothing at all contradictory in this conclusion once the duality of cost in any choice is fully recognized. An anticipated cost is not and cannot be a substitute for a realized burden, nor can these two be dimensionally equivalent. “The coward dies a thousand deaths” before he dies.
Private and Social Cost
Equality between marginal private cost and marginal social cost is the allocative criterion of Pigovian welfare economics,1 and the principle remains acceptable to most modern welfare economists. Corrective taxes and subsidies are deemed to be required in order to satisfy the necessary conditions for optimality when external effects are observed to be present. The subject of discussion here is limited to the cost conception that is implicit in the Pigovian policy criterion; for this reason, there is no need to review recent works in the theory of externality, as such, some of which place major qualifications on the Pigovian norms.2 The purpose of this chapter is to demonstrate that the Pigovian principle embodies a failure to make the distinction between costs that may influence choice and costs that may be objectively measured.
[1. ]The companion criterion, equality between marginal private product and marginal social product, reduces to the cost criterion when the latter is stated in opportunity-cost terms. The failure to take action that exerts external benefits can be treated as analytically equivalent to the taking of action that exerts external costs. In his own formulation, Pigou used the product terminology almost exclusively, although he referred to both types of divergence. See A. C. Pigou, The Economics of Welfare (4th ed.; London: Macmillan, 1932), esp. pp. 131-35.
[2. ]Notably, R. H. Coase, “The Problem of Social Costs,” Journal of Law and Economics, III (October 1960), 1-44; Otto A. Davis and Andrew Whinston, “Externality, Welfare, and the Theory of Games,” Journal of Political Economy, LXX (June 1962), 241-62.