The Online Library of Liberty

A project of Liberty Fund, Inc.

• Foreword
• Geoffrey Brennan
• Preface
• Acknowledgments
• The Power to Tax
• 1.: Taxation In Constitutional Perspective
• 1.1.: The Notion of a “constitution”
• 1.2.: The Logic of a Constitution
• 1.3.: The Means of Constitutional Constraint
• 1.4.: The Wicksellian Ideal and Majoritarian Reality
• 1.5.: The Power to Tax
• 1.6.: The Enforceability of Constitutional Contract
• 1.7.: Normative Implications
• 2.: Natural Government a Model of Leviathan
• 2.1.: Leviathan As Actuality and As Contingency
• 2.2.: Monopoly Government and Popular Sovereignty
• 2.3.: The Model of “leviathan”: Revenue Maximization
• 2.4.: The Model of Leviathan As Monolith
• 2.5.: The Constitutional Criteria
• 3.: Constraints On Base and Rate Structure *
• 3.1.: Government As Revenue Maximizer Subject to Constitutional Tax Constraints
• 3.2.: Tax-base and Tax-rate Constraints In a Simple Model
• 3.3.: One Among Many
• 3.4.: Tax Limits and Tax Reform
• Appendix: Progression In the Multiperson Setting
• 4.: The Taxation of Commodities
• 4.1.: The Conventional Wisdom
• 4.2.: Constitutional Tax Choice
• 4.3.: Alternative Forms of Commodity Tax: the Choice of Base
• 4.4.: Uniformity of Rates Over Commodities
• 4.5.: Uniformity of Rates Over Individuals
• 4.6.: Discrimination By Means of the Rate Structure
• 4.7.: Summary
• Appendix
• 5.: Taxation Through Time Income Taxes, Capital Taxes, and Public Debt
• 5.1.: Income Taxes, Capital Taxes, and Public Debt In Orthodox Public Finance
• 5.2.: The Timing of Rate Announcement
• 5.3.: Income and Capital Taxes Under Perpetual Leviathan
• 5.4: Leviathan’s Time Preference
• 5.5.: The Time Preference of the Taxpayer-citizen With Respect to Public Spending
• 5.6.: The Power to Borrow
• 5.7.: Conclusions
• 6.: Money Creation and Taxation
• 6.1.: The Power to Create Money
• 6.2.: Inflation and the Taxation of Money Balances: a “land” Analogy
• 6.3.: Inflation and the Taxation of Money Balances
• 6.4.: Inflationary Expectations Under Leviathan
• 6.5.: Inflation, Wealth Taxation, and the Durability of Money
• 6.6.: The Orthodox Discussion of Inflation As a Tax
• 6.7.: The Monetary Constitution
• 6.8.: Inflation and Income Tax Revenue
• 6.9.: Monetary Rules and Tax Rules
• 7.: The Disposition of Public Revenues *
• 7.1.: The Model
• 7.2.: Public-goods Supply Under a Pure Surplus Maximizer: Geometric Analysis
• 7.3.: The Surplus Maximizer: Algebraic Treatment
• 7.4.: The Nonsurplus Maximizer
• 7.5.: Toward a Tax Policy
• 8.: The Domain of Politics
• 8.1.: Procedural Constraints On Political Decision Making
• 8.2.: The Rule of Law: General Rules
• 8.3.: The Domain of Public Expenditures
• 8.4.: Government By Coercion
• 9.: Open Economy, Federalism, and Taxing Authority
• 9.1.: Toward a Tax Constitution For Leviathan In an Open Economy With Trade But Without Migration
• 9.2.: Tax Rules In an Open Economy With Trade and Migration
• 9.3.: Federalism As a Component of a Fiscal Constitution
• 9.4.: An Alternative Theory of Government Grants
• 9.5.: A Tax Constitution For a Federal State
• 9.6.: Conclusions
• 10.: Toward Authentic Tax Reform Prospects and Prescriptions
• 10.1.: Taxation In Constitutional Perspective
• 10.2.: Tax Reform As Tax Limits
• 10.3.: Tax-rate Limits: the Logic of Proposition 13
• 10.4.: Tax-base Constraints
• 10.5.: Aggregate Revenue and Outlay Limits: Ratio-type Proposals For Constitutional Constraint
• 10.6.: Procedural Limits: Qualified Majorities and Budget Balance
• 10.7.: Toward Authentic Tax Reform
• Epilogue

4.1.

The Conventional Wisdom

It will be useful to begin our discussion of commodity taxation with a brief review of the central elements of orthodox doctrine. This procedure will allow us to point up the contrasts between the standard normative results and those which emerge under the alternative constitutional perspective on taxation applied within a Leviathan or Leviathan-like model of political process. In commodity-tax analysis, as elsewhere in orthodox tax literature, the point of departure is some presumed requirement that government raise a fixed and exogenously determined amount of revenue. Given this fixed-revenue requirement, the question is: How should taxes be levied so as to minimize welfare loss? As noted earlier, the orthodox procedure is to attempt to answer this question independent of any consideration concerning the uses to which tax revenues may be put. This analytical weakness aside, the traditional argument has concentrated on the efficiency aspects of differing commodity-tax arrangements. Equity and/or distributional implications have been less emphasized in commodity-tax analysis than in income-tax analysis. The issue of the normatively desired form of commodity taxation has been treated largely as a problem of minimizing excess burden, with some consideration of horizontal equity (i.e., of avoiding discrimination among individuals on the basis of tastes or other “irrelevancies”). Vertical equity issues have tended to be effectively ignored. The literature has noted the equivalence between a uniform tax on all commodities and a personal tax on consumption expenditure with a proportional rate structure;1 nonetheless, within the indirect tax analysis, as such, the concentration has remained on the efficiency properties of alternative tax arrangements.

Basically, the application of the same normative framework to both commodity and income taxes tends to generate policy recommendations of the same type and direction. Personal taxes should allegedly be broadly based so that there is no (or minimal) discrimination among individuals on the basis of how income is earned; similarly, commodity taxes should allegedly also be broadly based—and ideally should tax all “goods,” including leisure, equally—so as to minimize discrimination among individuals on the basis of how income is spent. Likewise, just as failure to tax all income sources equally under direct taxation is adjudged to lead to efficiency losses as individuals attempt to substitute less productive but relatively lightly taxed activities for those more highly taxed, so failure to tax all goods equally under commodity taxation is taken to lead to efficiency losses on the consumption side.

In both cases, or so says the prevailing tax-analysis orthodoxy, lump-sum taxation represents the idealized benchmark. Given the infeasibility or even the impossibility of lump-sum taxation, the practical question necessarily becomes one of selection among second-best options. Whereas with personal taxes the “second-best” arrangement is normally assumed to be the broadest-based income tax (or consumption-expenditure tax) that is feasible, with indirect taxes the possibility of using differential rates on goods according to their degree of complementarity with leisure (relatively high rates on leisure complements, and lower rates on goods relatively highly substitutable with leisure) naturally presents itself. As emphasized by Corlett and Hague, Harberger, Lerner, Baumol, and Bradford and in much of the “optimal-taxation” literature in general,2 a set of differential excises can be devised that involves a smaller welfare loss or “excess burden” than does an equi-revenue tax falling equally on all the directly taxable commodities (i.e., excluding leisure).3 It is always more efficient to raise a given amount of revenue by means of a set of taxes in which the tax rate applied to each good is appropriately related to the degree of substitutability between that good and the untaxed good, leisure, than by an equal rate on all taxed goods.4

[1. ] Or an intertemporally neutral “income tax” of the type recommended by J. S. Mill, Principles of Political Economy (London: Longmans, Green, 1926); Irving Fisher and Herbert W. Fisher, Constructive Income Taxation (New York: Harper & Brothers, 1942); W. D. Andrews, “A Consumption Type or Cash Flow Personal Income Tax,” Harvard Law Review, 87 (April 1974), 1113-88; and most recently by James E. Meade, The Structure and Reform of Direct Taxation, report of a committee chaired by J. E. Meade (London: George Allen & Unwin, 1978).

[2. ] See W. Corlett and D. Hague, “Complementarity and the Excess Burden of Taxation,” Review of Economic Studies, 21 (1953-54), 21-30; Arnold Harberger, “Taxation, Resource Allocation and Welfare,” in National Bureau of Economic Research/Brookings Institution, The Role of Direct and Indirect Taxes in the Federal Revenue System (Princeton: Princeton University Press, 1963), pp. 25-70; Abba Lerner, “On Optimal Taxes with an Untaxable Sector,” American Economic Review, 60 (June 1970), 284-96; and W. J. Baumol and D. F. Bradford, “Optimal Departures from Marginal Cost Pricing,” American Economic Review, 60 (June 1970), 265-83.

[3. ] There is, of course, an exactly analogous horizontal equity argument applicable in all cases except where tastes are identical. See Geoffrey Brennan, “Second-Best Aspects of Horizontal Equity Questions,” Public Finance/Finances Publiques, 27, no. 3 (1972), 282-91. Of course, the precise policy implications for horizontal equity will in general differ from those for efficiency (unless all individuals have homothetic preferences) because goods that may be complementary with leisure at the margin will not be complementary with leisure over the entire range.

[4. ] On the other hand, an arbitrary set of excises is worse in an expected sense than a uniform tax on all goods (excluding leisure). Thus, if the complement-substitute relations are not known, uniformity of rates is to be preferred. See Y. K. Ng, “Towards a Theory of Third Best,” Public Finance/Finances Publiques, 32, no. 1 (1977), 1-15; and G. Brennan and T. G. McGuire, “Optimal Tax Policy under Uncertainty,” Journal of Public Economics, 4 (February 1975), 205-9.