The Online Library of Liberty

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• 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

5.1.

Income Taxes, Capital Taxes, and Public Debt in Orthodox Public Finance

In the traditional public-finance literature, it has long been recognized that a tax on the income from an asset is equivalent to a tax on the asset’s capital value. A tax of one type can readily be converted into its equivalent as a tax of the other type. A tax of 1 percent levied on the capital value of an asset yielding 10 percent per annum is equivalent to a tax on current income from the asset of 10 percent. And as Ricardo argued, essentially the same “equivalence” logic can be applied to show that the public debt issue is identical with either of the two taxes: a specific public debt liability, implying future tax commitments to service and redeem the debt, can be converted into its equivalent as a current tax on either capital or income.1

Our initial concern here is not, however, with the “equivalence” logic.2 For the purposes of this discussion, we can assume that the taxpayer is subjectively indifferent among the various alternatives on an equivalent net liability basis. But indifference among equi-revenue present-value liabilities at a specified point in time does not imply indifference on the part of a potential taxpayer as among the several fiscal arrangements at some constitutional level. In constitutional perspective, the present values of the liabilities under the several instruments are not specified, and the tax-fiscal arrangements may vary enormously in their revenue potential and significance. Crucial for the citizen’s constitutional choice are not his own predicted attitudes toward equivalent liability instruments within a single period, but rather the different possible governmental responses that emerge under access to the various revenue-raising instruments, and in particular with respect to capital taxes and debt. The distinction between the normative implications of the orthodox public-finance analysis and our own approach is critical at this point, and further discussion seems warranted. Public-finance orthodoxy includes the demonstration or proof that, within the assumptions of a rational behavior model, a tax on an income flow is equivalent to a tax on the value of the capital asset yielding the income flow. Further, by an extension of the same logic, especially if the distribution of net liabilities can be assumed away, a somewhat more extreme model of rational behavior allows for a demonstration that the tax on income or capital is also equivalent to an issue of public debt. In a single postconstitutional period, the individual taxpayer “should be,” therefore, indifferent among these fiscal instruments, provided only that the rates are adjusted so as to make his net liability identical under each instrument. Given this indifference, which emerges from a postulate of rational behavior on the part of the taxpayer, the alternative fiscal instruments produce identical behavioral responses. The implication is that, on the economist’s criterion of efficiency, the three alternatives are perfect substitutes.

We should not, however, lose sight of the implicit assumptions that underlie this familiar logic. The revenue requirements of government are presumed to be settled somehow independently of the taxing process. Here, as elsewhere, the orthodox analysis implicitly commences with: “Given any revenue requirement.” Such an approach totally neglects the possible feedback effects that fiscal institutions may exert on the setting of revenue requirements in the first place. And, of course, these feedback effects become central to our whole constitutional analysis. The difference here does not depend on the Leviathan model of government at all. Whether we model government as a continuing Leviathan, as a probabilistic Leviathan, or as a median-voter-dominated majoritarian democracy, differing fiscal or revenue-raising instruments may exert differing effects on the amounts of revenue that governments will seek to raise. Once these effects are recognized, the equi-revenue or equi-liability setting for the orthodox analysis simply becomes irrelevant in any genuine choice among fiscal arrangements at the constitutional level.

In this chapter, we shall retain—except where otherwise stated—the central ingredients of the Leviathan model as outlined in preceding chapters. That is, we assume that government will seek to maximize revenue, but is constrained—by virtue of other elements in the fiscal constitution—to spend some proportion of that revenue on public goods genuinely desired by the citizenry. Purely electoral constraints are, however, taken to be ineffective.

[1. ] It can, of course, be argued that the full discounting of future tax liabilities that is required for full Ricardian equivalence is psychologically and empirically unrealistic, and hence that policy analysis should not be based on it. See James M. Buchanan, “Barro on the Ricardian Equivalence Theorem,” Journal of Political Economy, 83 (April 1976), 337-42.

[2. ] For our criticism of this basic theorem, see Geoffrey Brennan and James M. Buchanan, “The Logic of the Ricardian Equivalence Theorem,” Finanzarchiv, Heft 38/1 (1980), 4-16.