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

5.4

Leviathan’s Time Preference

One interesting question that arises out of the tax comparisons summarized in Table 5.1 concerns the extent to which Leviathan’s revenue-collecting strategy may depend on the timing of tax receipts, as well as on the maximum revenue in present-value terms. Initially, we restrict our attention to the two-period model with the perfect taxpayer foresight previously employed. In such a setting, the Leviathan fiscal authority will always choose that tax arrangement which maximizes the present value of its tax receipts provided it is not constrained in its ability to lend, and if it is assumed it can do so at the market rate of return.

The “best” arrangement for a revenue-maximizing Leviathan is that in which it has access to both the income tax and the capital levy. It would, of course, impose both at the maximum revenue rate, and it would obtain A′A in period 1 plus B′S′ in period 2. This is the arrangement that maximizes the present value of total revenue. Because of the presumed power to lend at will, Leviathan’s revenue-raising and consumption activities become completely separable. The present value of total revenue is maximized, and then by

lending at the market rate of interest, the resultant surplus7 is allocated intertemporally in accordance with Leviathan’s utility function. We may depict Leviathan’s consumption possibilities in Figure 5.4 by the line IK.8

The assumptions of our model, in which all labor income is earned in period 1, necessarily allocate the major portion of Leviathan’s consumption prospects in period 1 if no lending is attempted. (We shall examine the matter of borrowing in more detail below.) Here, we assume that Leviathan’s time preference indicates a desire to postpone some consumption to period 2. We need to ask the question concerning the effect of possible restrictions on Leviathan’s capacity to lend (invest) at market rates. Suppose, first, that Leviathan is not allowed to lend on the open market; government is not allowed to purchase income-earning assets. However, government might still retain a capacity to hoard; in this case, the consumption possibilities are reduced to IQ in Figure 5.4, where IQ has a slope of unity. In such a setting, will it be possible for Leviathan to allocate his desired consumption intertemporally more effectively by not maximizing present value of tax revenues? There seem to be two instruments which might facilitate this result. Leviathan may find it to his interest to reduce the rate of tax on income and to collect more revenue under the capital levy in period 2 as individuals save more in period 1. The second method would be to use the consumption-expenditure tax.

Consider the first of these possible adjustments. As the rate of tax on labor income is reduced, individuals will save more; this ensures that the maximum revenue capital levy will collect more. Revenue is forgone in period 1, but more revenue is collected in period 2. Whether or not Leviathan will find it advantageous to make this shift depends critically on the rate of trade-off faced. As the tax rate is reduced on first-period income, however, only some share of the extra dividend will be saved by taxpayers. Under normal conditions, the rate of return on the extra savings, along with the initial capital, could not produce a period 2 capital levy prospect for Leviathan that would exceed that which he could have available by the desired share of first-period collections simply hoarded for second-period use. In the geometry of Figure 5.4, the prospects for Leviathan that might be generated by forgoing income-tax revenue in period 1 and substituting capital-tax revenue in period 2 are shown by IN″, which lies entirely within IQ, the latter being the opportunities under hoarding.

Let us now consider the possible intertemporal trade-off that is offered by the consumption-expenditure tax. As the summary Table 5.1 indicates, Leviathan would never rely on this revenue-raising instrument if the objective is to maximize present value of revenue over a time sequence. However, if intertemporal adjustment in revenue use is restricted, and, specifically, if hoarding but not lending is possible, resort to less-than-optimal fiscal instruments may be considered. Since the tax on consumption expenditure wholly eliminates saving from tax, individuals would be predicted to shift more of their own consumption to period 2. In so doing, of course, they carry over, at the same time, more revenue potential for exploitation by Leviathan. If the additional saving generated by a shift to consumption taxation should be relatively great, such a prospect may be effective for a Leviathan whose utility function is weighted toward period 2 use of revenues. Under normal circumstances, however, in this as in the income-tax case, Leviathan, if given the opportunity to hoard revenues once collected, will still find it advantageous to arrange tax structures so as to maximize the present value of revenues independently of Leviathan’s own time preference.9

We may impose yet more restrictive conditions on Leviathan’s intertemporal adjustment opportunities. If government is denied the power to hoard as well as to invest at some positive return, resort to non-present-value maximization would seem more likely to be desirable. This situation is not nearly as bizarre as it might seem at first glance. In particular, many lower-level agencies and bureaus operate on a no-carryover basis. Funds made available to such units can be neither invested nor hoarded. If the Leviathan model is interpreted, not as some centralized decision-making monolith, but instead as a useful “as if” model for the very complex set of interdependent arrangements that describe modern governments, the no investment-no hoarding model becomes much more plausible.

In this setting, where neither the investing nor the hoarding of revenue collections is possible, Leviathan must, of course, use revenues gathered in each period. From this perspective, access to both the income tax and the capital levy will clearly dominate reliance on either of these taxes on its own. The relevant alternative for Leviathan’s consideration would be a tax on consumption expenditure. Would such a tax prove more desirable than some combination of the income tax and the capital levy? By comparison with the income tax, the consumption tax will encourage the taxpayer to save more in period 1, and to plan on consuming more in period 2. If Leviathan’s intertemporal preferences, along with the taxpayer’s consumption-saving behavior, fall within specific configurations, it is possible that the consumption tax will be utilized, even when the income-tax-capital-levy combination is available. Under most plausible circumstances, this sort of fiscal arrangement on the part of Leviathan is not likely to emerge. And, of course, any such possible departure from present-value maximization of revenues depends critically on an assumption that neither investment nor hoarding is possible.

The possible departures from present-value maximization on the part of Leviathan that we have examined in preceding paragraphs are made to seem more important than they are by the simplified two-period model we have introduced. In a more general model, of course, some taxpayers will be earning income from labor in every period. Once this point is recognized, it seems almost impossible to construct a scenario that would suggest that Leviathan’s interest would dictate departure from those tax arrangements that are predicted to maximize the present value of revenues at each point in time.

Questions such as those discussed in this section arise only if we remain in the perpetual or continuing Leviathan model. If we consider the behavior of the revenue-maximizing government that only occasionally emerges and remains in power for only a single period, rational behavior will, of course, dictate maximum revenue extraction within that period.

[7. ] Surplus is a proportion (1 - α) of (maximum) revenue, where a is the proportion of revenues collected that must be spent on public goods.

[8. ] Both axes reflect maximum revenue in each period scaled down by the factor 1 - α.

[9. ] Under the consumption-tax arrangement, the locus of potential equilibria in Figure 5.2 is A′B′, so that the locus of potential revenue receipts is AB minus A′B′, or A′B′ (since the maximum revenue consumption rate is 50 percent). Thus, the consumption-tax revenue combination lies somewhere along the line AV in Figure 5.4, and this will lie inside IQ, unless the maximum revenue under the capital tax (B′S′ in Figure 5.3) is less than interest on A′A, depicted as QK in Figure 5.4. It is conceivable that B′Q in Figure 5.2 exceeds B′S′ in Figure 5.3, but it is not by any means necessary and indeed seems somewhat unlikely. We have drawn it this way in Figure 5.3. In any case, it is clear that for this to be a utility-maximizing possibility for Leviathan, the taxpayer must save a great deal, so that the superior efficiency of the individual as a saver offsets the revenue loss due to the removal of the income-capital tax combination.