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

6.1.

The Power to Create Money

Despite the widespread reference to inflation as a means of raising revenue, inflation is not the only aspect of government’s power to create money that has revenue significance. Even under a zero-inflation regime, the granting to government of a monopoly franchise in the creation of fiat money is worth something because this franchise carries with it the power to create at essentially zero cost an asset upon which individuals place economic value. In what follows, we offer a brief discussion of the nature of money in some very simple settings in order to establish elementary propositions about the revenue significance of the money-creation monopoly. This discussion also serves to set the analytic stage for the ensuing, and more detailed, discussion of inflation as a tax. Initially, however, we abstract from inflation entirely. We also abstract from the host of questions that have occupied the attention of monetary theorists relating to the issue of how money might emerge in a barter economy. We simply assume, for the purposes of our argument, that the government is to be assigned its monopoly franchise in money creation ab initio. We shall restrict the analysis to an economy that is stationary; there is no growth and the basic parameters (wants, resources, technology) are assumed to be unchanging through time. The basic analysis could, of course, be readily extended to allow for economic growth and, hence, for increasing demands for money. For simplicity and economy in exposition, we shall forgo this extension here. As elsewhere in our book to this point, we assume the economy to be closed. In this setting, the government can, if authorized to create money, ignore any constraints that are imposed on its behavior by the presence of competing monies.1

We consider initially a simple two-period model. In period 1, a set of transactions among individuals occurs in which a set of buyers, B, exchange cash for a set of goods initially in the possession of a group of sellers, S. In period 2, these sellers, S, must be able to exchange that cash for goods which they value, since the cash has no intrinsic value. If this were not so, the sellers would not accept cash for goods in period 1. The creation of money then requires that in the second period the money-creating authority must be in a position to replace cash with goods or their equivalent.2 If the money-creating authority is the government, how can this be done? There are two means:

• 1. The government can return to individuals the resources it acquired from them in return for cash at the beginning of period 1. Those individuals would have forgone interest on their money stocks in return for the transaction services of money. Government would have obtained an interest-free loan of an amount of assets equal to the money stock—which is worth r · M, where r is the rate of interest and M is the real value of the money stock.3
• 2. The government can permit the cash to be “paid” in lieu of taxes. In this case, the government forgoes (part of) the real goods and services that it would otherwise have obtained in period 2, because it accepts cash in lieu of those real tax resources in that period.

It seems clear, from either perspective, that money is rather like a form of debt. Money creation permits the government to reallocate the fruits of its taxing power intertemporally: government can by virtue of its money-creation (and taxing) powers shift the period 2 tax revenues to period 1. In addition, however, because it needs to pay no interest on its implicit loan, government obtains from its power to create money the equivalent of the interest on the money stock. Government could invest the resources it obtains in return for cash in period 1, and “repay” an amount equal to the same absolute value of those resources in period 2, keeping the interest.

The power to create money therefore assigns to government the market value of the transactions services of money for revenue purposes. In this simple model, that power is contingent on the government’s preparedness to accept money as payment of tax liabilities, or equivalently on government’s preparedness not to use up the resource base that money creation initially provides. Here and throughout the subsequent discussion, we neglect the deposit banking: government fiat issue is the only money.

Let us now extend this model by removing the simplifying assumption of two periods. In the case with infinite time horizons, the value of the money stock to government is the present value of the infinite stream of transactions services it provides to citizens. In other words, the value to government of a perpetual interest-free debt is equal to the principal—the real value of the money stock itself, in this case. If government obtains r · M per period forever, the capitalized value of this is 1/r · rM, or M.

It is quite clear therefore that, even in the absence of inflation, the power to create money is of revenue significance. The question we must ask here, however, relates to whether a Leviathan government could be expected to be content with the zero-inflation regime. What pattern of inflation (or deflation) might we predict Leviathan to choose? And what is the significance of this for the assignment of an unconstrained money-creation authority to government?

In order to answer these questions, we need to focus on inflation per se. In our discussion, we aim to do several things. First, we seek to establish the connection between inflation and the tax on money balances. Second, on the basis of this connection, we shall be able to reiterate the main conclusions of Chapter 5 concerning wealth taxes in specific application to inflation.

[1. ] It is evident that any “opening” of the economy tends to place limits on the power of government to create money, quite apart from constitutionally imposed constraints. The revenue-maximizing rate of inflation could be expected to be lower in the presence of competing monies, simply because domestic monopoly power is reduced. See F. A. Hayek, The Denationalization of Money: An Analysis of the Theory and Practice of Concurrent Currencies (London: Institute of Economic Affairs, 1976).

[2. ] For a discussion of the necessity of repurchase or its equivalent in a wholly different analytical context, see Boris P. Pesek and Thomas R. Saving, Money, Wealth and Economic Theory (London: Macmillan, 1967).

[3. ] It would also be possible to imagine a situation in which government printed only “period 1 monies”—that is, money that explicitly is legal tender only for a specified period. The capital value of such a money stock would presumably be the value of the transaction services it provides over the period of its legality. In the case of the example cited here, this period 1 value would presumably be rM. There are some interesting aspects to a regime of annual monies, not the least of which is that it seems to deprive government of any possible benefits from inflation. However, money as we know it is a durable asset—a stock, not an annual flow of transactions services—and all our discussion here is predicated on that fact.