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

6.8.

Inflation and Income Tax Revenue

Throughout this chapter, we have focused on the direct effects of money creation as a revenue device in its own right. We have ignored the possible indirect effects of inflation on revenue arising from its intersection with income taxation, a topic that is probably more familiar to mainstream public-finance specialists than those we have dealt with here. These indirect effects are of two types. The first and most obvious is that inflation, in the absence of any countervailing measures, increases real rates of progressive income taxation by pushing taxpayers into higher tax brackets.

To the extent that these apparently gratuitous effects of inflation are less conspicuous than explicit tax-rate increases, it follows that inflation presents government with a discreet and unobtrusive means of raising additional revenue. Such a possibility hardly fits neatly into our analytic framework. We have not introduced “fiscal illusion” at any other point: the entire discussion so far has proceeded in the bright glare of full taxpayer rationality. Leviathan is unashamedly exploitative, and taxpayers are completely aware of this. The revenue-maximizing rates for a given degree of progression will be arrived at, and beyond some point at least, increases in those rates can only reduce revenue. Discussion of this problem properly belongs to an analysis of fiscal illusion, and we have not included any such analysis in this book for obvious reasons of economy.16

The second aspect of the interaction between inflation and income taxation does not depend on progression at all, but rather on the extent to which income taxation, by virtue of taxing property income as well as labor income, involves an element of wealth taxation. As mentioned in Chapter 5, the extent of this tax on wealth can be increased by increasing the rate of inflation, given that nominal property returns are taxed. For example, if the rate of inflation is 9 percent and the real rate of return 3 percent, a nominal income tax rate of 25 percent becomes equivalent to an effective rate of 100 percent on property income. By setting the rate of inflation at the required level, it becomes possible for a single income tax to obtain maximum revenue both from labor income and from wealth without any overt discrimination, even though the demand elasticities between leisure and effort on the one hand, and between present and future consumption on the other, are quite different. This possibility would not of course be present if the “income tax” were levied solely on consumption expenditure.

[16. ] For a more lengthy treatment of this topic by one of the authors, see James M. Buchanan, Public Finance in Democratic Process (Chapel Hill: University of North Carolina Press, 1967), chap. 10.