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

7.5.

Toward a Tax Policy

The analysis of this chapter indirectly supplies an efficiency argument for a particular form of behaviorally induced earmarking. There need be no constraint that explicitly directs government to use tax revenues for specific spending functions. Instead, the nature of the tax bases, in themselves, ensures that government will be induced to utilize revenues for the spending desired. The normative implication is that each activity of government, each budgetary component, should have assigned to it a specified tax instrument, or set of instruments, designed not merely to ensure a level of revenue adequate to and appropriate for a predicted desirable level of the activity, but more particularly to introduce complementarity between the tax base and the governmental activity. We have already referred to the most obvious real-world example: the financing of roads from gasoline and/or automobile taxes. Government broadcasting financed by taxes on receivers offers another. When possible, the argument suggests that fees and tolls should be used in the governmental sale of partitionable services, perhaps even at the cost of some underutilization of facilities; it is unlikely that there could be tax bases for a good more complementary than the good itself.

Less conspicuous examples are worth mentioning. Earl Thompson has argued for taxes on capital to finance defense on the grounds that capital accumulation leads to the threat of external aggression.7 A similar argument might be made as concerns internal law and order. Thompson’s argument is that there will be excessive accumulation of coveted capital in the absence of capital taxation. One implication is that capital and defense outlay are complementary. Leaving aside the major objections to capital taxes discussed in Chapter 5, our analysis could point toward a similar conclusion to Thompson’s, but for somewhat different reasons. A tax on new capital formation might be justified on the grounds that it would encourage outlay on defense against external aggressors and on internal provision of law and order.8

The analysis can also be employed normatively to identify perverse elements in observed fiscal arrangements, elements that tend to create incentive structures that oppose those which efficiency in revenue disposition would require. Once again, we can find a good example in transportation. Since 1974, a portion of the U.S. federal tax on gasoline (and indirectly on highway usage) has been allocated to the financing of urban mass transit systems (bus, rail, subway lines). In this case, the base of tax (highway usage) is a substitute rather than a complement for the public good (transit facility) that the government is supposed to provide. It is clearly in the direct interest of the urban-transit bureaucrats to reduce rather than to increase the supply of public good (to reduce the value of α) because in so doing they will be able to increase the amount of revenue available for disposition.

Our purpose in the discussion above was to suggest examples for possible application of our analysis. We have made no attempt to determine whether or not the norms suggested for tax policy can be extended to cover all components in the budgets of modern governments. And we have not examined the severe informational requirements necessary for rational choice in a genuine constitutional setting. However, the general institution of earmarked taxes is familiar. The conventional wisdom in normative public-finance theory has condemned earmarking essentially on the grounds that any restriction on revenue usage tends to reduce the flexibility of the budgetary decision maker who is charged with the responsibility of allocating total governmental outlay among activities. This normative argument against earmarked bases is conceived in a benevolent despot image of governmental process, one that envisages a centralized decision maker divorced from the citizenry but always motivated to act strictly in the interests of the latter, in the “public interest.” Such an image is not consistent either with models of democratic decision making or with models that allow some role for the self-interest of politicians and bureaucrats. Once the government is perceived in an institutional setting that bears any remote resemblance to reality, the role of earmarking as one means of securing more efficient fiscal outcomes must be reexamined.

An argument in support of earmarked taxes has been advanced in post-Wicksellian, public-choice theory,9 and it will be useful to compare this with that argument which emerges here. If decisions on public spending are assumed to be made democratically even at the postconstitutional level, there is a self-evident argument for requiring that benefits be tied directly to costs. Voters, or their representatives, are likely to choose outcomes more rationally, more efficiently, if they can compare costs and benefits for each separate activity rather than for a multicomponent budget. General-fund financing ensures that fiscal choices are made under almost maximal uncertainty.

Our analysis differs from the standard public-choice model in its basic assumption about postconstitutional political process. We explicitly drop the central assumption that budgetary spending and taxes are determined through an effectively democratic voting process in postconstitutional periods. The argument for the behaviorally induced earmarking that emerges is derived directly from the political model in which in-period fiscal decisions are made by revenue-maximizing politicians-bureaucrats who may have at least some power to secure a share of tax revenues as surplus for themselves. A constitutional utilization of the relations between tax bases and the provision of desired public goods becomes a means of exerting discipline on those who do make fiscal decisions. As such, it is not at all out of place in a democratic decision model, and it may be interpreted as reinforcing other arguments noted above. One plausible model of democracy involves attempts by rotating majority coalitions to maximize net fiscal transfers to their members at the expense of members of minorities. The disciplinary argument for earmarking applies equally well to this model as to the more cynical model of bureaucratic domination. All that is required is that the words “majority coalition” be substituted for the word “king” in the earlier parts of the chapter.

Our basic argument is indeed simple. Effectively designed earmarking may limit the extent to which government, any government, can exploit the taxpaying public; government may be given a positive incentive to provide the goods and services that taxpayers want. The decision makers, whoever these may be, can be kept “honest.”

8.

The Domain of Politics

Our concern in this book is with the fiscal constitution, with alternative means of constraining government’s power to tax and to spend. We are not directly concerned with nonfiscal constraints on governmental powers, whether these be constitutionally or otherwise imposed. Our analysis would, however, be seriously incomplete if we did not recognize the relationship between fiscal and nonfiscal constraints. The potential substitutability between fiscal and nonfiscal constraints keeps us from claiming that the former are in all circumstances absolutely essential for keeping governments within appropriate limits. Conversely, the complementarity between fiscal and nonfiscal constraints keeps us from extending to wild extremes the argument that fiscal limits alone will accomplish the purpose of constraining Leviathan.

The construction of this book can perhaps best be interpreted as being predicated on the assumption that an appropriate set of nonfiscal rules is operative, setting the context within which alternative fiscal constraints can be analyzed and evaluated. Broadly speaking, the nonfiscal constraints in existence are simply assumed to be those that we generally observe in modern Western democracies. Beyond this, however, our analysis requires the assumption that the imposition of specifically fiscal constraints will not itself generate successful “escape” from fiscal limits through nonfiscal channels. Although we shall make no attempt at exhaustive analysis here, this chapter is devoted to an examination of the interdependencies between those means of limiting Leviathan which involve restrictions on the taxing power and those which do not. In particular, we include in the latter category restrictions on the domain of government spending, as well as specific types of procedural restrictions on the nature of political process.

[7. ] Earl Thompson, “Taxation and National Defense,” Journal of Political Economy, 82 (July-August 1974), 755-82.

[8. ] In this general sense, it is clear that the analysis is related to the discussion and analysis of the capitalization of public-goods benefits and taxes into land values, especially in the context of a set of local governments among which persons may move.

[9. ] See James M. Buchanan, “The Economics of Earmarked Taxes,” Journal of Political Economy, 71 (October 1963), 457-69. Also see James M. Buchanan, Public Finance in Democratic Process (Chapel Hill: University of North Carolina Press, 1967), especially chap. 6.