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

8.4.

Government by Coercion

To this point, we have examined nonfiscal constraints that might serve as possible substitutes for fiscal constraints on the activities of government. We have been interested in determining the extent to which the presence or potential introduction of such nonfiscal limits might reduce the need for any imposition of constitutional controls over the power to tax. A wholly different set of interdependencies emerges when we look at nonfiscal constraints as necessary complements to the fiscal controls. Here the issues to be analyzed concern the potential effectiveness of overtly fiscal constraints in view of their critical dependence on the maintenance and enforceability of nonfiscal instruments that will serve to prevent the former from being successfully avoided by government with Leviathan proclivities.

If we remain strictly within the revenue-seeking model of government, the problems to be discussed here do not formally arise since, by our somewhat artificial assumption, the single maximand is tax revenues. Hence, any constraint on the power or authority to tax must be effective by definition. Once we depart from this artificial construction, however, to grant that Leviathan’s instrumental desire for tax revenues is for the purpose of ultimately acquiring command over real goods and services, the possible avoidance of any explicit tax limit or constraint must be reckoned with. If, when confronted with a legal limit on its taxing power, government should find it relatively easy to secure real goods and services by nontax means, there would be little purpose in the whole tax-limit exercise.

As we have noted, there exist legal-constitutional restrictions on the government’s power to take, and, indeed, without some such restrictions there would presumably be no raison d’être for the institution of taxation itself. The government could, in the absence of legal constraints on the taking of power, simply coerce persons into relinquishing possession of the goods and services it wants. In the established legal traditions of Western nations, governmental coercion of this variety has been and continues to be considered beyond the legitimate exercise of state authority. Certain exceptions prove the rule—conscription for military services and eminent domain are two. In the latter case in particular, governmental taking is accompanied by the legal requirement for “just compensation,” which becomes a part of the more general legal requirement for “due process.”

The existence of legal limits to the taking power does not, of course, guarantee against an extension of such power. And it must be acknowledged that any imposition of constraining tax limits on government will create additional incentives for the direct “taking” of goods and services from persons, independently of the fiscal channel that involves first, taxation, and subsequently, governmental purchase of such goods and services in the marketplace. If tax limits are expected to be effective at all, legal restrictions on governmental taking power must be maintained in the face of increased incentives.

If the agents of Leviathan, the rulers, seek to use the fiscal system or the taking power for the purpose of acquiring command over goods and services for their own direct consumption or use (over and above that share which they might legally be required to return to members of the community as public-goods benefits), the potential dangers embodied in dramatic extensions of the taking power may not loom as significant. Established legal traditions are important, and overt coercion on the part of governmental agents could presumably be held within reasonably narrow limits, despite enhanced incentives offered to such agents. But a much more severe, and possibly intractable, problem arises when we allow the agents of Leviathan to incorporate what we may call “nonpersonal” arguments in their utility functions, when we allow these agents to promote or to seek to further a set of “[jectives” that can be plausibly “legitimized” on what may be called “public interest” or “general welfare” grounds. In such a setting, tax limits per se may be ineffective in containing government. This seems to be a fact that must be squarely faced.

Consider a familiar example. Prior to the mid-1960s, individual citizens in the United States were, for the most part, unconstrained in their access to and their usage of the air- and waterways except to the extent that limits were inherent in the laws of nuisance as carried down from the English Common Law. In a reconstructed scenario different from the one actually followed, the government could have, in recognition of the pollution-environmental problems, declared “clean air” and “clean water” to be “public goods.” It could have then levied taxes for the financing of such “goods,” which in this case would have involved the purchase of individuals’ agreements to reduce polluting activities. As we know, such a scenario was not followed; government did not utilize the fiscal route to the accomplishment of its avowed and newly found environmental objective. Instead, the government simply enacted laws that embodied direct prohibitions on specific types of activity, or in lieu of this, enacted laws that authorized administration agents (bureaucrats) to define the scope of prohibited activities. Individuals were simply prevented from being allowed to do things that had previously been available to them. In a real sense, government used the taking power; it took valued rights from persons, and without questions of due process being raised, and without compensation. The alleged “public good” was secured without resort to taxing and spending.

It seems evident that the presence or the absence of tax limits would have had, and could have, relatively little effect on extensions of governmental activity of the sort exemplified in the wave of environmental regulation of the late 1960s and the 1970s in the United States—air and water pollution, automotive and occupational safety, and consumer protection. Indeed, it may be persuasively argued that the interferences with personal freedoms reflected in regulatory laws of this nature present more serious issues than the more indirect extensions of governmental power by means of the fiscal process and reflected in explicit taxation.4

There are, of course, relationships between the extension of direct governmental regulation and the size of the budget. Regulatory action implies regulatory agency, and agency in turn implies a regulatory bureaucracy, which, in its own turn, implies bureaucrats who work for money rather than peanuts. And as they impinge on agency budgets, tax limits can have a constraining influence. As the pollution control examples reveal, however, differing means of accomplishing differing governmental objectives have widely differing budgetary implications. The environmental regulatory bureaucracy requires financing, and from tax revenues, but the fact that it is empowered to regulate directly rather than through the fiscal process of spending on compliance very substantially reduces the bureaucracy’s demands on the government treasury. It is relatively easy to envisage a federal budget making up no more than 20 percent of GNP that would reflect more interference with personal liberties than an alternative budget of 40 percent of GNP, but with substantially less direct regulation.

As economists here, we might call upon ceteris paribus and suggest that, under a given legal environment concerning direct regulatory action by government, the imposition of fiscal constraints must remain potentially effective. The government that commands 20 percent of GNP is less intrusive in the economy than the government that commands 50 percent, provided that the legal setting for direct regulation in the two cases is at all comparable. But this sort of argument would ignore the very real feedback that exists between the government’s proclivity to regulate directly and to tax. A government subjected to tax-limit pressures will surely be predicted to exert more efforts through the legal process toward opening up direct regulatory channels.

There is little that we can do here other than to acknowledge the “limits of tax limits” in this respect. Tax limits, or fiscal constraints generally, can be expected to curb government’s appetites to the extent that the utility function of governmental decision makers contains arguments for privately enjoyable “creature comforts,” for final end items of consumption. Such constraints become much less effective, and may well be evaded, if the motive force behind governmental action is “do-goodism.” The licentious sinners we can control; the saintly ascetics may destroy us.

Acknowledging the limits of tax limits amounts to saying that there are other elements of the political-legal constitution that warrant attention, over and beyond those that we analyze in this book. In particular, we should note that some of the procedural constraints discussed earlier in this chapter can serve to constrain direct regulatory behavior as well as the taxing power. As such, these procedural constraints are more general in their impact since they modify the decision-making structure itself. If such more general procedural changes are not within the realm of the possible, fiscal constraints will require the accompaniment of legal limits on the exercise of direct regulation. The argument for the imposition of fiscal limits, derived from the choice calculus of the individual who places himself behind the veil of ignorance at some constitutional stage of decision, takes on meaning only to the extent that it lends support, at the same time, to the companion imposition, or enforcement, of severe restrictions on the range of direct regulation.

9.

Open Economy, Federalism, and Taxing Authority

Implicit in all of the analyses of earlier chapters has been the assumption that the polity and the economy are perfect mappings of each other with respect to geography, membership, and the extent of trade and resource allocation. That is, we have assumed the economy to be closed: neither trade nor migration extends the economy beyond the boundaries of the political unit. Consequently, all fiscal activities are carried out exclusively within the polity.

In this chapter we propose to relax the closed-economy-closed-polity assumption. We shall do so in two stages, the first of which contains two parts. In Section 9.1, we allow the economy to be open to trade; hence, citizens may buy and sell goods from citizens of other polities-economies. In that section, however, we continue to assume that migration across governmental boundaries does not occur. The model is the relatively familiar one of a small, independent, national state whose citizens trade in an international market but who remain resident within the small state. In Section 9.2, this model is modified to allow for interunit migration. The analysis of this section provides a bridge between the first and second stages of the analysis of this chapter. In the remaining sections, we examine the prospect of deliberate constitutional partitioning of the political power (and hence of the taxing power) within the confines of a larger and more inclusive political jurisdiction, within which internal trade and migration are unrestricted. Federalism is a means of constraining Leviathan constitutionally; hence, it becomes a topic of some importance in the framework of our analysis.

[4. ] The phenomena discussed here need not be restricted to “environmental regulation,” even if this rubric is broadly and inclusively defined. All that is required is that, at some stage of the legitimization argument, appropriate reference is made to “public interest” sufficient to surmount minimal legal standards of acceptance. In his important paper “Taxation by Regulation,” Bell Journal of Economics and Management Science, 2 (Spring 1971), 22-50, Richard A. Posner stressed the internal subsidization aspects of such things as the regulation of rail passenger service, local airline service, and natural gas pricing.