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

10.1.

Taxation in Constitutional Perspective

We stated above that tax reform deserves to be discussed constitutionally. To justify our argument, the differences between the nonconstitutional and the constitutional setting must be emphasized. What does it mean to say that taxes and tax reform are sometimes treated nonconstitutionally? In such a context, tax rules and institutions are considered to be subject to period-by-period changes; they are not treated as permanent or quasi-permanent features of the political structure. In the limiting case, the allocation of tax shares among individuals and groups in the economy and the choice of tax instruments that generate the imputations of such shares are considered “up for grabs” during each and every new budgetary period. In such a nonconstitutional setting, the prospective taxpayer is, of course, vulnerable to exploitation by government to the maximum limits of his taxpaying capacity. Under anything resembling our Leviathan assumptions about governmental processes, the prospective or potential taxpayer will clearly have some interest in imposing constitutional constraints on the taxing power in advance of the budgetary period, constraints that will act to bind the exercise of fiscal authority over the whole postconstitutional sequence.

Even if we relax the Leviathan assumptions, however, and allow for some genuine electoral in-period controls to be exercised by a majority coalition of taxpayers, the single individual must face the prospect that, within any given budgetary-fiscal period, he may find his tax obligations arbitrarily settled by the dominant political coalition which may act contrary to his own interests. Under almost any set of projections or predictions about governmental processes, even those that model politics as ideally benevolent in some respects, the individual would prefer that basic tax rules be considered to be constitutional. There is positive value in predictability. And, indeed, a constitutional interpretation of tax rules implicitly informs much of the tax practice in Western countries. Tax arrangements, once in being, tend to be relatively long-lived, and the adage that “an old tax is a good tax” is a part of a more general attitude toward tax practice even if it does not seem to have been recognized widely in the economic analysis.2

In a sense, our argument becomes a plea for a more explicit constitutional attitude toward tax reform. Tax rules should be considered, analyzed, and discussed as a set of quasi-permanent arrangements within which persons can anticipate making appropriate behavioral adjustments, including those that require a long planning horizon. As earlier analysis has indicated, one means of constraining Leviathan lies in the restriction of its ability to modify tax rules with such frequency that taxpayers must face continued uncertainty as to just what the rules will be period by period. If government can succeed in keeping taxpayers off balance in their planning, additional revenue potential may be available for exploitation, provided, of course, that the fiscal uncertainty itself is not pushed beyond revenue-maximizing limits.

The categorical distinction between tax rules as elements in the basic constitutional contract and tax rules as pawns in in-period conflicts over tax shares emerges only in a non-Leviathan context. If electoral politics is assigned the task of imputing or reimputing relative shares in total tax liability as among differing groups of taxpayers in each budgetary period, or even if such reimputation is treated as being available for consideration, the analytical model becomes that of a never-ending, negative-sum, n-person game. Continual manipulation of the basic tax-share distribution can be judged to be an undesired attribute of “tax reform,” even in the most “democratic” electoral-political process, even when political outcomes sensitively mirror the true demands of members of effective majority coalitions among voters and, hence, among taxpayers. In such a setting, “tax-reform” advocacy largely takes on the pattern of mutually offsetting attempts to shift tax shares among groups. Little or nothing is gained by any group in the process and, over a sequence of periods, all groups would reasonably expect to lose. In playing off groups against each other, the opportunities available to any revenue-seeking authority can be effectively exploited.

It is essentially in the context of a presumed “democratic” model of politics that F. A. Hayek has advanced two distinct proposals for fiscal reform worthy of brief discussion here. In his treatise, The Constitution of Liberty,3 Hayek strongly argued against progressivity in rate structures of income taxation. His argument for proportionality in rates was related directly to his more general argument for the “rule of law.” Proportional taxation was classified as falling within his normative requirement that all rules or laws be general in the sense that all persons in the community be equally subjected to their impact and effect. By contrast, progression in tax rates was held to violate this basic precept of generality.

As our earlier analysis in this book has indicated, a requirement for tax-rate proportionality may not seriously constrain a governmental Leviathan bent on maximizing surplus, either because the decision makers are effectively isolated from the taxpaying citizenry or because the public-spending structure can be manipulated to achieve any result desired. If, however, we shift out of the extreme Leviathan model, as we move toward more “realism” with models that contain Leviathan-like elements but which also require that decision makers (politicians and bureaucrats) remain as members of the taxpaying citizenry and which, further, restrict the range for overt transfers, the proportionality restriction might well serve to constrain discrimination among different groups of taxpayers. One effect would surely be to reduce, or even substantially to eliminate, the debate-conflict over relative tax shares (over the “degree of progressivity”) that characterizes much modern discussion of alleged “tax reform.”

In his more recent work, Law, Legislation and Liberty, vol. 3,4 Hayek proposes a different, and more structural, reform of political process that relates directly to the taxing power. He proposes that the structure of taxation, the distribution of relative tax shares among persons and groups, be chosen in the deliberations of a new and differently elected and differently organized assembly, an upper house, whose sole function is limited to the enactment of general laws or rules, which would presumably, once enacted, remain in force over long periods of time. Hayek’s “general laws” seem equivalent to what we should here call “constitutional rules.” He would then allow the other assembly, the ordinary legislature or parliament, to choose levels of taxation and, of course, levels of outlay along with the allocation among uses.5 As with his earlier proposal for tax proportionality, the structural reform suggested by Hayek is designed primarily to reduce or to eliminate the in-period political squabbles over the distribution of relative tax shares. In a sense, both of Hayek’s proposals have as their objective some insurance that tax rules be treated constitutionally rather than nonconstitutionally.

[2. ] For a specific discussion of this adage, see James M. Buchanan, Public Finance in Democratic Process (Chapel Hill: University of North Carolina Press, 1967), chap. 5.

[3. ] F. A. Hayek, The Constitution of Liberty (Chicago: University of Chicago Press, 1960).

[4. ] F. A. Hayek, Law, Legislation and Liberty, vol. 3, The Political Order of a Free People (Chicago: University of Chicago Press).

[5. ] We should note that the political structure that Hayek is implicitly suggesting be modified is one of parliamentary government, akin to the British structure. His suggestions for change fit less readily into the U.S. context.