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October 21, 2011

Mises
Daily

In
Praise of the Capitalist 1
Percent

by George
Reisman

America's
Unique Fascism
by Anthony
Gregory

The
Value of Labor
by Richard
Cantillon

The
Consumption Tax: A Critique
by
Murray N. Rothbard on October 21, 2005

[This article serves as a complete response to
Alan
Greenspan's call for a consumption tax. It
originally appeared in the "Review of Austrian
Economics," 1994, Volume 7, No. 2, pp.
75–90.]

The Alleged Superiority of the Income Tax

Orthodox neoclassical economics has long
maintained that, from the point of view of the
taxed themselves, an income tax is "better than"
an excise tax on a particular form of consumption,
since, in addition to the total revenue extracted,
which is assumed to be the same in both cases, the
excise tax weights the levy heavily against a
particular consumer good. In addition to the total
amount levied, therefore, an excise tax skews and
distorts spending and resources away from the
consumers' preferred consumption patterns.
Indifference curves are trotted out with a
flourish to lend the scientific patina of geometry
to this demonstration.

As in many other cases when economists rush to
judge various courses of action as "good,"
"superior," or "optimal," however, the ceteris
paribus assumptions underlying such judgments — in
this case, for example, that total revenue remains
the same — do not always hold up in real life.
Thus, it is certainly possible, for political or
other reasons, that one particular form of tax is
not likely to result in the same total
revenue as another. The nature of a particular tax
might lead to less or more revenue than another
tax. Suppose, for example, that all present taxes
are abolished and that the same total is to be
raised from a new capitation, or head, tax, which
requires that every inhabitant of the United
States pay an equal amount to the support of
federal, state, and local government. This would
mean that the existing total government revenue of
the United States, which we estimate at 1
trillion, 380 million dollars — and here exact
figures are not important — would have to be
divided between an approximate total of 243
million people. Which would mean that every man,
woman, and child in America would be required to
pay to government each and every year, $5,680.
Somehow, I don't believe that anything like this
large a sum could be collectible by the
authorities, no matter how many enforcement powers
are granted the IRS. A clear example where the
ceteris paribus assumption flagrantly breaks
down.

But a more important, if less dramatic, example
is nearer at hand. Before World War II, Internal
Revenue collected the full amount, in one lump
sum, from every taxpayer, on March 15 of each
year. (A month's extension was later granted to
the long-suffering taxpayers.) During World War
II, in order to permit an easier and far smoother
collection of the far higher tax rates for
financing the war effort, the federal government
instituted a plan conceived by the ubiquitous
Beardsley Ruml of R.H. Macy & Co., and
technically implemented by a bright young
economist at the Treasury Department, Milton
Friedman. This plan, as all of us know only
too well, coerced every employer into the unpaid
labor of withholding the tax each month from the
employee's paycheck and delivering it to the
Treasury. As a result, there was no longer a need
for the taxpayer to cough up the total amount in a
lump sum each year. We were assured by one and
all, at the time, that this new withholding
tax was strictly limited to the wartime
emergency, and would disappear at the arrival of
peace. The rest, alas, is history. But the point
is that no one can seriously maintain that an
income tax deprived of withholding power, could be
collected at its present high levels.

$22.00
$22.00

One reason, therefore, that an economist cannot
claim that the income tax, or any other tax, is
better from the point of view of the taxed person,
is that total revenue collected is often a
function of the type of tax imposed. And it would
seem that, from the point of view of the taxed
person, the less extracted from him the better.
Even indifference-curve analysis would have to
confirm that conclusion. If someone wishes to
claim that a taxed person is disappointed at how
little tax he is asked to pay, that
person is always free to make up the alleged
deficiency by making a voluntary gift to the
bewildered but happy taxing authorities.[1]

A second insuperable problem with an
economist's recommending any form of tax from the
alleged point of view of the taxee, is that the
taxpayer may well have particular subjective
evaluations of the form of tax, apart from the
total amount levied. Even if the total revenue
extracted from him is the same for tax A and tax
B, he may have very different subjective
evaluations of the two taxing processes. Let us
return, for example, to our case of the income as
compared to an excise tax. Income taxes are
collected in the course of a coercive and even
brutal examination of virtually every aspect of
every taxpayer's life by the all-seeing,
all-powerful Internal Revenue Service. Each
taxpayer, furthermore, is obliged by law to keep
accurate records of his income and deductions, and
then, painstakingly and truthfully, to fill out
and submit the very forms that will tend to
incriminate him into tax liability. An excise tax,
say on whiskey or on movie admissions, will
intrude directly on no one's life and income, but
only into the sales of the movie theater or liquor
store. I venture to judge that, in evaluating the
"superiority" or "inferiority" of different modes
of taxation, even the most determined imbiber or
moviegoer would cheerfully pay far higher prices
for whiskey or movies than neoclassical economists
contemplate, in order to avoid the long arm of the
IRS.[2]

The Forms of Consumption Tax

In recent years, the old idea of a consumption
tax in contrast to an income tax has been put
forward by many economists, particularly by
allegedly pro-free-market conservatives. Before
turning to a critique of the consumption tax as a
substitute for the income tax, it should be noted
that current proposals for a consumption tax would
deprive taxpayers of the psychic joy of
eradicating the IRS. For while the discussion is
often couched in either-or terms, the various
proposals really amount to adding a new
consumption tax on top of the current massive
armamentarium of taxing power. In short, seeing
that income tax levels may have reached their
political limits for the time being, our tax
consultants and theoreticians are suggesting a
shining new tax weapon for the government to
wield. Or, in the immortal words of that exemplary
economic czar and servant of absolutism,
Jean-Baptiste Colbert, the task of the taxing
authorities is to "so pluck the goose as to obtain
the largest amount of feathers with the least
amount of hissing." We the taxpayers, of course,
are the geese.

But let us put the best face on the
consumption-tax proposal, and deal with it as a
complete replacement of the income tax by a
consumption tax, with total revenue remaining the
same. Our first point is that one venerable form
of consumption tax not only retains existing IRS
despotism but makes it even worse. This is the
consumption tax first prominently proposed by
Irving Fisher.[3] The Fisher tax would retain the
IRS, as well as the requirement that everyone keep
detailed and faithful records and truthfully
estimate his own taxes. But it would add something
else. In addition to reporting one's
income and deductions, everyone would be required
to report his additions to or subtractions from
capital assets (including cash) over the year.
Then, everyone would pay the designated tax rate
on his income minus his addition to capital
assets, or net consumption. Or, contrarily, if he
spent more than he earned over the year, he would
pay a tax on his income plus his reduction of
capital assets, again equaling his net
consumption. Whatever the other merits or demerits
of the Fisherine tax, it would add to IRS
power over every individual, since the state of
his capital assets, including his stock of cash,
would now be examined with the same care as his
income.

A second proposed consumption tax, the VAT, or
value-added tax, imposes a curious hierarchical
tax on the "value added" by each firm and
business. Here, instead of every individual, every
business firm would be subjected to intense
bureaucratic scrutiny, for each firm would be
obliged to report its income and its expenditures,
paying a designated tax on the net income. This
would tend to distort the structure of business.
For one thing, there would be an incentive for
uneconomic vertical integration, since the fewer
the number of times a sale takes place, the fewer
the imposed taxes. Also, as has been happening in
European countries with experience of the VAT, a
flourishing industry may arise in issuing phony
vouchers, so that businesses can overinflate their
alleged expenditures, and reduce their reported
value added. Surely a sales tax, other things
being equal, is manifestly both simpler, less
distorting of resources, and enormously less
bureaucratic and despotic than the VAT. Indeed the
VAT seems to have no clear advantage over the
sales tax, except of course, if multiplying
bureaucracy and bureaucratic power is considered a
benefit.

The third type of consumption tax is the
familiar percentage tax on retail sales. Of the
various forms of consumption tax, the sales tax
surely has the great advantage, for most of us, of
eliminating the despotic power of the government
over the life of every individual, as in the
income tax, or over each business firm, as in the
VAT. It would not distort the production structure
as would the VAT, and it would not skew individual
preferences as would specific excise taxes.

Let us now consider the merits or demerits of a
consumption as against an income tax, setting
aside the question of bureaucratic power. It
should first be noted that the consumption tax and
the income tax each carry distinct philosophical
implications. The income tax rests necessarily on
the ability-to-pay principle, namely the principle
that if a goose has more feathers it is more ripe
for the plucking. The ability-to-pay principle is
precisely the creed of the highwayman, of taking
where the taking is good, of extracting as much as
the victims can bear. The ability-to-pay principle
is the philosophical embodiment of the memorable
answer of Willie Sutton when he was asked, perhaps
by a psychological social worker, why he robbed
banks. "Because," answered Willie, "that's where
the money is."

The consumption tax, on the other hand, can
only be regarded as a payment for
permission-to-live. It implies that a man will not
be allowed to advance or even sustain his own life
unless he pays, off the top, a fee to the State
for permission to do so. The consumption tax does
not strike me, in its philosophical implications,
as one whit more noble, or less presumptuous, than
the income tax.

Proportionality and Progressivity: Who?
Whom?

One of the suggested virtues of the consumption
tax advanced by conservatives is that, while the
income tax can be and generally is progressive,
the consumption tax is virtually automatically
proportional. It is also claimed that progressive
taxation is tantamount to theft, with the poor
robbing the rich, whereas proportionality is the
fair and ideal tax. In the first place, however,
the Fisher-type consumption tax could well be
every bit as progressive as the income tax. Even
the sales tax is scarcely free from progressivity.
For most sales taxes in practice exempt such
products as food, exemptions that distort
individual market preferences and also introduce
progressivity of taxation.

But is progressivity really the problem? Let us
take two individuals, one who makes $10,000 a year
and another who makes $100,000. Let us posit two
alternative tax systems: one proportional, the
other steeply progressive. In the progressive tax
system, income tax rates range from 1 percent for
the $10,000-a-year man, to 15 percent for the man
with the higher income. In the succeeding
proportional system, let us assume, everyone,
regardless of income, pays the same 30 percent of
his income. In the progressive system, the
low-income man pays $100 a year in taxes, and the
wealthier pays $15,000, whereas in the allegedly
fairer proportional system, the poorer man pays
$3000 instead of $100, while the wealthier pays
$30,000 instead of $15,000. It is, however, small
consolation to the higher-income person that the
poorer man is paying the same percentage of income
in tax as he, for the wealthier person is being
mulcted far more than before. It is unconvincing,
therefore, to the richer man to be told that he is
now no longer being "robbed" by the poor, since he
is losing far more than before. If it is objected
that the total level of taxation is far
higher under our posited proportional than
progressive system, we reply that that is
precisely the point. For what the higher-income
person is really objecting to is not the mythical
robbery inflicted upon him by "the poor"; his
problem is the very real amount being extracted
from him by the State. The wealthier
man's real complaint, then, is not how badly he is
being treated relative to someone else, but how
much money is being extracted from his own
hard-earned assets. We submit that progressivity
of taxes is a red herring; that the real problem
and proper focus should be on the amount
that any given individual is obliged to surrender
to the State.[4]

The State, of course, spends the money it
receives on various groups, and those who claim
that progressive taxation mulcts the rich on
behalf of the poor argue by comparing the income
status of the taxpayers with those on the
receiving end of the State's largess. Similarly,
the Chicago School claims that the tax system is a
process by which the middle class exploits both
the rich and the poor, while the New Left insists
that taxes are a process by which the rich exploit
the poor. All of these attempts misfire by
unjustifiably bracketing as one class the payers
to, and recipients from, the State. Those who pay
taxes to the State, be they wealthy, middle class
or poor, are certainly on net, a different
set of people than those wealthy,
middle-class, or poor, who receive money from
State coffers, which notably includes politicians
and bureaucrats as well as those who receive
favors from these members of the State apparatus.
It makes no sense to lump these groups together.
It makes far more sense to realize that the
process of tax and expenditures creates two and
only two separate, distinct, antagonistic social
classes, what Calhoun brilliantly identified as
the (net) taxpayers and the (net) tax consumers,
those who pay taxes and those who live off them. I
submit that, looked at in this perspective, it
also becomes particularly important to minimize
the burdens which the State and its privileged tax
consumers place on the productivity of the
taxpayers.[5]

The Problem of Taxing Savings

The major argument for replacing an income by a
consumption tax is that savings would no longer be
taxed. A consumption tax, its advocates assert,
would tax consumption and not savings. The fact
that this argument is generally advanced by
free-market economists, in our day mainly by the
supply-siders, strikes one immediately as rather
peculiar. For individuals on the free market,
after all, each decide their own allocation of
income to consumption or to savings. This
proportion of consumption to savings, as Austrian
economics teaches us, is determined by each
individual's rate of time preference, the degree
by which he prefers present to future goods. For
each person is continually allocating his income
between consumption now, as against saving to
invest in goods that will bring an income in the
future. And each person decides the allocation on
the basis of his time preference. To say,
therefore, that only consumption should be taxed
and not savings is to challenge the voluntary
preferences and choices of individuals on the free
market, and to say that they are saving far too
little and consuming too much, and therefore that
taxes on savings should be removed and all the
burdens placed on present as compared to future
consumption. But to do that is to challenge
free-market expressions of time preference, and to
advocate government coercion to forcibly alter the
expression of those preferences, so as to coerce a
higher saving-to-consumption ratio than desired by
free individuals.

We must, then, ask, By what standards do the
supply-siders and other advocates of consumption
taxes decide why and to what extent savings are
too low and consumption too high? What are their
criteria of "too low" or "too much," on which they
base their proposed coercion over individual
choice? And what is more, by what right do they
call themselves advocates of the "free market"
when they propose to dictate choices in such a
vital realm as the proportion between present and
future consumption?

Supply-siders consider themselves heirs of Adam
Smith, and in one sense they are right. For Smith,
too, driven in his case by a deep-seated Calvinist
hostility to luxurious consumption, sought to use
government to raise the social proportion of
investment to consumption beyond the desires of
the free market. One method he advocated was high
taxes on luxurious consumption; another was usury
laws, to drive interest rates below the
free-market level, and thereby coercively channel
or ration savings and credit into the hands of
sober, industrious prime business borrowers, and
out of the hands of "projectors" and "prodigal"
consumers who would be willing to pay high
interest charges. Indeed, through the device of
the ghostly Impartial Spectator, who, in contrast
to real human beings, is indifferent to the time
at which he will receive goods, Smith virtually
held a zero rate of time preference to be the
ideal.[6]

The only coherent argument offered by advocates
of consumption against income taxation is that of
Irving Fisher, based on suggestions in John Stuart
Mill.[7] Fisher argued that, since the
goal of all production is consumption, and since
all capital goods are only way stations on the way
to consumption, the only genuine income
is consumption spending. The conclusion is quickly
drawn that therefore only consumption income, not
what is generally called "income," should be
subject to tax.

More specifically, savings and consumption, it
is alleged, are not really symmetrical. All saving
is directed toward enjoying more consumption in
the future. Potential present consumption is
foregone in return for an expected increase in
future consumption. The argument concludes that
therefore any return on investment can only be
considered a "double counting" of income, in the
same way that a repeated counting of the gross
sales of, say, a case of Wheaties from
manufacturer to jobber to wholesaler to retailer
as part of net income or product would be a
multiple counting of the same good.

This reasoning is correct as far as it goes in
explaining the consumption-savings process, and is
quite helpful in leveling a critique of
conventional national income or product
statistics. For these statistics carefully leave
out all double or multiple counting in order to
arrive at total net product, yet they arbitrarily
include in total net income, investment in all
capital goods lasting longer than one year —
a clear example itself of double counting.
Thus, the current practice absurdly excludes from
net income a merchant's investment in inventory
lasting 11 months before sale, but
includes in net income investment in
inventory lasting for 13 months. The cogent
conclusion is that an estimate of social or
national income should include only consumer
spending.[8]

Despite the many virtues of the Fisher
analysis, however, it is impermissible to leap to
the conclusion that only consumption should be
taxed rather than income. It is true that savings
leads to a greater supply of consumer goods in the
future. But this fact is known to all persons;
that is precisely why people save. The
market, in short, knows all about the productive
power of savings for the future, and allocates its
expenditures accordingly. Yet even though people
know that savings will yield them more future
consumption, why don't they save all their current
income? Clearly, because of their time preferences
for present as against future consumption. These
time preferences govern people's allocation
between present and future. Every individual,
given his money "income" — defined in conventional
terms — and his value scales, will allocate that
income in the most desired proportion between
consumption and investment. Any other
allocation of such income, any different
proportions, would therefore satisfy his wants and
desires to a lesser extent and lower his position
on his value scale. It is therefore incorrect to
say that an income tax levies an extra burden on
savings and investment; it penalizes an
individual's entire standard of living, present
and future. An income tax does not penalize saving
per se any more than it penalizes consumption.

Hence, the Fisher analysis, for all its
sophistication, simply shares the other
consumption-tax advocates' prejudices against the
voluntary free-market allocations between
consumption and investment. The argument places
greater weight on savings and investment than the
market does. A consumption tax is just as
disruptive of voluntary time preferences and
market allocations as is a tax on savings. In most
or all other areas of the market, free-market
economists understand that allocations on the
market tend always to be optimal with respect to
satisfying consumers' desires. Why then do they
all too often make an exception of
consumption-savings allocations, refusing to
respect time-preference rates on the market?

Perhaps the answer is that economists are
subject to the same temptations as anyone else.
One of these temptations is to call loudly for
you, him, and the other guy to work harder, and
save and invest more, thereby increasing one's own
present and future standards of living. A
follow-up temptation is to call for the gendarmes
to enforce that desire. Whatever we may call this
temptation, economic science has nothing to do
with it.

The Impossibility of Taxing Only
Consumption

Having challenged the merits of the goal of
taxing only consumption and freeing savings from
taxation, we now proceed to deny the very
possibility of achieving that goal, i.e.,
we maintain that a consumption tax will devolve,
willy-nilly, into a tax on income and therefore on
savings as well. In short, that even if, for the
sake of argument, we should want to tax
only consumption and not income, we should not be
able to do so.

Let us take, first, the Fisher plan, which,
seemingly straightforward, would exempt saving and
tax only consumption. Let us take Mr. Jones, who
earns an annual income of $100,000. His time
preferences lead him to spend 90 percent of his
income on consumption, and save and invest the
other 10 percent. On this assumption, he will
spend $90,000 a year on consumption, and
save-and-invest the other $10,000. Let us assume
now that the government levies a 20 percent tax on
Jones's income, and that his time-preference
schedule remains the same. The ratio of his
consumption to savings will still be 90:10, and
so, after-tax income now being $80,000, his
consumption spending will be $72,000 and his
saving-investment $8,000 per year.[9]

Suppose now that instead of an income tax, the
government follows the Irving Fisher scheme, and
levies a 20 percent annual tax on Jones's
consumption. Fisher maintained that such
a tax would fall only on consumption, and not on
Jones's savings. But this claim is incorrect,
since Jones's entire savings-investment is based
solely on the possibility of his future
consumption, which will be taxed equally. Since
future consumption will be taxed, we assume, at
the same rate as consumption at present, we cannot
conclude that savings in the long run receives any
tax exemption or special encouragement. There will
therefore be no shift by Jones in favor of
savings-and-investment due to a consumption tax.[10] In sum, any payment of taxes
to the government, whether they be consumption or
income, necessarily reduces Jones's net income.
Since his time-preference schedule remains the
same, Jones will therefore reduce his consumption
and his savings proportionately. The consumption
tax will be shifted by Jones until it becomes
equivalent to a lower rate of tax on his own
income. If Jones still spends 90 percent of his
net income on consumption, and 10 percent on
savings-investment, his net income will be reduced
by $15,000, instead of $20,000, and his
consumption will now total $76,000, and his
savings-investment $9,000. In other words, Jones's
20 percent consumption tax will become equivalent
to a 15 percent tax on his income, and he will
arrange his consumption-savings proportions
accordingly.[11]

We saw at the beginning of this paper that an
excise tax skewing resources away from more
desirable goods does not necessarily mean we can
recommend an alternative, such as an income tax.
But how about a general sales tax, assuming that
one can be levied politically with no exemptions
of goods or services? Wouldn't such a tax burden
be only on consumption and not income?

In the first place, a sales tax would be
subject to the same problems as the Fisher
consumption tax. Since future and present
consumption would be taxed equally, there would
again be shifting by each individual so that
future as well as present consumption would be
reduced. But, furthermore, the sales tax is
subject to an extra complication: the general
assumption that a sales tax can be readily shifted
forward to the consumer is totally fallacious. In
fact, the sales tax cannot be shifted forward at
all!

Consider: all prices are determined by the
interaction of supply, the stock of goods
available to be sold, and by the demand schedule
for that good. If the government levies a general
20 percent tax on all retail sales, it is true
that retailers will now incur an additional 20
percent cost on all sales. But how can they raise
prices to cover these costs? Prices, at all times,
tend to be set at the maximum net revenue point
for each seller. If the sellers can simply pass
the 20 percent increase in costs onto the
consumers, why did they have to wait until a sales
tax to raise prices? Prices are already
at highest net income levels for each firm. Any
increase in cost, therefore, will have to be
absorbed by the firm; it cannot be passed forward
to the consumers. Put another way, the levy of a
sales tax has not changed the stock already
available to the consumers; that stock has already
been produced. Demand curves have not changed, and
there is no reason for them to do so. Since supply
and demand have not changed, neither will price.
Or, looking at the situation from the point of the
demand and supply of money, which help determine
general price levels, the supply of money has
remained as given, and there is also no reason to
assume a change in the demand for cash balances
either. Hence, prices will remain the same.

It might be objected that, even though shifting
forward to higher prices cannot occur immediately,
it can do so in the longer run, when factor and
resources owners will have a chance to lower their
supply at a later point in time. It is true that a
partial excise can be shifted forward in this way,
in the long run, by resources leaving, let us say,
the liquor industry and shifting into other
untaxed industries. After a while, then, the price
of liquor can be raised by a liquor tax, but only
by reducing the future supply, the stock of liquor
available for sale at a future date. But such
"shifting" is not a painless and prompt passing on
of a higher price to consumers; it can only be
accomplished in a longer run by a reduction in the
supply of a good.

The burden of a sales tax cannot be
shifted forward in the same way, however. For
resources cannot escape a sales tax as they can an
excise tax — by leaving the liquor industry and
moving to another. We are assuming that the sales
tax is general and uniform; it cannot therefore,
be escaped by resources except by fleeing into
idleness. Hence, we cannot maintain that the sales
tax will be shifted forward in the long run by
all supplies of goods falling by
something like 20 percent (depending on
elasticities). General supplies of goods will
fall, and hence prices rise, only to the
relatively modest extent that labor, seeing a rise
in the opportunity cost of leisure because of a
drop in wage incomes, will leave the labor force
and become voluntarily idle (or more generally
will lower the number of hours worked).[12]

In the long run, of course, and that run is not
very long, the retail firms will not be
able to absorb a sales tax; they are not unlimited
pools of wealth ready to be confiscated. As the
retail firms suffer losses, their demand curves
for all intermediate goods, and then for all
factors of production, will shift sharply
downward, and these declines in demand schedules
will be rapidly transmitted to all the ultimate
factors of production: labor, land, and interest
income. And since all firms tend to earn a uniform
interest return determined by social time
preference, the incidence of the fall in demand
curves will rest rather quickly on the two
ultimate factors of production: land and
labor.

Hence, the seemingly common-sense view that a
retail sales tax will readily be shifted forward
to the consumer is totally incorrect. In contrast,
the initial impact of the tax will be on the net
incomes of retail firms. Their severe losses will
lead to a rapid downward shift in demand curves,
backward to land and labor, i.e., to wage
rates and ground rents. Hence, instead of the
retail sales tax being quickly and painlessly
shifted forward, it will, in a longer run, be
painfully shifted backward to the incomes of labor
and landowners. Once again, an alleged tax on
consumption, has been transmuted by the
processes of the market into a tax on
incomes.

The general stress on forward shifting, and
neglect of backward shifting, in economics is due
to the disregard of the Austrian theory of value,
and its insight that market price is determined
only by the interaction of an
already-produced stock, with the subjective
utilities and demand schedules of consumers for
that stock. The market supply curve, therefore,
should be vertical in the usual supply-demand
diagram. The standard Marshallian forward-sloping
supply curve illegitimately incorporates a time
dimension within it, and it therefore cannot
interact with an instantaneous, or freeze-frame,
market-demand curve. The Marshallian curve
sustains the illusion that higher cost can
directly raise prices, and not only indirectly by
reducing supply. And while we may arrive at the
same conclusion as Marshallian supply-curve
analysis for a particular excise tax, where
partial equilibrium can be used, this standard
method breaks down for general sales taxation.

Conclusion: The Amount vs. the Form of
Taxation

We conclude with the observation that there has
been far too much concentration on the
form, the type of taxation, and not
enough on its total amount. The result has been
endless tinkering with kinds of taxes,
coupled with neglect of a far more critical
question: how much of the social product
should be siphoned away from the producers? Or,
how much income should be retained by the
producers and how much income and resources
coercively diverted for the benefit of
nonproducers?

It is particularly odd that economists who
proudly refer to themselves as advocates of the
free market have in recent years led the way in
this mistaken path. It was allegedly free-market
economists for example who pioneered in and
propagandized for the alleged Tax Reform Act of
1986. This massive change was supposed to bring us
"simplification" of our income taxes. The result,
of course, was so simple that even the IRS, let
alone the fleet of tax lawyers and tax
accountants, has had great difficulty in
understanding the new dispensation. Peculiarly,
moreover, in all the maneuverings that led to the
Tax Reform Act, the standard held up by these
economists, a standard apparently so self-evident
as to need no justification, was that the sum of
tax changes be "revenue neutral." But they never
told us what is so great about revenue neutrality.
And of course, by cleaving to such a standard, the
crucial question of total revenue was deliberately
precluded from the discussion.

Even more egregious was an early doctrine of
another group of supposed free-market advocates,
the supply-siders. In their original Laffer-curve
manifestation, now happily consigned to the
dustbin of history, the supply-siders maintained
that the tax rate that maximizes tax revenue is
the "voluntary" rate, and a rate that should be
diligently pursued. It was never pointed out in
what sense such a tax rate is "voluntary," or what
in the world the concept of "voluntary" has to do
with taxation in the first place. Much less did
the supply-siders in their Lafferite form ever
instruct us why we must all uphold maximizing
government revenue as our beau idéal. Surely, for
free-market proponents, one might think that
minimizing government depredation of the
private product would be a bit more appealing.

$35.00
$20.00

It is with relief that one turns for a
realistic as well as a genuine free-market
approach to Jean-Baptiste
Say, who contributed considerably more to
economics than Say's
law. Say was under no illusion that taxation
is voluntary nor that government spending
contributes productive services to the economy.
Say pointed out that, in taxation,

The government exacts from a taxpayer the
payment of a given tax in the shape of money. To
meet this demand, the taxpayer exchanges part of
the products at his disposal for coin, which he
pays to the tax-gatherers.

Eventually, the government spends the money on
its own needs, so that

in the end … this value is consumed; and then
the portion of wealth, which passes from the
hands of the taxpayer into those of the
tax-gatherer, is destroyed and
annihilated.

Note that, as in the case of the later Calhoun,
Say sees that taxation creates two conflicting
classes, the taxpayers and the tax gatherers. Were
it not for taxes, the taxpayer would have spent
his money on his own consumption. As it is, "The
state … enjoys the satisfaction resulting from
that consumption."

Say proceeds to denounce the

prevalent notion, that the values, paid by
the community for the public service, return it
again … that what government and its agents
receive, is refunded again by their
expenditures.

Say angrily comments that this "gross fallacy …
has been productive of infinite mischief, inasmuch
as it has been the pretext for a great deal of
shameless waste and dilapidation."

On the contrary, Say declares, "the value paid
to government by the taxpayer is given without
equivalent or return; it is expended by the
government in the purchase of personal service, of
objects of consumption."

Say goes on to denounce the "false and
dangerous conclusion" of economic writers that
government consumption increases wealth. Say noted
bitterly that "if such principles were to be found
only in books, and had never crept into practice
one might suffer them without care or regret to
swell the monstrous heap of printed absurdity."

But unfortunately, he noted, these notions have
been put into "practice by the agents of public
authority, who can enforce error and absurdity at
the point of a bayonet or mouth of the cannon."[13] Taxation, then, for Say
is

the transfer of a portion of the national
products from the hands of individuals to those
of the government, for the purpose of meeting
the public consumption of expenditure.… It is
virtually a burthen imposed upon individuals,
either in a separate or corporate character, by
the ruling power … for the purpose of supplying
the consumption it may think proper to make at
their expense.[14]

$8.00
$5.00

But taxation, for Say, is not merely a zero-sum
game. By levying a burden on the producers, he
points out, taxes, over time, cripple production
itself. Writes Say,

Taxation deprives the producer of a product,
which he would otherwise have the option of
deriving a personal gratification from, if
consumed … or of turning to profit, if he
preferred to devote it to an useful employment.…
[T]herefore, the subtraction of a product must
needs diminish, instead of augmenting,
productive power.

J.B. Say's policy recommendation was crystal
clear and consistent with his analysis and that of
the present paper. "The best scheme of [public]
finance is, to spend as little as possible; and
the best tax is always the lightest."

Murray N. Rothbard (1926–1995) was dean of the
Austrian School. He was an economist, economic
historian, and libertarian political philosopher.
See Murray N. Rothbard's article
archives.

This article serves as a complete response to
Alan
Greenspan's call for a consumption tax. It
originally appeared in the "Review of Austrian
Economics," 1994, Volume 7, No. 2, pp. 75–90.
It appeared on Mises.org on March 18, 2005.

You can subscribe to future articles by Murray
N. Rothbard via this RSS
feed.

Notes

[1] In 1619, Father Pedro Fernandez
Navarrete, "Canonist Chaplain and Secretary of his
High Majesty," published a book of advice to the
Spanish monarch. Sternly advising a drastic cut in
taxation and government spending, Father Navarrete
recommended that, in the case of sudden
emergencies, the king rely soley on soliciting
voluntary donations. Alejandro Antonio Chafuen,
Christians
for Freedom: Late Scholastic Economics
(San Francisco: Ignatius Press, 1986), p. 68.

[2] It is particularly poignant, on
or near any April 15, to contemplate the dictum of
Father Navarrete, that "the only agreeable country
is the one where no one is afraid of tax
collectors," Chafuen, Christians for
Freedom, p. 73. Also see Murray N. Rothbard,
"Review of A. Chafuen, Christians
for Freedom: Late Scholastic Economics,"
International Philosophical Quarterly 28
(March 1988): 112–14.

[3] See, for example, Irving and
Herbert N. Fisher, Constructive Income
Taxation (New York: Harper, 1942).

[4] For a fuller treatment, and a
discussion of who is being robbed by whom, see
Murray N. Rothbard, Power
and Market: Government and the Economy,
2nd ed. (Kansas City: Sheed Andrews & McMeel,
1977), pp. 120–21.

[5] See Murray N. Rothbard, Man,
Economy, and State: A Treatise on Economic
Principles.

[6] See the illuminating article by
Roger W. Garrision, "West's 'Cantillon and Adam
Smith': A Comment," Journal of Libertarian
Studies 7 (Fall 1985): 291–92.

[7] See Rothbard, Power and
Market, pp. 98–100.

[8] We omit here the fascinating
question of how government's activities should be
treated in national income statistics. See
Rothbard, Man, Economy, and State, 2, pp.
815–20; idem, Power and Market, pp.
199–201; idem, America's
Great Depression, 4th ed. (New York:
Richardson & Snyder, 1983), pp. 296–304;
Robert Batemarco, "GNP,
PPR, and the Standard of Living," Review
of Austrian Economics 1 (1987): 181–86.

[9] We set aside the fact that, at
the lower amount of money assets left to him,
Jones's time-preference rate, given his
time-preference schedule, will be higher, so that
his consumption will be higher, and his savings
lower, than we have assumed.

[10] In fact, per note 9, supra, there will
be a shift in favor of consumption because a
diminished amount of money will shift the
taxpayer's time preference rate in the direction
of consumption. Hence, paradoxically, a pure tax
on consumption will and up taxing savings more
than consumption! See Rothbard, Power and
Market, pp. 108–11.

[11] If net income is defined as
gross income minus amount paid in taxes, and for
Jones, consumption is 90 percent of net income, a
20 percent consumption tax on $100,000 income will
be tantamount to a 15 percent tax on this income.
Rothbard, Power and Market, pp. 108–11.
The basic formula is that net income,

where G=gross income, t=the tax rate on
consumption, and c, consumption as percent of net
income, are givens of the problem, and N = G – T
by definition, where T is the amount paid in
consumption tax.

[12] Rothbard, Power and
Market, pp. 88-93. Also see the notable
article by Harry Gunnison Brown, "The Incidence of
a General Sales Tax," in Readings in the
Economics of Taxation, R. Musgrave and C.
Shoup, eds. (Homewood, Ill: Irwin, 1959), pp.
330–39.

[13] Jean-Baptiste Say, A
Treatise on Political Economy, 6th ed.
(Philadelphia: Claxton, Remsen & Heffelfinger,
1880), pp. 412–15. Also see Murray N. Rothbard,
"The Myth of Neutral Taxation," Cato
Journal 1 (Fall 1981): 551–54.

[14] Say, Treatise, p.
446.

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12.05.
Triangular Intervention: Price Control

12.04.
Utility "Ex Post": Free Market and
Government

12.03.
Direct Effects of Intervention on Utility

12.02.
A Typology of Intervention

12.01.
The Economics of Violent Intervention in the
Market: Introduction

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