Could we permanently fund the government via a one-time wealth tax?
A radical proposal for increasing prosperity
Here’s a proposal: write a constitutional amendment abolishing taxation after we do it just one more time. Once, and only once, the government will be allowed to take some fraction of the wealth stock, and then never again. Importantly, the government retains all of its other powers — the power to enforce laws, provide for the national defense, pay welfare, and adjudicate disputes between people — but it must fund those activities using the capital income from the wealth it now owns.
Why would we want to adopt such a proposal? There are two main reasons. The first reason is that it will effectively permanently eliminate the lost economic efficiency from taxation. The second reason is that, by giving the government a relatively fixed share of wealth, it will now be encouraged to be fiscally responsible, rather than shortsightedly take out debt that it will not be able to pay back without constantly raising taxes.
I’ll elaborate on my two justifications in turn, and then address a few objections.
Benefits of abolishing taxation
Many people might not see the benefit of abolishing taxation. Sure, no one likes to pay taxes, but aren’t they our civic duty? Plus, our taxes often go towards beneficial social spending, and that’s morally good.
It’s important to note that my proposal does not necessarily eliminate the positive aspects of taxation. The government is still allowed to exist, and pay for social programs using capital income from the wealth it retains from the initial wealth tax.
My proposal is also agnostic about the size of government. Hypothetically, the government could take an initially large fraction of the total wealth and generously fund social programs, or an initially very small fraction of the total wealth and fund none at all. In other words, my proposal is consistent with both complete Soviet-style nationalization of industries, and a Milton Friedman-style hands-off approach.
Rather than eliminating government, this proposal would merely eliminate one of its main drawbacks. Taxation is not merely bad to those who think that it’s theft, and therefore immoral. Taxation is bad for perfectly ordinary common-sense moral reasons that I hope will become clear with an example.
Suppose you are running a lemonade shop on a beach. You calculated that, given the cost of supplies and your personal labor, the total production cost of a cup of lemonade was $1. To make a profit, you sell your lemonade for $2 a cup. About 100 people on the beach think this is a reasonable price, and lower than the maximum that they’d be willing to pay, and therefore purchase your lemonade. You make $100 profit, and 100 people get value from purchasing cold lemonade. So far, so good.
Now, the government steps in and demands you pay a $2 tax for each cup of lemonade sold. Since you were only receiving $1 of profit from each cup of lemonade sold before, the only way you can still operate your business is by raising prices. Your production costs remain the same, and therefore in order to make the same amount of profit per cup of lemonade, you must raise your prices by $2 — the amount of the tax. Since a cup of lemonade now costs $4, only 10 people are now willing to purchase the lemonade. The government now takes in $20 revenue that it can use for beneficial social purposes, but now you only make only $10 of profit, and only 10 people are able to get cold lemonade, rather than 100.
The moral of the story here is that the moral wrongness of taxation is not merely a matter of not wanting your money to go to the government. You could very well think that the government spends your money well. However, by charging a tax on a particular market, the government made it so that both producers and consumers receive less value overall than if it had not imposed any tax at all.
In economics, this lost value created from taxation is called deadweight loss, and it’s illustrated via the triangle in the chart below.
Do all taxes have this effect? No, but nearly all do. Astral Codex Ten recently reviewed a book from Henry George in which he proposes one tax that famously doesn’t have any deadweight loss: the land value tax.
There is also another tax that doesn’t have this effect: a lump sum tax, paid once. Imagine, in the example above, instead of charging $2 per lemonade sold, the government unexpectedly demanded $20 upfront. Since the government is collecting the same amount of revenue, you might think that this would have the same effect as the per-unit tax.
However — so long as the tax was unexpected, and can’t be expected to happen again — it would not produce any deadweight loss. To recoup your losses, you could set up a lemonade stand and produce $100 of profit, just as you did before with no tax. Then you’d get $80 of total profit, consumers would get to enjoy their lemonade and the government would retain the same revenue.
Fiscal responsibility
Contrary to popular misconception, fiscal responsibility in governance is less about trying to reduce the budget deficit as much as possible and more about about ensuring that any debt we do take out is a responsible investment that should be expected to pay off eventually.
The problem is that politicians have little incentive to act fiscally responsibly. In the United States politicians in the federal government serve terms between 2 and 6 years long. Most are concerned primarily with winning the next election, and could barely give a damn about what happens after that. In fact, some politicians — particularly those in the House of Representatives — spend more time campaigning than they do drafting and negotiating legislation.
One easy way to win elections is to give voters government handouts. Then, each voter knowing that their politician gave them handouts, is more likely to vote for them in the future. “Government handouts” is not necessarily a pejorative here; I think there’s some valid reasons to give voters things they want. But the problem is that these handouts often don’t make any long-term fiscal sense, and politicians often have no incentive to make good choices about which handouts are best. Remember, they just care about winning votes.
A general rule is that government policy must be paid via taxes eventually. The government can take out debt, but taxes must be used to pay the interest on our debt. Since interest payments are spread over time, the primary financial burden of government debt is taken by people in the future — far past the next election — rather than taxpayers in the present.
In a nutshell, that’s the argument why politicians should be expected to be financially irresponsible.
While my proposal can’t fix all the issues with governance, it can conceivably fix this one. Why? If government could no longer raise new funds via taxation, then it will know that the only way to raise new funds is via capital investments. Therefore, it will only take out debt if that debt is reasonably likely to give way to real financial returns.
But suppose politicians act irresponsibly anyway and take out a ton of debt with no plan for how to pay for it. All this would mean is that the size of government would shrink. Since the government can no longer levy new taxes, the only way for it to pay the interest on debt incurred poorly would be for it to sell some of its capital and hand some control back to the private sector.
Now, I will address some objections.
Hold on, under your proposal, wouldn’t the government eventually shrink until it ceases to exist? This is just anarcho-capitalism in disguise…
As stated above, the one main reason to expect the government to shrink is that it acts irresponsibly and politicians take out debt with no good plan to pay it back. However, if this happens, shouldn’t we celebrate that the government is shrinking?
Look at this way: the fact that the government acted irresponsibly is evidence that it’s not a good institution for growing the world’s wealth. Since the capital stock is one of the key determinants of wages, and growth in per-capita income, it should be good to know that institutions which manage it poorly would shrink, and institutions which manage it well would grow.
It’s worth noting that the reverse is also totally possible. If you believe that government more efficiently spurs economic growth than the private sector, then under this proposal, we should expect it to grow in relative power, and eventually, become far more powerful than the private sector. But this is also good.
If the private sector underperforms the public sector at the task of growing wealth, then it’s all the better that it shrinks.
The private sector will just sabotage the government, and try to kill it.
I see no compelling reason why the private sector would sabotage the government. One of the main current reasons why companies don’t like the government is that companies must pay taxes. But if no one had to pay taxes anymore, then the only remaining reason is that companies don’t like the existing laws.
While some private actors would certainly wish for many government laws to go away, there’s a good reason to think that they couldn’t do it wholesale. The reason is that the government has a natural advantage in power.
Unlike the private sector, the government retains the power to enforce laws, and this ability is asymmetric. That is to say, there’s no equivalent power allowing Standard Oil to break up the government into 34 constituent smaller governments.
Those in the private sector must follow all the rules of the government. By contrast, no one in the government is beholden to the rules of the private sector. Both private and public entities must grow their wealth in the same way — by making responsible investments. However, only the public sector maintains the ability to enforce arbitrary limits on the power of its competition.
With no taxation, wouldn’t inequality skyrocket?
Not necessarily. Remember, the government would be funded in perpetuity via a one-time wealth tax. Economists have pointed out that a wealth tax is among the most progressive taxation proposals, whose burden falls almost entirely on the top 10% of the population.
Thomas Piketty has pointed out that the main reason why income and wealth inequality has risen in the last few decades has been to the fundamentally greater returns on capital income as compared to overall economic growth. To illustrate, if people see their wages grow at an average of 4% a year, but the capitalist class sees their wealth grow at 6% a year, over a long enough period of time, aggregate income from capital will far outstrip aggregate income from wages.
Since government functions will be funded via capital income, it will in theory maintain the same growth advantage as those who own capital privately. And as noted earlier, government will have the additional advantage that it can enforce laws.
The government could use its large capital income to fund a generous welfare state, in theory. That’s why I don’t see any inherent reason to expect inequality to go up.
But as has been long pointed out, governments often don’t always spend money to target the poor. Education subsidies benefit those who are statistically more likely to be rich, and social security and healthcare spending benefit the old, who are disproportionately wealthy.
To the extent that you think government will fail at the task of redistributing income, then your problem is with democracy itself as a means of reducing inequality, not with my proposal.
But is it really possible to fund all government activities using only the pure returns on wealth?
It turns out, yes, but it’s complicated. Steve Roth points out in Capital’s Share of Income Is Way Higher than You Think that if you just look at rents paid to capital owners — what laypeople normally think of when they imagine returns on investments — the current amount of yearly capital income in the United States is only about 28% of the GDP. Since the US government spends 44% of the GDP, we are going to have a bit of a problem.
However, most investors recognize that dividends, and other rent payments, aren’t the full story. Investors gain when the market price of their assets go up. When we take into account capital gains, both realized and unrealized, the share of capital income rises dramatically, to about 51%.
Still, this means that government would need to take about 86% of all wealth in the United States in order to permanently fund its current level of spending given both rent payments and capital gains.
Since the government seizing 86% of all the nation’s resources suddenly would almost certainly trigger a depression, I do not currently recommend it.
However, I still believe this proposal is worth thinking about for one important reason. If Picketty is right, and the returns from capital have been consistently outstripping GDP (as you can sort of make out in the chart above), then perhaps some time in the future, capital income will far outstrip ordinary income paid to labor. At such time, politicians could propose a one-time wealth tax and then henceforth be done with taxation forever. And that might be a win for everyone.
Once the government is "allowed to take some fraction of the wealth stock," it will do it again, and again—forever. Weren't income taxes supposed to be temporary? If we can learn anything from "Robin Hood" (1973), it is that the government will take wealth as it pleases, whenever it pleases, as many times as it pleases, regardless of the damage it may cause. Large bureaucracies are unfeeling and, more often than not, inhumane. How much of this rings true to you?
Life Lesson: “Taxation is theft.” —Murray Rothbard
"Prince John says that taxes should hurt."
Movie Scene: https://moviewise.wordpress.com/2021/08/23/robin-hood/