All taxes blunt incentives. That being the case, however, a direct income tax on individuals is the least damaging, and, at the same time, places before the electorate the cost of government. User fees for government services, like camping fees and grazing fees, are also legitimate direct taxes. Indirect taxes such as sales taxes, value added taxes, payroll taxes, most excise taxes, and similar levies are not just or economically sound methods for covering government spending. They fall most heavily on the poor, thus taxing the people least able to pay, and least able to hold the government accountable for its actions.
This is because indirect taxes mask the spending patterns of public servants and elected officials from close taxpayer scrutiny and direct accountability. Most insidious of all is the "hidden tax" of inflation. By manipulating money and credit and separating money creation from direct connection to the present value of existing and future marketable goods and services via private property, the State effectively taxes and transfers wealth without the consent of the people.
Indirect taxes (including Social Security and unemployment taxes) also add to the costs of marketable goods and services. This shifts taxes to the consumer, reducing the competitiveness of American companies and also our growth within the global marketplace. Taxes on property discourage new construction, improvements, and maintenance. Taxes on corporations, however, are the most counterproductive of all forms of indirect taxes. The corporate income tax damages the corporation, a human invention that is indispensable to the maximum production of wealth. To the extent return on investment is reduced, growth is stifled and the investment goes elsewhere.
There is, however, a more serious adverse and unjust effect of present corporation income tax laws. This effect flows from the wide array of incentives the tax system offers to the financing of industrial growth without the issuance of new equity instruments. The non-deductibility of dividends encourages the use of retained earnings as collateral for conventional borrowings for financial growth over the issuance of new equity shares to broaden the base of capital ownership. Tax subsidies, investment tax credits, tax exclusions, and other loopholes that encourage investment in ways that make the rich richer reinforce this restriction of access to collateral and prevent people who currently lack an ownership stake from becoming owners of the means of production. By perpetuating exclusionary patterns of corporate finance, the corporation tax minimizes opportunities for all households to share in the growth opportunities of the economy.
All Taxes are Income Taxes
Despite the unfairness of the current tax structure, a just social order as well as basic common sense requires direct taxation. As John Locke and others have pointed out, the justification for taxes is that citizens must pay for the services of government, chiefly protection of life, liberty, and property. That being the case, and assuming that everyone's life is of equal value — a basic principle of democracy, as well as the Judeo-Christian tradition (which in this instance includes Islam) — all citizens should pay an equal amount for the benefits government bestows in protecting life and liberty.
The life of the citizen in the State, however, encompasses more than simple protection of life and liberty. The role of the State with respect to the "politikos bios" also includes protection of the principal means by which citizens carry out their lives in a social context: private property, specifically income-generating assets.
Lives and liberties are considered as being of equal value before the law. With respect to property, however (setting aside such aberrations as socialism), while every citizen has an equal right to become an owner, and equal rights to exercise his or her property within the common good, the amount of wealth owned is not equal, and could only be so by coercively imposing equality of results.
Protection of a poor man's small store of wealth — defining wealth exclusively as income-generating assets — is worth as much to the poor man, as protection of a rich man's large store of wealth is to the rich man. That being the case, the subjective value of that protection is equal: the poor man and the rich man are (presumably) equally protected by the State. The objective cost of providing that protection, however, is generally much greater for the rich man than it is for the poor man. It costs the State more to protect a great store of wealth belonging to a rich man than it does to protect the small or non-existent store of wealth belonging to the poor man.
Someone with a great store of wealth, then, should in justice pay more in taxes than someone with a small store of wealth or no wealth at all. Logically, this should result in a single rate tax imposed on all income-generating assets a citizen owns. Taxing assets that do not generate income could be considered unjust, as it effectively decreases the value of the asset; such things are what the income from income-generating assets is spent on, they do not themselves generate the income to pay a tax. Conceptually, taxing non-income generating assets is like taxing someone on the basis of the number of loaves of bread he has. It is a method of redistribution, not of paying for the services of government that properly should be an expense of being a citizen.
A problem, however, occurs almost immediately even when restricting the meaning of wealth to income-generating assets. First, how is wealth to be valued?
The question of how to value wealth is actually the easiest question to answer. An income-generating asset is valued at the present value of the future stream of income it generates, discounted at the current cost of capital.
A more serious issue involves how many times the State should tax the same asset. A tax on wealth means, effectively, that the taxpayer pays taxes periodically on the value of what he or she owns. A 5% tax on wealth in an economy with a stable price level would mean that a taxpayer would pay out the full value of the asset in taxes in 20 years; over time the full value of the asset would be taken by the State in taxes.
What, however, is really being taxed? Except in what are considered exceptional circumstances, no one pays a wealth tax by liquidating a portion of his or her wealth. A farmer does not usually sell his or her land at tax time to pay property taxes. Neither does a manufacturer ordinarily auction off his or her machinery to meet the tax liability.
Instead, the farmer or the manufacturer meets the tax liability out of the income generated by the asset, not by disposing of a portion or the whole of the asset. Thus, even where a wealth tax is imposed, what is really being taxed is not the wealth, but the income generated by the wealth. A wealth tax — or any other tax, for that matter — is essentially an income tax. It is less obvious than a direct income tax (and thus makes the taxing authority less accountable to the taxpayers), but it is an income tax nonetheless.
The Income Tax is a More Just Tax
In 1913 under the aegis of the Democratic Party, newly in power, the federal government took action to break up the concentrated financial control exercised over the economy by financier J. P. Morgan . . . who could claim in perfect truth and in a straightforward statement that he did not own the Bank Trust whose actions caused the "Panic of 1907." When, however, Morgan was asked point blank by the Congressional investigating committee if he controlled the Bank Trust, he equivocated, stating that he did not see how a single individual could possibly control so much financial power.
The committee correctly interpreted Morgan's non-answer as admitting that he did, in fact, control the Bank Trust. Morgan also paid few taxes that he was not able to pass on to others by increasing costs to consumers. Reputedly the richest man in the world — he financed the construction of the R.M.S. Titanic mostly out of his own pocket — Morgan's income was enjoyed free of all direct taxation. It comes as no surprise, then, that the findings of the committee that investigated the causes of the Panic of 1907 were also used to help persuade legislators to pass the Sixteenth Amendment allowing the income tax, and the Clayton Antitrust Act to remedy certain defects in the Sherman Antitrust Act. It was, however, in the establishment of a central banking system for the United States that the committee's findings and recommendations had the most effect.
The Federal Reserve System — the central bank of the United States — was formed and, to prevent the federal government from being able to monetize its deficits, was forbidden to purchase securities directly from the federal government. How the federal government managed to evade that restriction is another story, but it still left the question open as to how the government was going to obtain sufficient funds to keep running, especially with the increasing demands for more social programs.
Fewer and fewer people owned the means of production, but individual incomes were growing as they hired on in the new businesses and companies. People with no income-generating assets nevertheless were enjoying adequate incomes, sometimes very large incomes from selling their labor (mental or physical). The obvious answer was that, since the primary source of income was becoming less and less based on ownership, a direct income tax should be instituted, making the tax system "ownership neutral." Further, the original exemption was set high enough so that most Americans didn't even pay income taxes until World War II. During the first half of the 20th century most people paid no income taxes.
The "New Deal" changed the whole rationale of and approach to taxation. Keynesian economics was used to justify the increasing powers of the federal government far beyond anything the United States had previously experienced. Further, the concentration of ownership of the means of production was not only seen as inevitable, it was considered a positive good. As Keynes remarked at the close of the First World War, "The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war, could never have come about in a Society where wealth was divided equitably. (John Maynard Keynes, The Economic Consequences of the Peace, 1919, 2.III.)
This acquiescence in highly concentrated wealth is, essentially, another aspect of the understanding of money and credit that developed in the 20th century, and which seems to have been behind the "hijacking" of the central bank, the Federal Reserve System, to serve the needs of the State rather than of the private sector. As Harold G. Moulton commented in his analysis of the changing role of the Federal Reserve as a result of the New Deal,
This shift is a reflection of the philosophy that not only is it a proper function of the Government to assume control over the entire credit system, but that only the Government can be depended upon to exercise such control in the interest of the public welfare as a whole. This conception appears to be the result of two factors — the failure of the former system of control to prevent financial crises, and the greatly increased importance of government fiscal and financial operations in the larger scheme of things. Whether the new alignment will be able to avoid the weaknesses disclosed in former periods of political control, time will demonstrate. (Harold G. Moulton, Financial Organization and the Economic System. New York: McGraw-Hill Book Company, Inc., 1938, 417.)The increasing power of the State was not, however, something new on the political scene. It was, admittedly, still something of a novelty in the American Republic, founded explicitly on personal sovereignty and the dignity of the human person. In modern times, the belief that the State is the ultimate owner of everything was most effectively argued in Thomas Hobbes's virtual manual for totalitarian government, Leviathan. As far as Hobbes was concerned, taxation is an exercise of the State's ultimate right of property in everything, effectively abolishing private property (see Karl Marx and Friedrich Engels, The Communist Manifesto. London: Penguin Books, 1967, 96; cf. John Maynard Keynes, A Treatise on Money: Volume I, The Pure Theory of Money. New York: Harcourt, Brace and Company, 1930, 4-5). As Hobbes asserted,
A Fifth doctrine, that tendeth to the Dissolution of a Common-wealth, is, That every private man has an absolute Propriety in his Goods; such, as excludeth the Right of the Soveraign. Every man has indeed a Propriety that excludes the Right of every other Subject: And he has it onely from the Soveraign Power; without the protection whereof, every other man should have equall Right to the same. (Thomas Hobbes, Leviathan, II.29.)To Hobbes, then, taxation was simply "the Soveraign Power" — the State — exercising its ultimate right of property in goods that the State already owns, and against which the citizens have no recourse. This socialistic understanding of the right to be an owner — the right to property — directly contradicts the natural law orientation of the Founding Fathers of the United States. That is, every human being has, by nature itself, inherent rights. Among these rights are life, liberty, access to the means of acquiring and possessing private property in the means of production, and full participation in the institutions of the common good in order to acquire and develop virtue and thereby fulfill each individual's capacity to become more fully human ("pursue happiness").
The American Republic was founded on the sovereignty of the individual. Consequently the Founding Fathers used Locke and Sidney (and, albeit indirectly in most cases, Bellarmine; see John Clement Rager, The Political Philosophy of Blessed Robert Bellarmine. Washington, DC: Catholic University of America Press, 1926) — and Montesquieu — instead of Hobbes as their guides in political theory. This meant that taxation, far from being an exercise of property on the part of the State in the goods of its citizens, was a grant from the people to the State, and illegitimate without their consent. As Locke explained,
'Tis true, Governments cannot be supported without great Charge, and 'tis fit every one who enjoys his share of the Protection, should pay out of his Estate his proportion for the maintenance of it. But still it must be with his own Consent, i.e., the Consent of the Majority, given it either by themselves, or their Representatives chosen by them. For if any one shall claim a Power to lay and levy Taxes on the People, by his own Authority, and without such consent of the People, he thereby invades the Fundamental Law of Property, and subverts the end of Government. For what property have I in that which another may by right take, when he pleases to himself? (John Locke, Second Treatise of Government, § 140.)Today's unbelievably complex tax code and the injustice evident in its design and execution are thus directly contrary to the intent of the Founding Fathers as well as to the purpose and justification of taxation in the first place. The new attitude that seems to pervade the halls of Congress, that the State somehow has the inherent right to manipulate the tax code to levy direct taxes, as well as money and credit to impose indirect and hidden taxes, is directly contrary to both the purpose of taxation itself, and the basic principles on which the United States was founded.