The Myth of a Fair Tax

0:00Good morning and welcome to everyone in attendance and viewing online. If you are viewing online, you can post a question on the Mises Academy page by registering and it's free to register. An unhappy tax day to everyone. Let me introduce the program for today. I'll be giving the first talk, I'm Joe Salerno, I'm the Vice President of Academic Affairs for the Mises Institute. I'll be talking on the myth of a fair tax. After me, Matthew McCaffrey, who's a doctoral candidate in economics at the University of Angers, will be talking about taxes and the black hole of government spending, and Daniel Sanchez, our editor of the Mises website, will be talking about taxes and history. After that there'll be a discussion in which you can pose questions and we'll go from there.

1:00So, my talk is entitled, The Myth of the Fair Tax, and you could substitute for that the myth of the just tax, those words aren't exactly interchangeable, but they're used that way. For centuries, people, economists, argued about what the just price was, what was the What was a correct price? What was a price that could be considered just? Finally, in the late Middle Ages, this actually led to the development of economics, the attempt to answer this question. And interestingly enough, the answer that was finally settled upon by almost everyone in the economics discipline was that the just price was simply the price that was agreed upon on the market, the market price.

1:52The reason being that it was voluntarily agreed upon and therefore benefited both parties, made both parties better off from their own point of view. Unfortunately today, well actually let me just say a little bit more about that. We can look at it from the point of view of buyers and sellers for a moment. In every exchange the buyer always values what he or she receives more than the price paid. So, for example, if I purchase this from a vending machine for $2, that indicates, that demonstrates that I prefer the water to the $2 given up. And on the other hand, the seller always values the money price received, that is the $2 in this case, the vending machine company, to the water that they're giving up.

2:40So both parties give up something that they value less for something they value more. And that applies to everything, not just a bottle of water, but if you pay $599 for an iPad or $30,000 for a car, it demonstrates that you as a buyer expect to benefit, expect to improve your welfare by giving up the price and getting something that you consider subjectively more valuable. And on the other hand on the market, people who don't value a good as much as the price are not forced to exchange. Change. So if you stood by a vending machine where they were selling soda and water, you would see some people making the purchase and other people just walking by. Those people aren't forced to buy because they believe that the $2 is more valuable to them in some other use than the water.

3:31So that's sort of a capsule summary of what the just price is. Now, what about the just tax that economists are still arguing about today? There is still no settled principle of how you determine if a tax is just. Economists are still at odds with one another. I suggest that there is a reason for this, and Austrian economists in general point this out. All taxation involves coerced exchange. That is, you are forced to give up the money, in this case the tax, for a good, whether or not you value the good more than the money. And by the very fact that you're forced, that is, there's a threat of force, in the U.S. for example, if you don't pay your taxes, your income will be forcibly garnished, your assets will be seized, and if you continue to resist, you could ultimately be shot.

4:29The SWAT team will surround your house and drag you out and if you resist, it could involve a fatal force against you. So the presumption then obviously is that people, for the most part, value the tax money more than the goods they're getting. They don't value the government public schools as much as the, let's say, $5,000 in property taxes that they're paying for it. But there's something else that's important before we can judge the justice of taxation and that is it always involves redistribution of income and wealth because it always involves taking the money from the taxpayers and someone has to receive those monies or those revenues. The revenues are received by the government politicians, bureaucrats and those in society who receive government, very lucrative government contracts or are subsidized by government.

5:26For example, agribusiness involved in producing ethanol, large defense contractors, banks that are bailed out using these funds, welfare recipients, people building stadiums, rich Rich investors in sports teams who have public stadiums built for them, and so on, and on, and on. So, those people are the net tax consumers. They don't pay taxes. They receive the tax monies. So, there are some people who benefit from taxes, but other people are necessarily made worse off. Unfortunately, most economists overlook this distinction.

6:14and they just say well you know we want we want to find the tax that's more or less is consistent with the market doesn't disturb the marketplace and we call that a neutral tax it allows people to do the same things they would have done without the tax well obviously they have less money to begin with so they can't do everything that they would have done so that that's the first problem but so what happens is they don't focus on the exchange itself whether it's voluntary or coercive and everything that follows from those two different ways of obtaining money. Remember, there's only two ways of obtaining money in society, either through production and voluntary exchange, which benefits both parties, or through the political means, which is through force, which makes some parties worse off. Even if you build a charitable hospital, okay, with tax funds, it still makes the person who's forced to give those tax funds worse off, despite the fact that the intentions

7:11are good, let's say, okay. that's not being built for political reasons, but it's being built to really help other people. On the other hand, if a charitable hospital is set up through donations, through voluntary donations, well then the giver improves his or her welfare, otherwise they would not have made the donation, as well as the people receiving the charity. So what have economists done to try to find sort of a principle of a just tax? What they focused on is the fair distribution of the tax burden. Notice the word burden right there to tell you that this has nothing to do with the market. In the market, no exchange involves a burden. It involves costs.

7:56A cost is something you give up that you value less to get something that you value more, but there's always a net benefit. Okay, there's not a burden, but people do treat taxes as burdens as they should. and economists recognize this. Okay, so by focusing on this fair distribution, what happens is that you ignore the coercion involved in taxation and the fact that the tax consumers are not burdened with taxes. In other words, the politicians, bureaucrats and those who are subsidized by the tax money, they don't bear any burden. They're the tax consumers. They're consuming the fruits of other people's burdensome taxes. So those two things are left out of account.

8:43And by the way, even if a bureaucrat files a tax return, let's say for $100,000 and pays $20,000 in taxes, that's an accounting fiction. The bureaucrat ultimately receives $80,000 in tax revenues. He doesn't pay taxes. He consumes taxes. In fact, that adds to the burden on taxpayers because you have to go through, the resources are used up that involve him sending in the taxes, carrying through with this fiction, sending in the tax monies and so on, and having the IRS then process his forms and so on, so we have to pay even more for this fiction. Now, the UN, for example, if you work for the UN, you don't pay any taxes on your income.

9:29Obviously, that money comes from the country's taxpayers, okay? And I think that might be true of the IMF, too, the International Monetary Fund, okay? It would be much more honest and genuine if politicians and bureaucrats just received the money that they were going to receive in net payment, okay? They do not pay taxes, okay? They consume taxes. Now, every economist who deals with taxes all agrees with one principle, okay? Whatever principle of justice of taxation they hold, they all agree that everyone should be treated equally. There should be equality of treatment. It's sometimes called uniformity of treatment.

10:16What that means is everyone should be taxed in accordance with, If you believe in the ability to pay principle, his ability to pay, or if you believe in the benefits that he receives, people should pay in proportion to the benefits they receive, then everyone who receives the same benefits should pay the same amount, everyone who has the same ability to pay, if that's your criterion, pays the same amount, or if you believe that everyone should pay proportionally to their income, the same percentage, then everyone in the same income class pays the same amount. Everyone accepts this. It sounds fair. on the surface superficially, but of course it's not at all because think about it, let's say everyone is enslaved, right, everyone is treated equally by the master, but the master occasionally will release one slave okay, well I mean they're not, people aren't being treated equally or maybe he'll allow the slave to work part-time for himself and only be half-time enslaved so fifty percent slave, well should the other slaves all get together and say

11:19Well, this is terrible. He has a slavery loophole. He has a special exemption. That's ridiculous. The point is, slavery is unjust. So who cares how the burdens of slavery are distributed? Or another example is, in the old days, and maybe even today, in some of the bigger cities where the mafia operated, they would operate a protection racket where every store would have to, in the neighborhood, would have to pay them a certain amount not to have their windows broken or their store set on fire, and they would actually, the mafia would prevent crime from occurring, that is from other criminals, okay, and peace would reign in the neighborhood, but everyone would be forced to pay that $400. Well, what if the local pizza place and the bar and Social clubs and so on, where the mobsters hung out. What if they were given an exemption?

12:21They only had to pay $200 a month, okay, because they were the mob's favorite hangouts. Okay, do we suddenly say, this is not fair? They should pay $400 too? Of course not. You're reducing injustice, okay? You should be calling for exemption of everyone from the whole $400, because it's a coerced exchange, okay? So, it's not clear that everyone should share the burden, in fact, it's quite the opposite. If it's a burden, why would people want to get involved in that kind of an exchange, that is the forced exchange? So, all this talk that we hear today of people who are exempted from taxes having these loopholes that they sneak through or being subsidized, Not taxing someone is not necessarily not subsidizing them.

13:17A subsidy from government involves taking money from one side of the room, for example, and then paying it to the other side of the room. An exemption is someone on this side of the room is simply allowed not to pay me. I'll just take the other four people there and take their money and pay this side of the room. That person should be blamed for a loophole. In fact, Mises had a very good quote on this. Yes, he said, Ludwig von Mises, the great Austrian economist and teacher of Murray Rothbard, he said, what is a loophole? If the law does not punish a definite action or tax a definite thing, this is not a loophole, it is simply the law. The income tax exemptions in our income tax are not loopholes. Thanks to these loopholes, this country is still a free country and that was written in the 1950s, early 50s. So, to conclude about this principle, uniformity Equality or Equality of Treatment in Taxation is a self-contradiction. It's impossible to bring about in the real world.

14:17And one of the reasons is because the very act of taxation creates two classes. One class is the tax payers. The other class are those who receive the tax monies. The monies have to go somewhere, the tax consumers. They are not burdened. They live off the fruits of the tax burden that is placed on other people. So at least they are not treated equally. The second reason why you can never realize this is because the tax, as we'll see in a moment, is never ultimately paid by the people who are initially taxed. The tax is what's called imputed to others in society. The burden is pushed in different directions and sometimes it's very difficult to figure out who's actually paying the tax.

15:02Tax. Let me give you a great example of this. There was a luxury tax that was passed in 1990 by the first President Bush and a Democratic Congress. This is the same President Bush who said read my lips, no new taxes. So this luxury tax tax, which was passed in January 1990, would place a 10% tax on all yachts that cost more than $100,000. So on all luxury boats that had a price of more than $100,000. And also on all airplanes whose price exceeded $250,000. The aim of the tax was to raise revenue from millionaires and billionaires, that's how it was framed, that we're going to use this tax to make the millionaires and billionaires pay their fair share, because they assume those are the people that purchased these items, so you're going to make the rich pay.

16:03So for example, I'll focus on the luxury boat tax, or rather the luxury boat tax, so a yacht selling for $300,000, You would tax the $200,000 above the $100,000, you tax that at 10%, so that person would have to pay $20,000. But what wasn't counted on is that wealthy people have a lot of opportunities to spend their money on many, many different things, okay? They can easily substitute expensive art, European vacations, larger mansions, okay, for the purchase of a yacht, and in fact, that's exactly what they did. So then, they bought very few yachts, is all I'll show you, all right? So people who were very different from the millionaires and billionaires actually wound up paying this tax.

16:54First of all, the employment in the boat building industry was 600,000 people in 1988. It fell to 400,000 in 1992. Now not all of that loss, the 33% loss of jobs was due to the tax because we also had In 1991, the sales of luxury boats fell by 70% from the 1990 level, but overall boat sales fell only 16%. So the tax definitely put a damper on the yacht or luxury boat market.

17:46From 1989 to 1992, boat sales fell from 42%, from $17 billion to $10 billion. Now I come from New Jersey, and I remember a lot of articles on this, and I went back and looked them up. New Jersey is one of the largest producers of yachts, and it devastated the luxury boat business. Business. Let me just give you three sort of micro examples, three firms that suffered. There was a Viking yacht company, cut its workforce from 800 to 150 and closed down a facility. It also owned something in Tampa, Florida, closed down a facility in Tampa, Florida, which caused another 800 workers to lose their jobs. The Hague Harbor Yacht Company, which is the oldest boatyard in New Jersey, shut down completely and laid off 250 workers. It used to build 120 yachts per for a year. Finally, Ocean Yachts had sales of 60 million per year in 1988. It was a new up-and-coming business and it would build 12 boats a month. But by 1992, the plant was closed and the workforce was cut from 325 to 55.

18:54And let me mention Maryland is another state with a large maritime industry, about 300 of the 1,500, so 20% of the boat related businesses in Maryland closed down, again part of it was due to the recession, but a lot of it was due to the luxury tax. So who paid the luxury tax? Very few millionaires and billionaires bought boats, okay? There were some that still bought the boats, so they had to pay a partially higher. Oh, and prices came down. So prices came down. So let's say the price comes down by $10,000. So instead of paying $300,000, there's this $20,000 tax on there. You would think that, well, according to most people, or the way most people think, that the seller and then he passes the tax on to the buyer so that the person would have to pay $320,000 but boat prices fell so let's say the boat price fell to $285,000 and then with the $20,000 in tax the millionaire wound up paying only $5,000 because overall the boat cost was sold to him for $305,000 because the demand for boats fell so much their prices fell so part of the tax even after it was sold was born by the boat sellers themselves

20:12So, who paid most of the tax? The small entrepreneurs who owned these companies. Their capital, in some cases, disappeared. In other cases, it was tremendously shrunk in value. And tens of thousands of skilled workers who lost their jobs and incomes and did find jobs, but lower paying jobs, that did not use their higher valued skills. So the people in the boat business, in the luxury boat business, were the ones that paid most of the tax, were burdened by most of the tax. But since so few boats were sold, the government raised very little revenue, much less than it thought. So not only do we not know who ultimately pays any tax, economists can figure it out.

21:02and you can figure out the groups that ultimately wind up paying a tax and it's not the groups that are initially taxed. But secondly, it devastated a sector of the economy. The power to tax is the power to destroy. Fortunately, the boat industry was on the way to just completely collapsing. President Clinton finally repealed the tax in 1993 and then the sector began to de-flourish again. Let's talk about the underlying principles very briefly. How do economists justify these coercive taxes? These taxes that supposedly, even though they involve coercion, duplicate the market.

21:53That is, they're just like the market according to these economists. Let's call the ability to pay principle. People should pay taxes according to their ability to pay. It's very, very ambiguous. There's no clear standard about someone's ability to pay. Let me give you an example. Let's say two people both earn $50,000 per year, A and B. A has no savings. B, who earns the same income, has $200,000 in his 401k. Okay, A is in perfect health, B has $20,000 of medical bills every year, A has no children, B has five children, who has a greater ability to pay? B has more wealth, he has $200,000, but he has higher medical bills and he has five children.

22:38There's no way, there's no unit to measure people's ability to pay, it's an absurd standard, yet economists uphold this. One way they try to justify it is by saying, well, when people give money to their churches or to the Red Cross or to food banks or charities, they're expected to give it according to their means, okay, you're told by your pastor, your priest, to give what your means allow. And according to these economists, well, that's the same thing with government, right? It's a common organization. We should all give what our means allow. However, the pastor or priest doesn't come to your house if you don't give 10% of your income and hold a gun to your head, okay?

23:24The government does. There's no way to resign from the government. There's no way not to get out of that organization, okay, whereas all the other organizations you can get out of. But also, why do people voluntarily contribute to charity? Because they're able to? Of course not. Because they believe they're receiving a benefit by being charitable. So people pay according to the benefits they expect to receive from gifts, not according to their ability to pay. Many people will contribute to certain types of charities for moral reasons. So even if they have the means, they don't expect to get a benefit from it. Finally, market prices obey the law of one price. Everyone, regardless of wealth and income, pays the same amount of money for a loaf of bread, for an iPad, for steak dinner, for cell phone.

24:22The rich don't pay more or people with a greater ability to pay don't pay more. Imagine if everybody had to pay a price in proportion to their income. So then someone who is 10 times richer than someone else would have to pay not $20 for steak dinner but $100. Everybody would have to pay according to the proportion or a higher price according to how much higher their income was in the average, let's say. And there would be no reason then for people to work harder, to invest more and to acquire money income. If everybody had to pay according to their income, it would, in effect, equalize everybody's income. Therefore, there would be no reason to try to work hard for money income, and the economy would collapse.

25:08It's a ridiculous and absurd principle that leads to the collapse of the market economy. It's certainly not neutral to the market if it destroys the market, this ridiculous ability to pay principle.

25:26So how could that be neutral to the market? Let me just talk briefly about the last principle. There's a few others, but these are two of the big ones. The Benefit Principle. So the tax is supposed to be levied according to the benefits that people receive from society. Number of things wrong with this right off the bat. Immediately, benefits are equated with money. So if A earns more than B, then he receives more benefits from society. Well, let's put that aside for a moment. There's a couple of things wrong with that. A earns more than B in a market economy because A has provided goods that are of greater value to consumers than B has. That's why A earns more. So in some sense, if you want to use this terminology, A is giving back more to society already by his productive efforts and it's simply getting paid in proportion to how productive he or she is and secondly society is not government okay everybody participates freely in society when they go to work when

26:31they exchange goods and services okay that's not true of government and government is not society government is the tax consumers not the taxpayers and also on the market people So, on the market, people do not pay according to benefit, received, okay? They don't pay according to ability, ability to pay, nor according to benefit received. Let me give you an example. Let's say A is willing to pay up to $200 to see a rock concert, okay? He really loves this band. B was willing to pay up to $60, okay? Do they pay different prices? No, they both pay the market price of $50. Marketers Each one values a ticket more than the money they're giving up. It's true A would give up the $200 and B would give up the $60 for a ticket, but that's not relevant. Market price is uniform for everyone.

27:30The other point is that market exchanges, because they're voluntary, demonstrates benefit, it shows that everyone is benefiting, whereas, and by the way, it also shows the fact of the benefit, so it shows the fact of the benefit, but it does not measure it, it doesn't measure the benefit. That's subjective, how much people benefit from things, we just know that they do benefit. But on the other hand, taxes, because they're not voluntary, do not demonstrate any sort The presumption is all the other way, right? If there's this threat of force, that if you don't pay your taxes, you could be coerced, well then, in fact, we assume that the person actually would not have paid the taxes unless this threat existed.

28:15And finally, I might say that tax consumers benefit from the tax revenues they receive, but they don't pay according to the benefit. If this principle was applied to all government officials and the people who receive subsidies, they'd have to give back all of their salaries. That's the benefits that they get. So in conclusion, what I want to say is there is no just tax. The closest you could get to a neutral tax, though even here it's not neutral, is everybody pays exactly the same price for government services. Rich and poor alike, we all pay a couple hundred bucks to the federal government, or whatever. But that would have to be a very, very low tax, because very poor people couldn't pay very much, which would be great, so it would be a very, very low tax.

29:02But it's still not neutral to the market, because some people don't believe that government schools are worth even a penny. I don't. The only way to provide defense and courts and other public services that are now provided by government, if you want a way of doing it that is neutral to the market, is simply to allow the market to provide these defense services and courts. That is just to have just prices. Thank you.

29:39Thank you very much.