Taxes – the Necessary Good

Taxes shall be levied according to ability to pay. – Franklin D. Roosevelt

August 19, 2018

by Steve Stofka

In the aggregate taxes are necessary and beneficial to everyone. Because Federal taxes act as a drain from the economic engine, they are different from state and local taxes. How those taxes are levied is a matter of policy debate, but they are necessary for the survival of a nation’s government and its economy. Revenue from natural resource production that is owned by a national government acts as a tax. Failing to understand that concept weakens and cracks governments around the world.

The inability to create money constrains state and local governments (Note #1). Taxes paid act as income for goods and services received from those governments. The Federal government has no such constraints. It does not need tax income as such. Rather, it must drain taxes to offset the amount of spending that it pumps into an economy. Inflation, the chief measure of extra money in an economy, rises when the Federal government doesn’t drain enough in taxes. As inflation rises, people turn to goods and service exchange that is not recorded and not taxed. The underground economy tries to offset the hidden tax of inflation.

As Venezuelans flee the runaway inflation in their country, they are running from too much spending and not enough taxation. Yes, it is counterintuitive. Venezuela owns the world’s largest reserve of oil. The net revenue from that oil competes with the taxes that a private oil company would pay to the government. The national government “owes” itself the tax revenues that it would have collected from a private company. Oil production has declined from 2.4 million barrels per day in 2008 to 1.2 million barrels in 2018 (see Note #2). Corruption and incompetence are the chief causes of the decline. Net oil revenue has declined by 95% from the bull market levels of the mid-2000s. Because the national government has not been paying their taxes, inflation has exploded the economy.

Because national politicians begin their careers in local politics, they regard a nationalized resource (NR) as a source of income, not an economic drain. That drain must be kept open through spending in oil infrastructure, training and transportation. In Venezuela, 2016 gross oil revenues were 20% of GDP and a net of less than 5% (see Note #3). Inflation taxes 100% of an economy. Because NR revenue acts as a pressure relief on inflation, that 20% portion of GDP affects 100% of the economy. A lack of understanding of the nature of a NR led to the crisis and decline of Great Britain in the 1970s, China in the 1960s and 1970s, and Zimbabwe in 2008.

How should a national government levy taxes on the taxpayers within the economy? FDR suggested “ability to pay.” For the past one hundred years we have measured ability to pay by income. Is that a good measure? French economist Thomas Piketty suggests that assets are a better measure. Local governments use this method to collect property taxes. Consider a retiree with $500K in liquid assets, who is taxed on $10K in interest and dividends earned each year. Clearly, the retiree’s assets are a better indication of his ability to pay. Should Congress abolish the income tax and tax people and corporations a multiple of what they pay in property taxes on their primary residence or business locations? Those living in high tax suburban and ex-urban areas might move toward lower-taxed urban areas. Would suburban areas actively recruit businesses to widen their tax base and lower property taxes? An intriguing thought.

Tax levies are the subject of endless debate because people cannot agree on what constitutes a fair tax. In the aggregate, the pressure reducing function of taxes benefits everyone, but is especially beneficial to those with less income. Should a national government impose a head tax on everyone? It could. That would amount to $15,000 per person this year, more than some families make. How does a national government extract tax money from its poor? It doesn’t. From 1958 – 1962, China forced taxes out of poor farmers in Mao’s Great Leap Forward (Note #4). Millions starved as a result.

Everyone should contribute equally to shared benefits, but practicality triumphs over principle. The survival of the national government becomes paramount. Some form of redistributive taxation must ensue. How to shape that redistribution? A government could take all the wealth of the ten richest people in America and still be short $3.8 trillion (Note #5). All the debate falls between total equality and total unfairness, and neither accomplishes the task of draining enough taxes out of the engine. A government could spend nothing: no defense, no research, no border or shore protection, no pension, medical or education spending. That’s a government in name only, and not for long. Other governments will want to capture control of that country’s resources.

The vast middle of the debate is an endless variety of proposals of “fairness” in both taxing and spending, a debate that has changed little since Cicero argued for his proposals in the Roman Senate in the first century B.C.E. What is not debatable is that a nation’s taxes must be roughly guided by its spending. A nation like Venezuela, which taxes half of what it spends, was headed for an economic tsunami of high inflation and inevitable collapse.

The debate is important. Just as it did in Rome two thousand years ago, consolidated party power corrupts. Because the current Presidency and House are held by the same party, we can expect a strong growth rate of net input, spending less taxes, and the data confirms the prediction. Net Federal input in the first full year of the Trump administration, April 2017 – March 2018, grew at a record-breaking annual pace of 19.6%, far above the sixty-year average of 8%. However – because Federal input has been so low this decade, the Federal government must continue this torrid pace of input in 2018 and 2019 just to reach the 8% average.

Republicans have held the House for the majority of the past three decades. Neither party agrees with the other party’s priorities, so the Republican strategy has been simple. They talk fiscal discipline and curtail Federal spending during Democratic administrations so that Republicans can spend big on their priorities when they have the Presidency. The Democrats did this for forty years when they held the House from 1954-1994 and will do so again when they have their next Congressional “run.”

To sum up: taxes are good, in general, but bad in the particular. No nation’s leader has stood on the world stage and said, “To tax or not to tax, that is the question.” For a nation and its economy, “to tax” is synonymous wtih “to be.”

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Notes:

1. Before the Civil War, each state controlled banking within its border (National Bank Act). For a deeper dive into state financing, try this Brookings Institute article.

2. A background paper on Venezuela oil (PDF). Crude oil production in the first quarter 2018 fell to 2.19 million barrels, a thirty-year low (Reuters). The Venezuela government spends more than 40% of GDP but collects only 20% in taxes (Statistica). During the 1997-2006 oil bull market, net revenues to the Venezuelan government averaged $20B per year (background paper above). Last year it was less than $1B. On August 20th, Venezuelans will lose their gasoline subsidies and pay a competitive price for gasoline (PDVSA article).

3. Gross oil revenue in 2016 was $48B, 20% of GDP of $236B (Reuters article). Exxon Mobil had a net profit of 6.5% in 2011. Venezuela would greatly benefit if the oil production was owned privately and paid 25-30% in income and other taxes.

4. Frank Dikotter was one of several historians afforded access to People’s Party records of the Great Leap Forward. He wrote an exhaustive account of human folly in Mao’s Great Famine .

5. Richest people in America  – Wikipedia 

Miscellaneous

Gold is down more than 10% in the past few months. BAR is a gold ETF launched in the past year. As an alternative to GDL and IAU, it has the lowest expense ratio at .2%. Here is a June 2018 article on the ETF.

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