Taxation as Penalty

“That the power to tax involves the power to destroy; that the power to destroy may defeat and render useless the power to create;”
– Chief Justice Marshall, McCulloch v. Maryland (1819)

“Government taxes what it wants less of.”
– Commonly heard modern-day version

The first statement is generally true, while the second is generally not true, or at least, there is no necessary connection between the two things. Yet, the second is often stated as either a summary or a consequence of the first. Where is the difference exactly, and why do people who think they’re similar make this mistake?

First, why is the original statement true? Well, it’s mostly true, not strictly, axiomatically true in some lock-step logical manner. It’s true, to the extent that it is enforceable, because if taxation is increased to 100% on some product or activity, then there is no economic reason to produce that product or engage in that activity. A tax of 100% on income of any kind would effectively be slavery. (The history of tax revolts shows that you don’t need anywhere near a 100% tax rate to make taxation unenforceable. But there is as long a history of actual slavery, too.)

So, it’s easy to see that taxation can destroy an economic activity. Tax blueberry muffin income at 100%, and you won’t get very many blueberry muffins sold anywhere.

When we look at the second statement, though, we’ve moved from a statement about power and cause-and-effect to one about goals. In short, the first statement is one of means, and the second is one of ends.

Consider the story in The Seven Samurai (1954) by Akiro Kurosawa where a band of raiders plans to take most of the harvest of a local village. The first statement above could be re-stated as such: “The raiders have the power to destroy the village by taking all their food (or enough that they starve anyway).” But the second statement, similarly re-stated, makes little sense: “The raiders want the villagers to produce less food.”

Of course, it may be that the raiders are a combination of opportunistic and sadistic and would really like to see the villagers dead. But it’s easy to imagine that the raiders would be quite happy to have the villagers continue to produce food, even at a higher level, so that they might return season after season and steal from them. This makes perfect sense as a long-term plan, and if anything, the raiders should be quite happy to see the villagers produce more food than ever if that were possible.

Consider another story, that of Robin Hood, wherein a tyrannical usurper taxes the local populace mercilessly. As Rothbard says, the government is a gang of thieves writ large, and there is no essential difference between the two stories in that sense. And again, we don’t see the villainous king wishing for the population to have less income necessarily. He may wish it to the extent that a poorer population is less capable of fighting back, but this must be balanced against the fact that a starving population is not a great tax base, either. All else equal, he wants the tax revenue to increase.

Again, we see that the second statement is not necessarily true, even in cases where taxation is heavy-handed and vicious.

So, why does it seem like such an obvious conclusion to many?

At least partly, it stems from the idea of Pigouvian taxation of externalities. The actions of some (wrongly) impose costs on others. Taxing those actions will thereby reduce (or eliminate) those actions and thus reduce (or eliminate) the costs put on others. Here we have a clear connection between means and ends; taxes are the means, reduction of an activity is the end.  And with this connection, it’s easy for some to then view that means as essentially connected to that end. If you tax something, you must want less of it. Otherwise, why would you tax it? Don’t you know what that gets you?

Thus, for example, corporate taxation is intended to limit the number (and/or the power) of corporations. Taxing capital gains is intended to limit speculation. And so on.

While it’s possible that an individual politician has exactly that intent in mind, I don’t think it’s at all obvious that one implies the other. After all, there are many ways to limit an activity. Regulation is an obvious one. The number of doctors is limited primarily by the monopoly of the AMA and other enabling legislation, not by imposing a tax on doctors. The same goes for immigration, teaching, and so on.

Another reason for the conclusion is that most people assume that political planners intend most, if not all, of the consequences of their plans.  To take an action is to intend the consequences of that action.  But there are at least two problems with this.  One, government policies routinely result in unintended consequences.  In fact, this is unavoidable, not a matter of incompetence or lack of interest in forming good policy.  Two, politicians and bureaucrats have their own set of incentives that have little to do with the stated purposes of whatever legislation they put into place.  (Was the PATRIOT Act written by and voted for by patriots?  Of course not.)

To highlight this second point, consider the role of regulation.  In general, regulation can be thought of as a version of taxation because it imposes costs and can quite easily destroy an activity, either through an explicit ban or through the accumulation of indirect costs.  And so, people also tend to associate regulation with the desire to limit an activity.  However, regulation often tends to concentrate power in an industry, making it easier for certain dominant corporations to keep out rivals.  Often, the regulations are written and promoted by the industry itself in support of this end.  (Obamacare was primarily a gift to the insurance industry, even though it was portrayed as a way to rein in the power of the same industry.)

So, in conclusion, the fact that someone wants to tax something tells us very little indeed about their attitude towards it.  It’s theoretically possible that the intent is to destroy some activity, but given the array of other means available, the presumption should be the opposite until/unless some positive evidence is provided.  Just like regulation, both the intent and the result may be counterintuitive.

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