4. Taxation

In a modern economy, there are a number of different types of taxation, including personal income tax, corporation income tax, sales taxes and excise taxes.

Income taxes cannot possibly affect every individual equally, and therefore the income taxation alone redistributes wealth before the money is even spent.  Large corporations and high earning individuals tend to pay a larger proportion of the tax than anyone else, and this discourages productivity and affects the choices that individuals make.

When a corporation loses 100% of the dollars it loses, but it is only permitted to keep 60% of the dollars it gains, its policies are affected.  It does not expand its operations, or expands only those with a minimum risk.  Recognizing this, other entrepreneurs are deterred from entering the business.  Growth and technological progress are slowed down.  Productivity is held back from what it otherwise would have been if corporations were not force to pay 40% of their earnings in corporation tax.

There is a similar impact to individuals; there is less incentive to become productive and to take risks with their money.  Their income itself is reduced dramatically, and this reduces demand for goods and services and prevents new or improved industries from coming into being.  There is less employment and less capital available for investment.  Time-preferences tend to increase as people need to spend a higher proportion of their reduced income on consumption, raising interest rates and slowing growth.

Taxation distorts the economy by draining resources away from the private sector, penalizing production.  Even if it were a neutral income tax - a tax which would affect the income pattern, and all other aspects of the economy, in the same way as if the tax were really a free market price – then it would still tend to raise time preferences by reducing everyone’s level of (lifetime) income.  This would still hamper productivity.

But there can really be no such thing as a neutral tax, because taxation is coercive and thus differs fundamentally from a voluntary price. A so-called flat tax (where all incomes are taxed at the same percentage) is not the equivalent of a price, because in the market rich customers do not pay in proportion to their income. A head tax would be better (in this respect), but it too is coercive; some taxpayers would be forced to fund certain government activities that they abhor.

Taxes on businesses – corporate income taxes – will eventually raise prices paid by consumers: the businesses will either immediately raise prices, or they will lower their own profitability or pay lower costs to factors – either way, supply will decrease and this raises the prices.

Sales and excise taxes further increase the prices that must be paid by consumers.  Analytically therefore, there is little difference between income taxes, and sales and excise taxes.  They merely create different distortions to the market, with those goods and services were sales or especially excise taxes are payable suffering more than other goods and services.  The taxed items will become particularly less attractive to consumers, decreasing demand for them, but the taxes also make people poorer in general, reducing demand for all goods.

All taxes therefore distort the economy and transfer wealth from tax-payers to tax-consumers.  People working productively to satisfy the needs of individuals subsidize those who are beneficiaries of the government spending.  This includes government bureaucrats themselves, everyone working in government-run industries, everyone working in industries which supply governments or have a government-granted privilege, and people who are paid benefits (welfare) by the government.

As we have seen, overall, government taxation-and-spending can only worsen the structure of production, and make all individuals worse off in the long term.