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  • Writer's pictureMartin Schmalzried

Free markets, liberalism and taxation

Most liberals and especially libertarians and anarchists, argue that taxation is essentially theft: a “dictatorship of the majority” government imposed theft, under the threat of violence, robbing people of the fruits of their hard earned labour.

I have already written about rethinking private property rights, but let’s try to pick this argument apart, and especially, inspire ourselves from “free market” economics to help answer a few controversial questions like whether taxation should exist, and if so, what should be the level of taxation.

First, let’s examine taxation in and of itself. Let’s assume that the State starts with a certain amount of financial resources or capital. After all, liberals never examine the “legitimacy” of initial capital at any point in time, otherwise, it might be difficult for them to argue for the preservation of private property. While there are examples of “rags to riches” via hard work, there are also a lot of examples of fortunes that relied on violence, pillage, or nobility, passed on through the ages via inheritance, and therefore not falling in any way under the “fruits of hard earned labour”.

So the State has some capital, which it invests in things like infrastructure, schools and the likes, which are then used as a service by citizens. Taxation, in this light, is simply the same as paying a fee for the service a private company provides. Of course, there are a few caveats:

  • First, the State is a natural monopoly. Only the State can build roads, which goes against the “free market” rationale.

  • Second, only part of the citizens asked the State, more or less directly, to provide those services, thus you could argue that only the people that have voted and are represented by the ruling party should pay taxes. (Voting for a party which proposes a number of services can be interpreted as a 4 or 5 year contract between the consumers/citizens that have voted for a political party for the delivery of a number of services paid for by taxation)

  • Third, it is a strange form of contract since your payment does not depend on your individual “usage” of those services (Do you have kids going to school? Do you drive a car and thus take advantage of the roads?) but on some “bulk” criteria like a percentage of your salary or a sales tax. Thus not all forms of taxes are born equal. It makes for instance more sense, from a “liberal” perspective, for the State to charge for each service as you use it. One example is paying for a drivers license or the renewal of your ID or Passport (covering the administrative fee). The most radical (libertarians and anarchists) would say that the State should not even provide drivers licenses and ID cards to begin with…

Be that as it may, you could still justify taxation via the voting mechanism which is akin to signing a contract. After all, if you voted voluntarily, even if the “conditions” of the contract are “unfair” (paying a percentage of your salary instead of a fixed fee upon use), it doesn’t really matter and you should have the right to do so.

But let’s get to the “meat” of the debate. So taxes could at least be justified for all the people that voted for the ruling political party. But what about the levels of taxation? You could say that it’s whatever the party that the people voted decided to impose. But even liberals, libertarians or anarchists would have a problem with mass contracts between two or more parties which might affect a third parties’ personal well-being or freedom. For instance, imagine that over 50% of people agree to vote for a government that will tax them 100% and then burn the money to heat it’s government offices. The chaos that would result from such a situation is likely to affect even those who did not vote for that government: theft, violence, famine,… The same applies to war for instance. Even if over 50% of people decide to band together and take over by force the land or goods of the minority or behead the minority, it violates certain sacro-saint individual rights (right to private property, principle of non-aggression/coercion etc).

So the economic argument for a “limit” on how high taxes should be (or simply as low as politically possible), rests on two main points: first, the government is less efficient than the private sector or private investors in how it “invests” or spends its money and second, taxation directly affects how much the private sector or private individuals can invest (since part of that money is being taken away from them). Both of these points are linked to the “trickle down” economics theory: let people be rich, they will float everyone’s boat.

The problem with these arguments is that they are not means tested via “offer and demand” type mechanisms.

The better way to do it then to just “believe” liberals, libertarians or anarchists, is to quite simply test it! What I mean by that is that the private sector and private investors, should bear the burden of proof. If their justification for low taxes is to prevent economic detriment, they need to prove that it works. Unfortunately for them, taxes have been dropping steadily since the 1980s, in the US and Europe alike, especially on the wealthiest and large multinational corporations. Yet the economic performance is pretty bad.

What do I propose? Let an “offer and demand” mechanism settle the matter! The government should monitor the economic performance of their country, agree on a set of indicators (GDP growth, productivity growth…), and see if by raising taxes and investing/spending money in various ways (research, infrastructure,…), these indicators do better compared to the year before when taxes were lower. Taxes should go up until you reach an optimal level at which additional taxes would have a negative effects on the indicators chosen.

In this manner, we would finally have true “free market” type competition between the State and the private sector/private investors. After all, the major argument for lower taxes has always been the fact that the State is worse at investing or providing services then the private sector/private investors, simply because it would be difficult to defend a philosophical or principle based justification for low or no taxes if it makes the economy and society worse off… Besides, if the economy is doing better, a big chunk of the wealth created will end up in the same hands that paid the higher taxes (since they own big parts of the economy therefore, benefit the most when economic performance is high). So even to the wealthiest it might be interesting to pay higher taxes since if the State succeeds at better investing the money then they would, they will directly benefit and might even be richer then if they didn’t pay the taxes in the first place.

As I have said before, even principles like the “free market” and “offer and demand”, which seem incompatible with left wing policies, can work in its favour: in this case, justify higher taxes on the wealthiest.

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