Why Do We Really Have Taxes?
It's that time of year again where everyone starts to think about filing their tax return.
But let me ask you a simple question:
Why do we pay taxes?
What's the point?
What is the reason for taxes?
You might be thinking something like: Well, duh, Luke. Taxes obviously pay for things like roads, police, teachers, military, firefighters, libraries, park rangers, and countless other social services... don't they?
Well, yes. They do.
Your taxes do go toward paying for things like roads, police, and teachers.
BUT... it's not necessary for the government to tax you to pay for those things.
Let me say that again: Taxes contribute to government spending, but they are not necessary for government spending.
Now, think about that for a minute...
The government does use your money to pay for things. But it doesn't have to.
See, the government raises the money it needs in two main ways...
First, it collects taxes. In 2018, the U.S. federal government collected $3.3 trillion in total from taxes. And it used that money to pay for various things — mostly Social Security, Medicare/Medicaid, and defense.
But again, it didn't have to collect that money to pay for those things.
That's because the government has a second way of raising money up its sleeve: It creates money. Or, more accurately, it issues debt in the form of Treasury bonds.
According to the Treasury Department, the federal government issued $1.3 trillion in debt last year.
So the question arises: If the government can create new money through issuing debt, why does it need to tax its citizens?
The answer: It doesn't.
The federal government could pay for everything through issuing debt infinitely. There's nothing stopping it from issuing new debt to pay off the old debt.
Soooo... why not do that?
Well, aside from any problems that might arise from issuing new debt to pay off the old debt, there are other reasons the government wants to tax you.
In a 1964 article titled “Taxes For Revenue Are Obsolete,” former Fed chairman Beardsley Ruml explains what taxes are really for. He says there are really four main purposes of taxes. Those purposes are:
- As an instrument of fiscal policy to help stabilize the purchasing power of the dollar
- To express public policy in the distribution of wealth and of income as in the case of the progressive income and estate taxes
- To express public policy in subsidizing or in penalizing various industries and economic groups
- To isolate and assess directly the costs of certain national benefits, such as highways and Social Security
Let me break that down for you...
The first reason for taxes is to maintain demand for currency.
Stay with me here because this can be a little head-spinning...
The largest single source of demand for currency comes from paying taxes. Remember that $3.3 trillion the IRS collected last year? That's 16% of the nation's total GDP.
That means if taxes were eliminated, the main source of demand (paying taxes) would also be eliminated.
In short, taxes exist to maintain demand for currency and thus maintain utility.
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The second part of the first reason is a little more disturbing. In order to stabilize the purchasing power, taxes are issued to reduce aggregate demand... that's a fancy economist way of saying a reason for taxes is to take money out of your pocket for spending!
Yup, that's right, folks: One of the reasons we have taxes is to hold you back.
Why would the government want to do that?
Well, economists argue that without taxes, people might spend more. And that could lead to inflation. Again, remember that $3.3 trillion? No taxes could mean that much more added to individual spending and affect inflation. Consider, most people don't save and live paycheck-to-paycheck.
Ruml says the second reason for taxes is to affect wealth distribution. And they do. Approximately 25% of all taxes collected come from the top 1% of earners. Like it or not, that's the fact.
The third reason for taxes is less disturbing: to discourage socially expensive behavior. Taxes are used to curb things like pollution, heavy use of alcohol and tobacco, and other human and environmental health concerns. A popular term used to describe some of these taxes is "sin tax."
The last reason is perhaps the most fair: to create more of a “pay-to-play” system. For example, gasoline taxes, tolls, registration fees, and other extra costs of driving target individuals who use the roads the most. Another example: Taxes associated with boats and ships target those who use the waterways.
So there you go...
Why does the government tax you?
- To maintain demand for the currency and reduce aggregate demand
- To stimulate wealth distribution
- To discourage unwanted behavior
- To create more of a “pay-to-play” system
Up until this point, most people have learned that taxes are needed to pay for government operations and programs. They'd swear up and down that's why we have taxes.
But now, progressive monetary policies (specifically MMT) are dredging up these old questions. And with that, people may feel quite betrayed.
I do. I mean, think about it: The government has effectively taken a significant percentage of our money throughout our entire lives, all the while allowing us to believe that it was necessary to keep the lights on. They didn't lie. But they allowed us to believe a version of the truth that didn't reveal the whole story.
I'll leave you today with a bit of evidence of that. Take a few minutes to check out Schoolhouse Rock's Tax Man Max. See if you can find where Max mentions reducing aggregate demand.
Have a good one.
Until next time,
As an editor at Energy and Capital, Luke’s analysis and market research reach hundreds of thousands of investors every day. Luke is also a contributing editor of Angel Publishing’s Bubble and Bust Report newsletter. There, he helps investors in leveraging the future supply-demand imbalance that he believes could be key to a cyclical upswing in the hard asset markets. For more on Luke, go to his editor’s page.
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