By Roberto Ledezma
Taxes are not a contractual obligation between the state and the individuals it governs. By definition, taxes are noncontractual debts in which the state is the creditor, and the payment of these debts is demanded through coercion and violence. While there may be taxes linked to the performance of certain economic activities (e.g., the sale of products), all forms of this economic policy share the characteristic of being indifferent to the consent of those individuals being governed. This implies that, akin to expropriations, the ownership of private assets is transferred to the state, regardless of whether their former owners have expressed consent or not.
In this brief text, some characteristics of taxes as an economic policy will be explained through analytical statements and valid inferences. All of this is done with the aim of clarifying certain concepts in political philosophy, macroeconomics, and financial accounting.
Tax Payments as a Form of Robbery
Every legal obligation to pay taxes is, in itself, an attempt to commit robbery; however, it can only be considered robbery if executed effectively, meaning if taxes are paid. In such a case, the use of this resource by the state will not determine whether the transfer of property was, or was not, an act of robbery (e.g., unlawful spending). Conversely, even if no law were to classify tax payments as robbery—given the definition used here—this would not imply that these payments are not a form of robbery.
While taxes—as an economic policy—are incompatible with libertarianism, they are not incompatible with capitalism. This is because capitalism solely refers to a form of social organization in which there is wage labor and at least some means of production are privately owned. Therefore, as long as both conditions are met, capitalism is compatible with tax payments.
Furthermore, in a free market, the absence of legal restrictions on the exchange of the property rights of assets, or on other types of economic agreements, means that tax payments are semantically compatible with certain types of taxes—for example, taxes not conditioned on the execution of any economic activity, such as wealth taxes.
Higher Taxes Do Not Mean More Revenue
Let’s consider a population with the following characteristics:
- Five thousand taxpayers
- A single tax requiring 10 percent of each taxpayer’s monthly gross income
- All taxpayers have a monthly income of $2,000 dollars
- Everyone pays their taxes as mandated by law
Assuming these premises hold, we can infer that the tax revenue in this population would be $1 million dollars monthly. What happens if one of the quantitative variables increases while the rest of the variables remain constant? If so, the only semantically possible result is that the tax revenue would also increase. This shows us that tax revenue is not only determined by the rates of certain taxes but also by other variables such as the quantity of taxes, the number of taxpayers and the value of each individual tax base, the frequency of tax collection, and the effectiveness in law enforcement (rule of law).
Regarding the value of each tax base, this variable can increase due to various factors: a decrease in the quantity or value of exempt incomes, an increase in the quantity or value of tax-deductible expenses, or an increase in the value of the economic variable on which the tax is applied (e.g., income, profit, wealth).
Furthermore, if we not only analyze the behavior of tax revenue as a variable but also its ratio to the gross domestic product (GDP) of that population, we find that this ratio would be affected not only by the aforementioned variables, but also by the rates of economic growth or economic decline. Therefore, if tax revenue decreases in a country but the GDP value decreases at an even-greater rate, the value of the tax-to-GDP ratio will be higher.
Understanding Net Profits
Within an income statement, net profits do not reflect the free cash flow or net cash flow of a business. This is the case because, for the calculation of gross profit, credit sales are included within the category of net sales (net revenue). Furthermore, the cost of sales does not refer to the total amount paid to suppliers during a specific period but rather to the cost of the products sold.
There are further conceptual differences between these variables, such as the exclusion of fixed asset depreciation in the calculation of free cash flow and the omission of debt repayment in the determination of net profits. All of these show that the financial reality of a business can be very different from what its taxable income indicates.
While the maximum marginal tax rate to which a taxable income is subject may differ from its effective rate, in the case of businesses, tax rates can exceed 100 percent of net profits if—due to a tax regulation—certain expenses and costs within the income statement cannot be considered deductible. In this scenario, two businesses may be subject to the same effective tax rate on their taxable income but with different effective rates on their total income.
Higher Taxes Do Not Mean Lower Fiscal Deficits nor Less Poverty
The fiscal balance is the difference between a state’s revenues and expenditures. Meanwhile, the primary balance refers to the difference between a state’s revenues and expenditures, excluding interest payments on debt. While a state can have both a fiscal deficit and a primary deficit, it is also possible for it to have a fiscal deficit and a primary surplus.
However, both variables are subject not only to the value of the income variable but also to the expenditure variable. Therefore, an increase in tax revenue alone cannot mean a decrease in the primary deficit or the fiscal deficit. In both cases, it is necessary to know the value of the expenditure variable to determine whether such an increase in tax revenue leads to a reduction in a certain deficit.
Similarly, if by poverty we are referring, in part, to a group of individuals with a certain range of consumption, wealth, or income that starts at zero, it is fallacious to infer that a tax increase means a decrease in poverty. As explained earlier—because both surpluses and deficits can exist—state spending and tax revenues, as variables, are semantically independent.
Additionally, an increase in state spending may result solely in either increased military expenditures or higher salaries for top officials. Lastly, if social spending leads to cash transfers to individuals at poverty level, this alone may meet the condition of a minimum income. However, it does not necessarily mean it also fulfills the condition of a minimum consumption—for example, the minimum consumption of essential nutrients.
- About the author: Roberto Ledezma holds a Bachelor’s degree in Public Management from ITESO and a Master’s degree in Finance from Universidad Panamericana.
- Source: This article was published by the Mises Institute