After 232 years of the vicious dynamic of Interest Group Liberalism and rent seeking at work since ratification of the U.S. Constitution in 1789, democracy in America faces a crisis of contradiction: The more obese government becomes, the more people demand of it; the more inept government proves itself to be at providing even the most basic public services, the more people clamor for government to do more; the more government regulation fails to solve the problems it was created to correct, the more collateral damage it wreaks yet the more people bellow for it to regulate even more to solve the new problems it created trying to solve the original problems; the more government exhibits a corrupting and withering touch, the farther voters extend its creepy reach to poke and pry into the interstices of people’s lives; the more power and money voters give government to pursue the general welfare, the more it uses them both to pursue its own special interests and oppress the people under the guise of the “public interest” and the “greater good of the community.”
In short, the government produces little except more problems but it thrives on the problems it creates. That is why it so frequently is observed that; “Nothing succeeds in Washington, DC like failure.” Government is what biologists call coprophagous, consuming its own excrement. The only way it can possibly survive and flourish, therefore, is to siphon nourishment from its own citizens, acting as a parasite on the body politic.
Enter direct income taxation, a page right out of Karl Marx’s playbook, which recall from Chapter I, he viewed as a “despotic inroad on the rights of property” that would “wrest all capital” from the middle class. Even before presidents, the Congress and judges began wholesale shredding of the Constitution after 9/11, nothing had been more oppressive and destructive of liberty in the United States or done more to retard economic prosperity over a longer period of time or contributed more to the exorbitant growth of government and special-interest politics (“rent seeking”) than direct income taxation.
Indictment of Direct Taxes: Gateway to Collectivism
There is a second equally important, or perhaps even more important distinction among alternative tax systems than the economic-efficiency consideration, which must be taken into consideration if tax reform is to be debated in a rationally transparent manner: the distinction between direct and indirect taxes separate and apart from any economic-efficiency considerations. The Founding Fathers were well aware of this distinction and considered it so important that they enshrined it in the Constitution, requiring that all direct taxes be apportioned among the states on the basis of population just as representation in the House of Representatives was to be. As explained in the Federalist Papers, the Founders considered direct taxes so dangerous that they required explicit constitutional restrictions on how they could be levied.
Direct taxes on income not only retard economic growth and spoil prosperity, more importantly they also endanger liberty by turning into engines of collectivism. By contrast, indirect taxes, such as taxes on retail sales and a few other close cousins in the “Fisher-equivalent family of taxes on ‘spendings’” (e.g., business transfer tax (BTT), excises and tariffs), are neutral consumption-based, indirect taxes the most consistent with liberty because they shelter the individual from the prying eye and probing hand of government. And, as Alexander Hamilton observed in Federalist # 21, indirect taxes on sales also contain within them a check on excessive taxation:
“It is a signal advantage of taxes on articles of consumption, that they contain in their own nature a security against excess. They prescribe their own limit; which cannot be exceeded without defeating the end proposed, that is, an extension of the revenue. When applied to this object, the saying is as just as it is witty, that, ‘in political arithmetic, two and two do not always make four.’ If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds. This forms a complete barrier against any material oppression of the citizens by taxes of this [indirect] class, and is itself a natural limitation of the power of imposing them.”
A short diversion into the constitutional history of the federal government’s spending and taxing authority will help lay the predicate for the conclusion that direct taxes on property, wealth, wages, salaries and other forms of income, including The Flat Tax, are too politically toxic to permit their use by this national government unless they are levied under extraordinary constitutional constraints—constraints that were stripped from the U.S. Constitution with passage of the 16th Amendment.
The original design of the Constitution created a pincer of constraints limiting government’s misuse of its taxing and spending powers. First, the Constitution restricted how Congress could spend money, namely only on activities it was empowered to undertake by its enumerated powers and then only “to provide for the common defense and general welfare” of all Americans. Second, the federal government’s taxing power was severely limited by the requirement that all direct taxes must be apportioned by population. This constraint was designed to tie taxation even more closely to representation. It also was meant as another powerful restriction designed to protect against what today is called rent seeking, what the Founders called “faction”—and to ensure that Congress raised and spent tax revenue only to achieve the general welfare, not to benefit special interests with handouts and gifts at taxpayers’ expense by inuring only to selected groups of people.
Hamilton's exposition on the rationale behind the constitutional restriction on direct taxation illustrates the Founders’ remarkably sophisticated understanding of political economy that informed the original constitutional design. History has borne out the Framers' expectations that taxes on consumption are at least somewhat self-limiting, while direct taxes know far fewer internal limits. In the case of the original constitutional design, the self-limiting tendency of indirect taxes on consumption augmented the other arm of the constitutional pincer—limiting the national government solely to the exercise of delegated powers to provide for the general welfare—to make unnecessary other specific constitutional limitations on the national government's taxing and spending authority, e.g., explicit taxing, spending and borrowing limitations.
In Federalist #21, Hamilton also recognized that direct taxes, such as those on property, wealth and income, were unlikely to exhibit the same self-limiting nature as the more easily avoidable indirect taxes on consumption. He recognized that the new national government would rely almost exclusively on the more self-limiting, indirect taxes for some time, as in fact it did for its first 1½ centuries. At the same time, however, Hamilton anticipated that the national government eventually might come to rely more on direct taxes.
To prevent their abuse, Hamilton explained why the Framers believed direct taxes required explicit constitutional constraints in addition to the general restraining nature of a constitutional arrangement (Madison’s “interior structure of government”) to limit government solely to the exercise of delegated powers in pursuit of the general welfare:
“Those [taxes] of the direct kind…may admit of a rule of apportionment…In a branch of taxation where no limits to the discretion of the government are to be found in the nature of the thing, the establishment of a fixed [apportionment] rule, not incompatible with the end, may be attended with fewer inconveniences than to leave that discretion altogether at large.”
When the 16th Amendment was adopted to permit income taxes to be collected without being apportioned by population, it removed one jaw of the pincer that had held the federal government in check. The Constitution was put into a Zen-like state of one hand clasping. It lost its grasp on government and no longer could constrain democracy’s proclivities to tax and spend itself into a fiscal crisis, a political crisis and social upheaval.
The 16th Amendment also interacted with creation of the Federal Reserve in the same year to dissolve the finely crafted, automatic constitutional constraint on the government’s ability to borrow money. Once a central bank (the Fed) could print money at will, Congress had a ready partner to manage interest rates and monetize the national debt by soaking up excessive debt issued by the Treasury while keeping interest rates in check. The “only” price the government would have to pay for excessive printing and borrowing would be the invisible tax of inflation—a burden foisted on an unsuspecting citizenry. Worse yet, the inflation tax actually made the government’s life easier, at the expense of the people, because the Treasury could pay back debt principle in devalued (“cheaper”) dollars.
Although the constitutional apportionment of direct taxes by population now may appear to be a quaint historical curiosity, it provided an important check on the national government's taxing power and limited the destruction Congress could wreak using it. States, on the other hand, were left largely unencumbered in their ability to tax their own citizens; and they were constrained by the national Constitution only to the extent necessary to prevent them from burdening interstate commerce or discriminating against U.S. citizens from other states.
In the general design of the American federal system and in the specific design of the national government's fiscal authority, the Framers were extremely sensitive to the need to design the system so that it constrained each level of government in a manner appropriate to the circumstances attendant to each level. The national government required greater constitutional checks on its exercise of power than did the states because voters had available to them an alternative to the ballot box to keep state and local governments in check—voting with their feet—which, for all practical purposes, was unavailable to constrain the federal government.
When the explicit constitutional constraint on direct taxation (the apportionment rule) was neutered with ratification of the 16th Amendment, it also eliminated the national government’s need to rely on indirect taxes (which “prescribe their own limit”). Meanwhile, the courts also were gradually undermining the fundamental constitutional principle restricting the national government to the exercise of delegated powers only, which had restricted the objects and activities on which the federal government could spend money. In other words, the original constitutional design constrained both the means by which Congress spent (taxation and borrowing) and the ends on which Congress spent (limited delegation of powers to spend exclusively in the general welfare of all citizens). Over the years, both general constitutional constraints were removed either by outright legislative repeal or judicial fiat.
With the elimination of this dual constraint, the federal government has been transformed from a government of delegated powers, which must justify its authority to act by identifying a specific constitutional grant of authority, into one with plenary power, which may act unless specifically restricted from acting by the Constitution. And, as evidenced by the rapid erosion of Bill-of-Rights “thou-shalt-nots” on government, even explicit, unambiguous constitutional restrictions no longer suffice to restrain a maniacal government intent on total control. As long as the courts continue to permit the Congress to spend money raised through unrestricted direct taxes at its own discretion for virtually any purpose it desires, additional, explicit constitutional constraints on spending and taxation are required to prevent a continuation and recurrence of the nation’s current fiscal distemper and the political system’s eventual self-destruction.
By providing the government direct access into the pockets and bank accounts of every individual, direct taxes on wealth and income also provide politicians a powerful engine of redistribution, which allows them effortlessly to take wealth from politically ill-favored minorities and give it to politically favored minorities and majorities. Once such a rent-seeking dynamic is embedded in the government’s revenue-raising mechanism, the remaining limits on the size and scope of government are grossly inadequate to guarantee freedom and ensure prosperity.
Political liberals embrace direct income taxation as the dynamo of collectivism, the engine of the welfare state. Political conservatives pay lip service to mild and non-discriminatory taxation but they consistently have tolerated and even celebrated the revenue-raising capability of the income tax and applauded the visible pain inflicted by direct income taxation—in pursuit, they claim of “transparency” and efficiently “pricing government.” The pain is therapeutic, they claim, necessary and sufficient in their minds to restrain the size of government by nailing the price tag to people’s foreheads; another perverse Washington notion that you have to hurt the victim to protect him—sort of like destroying the village to save it.
The thesis of welfare-state conservatives has been that the annual ritualistic pain of filing income tax returns would demonstrate to taxpayers precisely what they pay the government and thereby provide a check on the growth of government. That hypothesis has been disproved by experience; especially since the fragrantly unconstitutional seizure of wages and salaries through income tax withholding was imposed on the public. The income tax is all pain and no gain…except for the politicians, tax lawyers and aristocrats of pull who play the tax code like a finely tuned musical instrument for their own enrichment.
Before the income tax was enacted and the IRS and Fed were created, government parasitism was constrained within narrow limits, just as Hamilton predicted, by the state’s limited ability to steal its citizens’ wealth and dictate their behavior under the color of law.
With enactment of the income tax and the creation of the IRS monstrosity, the state not only gained the fiscal means to confiscate and spend much of the nation’s treasure and to social engineer people’s behavior by manipulating economic incentives and punishments; government also achieved the means to gradually transform individual liberty into collectivist tyranny using the bureaucratic machinery of the tax collector to surveil, police, intimidate, control and eventually channel people’s behavior along the lines and into the patterns it desired.
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The subtle but irrevocable transformation of the old federalist republic into a modern majoritarian democracy set in motion what sociologist Jack Douglas called an “autocatalytic” process in which collectivization and regimentation in America fed on itself as it created increasing dependency on government and required more redistribution to finance it.
The growing tyranny that invariably accompanies collectivism would occur so gradually that like the proverbial frog gradually being boiled to death in a pot of water one degree at a time, few Americans realized what was happening to them. They luxuriated in the cesspool Washington made of the nation as if it were a hot tube.
As government cast the web of collectivization wider, it required ever-greater handouts and bailouts and safety nets to placate and anesthetize the public to prevent people from revolting against the tyranny and collectivization progressively enveloping them. What better device than the income tax and its IRS enforcer to facilitate and enable the enervating welfare state and effect the income redistribution and social control required?
Here is how Douglas characterizes the autocatalytic process by which the mega-state grows and becomes increasingly dictatorial:
“The mega-state ratchets up slowly, always in the guise of 'serving the common welfare' and generally in the pretense of meeting a crisis. Once the bureaucratic regimentation of everyday life has become pervasive, ‘it begins to bring about acute socio-economic crises such as inflation, recessions, shortages, monopolies,’ etc., which create ‘alienation and outrage’ throughout the country...‘These crises triggered by the higher levels of statist bureaucratization then become the enabling crises of further ratchets-up in statist powers’ -- it becomes a vital necessity for 'the common welfare' to 'solve' the problems being caused by the drift into statist collectivization by increasing the bureaucratic regulations, which in turn produce new crises that must be solved by further, ratchets-up.”
Sound familiar? It should. It’s same song, different verse.
Once a thirst for collectivization began to seize the hearts and minds of Americans under the guise of fairness, “social justice,” egalitarianism, public order and national security—all in pursuit of the “public interest” and the “greater good of the community”—the powerful political dynamos of collectivization began gradually plowing liberty under and cultivating the welfare-warfare state in its place. Collectivization American Style took on a life of its own, spreading like kudzu, fertilized as much by the demands of the people themselves as by the dictates of the state.
These are the dynamos of collectivism:
- The graduated income tax and an oppressive tax collector;
- Unlimited fiat money creation;
- Elimination of all effective constitutional constraints on government spending and borrowing;
- Erosion of constitutional rights and due process protections;
- Heretofore-unimaginable government regulation of personal behavior and business activity.
- An enormous military-industrial complex to wage perpetual war abroad against “evil others” and a militarized police force at home to wage perpetual domestic wars on drugs and terrorism and ruthlessly punish “non-compliance” with all the other dictates of the state by average people going about their daily business.
Here is my op-ed written, I think, in 2012:
The Bad Rap Against Indirect Taxes
The last few weeks, I have made the case against direct taxes—unfit for a free and prosperous people—largely because they create the perfect instrument of social engineering, economic redistribution and oppression. This week, I refute the case against indirect taxes made primarily by well-intentioned but misguided supporters of free markets and limited government, who believe them to be more efficient revenue engines that anesthetize the pain of taxation, disguise who bears the burden of taxation, and thereby lead to bigger government.
First, a reprise on the distinction between direct and indirect taxes. A direct tax, generally speaking, is one imposed directly on individuals’ wealth and paid directly to the government by the persons on whom the tax is imposed. Familiar examples are personal income taxes, the FICA wage tax imposed on workers to finance Social Security and Medicare and taxes on personal and real property. An indirect tax—such as a retail sales tax (RST), a value added tax (VAT) or a business transfer tax (BTT)—is a tax imposed on business activities (e.g., value added during a particular stage of production) and commercial and financial transactions (e.g., retail sales), rather than on individuals themselves. Indirect taxes generally are collected and remitted to the government by intermediaries (usually businesses) on whom the government also imposes the statutory liability for paying the tax.
In the modern era, however, direct taxes have mutated into a kind of hybrid tax where the government continues to impose the statutory liability for paying the tax on the individual, but he is not actually the person who remits the money to the government. Direct taxes increasingly are collected, enforced and remitted by third-party intermediaries as with employer withholding laws, the “employer share” of payroll taxes, mortgage-company withholding of property taxes, back-up interest withholding and account disclosure by financial institutions.
Modern-day direct taxes have added to their own deficiencies the worst attributes of indirect taxes— opaqueness due to third-party collection and remittance—without relieving the individual taxpayer of the burden and legal obligation to pay the tax, file the forms, and comply with all the regulations and compliance costs associated with it. These mutant direct taxes allow the government not only to take people’s income and wealth without their knowingly and voluntarily handing it over to the government, but they also anesthetize the taxpayer to their tax burden, and allow the government to conscript third parties to become tax collectors and compliance officers for the state; collecting, enforcing and remitting the tax as unpaid government agents.
The economic consequences and ultimate incidence (i.e., the actual burden) of a tax are largely accounted for by factors other than the direct or indirect nature of the tax. That is to say, indirect retail sales taxes, VATs or BTTs and direct income, wage or property taxes all can be levied in such a way as to be more or less distortive economically—it depends primarily on how the tax base is defined. Indeed, it has been shown that most of the above direct and indirect taxes, notwithstanding their direct or indirect nature, can be so structured as to belong to the same taxonomically equivalent family of minimally (but still substantially) distortive tax systems; the direct Haig-Simon income tax being the exception.
So, if the direct or indirect nature of the tax is not the determinative factor in whether a tax minimizes economic distortion, why do so many conservatives oppose them? Dean Clancy articulates the two main reasons limited-government advocates generally oppose a VAT or a BTT.
First: It's the most insidious of all taxes, because it is built into the price of everything and consumers can't see how much of the price is due to the tax. When taxes rise, prices rise, but consumers mistakenly assume that's just market forces at work. Politicians love a VAT: it lets them take a lot more money out of our wallets. And VATs usually exist side by side with income taxes, not in lieu of them. Taxpayers should hate VATs for the same reasons politicians love them.
True, but not unique to the VAT or any other general indirect tax, for that matter. Indeed, the difficulty in determining who pays any tax results from the fact that the burden or incidence of a tax is hidden and disguised by the shifting of that burden that occurs as workers, consumers, producers, savers, investors and entrepreneurs react to the imposition of the tax.
Direct income taxes, no less than indirect VATs, BTTs and retail sales taxes are “built into the price of everything,” and consumers can't see how much of the price changes occurring are due to the income tax. When income taxes rise, the increased burden falls ultimately on the factors of production—labor, capital and natural resources—and the tax wedge causes prices to rise and supply to decline. Consumers mistakenly assume “that it is just market forces at work.”
The true measure of the burden of a tax is the change in people’s economic situations as a result of the tax, which is difficult if not impossible to observe in a modern, complex economy. As a 1992 study by the U.S. Treasury Department put it:
The economic burden of a tax, however, frequently does not rest with the person or business who has the statutory liability for paying the tax to the government. This burden, or incidence, of a tax refers to the change in real incomes that results from the imposition of a change in a tax.
Second, there is the post-hoc-ergo-propter-hoc fallacy seemingly so persuasive among conservatives. Again, Clancy makes the argument clearly:
European countries have VATs; we do not. European countries collect a lot more in taxes than we do. These two facts are related.
Really? These facts may be related but this particular rhetorical technique that doesn’t consider alternative explanations—call it “proof by assertion”—doesn’t really prove anything except the writer’s predisposition in favor of whatever it is he is asserting. Might it be that European countries “collect a lot more in taxes than we do,” because their governments spend a lot more than ours do? And, could it be they employ VATs for other political or economic reasons, e.g., they are far less invasive and economically disruptive than Haig-Simon-like income taxes and ad hoc corporate income taxes, which are biased in favor of consumption because they tax saving and investment multiple times?
Is it really the VAT per se that conservatives like Clancy object to or is it the fact that the VAT would add another tax source on top of the ones we already have? If the latter, which I suspect it is, their objection is not really to any particular revenue source but rather to the combined revenue-generating capacity of them all taken together. Any “self-evident,” relationship between European spending and the presence of a VAT would be spurious, the artifact of a higher appetite for spending and the availability of more tax sources. The real question then is, which tax taken alone minimizes economic distortion and the political mischief of the welfare-warfare state?
The answer is not to be found in economic efficiency analyses because as already demonstrated, VATs, BTTs, Flat Taxes, Retail Sales taxes all can be designed to be taxonomically equivalent and equally efficient at producing revenue for the state. The deciding consideration in choosing indirect taxes over direct taxes, especially modern mutant direct taxes, is found in the indisputable fact that direct taxes stimulate social engineering, incite income redistribution and fuel oppressive bureaucracies.
