Benjamin Bestgen: Taxation
Leo Mattersdorf, friend and accountant of Albert Einstein, claimed the great physicist once said to him during a meal that “the hardest thing in the world to understand is the income tax”. Benjamin Bestgen this week takes a look at this divisive subject. See last week’s jurisprudential primer here.
In law school, we learn that tax law is simply “law applied to money” – and as money is involved almost everywhere in our day-to-day, so are taxes. Trainee lawyers learn from the beginning that your letter of engagement must exclude giving tax advice unless the client has expressly requested it. Not only that, but tax, a highly technical and complex subject, requires special expertise. Tax considerations can heavily influence both transactional and contentious work, so doing things in a tax-efficient manner is crucial, for otherwise the client may end up paying considerably more money to HMRC than legally necessary.
Philosophically, taxation is a topic directly linked to statecraft, social justice, equality and pursuit of the public good. It connects to ideas about “just deserts” and property rights. Tax can also be used by the state as a tool to incentivise or deter from certain behaviours and as means to influence foreign relations through tariffs or tax-free trade.
We are also told that tax is used by the state to supply goods, services and research which the private sector can’t or doesn’t engage in. Taxes provide an income to people in need as well as various social services and public benefits: if you want a functioning NHS, legal aid, court system, structurally sound roads, clean water, decent schools, safe streets etc., pay your taxes.
But why have taxes at all? What does the state really need them for?
The household metaphor
We are commonly taught by politicians and many economists that the state is like a household. While your family depends on your work income to fund itself, the state depends on tax revenue to fund its own projects and comply with its duties.
If there is not enough tax income, the state has to borrow, increasing the debt we are told our future generations have to pay off. Austerity measures are justified as “necessary belt tightening”: if your household doesn’t make enough money and cannot safely borrow more, you cannot spend. Politicians from Regan and Thatcher to Osborne, Schäuble or Obama have embraced the household metaphor.
But economist Stephanie Kelton flags some problems with this analogy:
- Households don’t issue their own currency. Households, like businesses or local state agencies, are users of currency. Only governments can legally issue it.
- As long as its debts are solely in its own currency (which must not be convertible into other goods, like gold, either), the state cannot fail to satisfy them – it can simply issue more of its currency. Your household, on the other hand, can go bust if it fails to pay its debts, no matter what currency they are in.
- Unlike people in your household, the state cannot die or sire “future generations”. As long as the state’s debts are in its own currency (as above), it fully controls them and will not unduly burden future citizens by borrowing.
- Your household requires money before it can spend it. The state can start spending and issue money later. Indeed, where do the £, $, € and ¥ come from that you spend? Before your household can pay taxes which the state allegedly needs to fund itself, the state needs to have issued and distributed the currency first – in other words, spent it.
- When Theresa May reminded the public in 2017 that there was “no magic money tree” to fund the NHS but shortly after found about £1bn to buy off the DUP for votes, she must’ve hired Indiana Jones to discover that precious tree. As long as a government enjoys monetary sovereignty, it cannot run out of money – it is the very source of it.
So why taxes?
If a government can simply print its own money or (more likely) increase it digitally in its Federal Reserve computers (US) or equivalent master accounts in the UK or elsewhere, why bother taxing?
Kelton notes that “just running the printing press” is unfortunately not going to work and names four reasons why taxation matters:
- Government needs people to work, earn money and pay tax to provision itself without using coercive force. If people had no need for a state’s currency (i.e. no need to pay taxes and having to earn money for that), the state would struggle to find all the teachers, plumbers, doctors and farmers who would be willing to provide their services or produce goods in exchange for currency.
- Inflation matters. If government allows too much money to exist in its system, it pushes up prices, as people may demand more money for the same goods or services. Therefore, government spending and taxes must be coordinated. E.g. increased government spending on healthcare or justice should increase taxes in other areas, forcing people or businesses to spend less or pay more tax when we do (i.e. currency flows back to the government through tax and therefore out of circulation).
- Taxes are a powerful tool to redistribute wealth and address unjustifiable social inequalities. Kelton states that capitalism runs on sales. If too much wealth is saved or invested long-term by an increasingly small number of people and companies, the majority of people don’t have sufficient income to spend and participate economically in society. Unjustifiable inequalities also corrode social cohesion and democratic forms of government.
- Taxes can incentivise or deter from behaviour deemed desirable or undesirable for the public good. This includes “sin taxes” on alcohol, tobacco or sugar but also beneficial tax breaks for minimising carbon emissions, saving water or investing in one’s education.
Given that not a week goes by where questions of taxation don’t come up at work, in the news or in your own home, it is worthwhile to reflect on what taxes are and why we have them at all. Kelton’s analysis of the household metaphor also reminds us that just because many people find an analogy intuitive, it doesn’t make it correct.
Benjamin Bestgen is a solicitor and notary public (qualified in Scotland). He also holds a Master of Arts degree in philosophy and tutored in practical philosophy and jurisprudence at the Goethe Universität Frankfurt am Main and the University of Edinburgh.