The Government Raises Money: Introduction to Some Basic Concepts of Taxes and Taxing Income

AuthorWilliam Kratzke
Chapter 1: The Government Raises Money: Introduction to Some
Basic Concepts of Taxes and Taxing Income
I. Introduction to Some Basic Concepts
The word is out: the United States Government needs money in order to operate.
The vast majority of us do want the government to operate and to continue to
provide benefits to us. There are many ways in which the Government may
endeavor to raise money, only one of which is to tax its own citizens on their
income. A few examples follow:
Tariffs: The Government might impose tariffs (i.e., taxes) on imports or exports.
In order to sell their wares in the United States, foreign merchants at one time had
to pay very high tariffs. Tariffs would of course protect domestic producers of the
same wares who did not have to pay such tariffs. However, this hardly helps
domestic consumers of products subject to a tariff because they must either pay an
artificially inflated price for an import or a higher price for a (lower-quality?)
domestic product. Export duties could also have a pernicious effect. They
encourage domestic producers to endeavor to sell their goods at home, rather than
in foreign markets where they might have made more profits. Export tariffs also
discourage imports of perhaps more efficiently produced (and therefore more
inexpensive) foreign imports. And notice: the use of tariffs as a means of raising
revenue creates a cost that mostly the buyers and sellers of those products alone
pay. The burden of paying for Government is not spread very evenly if tariffs are
the means of raising revenue to support the Government. Nevertheless, tariffs were
one very important source of revenue for our country in its early days. This is not
nearly so true any longer.
Government Monopoly: The Government might choose to enter a business and
perhaps make competition in that business unlawful. Lotteries were illegal in most
places until some wag discovered that the state could make a lot of money by
engaging in the business of running lotteries and giving itself a monopoly over the
business. Nowadays, most states have lotteries that they run with no competition
other than what they are willing to tolerate, e.g., low-stakes bingo games that
charities operate. One argument favoring this means of financing government is
that there is no compulsion to buy lottery tickets, i.e., willing buyers contribute to
the Government coffers. States may also become quite adept at making customers
feel good about buying lottery tickets because the state is able to do so much good
with the money it raises. Again, the burden of paying for what lottery proceeds
purchase falls only on the consumers of lottery tickets. Many non-purchasers derive
benefits from lottery proceeds at the expense of those willing to give up some of
their wealth in the forlorn hope of hitting it big. Governments may engage in
businesses other than lotteries. For example, many states own the liquor stores that
operate within its borders. Governments may charge for services that they provide
with a view to making profits that are spent in pursuit of other government
objectives. There is always the risk that the Government might not be very good at
running a particular business. Government-operated airlines are notorious money-
losers. And again, why should consumers of certain products or services be saddled
with the burden of paying for a government that (should) benefit(s) all of us?
Taxing Citizens: Instead of trying to raise money from those willing to give it to
the Government, Government may tax its citizens or residents and perhaps try to
tax non-citizens or non-residents. This raises the question of what it is government
should tax or more formally, what should be the “tax base.” There are various
The Head Tax: A head tax is a tax imposed on everyone who is subject to it, e.g.,
every citizen or resident, every voter. The tax is equal in amount for all who must
pay it. A head tax has the advantage that it is only avoidable at a cost unacceptable
to most (but not all) of us: leave the country, renounce one’s U.S. citizenship,
surrender the right to vote. Its relative inescapability assures that all who derive
some benefit from the existence of a government bear its cost burden. A head tax
of course has many drawbacks. Obviously, its burden falls unequally on those
subject to it. Some persons might hardly notice a head tax of $1000 per year while
others might find it to be a nearly insurmountable hardship. Surely we as a society
have a better sense of fairness than that. With one notable exception, we hear very
little of involuntary head taxes in the United States.
The notable exception was the poll tax whereby some southern states in the post-
Civil War era imposed a uniform tax, payment of which was necessary in order to
vote. The very purpose of imposing such a tax was to discourage recently
emancipated and almost uniformly poor Black persons from asserting their
constitutional right to vote. The unfairness of the relative tax burdens associated
with this cost of voting led to adoption of the 24th Amendment to the Constitution,
which made poll taxes unconstitutional.
Consumption Taxes: As the name implies, consumption taxes tax consumption.
There are different variants of consumption taxes. Three important consumption
taxes are the sales tax, the excise tax,
and the value added tax (VAT).
Sales Tax: A sales tax is a tax
on sales and are usually a flat
percentage of the amount of
the purchase. Sellers usually
collect sales taxes at the point
of sale from the ultimate
consumer. Many states and
localities rely on a sales tax
for a substantial portion of
their revenue needs. Sales
taxes are relatively easy to
collect. By their very nature,
sales taxes are not collected
on amounts that citizens or
residents save. Hence, their
effect is more burdensome to
those persons who must spend
more (even all) of their
income to purchase items subject to a sales tax. While such taxes are
nominally an equal percentage of all purchases, their effect is regressive
(infra) for those who accumulate no wealth and who spend all of their
income on items subject to them.
In states that have sales taxes applicable to all purchases, every citizen or
resident who buys anything pays some sales tax. In this sense,
citizen/beneficiaries may more equitably share the burden of paying for
state or local government than is the case of the financing schemes already
noted.1 The recent financial crisis has made clear that a state’s revenues are
1 Of course, state legislatures may carve out exceptions. Purchases of food might not be subject to a
sales tax, or be subject to a reduced sales tax. Purchases of services might not be subject to a sales tax.
Online purchasers from out-of-sta te sellers who have no physical presence within a state are not (yet)
subject to sales taxes. See Quill v. North Dakota, 504 U.S. 298 (1992).
The Ramsey Principle: Taxes on items for which
demand is inelastic raise the most revenue for
the state. See F.P. Ramsey, A Contribution to the
Theory of Taxation, 37 ECON. J. 47 (1927). For
our purposes, “inelastic demand” means that
the quantity that buyers buy does not change
(much) as prices increase or decrease. A life-
saving drug might be such an item. Taxes on
items for which demand is inelastic will not
divert consumers’ purchase to or from those
items, i.e., they do not distort markets as much
as other taxes might. Unfortunately, the things
for which demand is inelastic are often things
that poorer people must buy. Strict adherence
to the Ramsey principle would create an
excessive burden for those least well-
Moreover, the burdens of such taxes would not
fall evenly across those who benefit from them.

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