Regulatory Taxation; H. Sennholz

REGULATORY TAXATION t'J JJan6 :J.. Senn~olz WE often forget that the taxes levied by our govern ments aim not only at raising revenue but also at other purposes. Taxation today is the favorite weapon of in terventionism. Federal income taxes, for instance, un doubtedly are intended to yield some revenue but they also aim to bring about greater equality of wealth and income. Our legislators have always been aware of this "regu latory" aspect of taxation. Regulation through taxation formerly was limited, by and large, to protective tariffs which restricted the supply of certain goods in order to benefit certain producers. Today the regulatory objec tives are broader and more far-reaching. Some taxes aim at influencing the consumption of certain items. Some affect various sectors of production and trade. Others change business customs and conduct. And, finally, still others aim at controlling or changing our economic sys tem. In far too many cases, the revenue accruing to the government treasury is an insignificant side-effect of taxation.

Dr. Sennholz heads the Department of Economics at Grove City College, Pennsylvania. 100 REGULATORY TAXATION 101 Taxes intended to control consumption include those on alcoholic beverages and tobacco. Legislators and gov ernment officials, concerned about the health of taxpay ers, try to curb consumption by making these items more expensive. Such reasoning is dubious, however, be cause the demand for tobacco and alcoholic beverages is rather inelastic to price changes. People do not like to be coerced. They continue to smoke and drink in spite of taxes on consumption. Many of the legislators them selves are known to be notorious consumers of the very items they would tax out of use. These taxes, therefore, merely tend to lead to tax evasion and illegal production and trade. Another example of taxation aimed at consumption control is the levy on oleomargarine. The producers of butter, the dairy farmers, induced Congress and several state legislatures to tax oleomargarine because they found it offered serious competition to butter. They commanded a bloc of votes which directed the govern ment apparatus to take action against the margarine pro ducers. In this case, as in many others, government force has been employed to restrict competition in favor of one group to the detriment of another.

Other taxes are imposed to regulate certain sectors of production and trade. Almost half of our states levy spe cial taxes on chain stores. The avowed purpose of this tax ation is to handicap chain stores and restrict competition so as to favor small dealers. Again, a large bloc of votes directs the government apparatus against some citizens who lack effective representation.

102 HANS F. SENNHOLZ Another example of the regulatory objective of tax ation was the 10 per cent federal tax on state bank note circulation levied in 1865. In order to further the sale of war bonds, the federal government chartered national banks which were authorized to issue national bank notes against government bond collateral. The state bank notes, which banks could issue under state regula tion without war bond collateral, were taxed out of ex istence by the 10 per cent tax. The ultimate effect of this taxation was the supremacy of the federal government in matters of money and banking. Finally, the protective tariff is a tax that interferes with production and trade. It aims to handicap foreign producers and favor certain domestic producers to the detriment of all domestic consumers. If the rates are high enough, competition from foreign-made articles may be wholly denied, giving domestic producers a monopoly.

To Improve the Businessman's Conduct Other taxes aim to change business customs and con duct. Speculation, which is said to constitute harmful business conduct, is opposed by the central planners. They blame speculators for the economic booms and re cessions which their own intervention has caused. They charge the speculator with impeding and jeopardizing the government planning and blame him for their own failures. It cannot be surprising, therefore, that they try to turn the government apparatus against the speculator. Numerous Federal Reserve regulations restrict his use of REGULATORY TAXATION 103 money and credit. Speculation is further discouraged by taxes on short-term capital gains at double the rate on long-term gains. In order to improve business conduct in matters of em ployment, most states apply lower unemployment tax rates to employers with relatively stable employment rec ords. Their basic assumption is that business customs and procedures are responsible for unemployment which can be prevented, or at least alleviated, through a change of conduct. The effect of this tax discrimination, how ever, is quite the opposite of its intent. The industries that are most subject to losses during recessions are taxed at higher rates, which merely adds to their difficulties and increases unemployment.

A further example of this regulatory objective occurred during World War II when all wage increases paid with out prior government approval were treated as corporate income subject to tax in order to force businessmen to submit to government wage controls. More recently, in order to fight the "undesirable" business custom of re bates through trading-stamps, some states imposed heavy taxes on their issue, which in fact succeeded in eliminat ing them in those states. The last objective mentioned at the outset is the con trolling or changing of our economic system. Of course, the other objectives also aim at changing some aspects of our individual enterprise system. But they do not inten tionally aim to substitute interventionism or socialism for the enterprise system, although they interfere with the smooth operation of the economy and, therefore, 104 HANS F. SENNHOLZ may lead to more and more intervention until socialism is realized. The taxes that are· to control or change our free economic system are directed against its very founda tions: the profit incentive and capital accumulation.

This ominous objective came into the open some 25 years ago when Keynesian and institutional economics swayed people's minds. Numerous schemes were ad vanced for "taxing the country out of the depression." In order to encourage spending and penalize savings, the tax rates on corporate revenue and large personal in comes were raised sharply. A new tax, the undistributed profits tax of 1936, aimed at checking the accumulation of corporate earnings by management. It was hoped that there would be greater spending from dividends than from corporate earnings held back by management. The disastrous results of this new tax policy clearly reveal its fallacies. The New Deal taxes, together with a great number of antibusiness measures, aggravated and perpetuated the Great Depression, which held the nation in it~ grip from 1930 to the outbreak of World War II. Progressive income taxes and business taxes diminish the incentive to work. High-income executives and pro fessional men whose services are most urgently needed are induced to work less and retire sooner than they oth erwise would. Without the pecuniary incentive, fewer young men will choose a career requiring long and costly preparation or connected with uncertainty and risk; and this tends to reduce the supply of such labor, thus im peding economic progress.

It is no coincidence that throughout the capitalist era REGULATORY TAXATION 105 the most energetic and ambitious men in America went into business and became founders and promoters of successful enterprises. On the other hand, socialist and inteventionist societies offer to the ambitious little choice beyond the military services, a political career, or emigra tion to a capitalist country. Capital Consumed The destruction of personal incentive is not the only ominous result; the taxes that aim at the roots of our in dividual enterprise system also spend and consume what generations have built and accumulated. Heavy death duties and highly progressive business and income taxes tend to consume accumulated capital. True, such taxes do not immediately and visibly destroy such capital equipment as steel mills, railroads, or refineries. But they force the heirs or owners to sell all or part of the taxed estate in order to raise the cash demanded by the tax collectors. This cash or liquid capital then is taken and consumed by governments, thus preventing other invest ments and expansions which would have been made if there had been no inheritance tax.

In this connection, let us consider two other results of our confiscatory death duties. While still in his prime, the man who is both successful and responsible prepares financially for his demise. The owner and operator of a highly specialized enterprise tries to avoid leaving his business to his widow or heirs and the tax collectors. His widow usually knows little of its management and opera106 HANS F. SENNHOLZ tion. And she could hardly hope to sell it profitably with in the short period of time allowed for tax payment. Therefore, the businessman, while he lives, feels com pelled to sell out to his competitors. He can sell his busi ness under conditions as favorable as possible and then reinvest the proceeds in readily marketable securities, such as U.S. Treasury bonds. The death duty thus elimi nates an independent enterprise and channels productive capital into government debt.

The other result which flows from the peculiarity of our tax legislation is the formation of tax-exempt foun dations. Under the present laws a man may irrevocably hand over all or part of his wealth to a foundation that spends it or the income for religious, charitable, or edu cational purposes. But he may keep and pass on to his heirs the voting rights of his wealth. In other words, by forming a foundation, a businessman and his heirs may stay in control of the enterprise although the returns are to be spent by the foundation trustees. Again funds are taken from a productive enterprise and channeled largely toward consumption. Steeply graduated personal income taxes also reduce saving. Consumption expenditures of the higher income groups usually are less flexible .than their saving. The taxes are paid chiefly out of the income which otherwise would have been saved. Often, taxpayers find they must draw upon their savings accounts, sell some of their stock holdings, or borrow from banks to provide the funds for tax payments, all of which signifies capital consumption and lower capacity to produce.

REGULATORY TAXATION 107 Business profits and losses are the signals of the free enterprise system. A profit indicates that the businessman is efficiently satisfying the needs of consumers. Profits not only encourage but also provide the means for expan sion. Losses, on the other hand, indicate to the business man that his costs of production exceed the market price of his products and that he must produce more efficiently or else face bankruptcy. Taxes on profits interfere with these important sig nals. They weaken the signal of encouragement to a prof itable business and confiscate the means needed for ex pansion. Thus, taxes frustrate the adjustment the market demands, destroying the dynamism of competitive enter prise, protecting inefficient operators at the expense of more capable competitors. The capitalist economy thus loses its characteristics of quick adaptability, managerial efficiency, and keen competition. The fundamental pil lars of the free market are dangerously weakened by the present taxes on business profits.

There are two other taxation objectives gnawing at the foundations of· our system. One aims at checking business recessions through tax changes; the other in tends to prevent inflation through taxation. After every period of active inflation brought about by government deficit spending and credit expansion, the American economy goes through a readjustment. Im mediately, proposals are made to alter the tax system in order to stimulate business. The federal government is urged to increase expenditures-to "prime the pump" and simultaneously cut taxes. The recession is attributed 108 HANS F. SENNHOLZ to a mysterious reduction of spending on the part of con sumers and businessmen, and increased government ex penditures and reduced taxes are supposed to put addi tional spending power into the pockets of the public. Such spending is supposed to improve markets and stim ulate the economy. The tax relief is granted only to lower income groups, on the theory that they are sure to spend the money, whereas tax reductions for higher income groups might only lead to more saving and hoarding.

The Result Is Inflation There is one aspect of this spending program that is seldom considered. The additional spending power is created through inflationary devices on the part of the Federal Reserve System. Without inflation, the addi tional purchasing power which tax reductions grant consumers would be offset by a reduction of government purchasing power necessitated by lower revenues. If both consumers and government are to have more money to spend, only inflation can provide it. So, what these spend thrifts advocate is inflation and monetary depreciation. It is true that inflation may alleviate recession. It causes product prices to rise, which tends to make busi ness profitable again. But at the same time, it has a great number of disastrous effects. The purchasing power of the money is reduced. Creditors lose; debtors gain. Fixed-income receivers suffer. Capital is squandered and malinvested. And finally, at the end of the inflation spree there must be another readjustment, another recession.

REGULATORY TAXATION 109 Inflation is but a temporary makeshift that breeds more disaster than it can possibly alleviate. Inflation is the increase of the money supply by our monetary authorities. For our government to fight infla tion is a simple matter; it merely must order the Federal Reserve authorities to cease and desist from further money expansions. Any other measures, such as price and wage controls or additional tax burdens on the people, merely aim at the inflation symptoms but leave un touched the source of the evil. Higher business .taxes may even intensify the inflationary effects, inasmuch as they tend to restrict the output of goods. It is no wonder that American product prices are rising incessantly year after year while the money supply grows and business taxes absorb over 50 per cent of corporate earnings. There is no prospect of relief from this situation until the American people understand that inflation comes from governmental depreciation of the money, and that the present taxes deny the incentives by destroying the fruits of competitive private enterprise.