Ancient Economic Wisdom Still Applies Today

05/09/2010 05:12 am ET | Updated May 25, 2011

You've probably never heard of Ibn Khaldun. He was a 14th century Arab historian. At least, he is remembered as a historian, although that was only his hobby. His real job was serving as a high official in several governments in North Africa, Spain and the Middle East. At his death, he was Egypt's Minister of Justice.

From his vantage point as a high government official, he witnessed the rise and fall of several states in the region. Regarding economic policy, he concluded:

At the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments. ...

When tax assessments and imposts upon the subjects are low, [businesspeople] have the energy and desire to do things. Cultural enterprises grow and increase, because the low taxes bring satisfaction. When businesses grow, the number of individual imposts and assessments mounts. In consequence, the tax revenue, which is the sum total of (the individual assessments), increases.

Royal authority with its tyranny, and sedentary culture that stimulates sophistication, make their appearance. ... The individual imposts and assessments upon the subjects, agricultural laborers, farmers, and all the other taxpayers, increase. Every individual impost and assessment is greatly increased, in order to obtain a higher tax revenue. ... Gradual increases in the amount of the assessments succeed each other regularly. ... Eventually, the taxes will weigh heavily upon the subjects and overburden them. Heavy taxes become an obligation and tradition, because the increases took place gradually, and no one knows specifically who increased them or levied them. They lie upon the subjects like an obligation and tradition.

... The result is that the interest of the subjects in business activity disappears, since when they compare expenditures and taxes with their income and gain and see the little profit they make, they lose all hope. Therefore, many of them refrain from business activity all cultural activity. The result is that the total tax revenue goes down, as (the number of) the individual assessments goes down. Often, when the decrease is noticed, the amounts of individual imposts are increased. This is considered a means of compensating for the decrease. Finally, individual imposts and assessments reach their limit. It would be of no avail to increase them further. The costs of all cultural enterprise are now too high, the taxes are too heavy, and the profits anticipated fail to materialize. Thus, the total revenue continues to decrease, while the amounts of individual imposts and assessments continue to increase, because it is believed that such an increase will compensate (for the drop in revenue) in the end. Finally, civilization is destroyed, because the incentive for buisness activity is gone. It is the dynasty that suffers from the situation, because it (is the dynasty that) profits from business activity.

If (the reader) understands this, he will realize that the strongest incentive for economic activity is to lower as much as possible the amounts of individual imposts levied upon persons capable of undertaking businesses. In this manner, such persons will be psychologically disposed to undertake them, because they can be confident of making a profit from them.

The secret of economic success is the Magic Formula:

Low Taxes
Stable Money

It should be intuitively obvious that a capitalist economy cannot thrive with high taxes and an unstable money. However, if we look at the economic policies of most governments today, they are clearly on a path toward higher taxes, and probably some monetary excitement as well.

The halls of power are filled today with advisors saying that we "need" higher taxes. It is a conversation no different than might have taken place in a minor sultanate in the mid-14th century.

The usual result of this strategy, Khaldun says, is the "end of the dynasty." Do we "need" to grind this nation into the dust of history? Or do we "need" to encourage business activity instead?

Look at this graph:

What do you see? I'll tell you what I see: a straight line.

The graph shows U.S. Federal tax revenues as a percent of GDP. It comes directly from the Congressional Budget Office. There is a little minor variation, mostly corresponding to the business cycle, but the line has basically been flat for sixty years.

During this time, tax rates have gone up, down, up again, and down again. Exemptions have grown or shrank. None of it has made a bit of difference.

As Khaldun says, higher tax rates won't bring in any more revenue. However, they can definitely have an economic effect. If a tax hike doesn't increase the revenue-to-GDP ratio, but GDP declines due to the economic effect of the tax hike, what is the net effect? Obviously, the same ratio multiplied by a lower GDP equals lower tax revenues, compared to doing nothing at all.

The tax hike results in lower revenues. Just like Khaldun said.

I know there will be a thousand -- nay, a million! - people saying I'm wrong. It doesn't matter. It's not a matter of opinion. It's a matter of cause and effect.