April 15th has come and gone, but the issue of taxation remains the course de jour. I was recently forwarded an article entitled Taxes For Revenue Are Obsolete, written in 1946 by Beardsley Ruml, the former Chairman of the Federal Reserve Bank of New York and published in a periodical named American Affairs. While Ruml was writing about the merits of corporate taxes, it is his discussion about how the function of taxes changed after the nation exited the gold standard that make this a must read. As Ruml's stated, with an "...inconvertible currency, a sovereign national government is finally free of money worries and need no longer levy taxes for the purpose of providing itself with revenue... It follows that our Federal Government has final freedom from the money market in meeting its financial requirements... All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue." He goes on to explain how, with Federal spending not revenue constrained, the first function of taxation is to regulate the value of the dollar, which we know as regulating inflation. The notion of the Federal government 'running out of money' and 'dependence on foreign borrowing' as well as 'sustainability' is categorically inapplicable. The operative CBO 'scoring' is the inflationary effect, rather than simply a revenue forecast. And while Social Security and Medicare may turn out to be inflationary, they are not 'bankrupting the nation' as most believe, including a Democratic Congress that cut Medicare spending with the recent health care bill and has all entitlements 'on the table.'
Ruml's original text:
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Taxes For Revenue Are Obsolete
The superior position of public government over private business is nowhere more clearly evident than in government's power to tax business. Business gets its many rule-making powers from public government. Public government sets the limits to the exercise of these rule-making powers of business, and protects the freedom of business operations within this area of authority. Taxation is one of the limitations placed by government on the power of business to do what it pleases.
There is nothing reprehensible about this procedure. The business that is taxed is not a creature of flesh and blood, it is not a citizen. It has no voice in how it shall be governed --- nor should it. The issues in the taxation of business are not moral issues, but are questions of practical effect: What will get the best results? How should business be taxed so that business will make its greatest contribution to the common good?
It is sometimes instructive when faced with alternatives to ask the underlying question. If we are to understand the problems involved in the taxation of business, we must first ask: "Why does the government need to tax at all?" This seems to be a simple question, but, as is the case with simple questions, the obvious answer is likely to be a superficial one. The obvious answer is, of course, that taxes provide the revenue which the government needs in order to pay its bills.
It Happened
If we look at the financial history of recent years it is apparent that nations have been able to pay their bills even though their tax revenues fell short of expenses. These countries whose expenses were greater than their receipts from taxes paid their bills by borrowing the necessary money. The borrowing of money, therefore, is an alternative which governments use to supplement the revenues from taxation in order to obtain the necessary means for the payment of their bills.
A government which depends on loans and on the refunding of its loans to get the money it requires for its operations is necessarily dependent on the sources from which the money can be obtained. In the past, if a government persisted in borrowing heavily to cover its expenditures, interest rates would get higher and higher, and greater and greater inducements would have to be offered by the government to the lenders. These governments finally found that the only way they could maintain both their sovereign independence and their solvency was to tax heavily enough to meet a substantial part of their financial needs, and to be prepared ---if placed under undue pressure --- to tax to meet them all.
The necessity for a government to tax in order to maintain both its independence and its solvency is true for state and local governments, but it is not true for a national government. Two changes of the greatest consequence have occurred in the last twenty-five years which have substantially altered the position of the national state with respect to the financing of its current requirements.
Free of the Money Market
Final freedom from the domestic money market exists for every sovereign national state where there exists an institution which functions in the manner of a modern central bank, and whose currency is not convertible into gold or into some other commodity.
The United States is a national state which has a central banking system, the Federal Reserve System, and whose currency, for domestic purposes, is not convertible into any commodity. It follows that our Federal Government has final freedom from the money market in meeting its financial requirements. Accordingly, the inevitable social and economic consequences of any and all taxes have now become the prime consideration in the imposition of taxes. In general, it may be said that since all taxes have consequences of a social and economic character, the government should look to these consequences in formulating its tax policy. All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue.
What Taxes Are Really For
Federal taxes can be made to serve four principal purposes of a social and economic character. These purposes are:
In the recent past, we have used our federal tax program consciously for each of these purposes. In serving these purposes, the tax program is a means to an end. The purposes themselves are matters of basic national policy which should be established, in the first instance, independently of any national tax program.
Among the policy questions with which we have to deal are these:
These questions are not tax questions; they are questions as to the kind of country we want and the kind of life we want to lead. The tax program should be a means to an agreed end. The tax program should be devised as an instrument, and it should be judged by how well it serves its purpose.
By all odds, the most important single purpose to be served by the imposition of federal taxes is the maintenance of a dollar which has stable purchasing power over the years. Sometimes this purpose is stated as "the avoidance of inflation"; and without the use of federal taxation all other means of stabilization, such as monetary policy and price controls and subsidies, are unavailing. All other means, in any case, must be integrated with federal tax policy if we are to have tomorrow a dollar which has a value near to what it has today.
The war has taught the government, and the government has taught the people, that federal taxation has much to do with inflation and deflation, with the prices which have to be paid for the things that are bought and sold. If federal taxes are insufficient or of the wrong kind, the purchasing power in the hands of the public is likely to be greater than the output of goods and services with which this purchasing demand can be satisfied. If the demand becomes too great, the result will be a rise in prices, and there will be no proportionate increase in the quantity of things for sale. This will mean that the dollar is worth less than it was before --- that is inflation. On the other hand, if federal taxes are too heavy or are of the wrong kind, effective purchasing power in the hands of the public will be insufficient to take from the producers of goods and services all the things these producers would like to make. This will mean widespread unemployment.
The dollars the government spends become purchasing power in the hands of the people who have received them. The dollars the government takes by taxes cannot be spent by the people, and, therefore, these dollars can no longer be used to acquire the things which are available for sale. Taxation is, therefore, an instrument of the first importance in the administration of any fiscal and monetary policy.
To Distribute the Wealth
The second principal purpose of federal taxes is to attain more equality of wealth and of income than would result from economic forces working alone. The taxes which are effective for this purpose are the progressive individual income tax, the progressive estate tax, and the gift tax. What these taxes should be depends on public policy with respect to the distribution of wealth and of income. It is important, here, to note that the estate and gift taxes have little or no significance, as tax measures, for stabilizing the value of the dollar. Their purpose is the social purpose of preventing what otherwise would be high concentration of wealth and income at a few points, as a result of investment and reinvestment of income not expended in meeting day-to-day consumption requirements. These taxes should be defended and attacked it terms of their effects on the character of American life, not as revenue measures.
The third reason for federal taxes is to provide a subsidy for some industrial or economic interest. The most conspicuous example of these taxes is the tariffs on imports. Originally, taxes of this type were imposed to serve a double purpose since, a century and a half ago, the national government required revenues in order to pay its bills. Today, tariffs on imports are no longer needed for revenue. These taxes are nothing more than devices to provide subsidies to selected industries; their social purpose is to provide a price floor above which a domestic industry can compete with goods which can be produced abroad and sold in this country more cheaply except for the tariff protection. The subsidy is paid, not at the port of entry where the imported goods are taxed, but in the higher price level for all goods of the same type produced and sold at home.
The fourth purpose served by federal taxes is to assess, directly and visibly, the costs of certain benefits. Such taxation is highly desirable in order to limit the benefits to amounts which the people who benefit are willing to pay. The most conspicuous examples of such measures are the social security benefits, old-age and unemployment insurance. The social purposes of giving such benefits and of assessing specific taxes to meet the costs are obvious. Unfortunately and unnecessarily, in both cases, the programs have involved staggering deflationary consequences as a result of the excess of current receipts over current disbursements.
The Bad Tax
The federal tax on corporate profits is the tax which is most important in its effect on business operations. There are other taxes which are of great concern to special classes of business. There are many problems of state and local taxation of business which become extremely urgent, particularly when a corporation has no profits at all. However, we shall confine our discussion to the federal corporation income tax, since it is in this way that business is principally taxed. We shall also confine our considerations to the problems of ordinary peacetime taxation since, during wartime, many tax measures, such as the excess-profits tax, have a special justification.
Let us examine these three bad effects of the tax on corporation profits more closely. The first effect we observed was that the corporation income tax results in either higher prices, lower wages, reduced return on investment, or all three in combination. When the corporation income tax was first imposed it may have been believed by some that an impersonal levy could be placed on the profits of a soulless corporation, a levy which would be neither a sales tax, a tax on wages, or a double tax on the stockholder. Obviously, this is impossible in any real sense. A corporation is nothing but a method of doing business which is embodied in words inscribed on a piece of paper. The tax must be paid by one or more of the people who are parties at interest in the business, either as customer, as employee, or as stockholder.
It is impossible to know exactly who pays how much of the tax on corporation profits. The stockholder pays some of it, to the extent that the return on his investment is less than it would be if there were no tax. But, it is equally certain that the stockholder does not pay all of the tax on corporate income --- indeed, he may pay very little of it. After a period of time, the corporation income tax is figured as one of the costs of production and it gets passed on in higher prices charged for the company's goods and services, and in lower wages, including conditions of work which are inferior to what they otherwise might be.
The reasons why the corporation income tax is passed on, in some measure, must be clearly understood. In the operations of a company, the management of the business, directed by the profit motive, keeps its eyes on what is left over as profit for the stockholders. Since the corporation must pay its federal income taxes before it can pay dividends, the taxes are thought of --- the same as any other uncontrollable expense --- as an outlay to be covered by higher prices or lower costs, of which the principal cost is wages. Since all competition in the same line of business is thinking the same way, prices and costs will tend to stabilize at a point which will produce a profit, after taxes, sufficient to give the industry access to new capital at a reasonable price. When this finally happens, as it must if the industry is to hold its own, the federal income tax on corporations will have been largely absorbed in higher prices and in lower wages. The effect of the corporation income tax is, therefore, to raise prices blindly and to lower wages by an undeterminable amount. Both tendencies are in the wrong direction and are harmful to the public welfare.
Where Would the Money Go?
Suppose the corporation income tax were removed, where would the money go that is now paid in taxes? That depends. If the industry is highly competitive, as is the case with retailing, a large share would go in lower prices, and a smaller share would go in higher wages and in higher yield on savings invested in the industry. If labor in the industry is strongly organized, as in the railroad, steel, and automotive industries, the share going in higher wages would tend to increase. If the industry is neither competitive nor organized nor regulated --- of which industries there are very few --- a large share would go to the stockholders. In so far as the elimination of the present corporation income tax would result in lower prices, it would raise the standard of living for everyone.
The second bad effect of the corporation income tax is that it is a distorting factor in management judgment, entering into every decision, and causing actions to be taken which would not have been taken on business grounds alone. The tax consequences of every important commitment have to be appraised. Sometimes, some action which ought to be taken cannot be taken because the tax results make the transaction valueless, or worse. Sometimes, apparently senseless actions are fully warranted because of tax benefits. The results of this tax thinking is to destroy the integrity of business judgment, and to set up a business structure and tradition which does not hang together in terms of the compulsion of inner economic or engineering efficiency.
Premium on Debt
The most conspicuous illustration of the bad effect of tax consideration on business judgment is seen in the preferred position that debt financing has over equity financing. This preferred position is due to the fact that interest and rents, paid on capital used in business, are deductible as expense; whereas dividends paid are not. The result weighs the scales always in favor of debt financing, since no income tax is paid on the deductible costs of this form of capital. This tendency goes on, although it is universally agreed that business and the country generally would be in a stronger position if a much larger proportion of all investment were in common stocks and equities, and a smaller proportion in mortgages and bonds.
It must be conceded that, in many cases, a high corporation income tax induces management to make expenditures which prudent judgment would avoid. This is particularly true if a long-term benefit may result, a benefit which cannot or need not be capitalized. The long-term expense is shared involuntarily by government with business, and, under these circumstances, a long chance is often well worth taking. Scientific research and institutional advertising are favorite vehicles for the use of these cheap dollars. Since these expenses reduce profits, they reduce taxes at the same time; and the cost to the business is only the margin of the expenditure that would have remained after the taxes had been paid --- the government pays the rest. Admitting that a certain amount of venturesome expenditure does result from this tax inducement, it is an unhealthy form of unregulated subsidy which, in the end, will soften the fibre of management and will result in excess timidity when the risk must be carried by the business alone.
The third unfortunate consequence of the corporation income tax is that the same earnings are taxed twice, once when they are earned and once when they are distributed. This double taxation causes the original profit margin to carry a tremendous burden of tax, making it difficult to justify equity investment in a new and growing business. It also works contrary to the principles of the progressive income tax, since the small stockholder, with a small income, pays the same rate of corporation tax on his share of the earnings as does the stockholder whose total income falls in the highest brackets. This defect of double taxation is serious, both as it affects equity in the total tax structure, and as a handicap to the investment of savings in business.
Shortly, an Evil
Any one of these three bad effects of the corporation income tax would be enough to put it severely on the defensive. The three effects, taken together, make an overwhelming case against this tax. The corporation income tax is an evil tax and it should be abolished.
The corporation income tax cannot be abolished until some method is found to keep the corporate form from being used as a refuge from the individual income tax and as a means of accumulating unneeded, uninvested surpluses. Some way must be devised whereby the corporation earnings, which inure to the individual stockholders, are adequately taxed as income of these individuals.
The weaknesses and dangers of the corporation income tax have been known for years, and an ill-fated attempt to abolish it was made in 1936 in a proposed undistributed profits tax. This tax, as it was imposed by Congress, had four weaknesses which soon drove it from the books. First, the income tax on corporations was not eliminated in the final legislation, but the undistributed profits tax was added on top of it. Second, it was never made absolutely clear, by regulation or by statute, just what form of distributed capitalization of withheld and reinvested earnings would be taxable to the stockholders and not to the corporation. Third, the Securities and Exchange Commission did not set forth special and simple regulations covering securities issued to capitalize withheld earnings. Fourth, the earnings of a corporation were frozen to a particular fiscal year, with none of the flexibility of the carry-forward, carry-back provisions of the present law.
Granted that the corporation income tax must go, it will not be easy to devise protective measures which will be entirely satisfactory. The difficulties are not merely difficulties of technique and of avoiding the pitfalls of a perfect solution impossible to administer, but are questions of principle that raise issues as to the proper locus of power over new capital investment.
Can the government afford to give up the corporation income tax? This really is not the question. The question is this: Is it a favorable way of assessing taxes on the people --- on the consumer, the workers and investors --- who after all are the only real taxpayers? It is clear from any point of view that the effects of the corporation income tax are bad effects. The public purposes to be served by taxation are not thereby well served. The tax is uncertain in its effect with respect to the stabilization of the dollar, and it is inequitable as part of a progressive levy on individual income. It tends to raise the prices of goods and services. It tends to keep wages lower than they otherwise might be. It reduces the yield on investment and obstructs the flow of savings into business enterprise.
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Further, I object to your assertion of double-taxation of corporate profits. I was of the understanding that the system of franknig credits applied to dividends simply assessed the individual income at the (pre-tax) dividend level, then taxed you at the personal rate. If the personal rate was lower than the CIT rate, you received the difference; if it was higher, you paid it.
The problem with taxing corporate income without discriminating between investment in R&D and capital goods, on one hand, and pay-through to individuals as investors is that in puts a damper on investment when investment is required for the economy to grow enough to match growth of population. The US grows at the rate of needing to create over 100,000 jobs every month just to stay even.
An interesting combination - Chartalist economic views combined with corporate tax-break advocacy. However, under Chartalist theory, the purpose of taxes is indeed not to finance government spending (as you rightly pointed out), it is to create a demand for fiat money, as the Government legislates taxation, and deamnds that taxes be paid in the currency of its choice. I'm not at all certain that your proposal would work, especially given the high - and increasing - trends of foreign ownership of the USA's businesses.
Therefore, disbursements should ideally be targeted to both consumption (consumer goods) and investment (capital goods), and taxation to reducing consumption but not necessarily investment, since increasing supply reduces excess demand. For this reason it is more economically advisable to tax consumption instead of investment in order to reduce demand when the economy is overheating. Corporate profits can only go to investment and taxable payments to individuals, employees and investors. Ruml is saying to leave retained earnings untaxed in anticipation of them being invested. However, all corporate earnings that accrue to individuals as income or other disbursements of profit (including to foreign investors) would subject to taxation.
This is the point of what Ruml is saying.
“The Bretton Woods Conference took place in July 1944, but did not become operative until 1959, when all the European currencies became convertible. Under this system, the IMF and the IBRD were established. The IMF was developed as a permanent international body. The summary of agreements states, "The nations should consult and agree on international monetary changes which affect each other. They should outlaw practices which are agreed to be harmful to world prosperity, and they should assist each other to overcome short-term exchange difficulties." Wikipedia
Thus, Ruml's analysis didn't apply until after 1971 when the President Nixon dropped gold convertibility. Subsequently, and his analysis became fully indeed applicable and remains so to this day.
The economist magazine says that Europe taxes companies less and individuals more
I agree because corporations aviod tax anyway, and as this author says,encourage better business practice re debt etc
But you have to tax the money that people get out of the corp. weather they call it stock option, salary,investment,free lunch, lodging provided, perks etc and probably tax it all at the same rate
which is a better idea as the writer says
...feel dumb because I misunderstood
http://bilbo.economicoutlook.net/blog/?p=9281&cpage=1#comment-5600
the gov't it not using tax policy wisely
it is subsidizing bad apples,while citizens cant make it
we want work that pays, no one with a job should need welfare
Debt is no problem til you melt down, ask greece and argentina
Countries that are not monetarily sovereign are like states in the US. That is, they are revenue constrained. Monetarily sovereign nations like the US are not revenue constrained under the current monetary regime.
Only the 'tax' of minting money is an unjust, recessive one, because by lowering the value of assets it increases pressure to invest and disproportionately punishes those individuals not wealthy enough to invest most of their income.
I disagree that a taxation upon investment is a bad thing. Disproportionately low taxes on investment have led to our nation being severely overcapitalized, and has as a result persistently destabilized our economy as people with more wealth than they know what to do with have thrown that wealth into anything that could promise them returns - with the tendency of the riskier ventures to catastrophically crash, actively harming the rest of the economy and American people.
It's walking and quacking like a duck.
Inflation makes savers of cash poorer and borrowers of cash wealthier. It makes owners of physical real assets wealthier. In purchasing power it makes all the citizens poorer relative to the rest of the world. It creates huge inefficiencies and typically drives poor decision making by individuals and corporations. All economic research points to the fact that the poor and middle class do worse in high inflation countries.
I do not understand the point of your article. Just because people use an inaccurate description of the problem, does not mean the problem does not exist. Constantly spending more than your revenues does cause a problem, inflation.
Are you trying to say it is okay to increase inflation as long as the value of the transfer payment (point 2) or the value of the public policy subsidized (point 3) is of moral enough standing? That we should not worry about the real cost if we are doing the morally right thing by transferring wealth from one citizen to another?
Please clarify the point of this. Thank you.
And note that Japan has a 'national debt' more than double the US and has been running very high annual deficits going on 20 years, with a strong currency, no inflation, and risk free rates near 0.
Looks to me like overly tight fiscal given their stated goals
see 'the 7 deadly innocent frauds of economic policy' at http://www.moslereconomics.com/?p=8662/
thanks!
First, although you do qualify most of your statements with the fact that a side effect of total currency in circulation greater than the need to support spending is inflation, you never quantify that cost. If we have twice as many dollars in the “store that is the economy” than is needed to purchase everything in the store then the price for the goods has to go up. The other choice is for taxes to go up so that the government can shred that money.
Second, the federal government is very minimally involved in education. It seems to me that you are suggesting that the federal government (not the children, oops, States) pay for it, as it can print the money to pay for the facilities and teachers and then either inflate or tax that excess money out of the system.
Lastly, you are absolutely correct that we benefit from trade. The concern is that if our partners were to sell the dollars and buy their own currency then the dollar would weaken and we could only buy fewer goods from others, making us worse off. The only reason it works is because many partners sterilize the currency impact by buying US Treasury bonds, which delays the weakening of our currency into the future.
I mean it is not like they benefit from any of that...oh wait....
http://www.huffingtonpost.com/warren-mosler/proposals-for-the-banking_b_432105.html
I expect he would have comparable proposals for reforming corporate structure as well, to improve incentives and reform excesses and deficiencies.
If we don't need taxes for revenue then how does government pull in revenue? Borrowing endlessly makes zero fiscal sense.
The federal government can fund anything it chooses politically without taxing or borrowing, and it can never ever “go bankrupt,” “run out of money,” “become insolvent,” or “default” on debt issued it issues in its own currency. Claiming that these things are even possible let alone likely, is like saying that games are limited because the scoreboard could run out of points, as Warren has pointed out elsewhere. It is just ridiculous.
We are in 2 wars and the gov has to have money from the entire population.
We are suffering from a chronic case of "head in sand" !!
Ruml and Lerner were writing at the time that the gold standard had collapsed and before the reinstitution of a convertible fixed rate international regime at Bretton Woods. Nixon later ended convertibility when he shut the gold window on August 15, 1971, subsequent to which the US became monopoly (sovereign) provider of a nonconvertible flexible rate currency of issue.
A nonconvertible flexible (floating) rate currency is called a fiat currency. "Fiat" is a Latin word meaning "let it be." A monetarily sovereign government issuing fiat currency is not monetarily constrained and does not need to fund its currency issuance with taxation or finance it with debt issuance. Currency is issued by crediting nongovernment bank accounts.
Funds are appropriated in the budget and the various government agencies disburse these funds as directed. Treasury credit the appropriate bank accounts or send out checks. The Federal Reserve (central bank) provides the reserves for settlement. This results in a net increase of nongovernment net financial assets because there is a nongovernment asset created (increase in a bank account) and no corresponding liability in nongovernment.
Government is not financially constrained, but may be politically constrained, e.g., by a requirement to balance the budget or to offset deficits with debt issuance. This simply limits policy options in the name of "fiscal responsibility," when no such requirement is needed or helpful. These voluntary constraints should be removed and government should use fiscal policy to manage nominal aggregate demand relative to real output capacity, so as to achieve full employment with price stability. Full employment is the mandate of the Federal Reserve, but monetary policy has shown itself to be unable to accomplish it. Instead, the Fed targets inflation using interest rates management and unemployment becomes a policy tool instead of a policy target. That is unnecessary with an operationally realistic understanding of how the current monetary system works.
And while reading your article I came to realize that since the Supreme Court gave the corporation the same status as individuals who vote, then they also should have the right to be taxed THE SAME as individuals in America.They should not get welfare handouts, tax deductions and loopholes to avoid paying taxes or any other tax exemption that is different from average taxpayers/voters. That would solve a lot of the deficit problems.
Not fair you say....? The American people say the decision by the Supreme court to buy votes is unfair. I say, if the corporations want to run Washington, let them pay ALL the bills. It's only fair.
The point of this post is his operational understanding that once the gold standard was dropped taxes function to control inflation, and not to raise revenue per se. Solvency is no longer an issue. It's about inflation, and not the govt running out of money or going broke.
This understanding is critical to understanding that fiscal responsibility is about getting the economy right, and not balancing the budget per se.
My article on China and foreign trade is elsewhere on this website.
Search 'mosler' for all of my previous posts, thanks.