The world according to GRP — Wednesday, January 23, 2008:
Right and wrong ways to abolish taxation
One Salient Oversight has proposed a "Zero Tax Economic System", which he explains as follows:
- All taxes are removed...
- The government creates the money it needs via seigniorage (printing money).
- The Central bank then controls inflation by increasing the Reserve requirement of bank deposits...
The proposal was picked up and debated at Angry Bear and later at Megan McArdle, where both McArdle and commenter "Leonard" tacitly acknowledge that the reserve fraction — that is, the fraction of deposits that financial institutions must hold in cash — would need to rise above 100%. Indeed, if the government issues new money in excess of that required by economic growth, the reserve fraction must rise in order to soak up the excess. If the creation of new money is recurrent, the rise of the reserve fraction must also be recurrent, in which case the reserve fraction will crash through 100% and keep on climbing.
But wait a minute. If the government is pumping money into circulation and withdrawing it almost as fast by raising the reserve fraction, why not "close the loop" by using the withdrawn money as revenue? In other words, why not treat the withdrawn money as tax? Commenter "jefff" at Angry Bear makes the same point when he writes:
If you make the banks sit on more and more cash each month that they are not allowed to use it is the same thing as a tax.
Basically you have created a source of money in your money printing to fund the government, and you have created a sink for money with the reserve requirement. It is the same as if that money the banks are not allowed to touch had gone to the government, and the government had not printed money. So if such a system could ever balance you would have simply replaced the current tax system with an effective tax on bank deposits.
Exactly. And the burden of the tax on bank deposits would be passed on to customers in the interest margin — that is, the margin by which the interest paid by borrowers exceeds that paid to depositors.
What sort of tax rate or interest margin are we talking about? For a ballpark estimate, suppose that the total of at-call deposits is 50% of annual GDP, and that government spending is 25% of GDP. Then the government annually spends 50% of total at-call deposits, in which case, to maintain a constant money supply, deposits must be taxed at 50% per annum, payable in the same money that the government spends. This tax sets a floor under net interest margins; to cover the tax, a bank must charge borrowers at least 50% per annum more than it pays to depositors.
Even in the absence of taxes, such a huge interest margin would be ruinous to depositors and borrowers. Both parties would need to "cut out the middleman", but this would be illegal because the "middleman" also happens to be the tax collector. So the only source of credit would be the underground economy, and life would be "solitary, poore, nasty, brutish, and short."
So One Salient Oversight is wrong when he claims that under his proposal,
... government revenue is indirectly raised from the broadest possible base. This proposed system does not really create money from nothing — the raising of the Reserve requirement of bank deposits balances out the seigniorage. This means, in effect, that the tax burden is still there — it's just that it has transferred into the marketplace in the form of higher market interest rates, which affects the entire economy.
If the tax burden were indeed simply replaced by higher interest, this would be bad enough, because it would encourage hoarding of money and deter productive investment. But in fact the tax burden would be replaced by a higher interest margin, which would not only deter investment but also chase away the deposits from which such investment might be funded, and which are supposed to be the source of public revenue.
This destruction of deposits is just another example of how a tax reduces the supply of the taxed commodity. One can avoid this effect by taxing a commodity in inelastic supply — such as land. Hence, while it is not feasible to finance government from the interest of bank deposits, it is perfectly feasible to finance government from the economic rent of land. Moreover, if a certain portfolio of land (or shares in land) yields enough revenue to replace existing taxes, that portfolio should have the same market value as the right to impose the taxes, in which case the government, without resorting to any compulsion, should be able to buy the land portfolio by giving up its taxing rights.
In other words, while one cannot abolish taxes through a tax/interest trade-off, one should be able to do so through a tax/rent trade-off. That's my approach to the "Zero Tax Economic System".
[Featured in the American Economics Blog Carnival (posted Mar.30) at Struck in Traffic.]
Copyright © Gavin R. Putland except as otherwise attributed. Posted at The world according to GRP under the title Right and wrong ways to abolish taxation. You may republish this item verbatim on your website or blog provided that you include this notice (with hyperlinks).
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