Taxes Are Paid

For most, this tax season is over. You may even have already received your refund or paid the taxes due. Some may consider going on a diet to save up enough money to pay that tax bill. Most of us are past the chore or the expense of getting taxes done. Now may be a suitable time to consider exactly why you pay taxes. So, before tax season totally disappears out of your rearview mirror, and while there is a lot of discussion in all corners of the media, let us see what good your tax dollars accomplish.

First, I want to cover federal taxes; your state and local taxes work differently, with some crossover with how federal taxes work. For most, if you ask them why they pay federal taxes, they will tell you it is to pay for anything the federal government does. Since everyone “knows that” let us look at what most folks do not know.

The single most powerful reason for the US government or any other national government to levy taxes is to make sure that people use the government’s currency. To illustrate, let us say Walmart creates its own “currency” called WallieBills. Walmart pays workers in WallieBills so they and customers can use WallieBills to buy stuff at Walmart. Using WallieBills results in lower prices. For customers that may work fine, WallieBills will function just like a store coupon. Workers face a significant issue. They cannot pay their taxes. The US federal government only accepts US dollars for tax payments. Sure, you can go to a bank that will accept your WallieBills and give you the going rate of exchange for US Dollars. Hopefully, you made enough WallieBills to pay your taxes. This situation will cause issues as tax season approaches, with an increase in people wanting to trade WallieBills and a decrease in those willing to exchange US dollars for them. Eventually people will demand their pay be in US dollars; eventually Walmart vendors will demand their payments be in US dollars as they run into tax payment shortages. Taxes enforce the government’s currency as the default method of payment. As this example illustrates.

Taxes assure the US Government of the US Dollar’s nationwide acceptance and also perform an important function in guiding social standards. Taxes imposed on activities considered a bad choice or that have a negative impact on society. In common parlance, these taxes are called “sin” taxes. The purpose of taxation is to place an added cost burden upon individuals who take part in socially unacceptable activities. So, we often see these taxes applied to items like alcohol, cigarettes, and marijuana. As societal values change, society may eliminate these taxes. These taxes serve as a deterrent. Pigovian taxes are defined as taxes whose sole purpose is to increase costs. Two examples that everyone would agree are socially positive Pigovian taxes are the cigarette tax and Bernie Sanders’ proposed tax on Wall Street trades.

Another major purpose of federal taxes is to regulate the risk of inflation. This is a powerful tool that governments must manage inflation risks, and like any other powerful tool, it needs to be wielded with discretion. Should we enter an era of high inflation over some arbitrary length of time, an increase in all tax rates could bring that inflation to a screeching halt. Sudden braking during a sharp curve can cause loss of vehicle control, heightening the risk. The lag time before the sudden decrease in spending money and when costs stabilize will toss many out of work, resulting in unpaid bills and further layoffs. A recession. Obviously, a blanket tax increase is not the most efficacious solution. Policymakers should cautiously increase taxes to manage inflation while ensuring the economy responds appropriately. In the long term, the driving analogy is apt since once the economy is running at high efficiency with full employment and total resource utilization, then a well-designed tax policy works wonderfully to keep the economy in its lane and traveling at the speed limit. Regarding taxation’s economic control, progressive taxation is crucial at the onset of inflation, as it imposes a smaller personal burden on higher earners compared to the working class. The purpose is to reduce demand so that supply can catch up. Eliminating demand across the income spectrum creates a situation where there will be near-zero demand for some goods and services. That will create layoffs and missed payments. Progressive tax increases on top earners enable the working class to manage expenses and sustain economic demand. This results in a lower demand for more expensive items within a limited market. Thus, the macroeconomic repercussions substantially diminish.

States and local governments also impose taxes. Of course, since inflation is a nationwide macroeconomic event, states do not tax to manage inflation. They do, however, collect Pigouvian taxes to manage negative externalities. But there is a fundamental difference between states and the federal government. The Constitution prohibits states from creating their own currency. But it allows Congress to create money, and by banning the only other sovereign entity (the states) from creating money, it has given Congress a monopoly power to issue money. It also gives Congress the sole authority to regulate interstate commerce. The two most important tools to manage the economy of the United States the Constitution reserves for the Federal government. Because of this, states, all individuals, and businesses are currency users, and only the US Government is a currency issuer.

Currency users must get money from the economy. People sell their labor to get currency and pay their taxes; businesses sell goods and services to get currency. States collect taxes to get currency as well, so that they can buy goods and services from the people and businesses. New US dollars originate whenever the Federal government spends. It does not need to get something it has in limitless supply. Tax collections affect how well the national economy runs since taxes serve as a “drain” for excess currency. The drainage helps manage inflation and it also works to prevent excess wealth from pooling in the hands of a few. This concept is the foundation of progressive taxation, wherein individuals with higher incomes are subject to a larger marginal tax rate as their earnings ascend. Money pools in the vaults of the ownership class, as has been seen throughout history. Higher marginal tax rates are introduced to compensate for the money no longer circulating in the economy, thus draining these financial reserves. Naturally, the very wealthy will put a tremendous political and financial pressure to resist funding public purpose programs. A common pushback technique is to blame the victim, and that is exactly what they do here. They make the argument that taxes fund federal spending, and it is YOUR tax dollars that are paying for highways you will not drive on, medical care for people that cannot even pay for insurance, and on and on.

Your tax dollars to your state pay for everything the state does. Your tax dollars to the Federal government manage the national economy by managing inflation and moderating income inequality. Pretty important stuff. The federal government does not collect taxes to pay for anything; it collects taxes to fulfill its Constitutional obligation to create an economy where the general welfare is provided for all, creating an economy where everybody has opportunity and an environment where wealth does not mean privilege.