Taxes have a long reign near the top of discussion topics. But it can be striking how much nonsense and confusion is both advanced and accepted about taxation.
A good way to understand some of the basics of taxation better is by analogy to the game of dodgeball.
In the game of tax dodgeball, government is the one doing the ball throwing. Those in government always insist they don’t want to hit/hurt anyone, but their desire for tax revenue leads them to throw the burdens at citizens anyway. They have no resources of their own to finance what they want to do, only what they extract from their people. Of course, that means politicians’ constantly expressed intent to only help citizens becomes meaningless, because they hurt others anyway.
In any market, the dodgers are made up of buyers/users on one team and sellers/producers on the other. None of the “players” wish to be hit with the burdens of taxes, so they dodge. Their efforts at dodging are costly, so those costs (e.g., floor burns and injuries sustained) of playing the game also must be included in their burdens, along with the tax revenue extracted from them (in the tax version of dodgeball, those extra burdens are due to the reduced production and exchange that will take place in those markets, which wipes out the wealth that those mutually beneficial arrangements would have otherwise created). The players’ overall dodging success will determine the frequency with which someone will be hit, and the tax revenue the government will collect, while the buyers’ and sellers’ relative dodging ability will determine the proportion of the burdens each group will bear.
In the tax version, the ability to dodge is measured by what economists call the elasticity of demand (essentially, how easily buyers can dodge taxes by changing their behavior, particularly by shifting into substitutes for products whose taxes are raised) on the buyers’ side and the elasticity of supply (essentially, how easily sellers can dodge taxes by changing their behavior, particularly by shifting production into substitute products which don’t face increased taxes) on the suppliers’ side.
In an extreme case, if both supply and demand are highly elastic (it is easy for both buyers and sellers to dodge), a substantial tax could even destroy the industry entirely, and all the wealth it would have created, without raising a dollar of tax revenue.
Since government wants to raise revenue from the game, it will be attracted to taxing products where sellers and/or buyers cannot dodge well. This is why government seeks to tax land and structures—it is hard for owners to dodge. It is also why government seeks “sin” taxes—buyers resist giving up their favorite sins when taxes make them more costly. Those who cannot dodge well can be forced to bear substantial burdens. But since little dodging is possible, the costs to the players of dodging, over the cost of the taxes raised, are smaller.
But such targets, which are the most attractive for raising revenue, are limited. What happens once government is large enough that it is already “hitting” all the most tempting targets? For government to keep growing, it requires heavier, more socially burdensome, tax rates on what it already hits, as well as extending taxes to other areas which will generate less tax revenue and more social harm from the game. As Adam Smith described the process involved, “There is no art which one government sooner learns of another than that of draining money from the pockets of the people.”
Such expansions mean the costs to society of taxation rise far faster than the size of government. And importantly, this changes the standard for government to advance our general welfare, in the commonsense understanding of benefiting us all rather than some at the expense of others. It is not just necessary that citizens get at least a dollar of value from every dollar government spends, a standard seldom met, but each dollar spent must create far more value than a dollar’s worth, as it must also cover the wealth wiped out by the added dodgeball games necessary to pay for it.
Further, when multiple taxes are applied to the same income stream, we must also recognize the resulting burdens as greater than is obvious. For example, corporate income to be paid out as dividends to stockholders must bear property taxes, state, federal, and even local corporation taxes, and then personal income taxes at federal and state levels. It is the cumulative burden of all the various dodgeball games that are being played (what economists call the cumulative marginal tax rate) that determines the extent of the distortions, not any single part of that bundle of burdens.
Similarly, regulations, which are essentially taxes (the cost of complying) combined with government dictation of how those dollars will be spent, add to those effective cumulative marginal tax rates, and to the wealth destroyed as a result.
This also explains why owners of capital like federalism and international tax competition rather than nationalism and tax cooperation across countries. They would like to be able to switch over to less taxing games of dodgeball run by some other government, limiting the power to tax “captives” without having to provide them sufficiently valued services in return. But bigger government advocates prefer forcing us into more costly games, because it allows them to drain more resources from those it allegedly serves.
This also explains why wealth taxes are attractive to those who want to fertilize the further growth of government. To the extent such taxation is imposed after the fact, it doesn’t allow targets to dodge the adverse incentives. However, once that ex post taxation is recognized, it will reduce current incentives for people to use their wealth to benefit others, and serious dodging will result. That is why the well-known shortsighted bias of governments can lead politicians to support policies that sacrifice huge potential economic gains in the future with heavy wealth taxation now, because people won’t recognize the large future burden now and know to blame them. Similarly, this process has played out with plant-closing legislation, which sought to exploit already sited, “captive” physical capital but sacrificed the future gains from attracting as-yet-uninvested capital. In both cases, they amount to delaying the dodgeball into the future, where people might not recognize the burdens.
Not seeing the analogy to dodgeball also helps explain how governments can mislead their citizens about who actually bears the burden of taxation, which economists call tax incidence. One standard trick is to impose the legal liability on the least politically popular side of the market (e.g., corporations, with respect to labor markets), when that side can more easily dodge the burdens (especially by relocating elsewhere) than workers, so people think that the burden falls on corporations when it may actually fall on workers. Another way is to legally mandate that employers pay for unemployment and worker’s comp insurance, but if employers can dodge better than employees, people will mistake who really bears the burdens. Similarly, splitting Social Security and Medicare taxes between employer and employee makes it appear that employers bear burdens employees actually bear.
In fact, the government sometimes misleads itself with taxation. Years ago, a luxury boat tax was implemented, because it was thought such owners wouldn’t dodge—it would tax the rich so government could give to the poor. It turned out boat buyers could dodge well (e.g., by buying outside the US), so the tax instead cratered boat production, harming the workers in those industries, who were far from rich, but raising very little tax revenue.
Thinking in terms of dodgeball can teach us some important lessons about taxation. They range from justifiable cynicism about politicians’ claims that they don’t want to hurt citizens, to recognizing that the cost of taxation to society is far higher than the tax revenue raised, to the fact that the costs to society of taxation grow faster than the size of government, and more. As with every analogy, there are limitations, but the dodgeball analogy is important, because it helps us overcome something even more costly—being misled about taxation.