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The analysis of taxation that Adam Smith presents in Book V, Chapter II, Part II of the Wealth of Nations has a number of interesting implications which if recognized have never been made widely known.
Smith begins like this: "The private revenue of individuals . . . arises ultimately from three different sources; Rent, Profit, and Wages. Every tax must finally be paid from some one or other of these. . . ." He then states four general principles which he claims should apply to all systems of taxation. They are these:
"I. The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to . . . the revenue which they respectively enjoy under the protection of the state."
"II. The tax which each individual is bound to pay ought to be certain, and not arbitrary."
"III. Every tax ought to be levied at the time, or in the manner, in which it is most likely to convenient for the contributor to pay it."
And "IV. Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings to the public treasury . . . ." And in relation to this maxim, Smith adds that a tax should not be levied in a way that "requires a great number of officers, whose salaries may eat up the greater part of the produce of the tax. . . ."
The first implication of Smith's maxims is that the personal income tax and the sales tax violate the fourth maxim.
Smith then goes on to discuss the taxes that can properly be levied on each of the three types of revenue, but it is his analysis of the tax on wages that we find the most interesting implication, which unfortunately, Smith never carries to its logical conclusion. He writes, "A direct tax upon the wages of labor . . . though the laborer might perhaps pay it out of his hand, could not properly be said to be even advanced by him. . . . In all such cases, not only the tax, but something more than the tax, would in reality be advanced by the person who immediately employed him."
From this it clearly follows that the wage earner really never pays the tax on wages; that that tax is paid by his employer.
Take the personal income tax as an example. Say a person is said to receive a wage of $60,000 yearly and the tax on this income is levied at 20%. The tax would be $12,000, and the person's real income would be merely $48,000. Now if the employer withholds the $12,000 from the employee's pay and sends it directly to the government, it is difficult to justify anyone's claim that the employee has been paid $60,000, since the $12,000 that is withheld from his pay is no more his than is the salary of the employer's CEO. In truth, the employee's income is merely $48,000. The $12,000 is a tax on the employer levied on the wages he pays that goes directly to the government.
So, the fact that currently the tax is attributed to the wage earner is merely a book keeping gimmick. For if the employee's wage was stated correctly as $48,000 and he had no tax to pay on it, his income would be exactly the same as it is under the current system. And if the government levied a direct tax of 20% on the wages paid by employers, the government's take would again be exactly the same as it is under the current system. Absolutely nothing monetarily would change.
If that were done, the IRS could be eliminated along with yearly personal tax filings, and the result would be that the tax rate levied on employers could be reduced, since without having to fund the IRS, the government would need less revenue. Furthermore, it would reduce the employer's paper work and yield considerable sayings, for instead of having to make tax calculations on each individual employee, the tax could be calculated in one simple operation.
But there are further implications of Smith's analysis that even he failed to see.
If we ask, as Smith did in relation to wages, where the money paid in taxes comes from in relation to rents and profits, we find this: "Rents are paid to landlords by tenants, and any tax the landlord pays on rents is really supplied by the tenant." So just as employees really pay no taxes, neither do landlords. But who are tenants? Well they are either landlords themselves, businesses or investors in businesses, or wage earners. Now since neither wage-earners nor landlords really supply the monies collected as taxes, only businesses and investors in businesses do. So although businesses are always looking for ways to avoid taxes, their search is futile. For no matter who conveys the tax to the government, it ultimately has been paid by business, since even the incomes of investors come from the businesses they have invested in.
But the analysis can be carried even further.
Taxes on commodities, commodity transactions (sales), and even the property tax are derivative. Nominally they are paid by consumers and homeowners. But consumers and homeowners break down into landlords, businesses or investors in businesses, or wage earners just as landlords are shown to break down above. So although it doesn't appear to be so, businesses ultimately pay all of these taxes too. All that business does is transfer the sums needed to pay these taxes to wage earners and investors who then transfer these taxes to the government. This practice is not only cumbersome and inefficient, it is deceptive, since it makes it appear that both investors and wage earners are getting a lot more in return for their investments and labor than they actually are.
How much simpler and more efficient the whole matter would be if businesses were taxed directly, rather than in these indirect ways, and all of these other tax schemes were eliminated!
But perhaps asking legislators to do things in the simplest and most efficient way is more than they could ever handle. It would make their jobs too easy. Legislators, apparently, have an innate drive for complexity. Not only is the tax code so complex that even the people charged with enforcing it don't always know what it says, and their legislation, too, is more often than not so complex that legislators have to vote without ever having read the bills. One hardly has to point out how absurd all of this is. How can good government ever be the product of such a system? (5/25/2005)