If You Give A Government A Tax, Then Soon It Will Want Another

image If you give a moose a muffin, or if you give a mouse a cookie (Laura Numeroff books), then, as the story goes, pretty soon it will make a mess, from which will follow a series of seemingly innocent demands until the kind protagonist is completely tied in knots.

A new tax means more government!
A new tax means more government!
Well, this week in 1913, we gave a government a tax. An itsy bitsy income tax, to be levied only on the rich (natch), and which would reduce other unfair tax burdens borne by everyone else. Of course, like any tax, including ‘temporary’ taxes, it didn’t stay small, and it didn’t remain just a burden upon the rich….

What happened next was entirely predictable, and you can click on this graph, courtesy of CATO Fellow Daniel Mitchell, to see how government’s share of GDP took off as soon as it had a ‘flexible’ source of revenue. (As compared to the founders’ vision of limited tariffs and excise taxes.)

Notwithstanding the best efforts of presidents Coolidge, Kennedy, and Reagan (and to a lesser extent, W), the government’s share of GDP has grown inexorably over the past century, getting close to 25% these last five years. There’s just one little problem…

You may have read a number of studies over the last 20 years which suggested that the government’s long term average slice of GDP was 18-20%, and that it would tend to regress to that norm if temporarily increased or decreased. That’s true, but there’s an underlying reason: just as the Laffer curve (see video) suggests an optimum, top tax rate of 33%, I believe a similar effect is at work with respect to government’s share of GDP from business and income taxes, and thus the government is unable to suck much more than 18-20% of GDP directly out of the economy.

Helicopter Ben_BernankeIf the government is taking in 18% and spending 25%, where is the difference going to come from? Is the money just going to fall out of the sky?

I’m glad you asked, and the answer is quite literally yes, thanks to Helicopter Ben! Of course, free money isn’t really free, you are paying the hidden tax of debasement of your purchasing power as the dollar sinks.

VAT fuels governmentThe welfare states of Europe cannot simply print money like we can (for now), but they hit on a new wheeze in the 1960s, which started small, and now adds almost 20% to every transaction in the euro-zone – I’m talking, of course, about the Value Added Tax (VAT), and as an extra layer of taxation, it manages to extract more money from the beleaguered citizens, over and above the limits that the Laffer curve imposes on income taxes.

The graph above, also courtesy Daniel Mitchell, shows how the VAT enabled further government expansion in Europe, much the same way that the income tax enabled the rapid expansion of the Federal government here. (Click to expand the gory details)

There is, of course a moral to this story – never give a government a new revenue stream, because they will use it to relentlessly expand control over our lives, and never, ever, give a government a sales or Value-Added tax without first driving a stake through the heart of any existing tax structure.