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What are Taxes for?

GB Geo-Blog

What are Taxes for?

Americans have always hated taxes. Our revolution began when British colonists in North America revolted against the taxes levied by the Crown to pay for the costs of the Seven Years’ War against the French. During the second half of the nineteenth century a larger and more muscular United States government relied on revenues from tariffs on trade, not taxes on American incomes, to finance infrastructure development at home and military expansion abroad. Since the late 1970s, Americans have similarly supported efforts to lower taxes and reduce the intrusion of “big government” on their personal resources. Political candidates across the country today – Republican and Democrat – must promise “no new taxes” if they want to have a chance at election. Freedom from taxation seems as American as apple pie.

In an era of diminished resources and increased competition, politicians are looking to recapture some elements of the extraordinary American economic growth experienced during the decades after the Second World War. Between 1945 and 1970, Americans from almost all classes and races lived many times better than their predecessors. Incomes rose, health improved, and consumption sky-rocketed. Depression-era citizens who scraped by in the 1930s and sacrificed to defend their country in the 1940s were succeeded by Baby-Boomers who lived in large suburban houses, worked in well-paid professions, and enjoyed fancy family recreations. The Great American Economic Growth of the postwar era was a tide that lifted virtually all boats.

What politicians and voters forget is that America’s postwar economic growth was not inevitable. The United States emerged in 1945 as the strongest economy in the world because of huge and unprecedented investments that the federal government made at home as a central part of the war effort. These government investments included direct spending on factories, research (especially atomic weapons), and training (often on university campuses.) The United States became the workshop of the world, with the best products and the best minds, because the government gave direct financial support for these endeavors.

This story continued, to the great benefit of Americans, after the end of the war. The United States economy “took off” because federal and state governments continued (and often expanded) wartime investments through the GI Bill that subsidized education and home ownership, government sponsorship of scientific research with defense and industry potential, and massive infrastructure projects – particularly the Interstate Highway System created under Republican President Dwight Eisenhower.  By the 1960s rural and urban American citizens had access to electricity, decent roads, and educational opportunities unthinkable just three decades earlier. Government investment made new productivity and mass consumption possible.

Where did American federal and state governments get the money to invest in economic growth? Taxes! University of Chicago historian, James Sparrow, has a forthcoming book (“Warfare State”) that shows how Americans who returned from war in 1945 undertook to pay more taxes than any prior generation of citizens. The data is striking. In 1940 just over 10% of Americans in the labor force paid federal personal income taxes. By 1945 more than 60% paid income taxes.  In 1940 less than 2% of total personal income in the country was absorbed by federal income taxes. By 1945 more than 11% of personal income was paid in taxes. The 1945 numbers remained consistent until the 1970s when they began to drop.

The massive growth of tax revenue after the Second World War was not always well-managed. Some of it was wasted. Some of it was misused. Nonetheless, one cannot escape the conclusion that tax-financed investments were crucial for American economic growth. The taxes paid for education and home ownership among veterans through the GI Bill; they paid for the research that created atomic weapons, computers, and the Internet; they built the roads and airports that carry our commerce.

The point here is not that all taxes are good, or that taxes should be raised at all in 2011. Those simple judgments are dangerous. The same is true, however, for simple judgments in the opposite direction. All taxes are not bad, and taxes should not be cut at all costs – especially if the costs involve crucial investments in economic growth. How can any leader expect to encourage improved living standards if he or she does not invest in educating the young, supporting creative endeavors, and building high quality infrastructure? Those basic public investments, the source of American economic growth after 1945, need public money.

Americans should cut bloated government and reduce excessive taxes in many areas. This effort will only bring renewed economic growth if citizens simultaneously ask themselves where they really want to spend tax money, and where they really need investments for a bright future.  Instead of simple slogans about “no new taxes,” Americans need a broad and informed discussion about the most important places for public investment. Americans then must use taxes to finance those crucial investments.

Freedom requires some government taxes. It requires public financing for necessary public goods that enhance the lives and the economic potential of citizens. We must think, therefore, of taxes as investments: increasing our commitment to those that produce high returns, cutting those that do not perform.

Citizens are investors in their society. They should discuss their financial future in those terms. They should choose leaders who emphasize investment, not simple tax cutting across the board. Wielding the ax to public budgets with little discrimination will impoverish everyone. Targeting investments for future growth and improvement, and then using tax money to pay for those investments, is the best chance Americans have at re-capturing some of their postwar prosperity.


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  1. Arijit Banik March 22, 2011

    Well said.

    Margaret Thatcher quipped that “there is no such thing as society. There are individual men and women, and there are families. And no government can do anything except through people, and people must look to themselves first.”

    And this begat the neo-liberal revolution with Thatcher, Reagan, et al; the supposed commanding heights of ideas has been nothing short of ideological illusion–even today David Cameron evokes Edmund Burke constantly in goading the British to embrace a volunteer society.

    I am the last to support government overeach–the anachronism of the CRTC within the Canadian landscape is a prime example of poorly utilized tax dollars– but there is a value to public goods, there is a space within a market economy for socialized services, and there are ways in which the government through either direct or indirect taxation can add to a nation’s productive capacity.

    The panacea of unending tax cuts is the fraud of our times; I dislike taxes but surely, given the checks and balances within a democratic society to ensure voter representation and engagement, it is the price we pay to live in a civilized state as opposed to a despotic state of nature?

  2. Jeremi Suri March 22, 2011

    Thanks, Arijit. You are absolutely correct about indiscriminate tax cutting as the “ideological illusion” of our time. Think of the societies where people pay few taxes — Nigeria, Algeria, Pakistan, Afghanistan. Anyone want to live there? We pay taxes to invest in a civilized, ordered, and progressive society. Taxes should be neither excessive nor deficient. We need to find the correct balance.

  3. paul gibbons March 23, 2011

    There are two features of the US tax situation that are all-American.
    – I have never heard a single European ever complain about taxes. My ‘data set’ for this observation is largely the sorts of people who in this country would be mainstay donors to anti-tax causes. You are right Jeremi: the anti-tax events associated with US founding are seared into its conscience. Part of this country growing up is changing this conversation for the very reasons you mention, but first among those is the parlous condition of US physcial infrastructure, urban blight, and pre University education.
    – the investment sorely needed would trvially be obtained if the US had a truly progressive tax system. Instead the graph of tax rate v income is bell shaped: the rich enjoy very low REAL marginal tax rates because of a cumbersome framework which allows much of their income to evade taxation.
    – saldly this is the result of something else very American. A political system where wealth determines elections and policies to a degree not seen elsewhere… the wealthy people and corporations simply buy themselves lower effective tax rates! Small businesses and the middle classes, ostensibly the tea party constituents, get hammered and pay a disproportionate share vis a vis their wealthier co-citizens.

  4. Jeremi Suri March 23, 2011

    Paul, your points are spot-on. Our complicated tax system clearly benefits wealthy earners who can find loopholes and other mechanisms for protecting income against taxation. Small business-owners and middle earners are hit with the heaviest real tax burdens.

    As you say, our tax system reflects the influence of wealth on political decision-making, not the investments needed to get our country growing and prospering again. That needs to change. “No tax” pledges take us in the wrong direction.

  5. Morris Davis March 24, 2011

    Hi Jeremi,

    Glad you posted this to a blog after our conversation about this.

    I think sensible people can debate the appropriate level of taxation — not “more” or “less” but “what is the right level” and “what should the government be doing” around 3 points:

    (1) Is the government using tax revenue to provide services that the private sector can not provide? This is the “market failure” argument — that there needs to be a market failure for the government to provide services.

    Typically this argument is made for public goods (parks / roads / defense). It has also been made for public health (sick people around you is an externality) and education (you want an educated electorate to make decisions).

    (2) Given taxes are distortionary — i.e. a tax on labor income changes the incentives to find work for people at the margins of the labor force; and a tax on capital income distorts the incentive to save vs. consume — is the benefit of “fixing” the market failure outweighed by the efficiency loss due to the cost of the distortion?

    This is the main argument against taxation. For example, and let me be extreme here, our social security system provides the public good of insurance that all our elderly will not starve once they retire. However, the cost of social security is that (i) it reduces the incentive to save to finance your own retirement and (ii) it reduces the incentive to work, since working is a taxed activity and the social security tax is not dollar-for-dollar related to social security benefits.

    (3) Related, given a demonstrable market failure, defined as a situation where private marginal costs or benefits are not equal to social marginal costs or benefits, is the government providing services efficiently with the tax dollars it collects.

    This is the “bang for the buck” argument. This is the strongest argument for low taxes and low government activity.

    Taking an example from a standard urban economics text: People think public housing costs twice as much to build as private housing of the similar quality. In addition, people value the services provided by public housing less than cash. This means that about 3/4 of the subsidy provided by public housing is wasted.

    So even though we like the idea of public housing, it’s so wastefully implemented that we may wind up in a situation where the benefit is less than the cost.

  6. Don Halfmann March 24, 2011

    Back in the day, when those taxes were invested in the economy and citizens, there was an honorable return on those investments. The recipients were receiving a “leg up” and repaid with honorable dividends. There was repayment in the form of well raised kids, citizens helping each other.

    These days recipients take the investment as an entitlement, sit around with no intention of thankfull repayment, and continue collecting and living the roll of perpetual victim as long as the government continues to support their selfishness. The tax funded “help” is simply thrown down a hole with no expectation of return….

    I am all for helping others who intend to better themselves, but when my tax money pays for free cell phones or 4K (babysitting) I have a problem.

  7. Jeremi Suri March 25, 2011

    You have a point, Don. After World War II tax money went largely into investments in education, infrastructure, defense, and other needs. Today too much tax money is allocated as transfer payments to a growing demographic of retired people who live longer and incur much higher health and nursing costs than their predecessors. That is where tax money is now used most of all.

    It is time to think of reallocating some of that tax money for more productive investments in our young. We spend much more on nursing old men than educating young boys. Isn’t that bad investing?

  8. Jason Leighton April 12, 2011

    Couldn’t a counter arguement be made that these “old men” have already made their investment (against their will, it might be added), paying into an entitlement system, having made their plans based upon that investment, and that they have every right to expect a return on that investment?

    I think there is a danger in phrasing tax spending as “investments.” There are many services that are needed, yet unprofitable. I believe it’s similarly dangerous to label these as “market failures,” as using purely economic terms tend to put important decisions into an exclusively economic vacuum. Speaking in these terms makes it easier for us to let ourselves off the hook for problems that occur in our society. The question becomes “Is it profitable to…?” rather than “Is it morally right to…?” This has become all too common (almost exclusively so) in American politics. It furthermore contributes to the (in my opinion faulty) notion that there is not enough money in America to go towards these programs while maintaining a healthy economy.

    There is certainly something to be said for making programs more efficient, eliminating redundancies, and cutting unnecessary fat in government programs. But the debate surrounding these cuts must be tempered with questions of morality and fairness, not simply sound economics. This is especially true when massive spending cuts and tax breaks for our wealthiest citizens seem to be the only policies being taken seriously. To me, no one can claim to be having a serious discussion about getting the budget/deficit under control in the absence of meaningful talks about raising taxes.

  9. Jeremi Suri April 12, 2011

    I agree, Jason, that we need to place our values at the center of public debate about taxes. What do we care about? What kind of society do we want to live in? My point is that a focus on values requires serious analysis about how to allocate our limited resources. What are the uses of money that will best serve our society? What are our priorities?

    Once we determine our priorities, we should raise (through taxes) the necessary resources. We should also cut spending (and potentially lower taxes) where our resources are not serving priorities. I would call this moral investment — allocating resources for the things we value most; avoiding spending on things we value least. We cannot afford to do everything, but we must focus on some things.

  10. Charles Hartley April 28, 2011

    Considering the fact that money and economics seem to dominate political discourse, is it an appropriate outlook to approach the United States citizens as “investors?” Aren’t there significant drawbacks to viewing the United States as a corporation or fiscal enterprise? I understand we are a capitalist and theoretically “free market” nation and money makes our world go round. It is our life blood. However, it seems as if too much emphasis is being placed on hard numbers and theoretical economic plans (not in your essay but on the national stage). Is there a human component that should be addressed along with the fiscal?

    You touched on reminding people what they are paying for (education, technology, etc.) but it seems as if more should be done to encourage the spirit of duty and service to the nation. By instilling a sense of ownership, a feeling that seems to be on a steadfast decline, and government accountability, which flew out the window decades ago, the majority of people would not only be willing to pay taxes, but might actively push for them. Taxes are absolutely essential to our well being and success, I entirely agree, however much of civil society seems to have lost not only the desire to pay them but the sense that they are receiving something in return.

  11. Jeremi Suri April 28, 2011

    These are excellent points, Charley. We need to think beyond money and re-instill a sense of community with recognized personal responsibilities. We must replace consumption and opposition with a new emphasis on compromise and cooperation. I think that the concept of “investment,” broadly defined, can help with the above. Smart investors always think beyond money. We invest in our children by nurturing them. We invest in ourselves by living healthy, fulfilling lives. We invest in our society by thinking beyond short-term gains, and formulating collective sacrifices for the common good. Taxes are just one essential, but certainly not sufficient, part of the process. My vision is of a society where everyone feels that he or she is a stakeholder, with benefits and responsibilities.

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