"Are a liberal economy and taxes two incompatible notions ?" - At the CIFA conference (23-25 april, www.cifango.org), held in Monaco, I had to answer this tough question in a short introduction to a larger panel on the subject, also featuring Cato's “libertarian Rock Star" Daniel J Mitchell, Lord Daniel Brennan, from the international bar association, and famous criminologist William K. Black, who inspired me several parts of my 2nd book on bank crisis. Here is an approximative reconstitution of this short speech from my memory. Please notice that I use the word liberal in its european meaning, i.e. “libertarian” for US audience.
Coming from a liberal think tank, some of you would expect that I'd say that taxation and liberal values are not compatible, since taxation is about coercion, and fundamentally contradicts liberty. But as states are there and are likely to last for a while, I've to take a more pragmatic approach and answer to the question, "what would be the taxation system which would be the closest to liberal values, in the real world ?"
The question of taxation and liberal values, as you can see, is not a technical one. It's a philosophical one, and technicalities only derive from philosophical and ethical considerations. I'll shortly develop five points of my definition of what could be the characteristics of a “liberally acceptable" taxation system.
1. Limited Purpose of the state
We can't separate the taxation from the second plate of the state's balance, expenditures. What does the state makes with the money it takes ? John Locke defined the role of a limited state in an harmonious society, as the protector and guarantor of property rights, and not more. It's trivial to say that today, states have gone widely beyond that limit. Current states are in education business, healthcare business, subsidies, banks bailouts, and so on.
And, even if you imagine a tax mix that could be "technically" liberally correct (we will see how later), to feed a state with such an anti liberal portfolio of interventions, it doesn't make a liberal tax system. Stockpiling even brightly designed taxes to feed a greedy state can't be a libertarian thing. A liberal taxation has to serve the purpose of limited state, ideally centered around its lockean core functions.
2. Tax institutions should operate strictly under the rule of law
And I mean, here, “the rule of the good law”, based on traditional english common law. In many countries, Tax services, like IRS or French DGI, have been Granted special powers by governments.
For example, French tax services can use fiscal investigations without suspicion of fraud, only to put pressure on someone. In France, journalists making investigations on prominent government figures end up more frequently with a fiscal control: this practice should of course be banned from every civilized country.
But there’s worse. In France and several others countries, tax services benefits from the reversal of normal charge of proof before courts: in many cases, you, taxpayer, have to prove that suppositions of under-declarations of your revenues made by tax service are false. So Tax control plus fantasy assumptions by IRS-like services can be used to put coercion on “subversive people”.
There’s been a scandal in Germany, when tax service used data bought by corruption to prosecute some prominent tax evaders. French government wanted to authorize such practice by law, but has been banned from doing so by our highest jurisdiction, the constitutional council. Even if you don’t like tax fraudsters, and I don’t, their defendant rights should be the same as ordinary defendants: if unlawful means can be used as way of proof by prosecutors against defendants in cases of fiscal evasion, it will soon be a common feature of our justice in any other case, with terrific consequences on the reliability of “proofs” used for convictions.
Fiscal investigations, as other law infringements cases, should be operated exclusively under the control of a judge and should never be arbitrary. And I consider that automatic data collection on every citizen is obviously arbitrary investigation, as automatic exchanges of financial data between countries are arbitrary investigations. Privacy is an essential feature of the “liberty pact” linking citizen and so called democracies. Privacy is not only a matter of legality, as people who say “if you’ve nothing to hide, you’ve nothing to fear” would like us to believe. First, notice that government can blur the lines between what’s legal or not. Very vague definitions of what some crimes are increase the possibilities for honest people, to be prosecuted in good faith. But there’s more: privacy is about intimacy, modesty, sense of decency. You wouldn’t like to see your conversations with your doctor listened by the government, or anyone else. It’s the same with your money: once you regularly paid your tax bill, government is not entitled to know what you do with your money, your conversations with your banker, your accountant, and so on.
Data collection, and international exchange of data, should be authorized only upon serious suspicions of fraud, backed by tangible elements, brought by a judge, under regular due process. Agreements exist between most democracies, including so called tax havens, to operate in that frame. So we don’t need extraordinary procedures.
A liberal tax system should end all these anomalies and go back into the frame of regular judicial due processes.
3. There should be no “behavioral Taxation”. Taxes should be as neutral as possible
Of course, taxation can never be 100% neutral, as long as you change behaviors as you create a tax on anything. But in society of liberty, taxation should not be used by a government to incentivize or coerce some of our choices.
This point can be viewed either on ethical or utilitarian grounds. Ethical, because behind every tax shelter or special deduction, there is the victory of a lobby over the rest of us. Utilitarian, because in nearly all cases, economic outcomes of government created tax shelters are bad, and sometimes disastrous. As said another speaker there, when people invest their tax money instead of their disposable money, they’re prone to malinvestment. This has been widely observed in France, in the housing field, where tax deductions have financed huge numbers of homes nobody wanted to live in, in places where there was no demand for low end rentals.
Another distortion I want to talk about, is more insidious, and is spread all over the world. It’s differential treatment of dividends (taxed) and interest on loans (exempted) in most corporate taxes. This distortion incentivize firms to over leverage their balance sheet, meaning they’re less sound in difficult economic times. Numerous studies, including from IMF, have underlined that this distortion has no more economic justification. But it’s a huge indirect subsidy to those whose job is to lend money: banks.
Taxation should be viewed as a way to fund state, not to change our behaviors, or giving an advantage to some against others.
4. No double taxation, thus no wealth taxes !
One of the most disgracious feature of most tax codes is that households pay several times taxes on the same dollar, through wealth or Real Estate taxes. When you’ve paid regular taxes on your wages and other revenues, you should be set free with taxes: the money has been taxed once. But it doesn’t happen in current real world. You use one part of your disposable income to build wealth, often beginning with your home. And then the state comes and says: “hey, you’ve to pay a yearly tax on this wealth you built from your money”. It’s like paying a rent to the state for owning things, though you’ve already paid to the state the right to get the money to purchase things. You’re not really the owners of your property any more.
Beyond this moral argument, wealth taxes are economically harmful too: in France, wealth tax brings less than €4Bns/Yr in state coffers, but has provoked the flight of more than €400Bns out of the country, according to very conservative estimates from the Montaigne Institute, a french economic think tank. This flight of money comes with the flight of the brains and experiences of those who have created it, most of them being definitively lost for France once they’ve made their lives abroad. So the loss for the country goes far beyond money and equity.
That’s why we should favor a system with taxes on flows (revenue, consumption), but not on savings and wealth.
5. Tax Fairness doesn’t exist, don’t try to use the concept to justify over taxation
Progressive taxation is often justified on the ground of “tax fairness”. But this notion has no objective definition. In France, progressive taxes are viewed as “fair”, but in most former eastern countries, they’ve been a factor of tax avoidance, so many of them came back to a flat tax. So what’s fair, I don't know. But what’s more efficient, we can guess. In fact, in most countries which set up flat taxes, we’ve seen a huge increase in tax compliance, tax “civism”, from population, especially from business people. Even IMF, who doesn’t promotes flat taxes, has acknowledged this fact through its own publications. And aren’t “fair things”, “accepted things” ?
So we can induce that governments should try to keep taxation reasonable, and it would work better than abuse of taxpayer coercion to achieve budget goals.
A good flat tax has no tax shelter, no tax loophole, and lets the most of your success revenue in your pocket. So you’re not tempted to cheat the system by grabbing government funded advantages, and are not discouraged to try to succeed. Flat tax is not a “liberal tax” per se: if the government uses the product of the flat tax to fund illiberal activities (see #1), this is not part of a liberal system. But from a technical point of view, flat taxes have a better liberal record than progressive ones, which are always plagued by tax exemptions who benefit to few lobbies.
To summarize, a liberal society is about freedom of choice and voluntary acceptance of exchange. A liberal taxation system would be the one which doesn’t interfere with people choices, serves a state with limited purpose, and lets most of the fruit of your success in your pocket, so it would be mostly accepted without the need for state coercion.
Needless to say, current tax systems all over the world don’t follow these rules.
Video: The CIFA conference - day 2 - summarized in three minutes - link if video doesn't work