Monday, January 12, 2009

Why tax?

Everyone agrees, more or less, that the Federal Government has the power to print money. That's what fiat money means by definition. Since the Federal Government can print it's own money, in whatever quantity it chooses, have you ever wondered why it taxes at all? In fact, if you chose to mail in your 2009 taxes in crisp Federal Reserve Notes, the Government would take that paper money and shred it.

The Federal Government does not need taxes in order to spend. At the Federal level, because the Fed is a currency issuer, the sole purpose of taxes is to extinguish money, reduce aggregate supply, and therefore limit inflation to a tolerable level.

At the State and City level, where the local government authorities are currency users just like the rest of us, this is not true. San Francisco has to tax if San Francisco wants to spend. But this is not true for US Gov.

Since Federal taxation is about extinguishing money, not raising revenue, then efficient taxation may be the wrong approach. Efficient taxation looks to tax so that the Government raises as much money as possible but distorts behavior, which reduces growth and creates waste, to a minimal degree. Maybe the goal, at the Federal level,should solely be behavior modification. After all, if Federal taxes are important to extinguish money, then they should target money in circulation, as savings are effectively extinguished--taken out of the money supply--anyway. Money in circulation is money that people are acting on.

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