Chapter 19 – The Virtues of Taxation

The Virtues of Taxation

IN THE SPRING OF 1989, astrophysicist Fang Lizhi, China’s most prominent dissident, asked the world’s leaders to withdraw foreign capital from China, starting with a suspension of World Bank loans and credits. “We must make our government realize that it is economically dependent on its citizens,” he said. Less than two months later, Fang sought asylum in the U.S. embassy after being accused of fueling the student democracy movement that ended in the bloody massacre at Tiananmen Square.

Many view taxation as little more than a means of redistributing income or, more cynically, as a means of supporting government in the style to which it is accustomed. The indiscriminate nature of taxation — politicians draw taxes from the national economy as if from a public commons, without a clear connection between the tax and the service it provides — robs taxation of legitimacy in many taxpayers’ minds. When politicians enlarge the commons beyond the national economy by borrowing to further boost tax revenues, the cynicism grows. Unlike borrowing, however, taxation — because it is quickly felt by the public — limits politicians and constituents in raiding the public commons. Taxation forces a confrontation, or an accommodation, between the taxer and the taxed, making the act of taxation an important accountability mechanism.

Fang recognizes the discipline imposed by taxation to be far more profound in an undemocratic setting such as China’s. By going outside the country for its money, the Chinese government could avoid accountability and divorce itself from its citizenry.

In Guyana, former Prime Minister Cheddi Jagan concurs. He blames Guyana’s woes — among them annual debt payments totaling 73 per cent of the government’s total revenues — on lavish foreign financing that allowed the government to be unencumbered by the rules of democracy. “Ironically it is money — more and more borrowed money — which is at the root of our problem,” he explains, since these funds fuel an “administrative dictatorship” that perpetuates a system of racial and political discrimination, nepotism, extravagance, and corruption.

From Guatemala, lawyers, professors, and businessmen repeat the same refrain: seemingly endless foreign borrowing can only “relieve the government from having to use taxpayers’ money for infrastructure and allow the government to continue spending without having to curtail the deficit.”

Analyses such as these call for a cessation of foreign lending until governments are fiscally accountable to their people. Lending by outsiders, they say, will only free governments from their citizenry and undermine local efforts to establish good governance.

THROUGHOUT HISTORY, governments have had to exercise caution in taxing their subjects, who have tolerated it to a point; beyond that point looms revolt and revolution.

The Ptolemies in ancient Egypt devised all manner of levies upon their productive citizenry to finance their great engineering works and expensive wars. As corruption grew, the government’s exactions grew, leading to industrial and agricultural decay as producers lost financial incentives, to revolts, and ultimately to the ruin of the civilization.

Two millennia later the question of taxes, and how best to extract them without invoking insurrection, remained vexatious. Sir William Petty, a 17th-century British economist, noted that people believed that their sovereign was taxing the wrong people too much for unnecessary purposes. The 18th century found Adam Smith arguing that all taxes should conform to standards of justice, certainty, convenience, and economy. Absentee landlords with more land than they needed for their subsistence, Smith explained by way of example, should be more heavily taxed than owner-occupants. At the same time, the issue of taxation without representation inflamed the American colonies, triggering the Boston Tea Party and the American War of Independence. Governments around the world have since recognized the risk in taxing a hostage public.

But exorbitantly taxing a represented public is risky as well. Government leaders know that public approval flows from expenditures, not from taxation. The difference between government spending and its tax revenues comes from borrowing money, or from printing it. But printing money has immediate repercussions: inflation, the debasement of the nation’s money supply and of the public’s savings. Borrowing delays the repercussions, allowing governments to shower the public with gifts while deflecting into the future the day of repayment.

Most governments try to circumvent tax revolts through deficit financing — a dangerous and dishonest invention of the 20th century which obscures the costs to the public of its government’s activities. Deficit financing — which amounts to future taxation since future taxpayers will be saddled with repayment — thus gives governments and their expenditures a degree of anonymity unimaginable were governments forced to confront taxpayers for every expenditure.

The economic function of deficit financing first advocated and popularized by John Maynard Keynes — to stimulate and fine tune economies to maximize employment and output — while attractive in theory has generally proved to be uncontrollable in practice. Governments, whether democratic or not, have no built-in incentives to stop borrowing in order to satisfy those who would throw them out of office: the benefits of borrowing come quickly and can be directly attributable to the government while the costs, which are difficult to attribute to any particular cause, come much later, making them a future government’s worry.

FOREIGN AID, like borrowing, also provides anonymity and removes the need for governments to be accountable to their people.

Had foreign aid been successful in developing the Third World, the anonymity it provides governments might have been justified as a necessary evil. But foreign aid has been an abject failure, particularly in those countries — such as Sub-Saharan Africa — which most received it. Africa’s share of world trade is now half what it was a generation ago, before the aid money started flowing. With aid to Africa increasing more than tenfold between 1970 and 1988 — from $1 billion to $13.4 billion per year — per capita incomes have decreased and private investment has all but dried up. In the last decade, with cash infusions of $100 billion, Africa’s economy has shrunk by 20 per cent. Africa’s GNP compares to that of Belgium, which has a population 2 per cent and a land mass 1 per cent that of Africa.

“Aid is not the answer,” concludes Nigeria’s Claude Ake, a Fellow at the Brookings Institution and an advisor to the World Bank on African affairs. If aid disappeared — something he would not oppose — Africa would “have to take the idea of self-reliance more seriously … and when you take the idea of self-reliance more seriously, you cannot ignore democracy.”

Aid programs, because they assume that Western donors and Third World government officials are better problem-solvers than individuals or private organizations, are often at odds with the priorities of their recipients. Anonymous aid allows governments to finance vanity projects — such as the Ivory Coast’s $100 million neoclassical basilica inspired by Rome’s St. Peter’s — or simply to line the pockets of leaders and influential officials.

Nepal provides a perfect picture of foreign aid run amok. That country’s best-known water resource specialist, Dipak Gyawali, is highly critical of aid agency consultants and engineers who run the country’s water department, implementing policies as an arm of the government without any public debate or legislative oversight. In the name of providing clean water to the capital city of Katmandu, the U.N. and the World Bank are proposing to divert the waters from the nearby Melamchi River catchment area, depriving thousands of the water they need for their irrigation systems and their ghattas, or water mills. To do so, the foreign aid agencies, on the advice of their Western consultants, propose to build a 27 kilometer long tunnel through an unexplored area of geologically fragile Himalayan mountains as well as an area known as the main Central Thrust — the most active of Himalayan faults. The project will cost an estimated $118 million — all to divert water to Katmandu’s municipal water supply system, which has a wastage and leakage rate of about 70 per cent. “Adding a costly supply scheme to a sieve is ludicrous,” says Gyawali, who objects to a foreign aid bureaucracy so pervasive that “every vegetable has a foreign aid project behind it.”

Gyawali’s view of foreign aid is widely shared. The Manila Declaration on People’s Participation and Sustainable Development, signed by citizens’ groups from every continent, claims that the international development institutions and their financial transfers have been damaging to the cause of democracy. Where governments and their foreign financiers do not recognize that “people must control their own resources, have access to relevant information, and have the means to hold the officials of government accountable, (development) often becomes a conspiracy between the donor or the lender and government against the people.”

To enable Third World citizens to establish responsible government, state-to-state development aid — whether through foreign aid agencies, export credit agencies, or the international agencies like the World Bank — should end, and these institutions — neither reformable nor worth reforming — should be closed down. (Emergency relief, being humanitarian and short-term, should continue, as should the only foreign aid efforts exhibiting any success — those carried out by independent private groups working with like groups in the Third World.)

THIRD WORLD STATES, spending unaccountably, have failed thoroughly to enrich the lives of their citizenry or to entrench just laws that would allow the citizenry to create the wealth to enrich themselves.

States should live within their means, balancing their expenditures with their revenues. Balanced budgets are of such importance to the economy, to the environment, and to responsible government that they should be entrenched in state constitutions.

With constitutionally mandated balanced budgets, legislators and their constituents would be forced to weigh government services against higher taxes, creating a continual debate about government priorities and keeping the government in touch with its people. A government claiming to need more money would have to deal with its own taxpayers — the ultimate test of legitimacy.

Sources and Further Commentary

For Chinese dissident Fang Lizhi’s views on foreign financing, see “Chinese dissident advocates divestment” by Joe Cuomo, in The Wall Street Journal, April 26, 1989. Mr. Fang made one exception to his appeal for foreign divestment from China: he thought World Bank and other loans should continue for education projects. Also see “Free to Speak” in The Far Eastern Economic Review, August 2, 1990. Guyana’s former prime minister, Cheddi Jagan, described his view of foreign financing in a letter to the editor of The Toronto Star, “Guyana founders under IMF austerity plan,” April 29, 1989. In “Guyana austerity plan will provoke turmoil opposition head says,” in The Globe and Mail, Toronto, October 4, 1989, Jagan, referring to an economic austerity program in his country, said that the country would be willing to face sacrifices if there were fair elections to produce a government with broad support. Electoral reform, he said, was an important demand of a coalition of five political parties in Guyana.

For the Guatemalans’ quotations see “Foreign aid inhibits market ideas in Guatemala” by Fernando Monterroso in The Wall Street Journal, November 3, 1989.

For further details on the Ptolemic tax burden see The Lessons of History by Will and Ariel Durant, Simon and Schuster, 1968, New York. Sir William Petty’s description of public reaction to taxes is from The Basic Teachings of the Great Economists by John W. McConnell, The New Home Library, New York, 1943. Adam Smith talked extensively about taxes in the second volume of his 1776 treatise The Wealth of Nations, published by J.M. Dent and Sons, London, 1910.

For a very interesting discussion of the political effects of deficit financing see several chapters in The End of the Keynesian Era, edited by Robert Skidelsky, The Macmillan Press, London, 1977. See in particular “The Political Meaning of the Keynesian Revolution” by Robert Skidelsky; “Can Democracy Manage an Economy?” by Samuel Brittan; “Keynes and the Developing World” by Harry G. Johnson; “Keynes and the Pax Americana” by David P. Calleo.

For the economic impacts of persistent deficit financing in the Third World, see “Why Asia boomed and Africa busted” by Keith Marsden, in The Wall Street Journal, June 3, 1985.


For the statistics on Africa see Sub-Saharan Africa: From Crisis to Sustainable Growth, A Long-Term Perspective Study, by The World Bank, Washington, D.C., 1989; also see “Africa, The Long Good-bye” by David Ewing Duncan, in The Atlantic, U.S., July 1990.

Claude Ake’s quotations are cited in “Redistributing the Blame in Africa” by Stephanie Cooke, in Institutional Investor, New York, September 1990.

Information about the state of foreign aid in Nepal comes from “Nepal faces economic `shambles’ of poverty and addiction to aid” by Sanjoy Hazarika, in The Globe and Mail, Toronto, May 15, 1990; “A White Lie” by P.C. Joshi and Ramesh Manandhar, in Impact, Philippines, May 1990; and from personal correspondence with Dipak Gyawali.

The Manila Declaration on People’s Participation and Sustainable Development was drafted in June 1989, and published in IFDA Dossier 75-76, (International Foundation for Development Alternatives), Switzerland, January/April 1990.