Why Americans Are Right to Be Suspicious of Mr. Bush's Tax Cuts

The tax proposals of President Bush -- elimination of taxes on estates and dividend income -- fly in the face of modern economics, retreating to a discredited mercantilist view of wealth, and will hamper our government's ability to carry out social and economic projects including defense and security.

Mercantilism, once the dominant economic theory of the West, measures the prosperity of a nation by the sheer quantity of money within its borders. Mercantilism drove imperialism: the need to have direct control over raw materials and captive markets for finished goods. Mercantilism promoted protectionist tariffs and industrial development, which can sometimes promote economic growth. However, mercantilist policies are now seen as simplistic, unproductive, anti-competitive and unfair.

Thanks to the economics revolution of the nineteenth and twentieth centuries -- "classical" economics as articulated by scholars like Adam Smith, John Ricardo, John Keynes, and Milton Friedman -- we now focus on the frequency and size of economic transactions (measured collectively as "GDP"), not money supply alone. GDP does not include intangible natural resources and costs like pollution, and gives positive value to lawsuits and insurance settlements, but it is our most meaningful economic measurement. A dollar is not productive if it sits in a wallet, but that same dollar can be a part of hundreds, even thousands of transactions, and it is counted as part of the GDP every time it moves.

Every dollar is taxed repeatedly because governments tax not the dollars but the transactions, through sales and income taxes, corporate profit and capital gains taxes. Investment income and large gifts are taxed because paying dividends or passing on property is a separate transaction from earning money. Rhetorically attacking "double taxation" reinforces the outdated mercantilist view that a dollar is a thing in itself, rather than a symbol of work and value to be taxed whenever it is active.

Paul Kennedy wrote: "The history of the rise and later fall of the leading countries ... shows a very significant correlation over the longer term between productive and revenue-raising capacities on the one hand and military strength on the other." (1) In other words, for a nation to be powerful, it must have a strong economy, as well as the ability to tap into that economy by taxation. The argument can easily be extended beyond military power to include the social projects that 20th and 21st century states undertake: for government to be effective, the economy must be both strong and adequately taxed.

Tax-free transactions require the government to tax the rest of the economy more heavily or starve. The long decline of the Roman Empire saw land steadily escaping government taxation; rising taxes on the remaining land drove even more people and land outside of the system. Japan and China traditionally relied almost entirely on agricultural land taxes, while their economies became increasingly urban and mercantile. Moreover, tax collection was degraded by poor administration and corruption. The best current example may be the failure of state governments to impose sales taxes on services and Internet transactions.

Conversely, governments that draw on the economy as a whole can be successful. Japan's nineteenth century modernization was fueled by the revitalization of the land tax (and elimination of unproductive expenditures, like samurai salaries), supplemented with income and commercial taxes which grew as the broader economy grew.

The income tax -- established in the United States by the Sixteenth Amendment to the Constitution in 1913 -- introduced a fabulously successful concept: governments which rely on income taxes need not care about economic shifts, as long as all income is treated similarly. The income tax system can be designed to tax most heavily those who have earned the most (progressive taxation). The sales tax is another thorough approach to taxation, directly taxing the transactions which make up the very essence of the economy. The complexity of present tax codes comes from treating different sources of income differently: earned vs. unearned personal income; income vs. profits in business; goods vs. services. We live in a complex society and economy. But the basic principle of broad and thorough taxation must be maintained.

The Bush policy, combining the eliminatination of taxes on large estates and dividend income, would benefit most those people with large amounts of capital and property. Drawing attention to this fact is not class warfare, but elementary logic.

If these tax cuts become law, we will then have three choices: 1. increase taxes on earned personal incomes and taxable sectors of the economy; 2. drastically reduce government spending, and therefore effectiveness and power; or 3. put these taxes back in place. But why reenact centuries of economic history, when we can keep these very appropriate taxes as they are?

(1)The Rise and Fall of Great Powers: Economic Change and Military Conflict from 1500 to 2000 (1987), p. xvi. Emphasis in the original.