Debts and Taxes
By Stephen Davies
States and polities—or rather the
ruling classes that control them—face two great tests in the course of history.
Failure to meet them typically leads to disaster and even the dissolution of
the State. The first and most familiar is war, armed conflict with other States
(or more accurately, other ruling groups). By analogy wars can be compared to
examinations or timed tests; the test of war is relatively short, intense, and
often sudden in onset, with the probable result obvious from the start and
often dramatic.
The second kind of existential test
can be likened rather to that of researching and writing a dissertation—longer,
more drawn out, with less immediate drama but presenting in many ways a more
thorough and searching examination. The consequences of failure, however, can
often be just as severe, even if they take longer to arrive. This second test
is that of managing taxation and public finance. As writers through the ages
have recognized, failure at this can ruin a polity as surely as defeat in war.
What, though, is the nature of the
test, and in what sense do ruling groups fail it? Historically, ruling groups
draw incomes (“rents” in the economists’ language) from the groups they
control. They do this through various means, including taxes, fines, fees,
tariffs, tolls, the selling of privileges and exemptions, and even outright
expropriation. In return they typically provide services, most notably defense
against irregular predators, a means of settling disputes, and a range of what
are commonly described as “public goods,” which can cover anything from public
works and infrastructure to education. Ultimately all these services have to be
funded out of the revenues the rulers can gain. It is true that a shortfall can
be met by borrowing, but the money lent is secured against future income and so
doing this is simply a way of spending income now in anticipation of its
arrival in the future.
The failure of rulers to handle this
can take two forms. The simplest is when the level of taxation and other exactions
is simply too high and discourages productive labor to such a degree that
wealth is destroyed rather than created. If taken too far, this can actually
destroy the basis for the rulers’ position. Just as a parasite that kills its
host is a biological failure, so ruling classes that destroy their own
productive base are clearly political failures. The more insidious failure,
however, arrives when ruling groups spend more money than they take in and fund
it through debt. This can go on for a long time, even indefinitely, provided
the underlying economy is productive and dynamic enough and the spending is not
too high. The evidence of history is that it cannot go on forever. Sooner or
later a crunch will come, and the way the ruling group responds determines
whether it passes or fails the test.
In 1783 the Treaty to Paris brought
an end to a worldwide conflict. For Americans this was the American Revolution,
when the colonies gained their independence from the British Empire. From a
world perspective, however, this was only the latest round in a struggle for
global leadership between Britain and France that could be traced back to the
1690s. Just as in previous episodes, the war had been financed mainly through
the issuing of debt, which was added to the accumulated obligations of earlier
conflicts. By 1783 the public finances of both France and Britain were in a
desperate state. In many ways the British finances were in worse shape than
those of the French: In 1784 total British debt amounted to 156 percent of GDP,
comparable to French levels but with an economy not as large as that of France
and so less able to support such a burden. However, the next six years saw the
British elite address this problem. Their French counterparts did not and
failed the test.
Diverging Paths
In Britain the new prime minister,
William Pitt the Younger, brought the public finances under control through
what was known as “economical reform.” This was a combination of extensive tax
increases and major cuts in government spending, most significantly through the
abolition of a large number of useless government jobs or sinecures. This had
significant political implications because access to these posts was a major
form of patronage and central to the political system of the time. Even so, the
cuts were made.
In France the new minister of
finance, Charles Alexandre de Calonne, did not address the state of the French
public finances in the same way, at least not initially. Instead he floated a
series of loans to bridge the gap between income and expenditure. Despite its
greater wealth, the French crown had to pay twice the interest rate of the
British State, because its creditors (the so-called “financiers”) had less
confidence in its capacity to repay the debt and its willingness and ability to
do what was necessary. Eventually Calonne proposed a series of reforms
including tax increases (in particular taxes on the aristocracy and clergy),
major cuts in government spending, and a move to internal free trade in France.
To overcome opposition, in 1787 he persuaded the king to summon an Assembly of
Notables. However, the elites opposed both the tax increases and spending cuts,
and he was dismissed. The publicizing of the desperate state of the finances
and the accelerating loss of confidence in France’s rulers by their creditors
meant the difficulties of the crown became even more acute until, in 1789, the
king in desperation called a meeting of the Estates General for the first time
in over 150 years to try to break the deadlock. What followed is, as they say,
history.
Contemporary America
Contemporary Americans should look
back at these events with increasing nervousness. As in Britain and France in
1783, the public finances are in a parlous state. The gap between revenue and
expenditure has never been wider and is even worse than the headline figures
suggest when the unfunded liabilities of Medicare and Social Security are taken
into account. For a long time now the American political class has been funding
expenditure through borrowing, depending ultimately on the confidence of their
creditors and the underlying productivity of the American people. If this
confidence should waver (and there are many signs of this) the cost of this
borrowing is bound to rise. If the spending and liabilities exceed the capacity
of even the most heroic future productive labor by American citizens (as they
clearly do) then something has to give.
Ultimately it is clear that either
spending must be cut or taxes and imposts increased or some combination of the
two. Just as in France, however, this depends on the willingness of both elites
and ordinary people to do what is necessary. That in turn depends on a broad
agreement as to the proper role and size of government. In the absence of such
an agreement, just as in France in 1787, tough decisions will be ducked and
matters will go from bad to worse. Arguments about taxes and the deficit are
thus proxies for a deeper debate.
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