Introduction

A tax has three characteristics, it is imposed by the legislature, it is levied by a public body,

and it is used to raise revenue to meet public expenditure1. It is the main function of the

political process to give expression to the collective preferences and to satisfy those

preferences out of the raised public expenditure. At the same time, it is through the political

process that the tax system is chosen. Through the political process the tax system is

therefore connected to the satisfaction of collective preferences.

The power to tax is derived from the state’s monopoly on the use of force. This monopoly of

force has been granted to the state, by its citizens, in exchange for security. The exercise of

this monopoly is limited by a constitution of negative liberties and expanded by positive

liberties. This limitation and expansion of the use of force, itself, is an expression of the

collective preferences. A negative liberty is the right to be free from the violence of others;

most notably the violence exercised through the administrative apparatus of the state.

Examples of negative liberties are freedom of religion, free speech and property rights.

Underlying the idea of negative liberties is that people should be free to do what they want,

provided that they don’t harm anyone. The idea of positive liberties, however, is that people

have the right to have certain wants satisfied. Examples of these are; the right to education,

the right to healthcare and the right to a minimum income. It is obvious that the ideas

underlying both these rights conflict. One entitles people to enjoy what they have; the other

entitles people to something they don’t. The satisfaction of the latter requires the violation

of the former.

1
John Tiley, ‘Revenue Law’ (6th edition Hart Publishers, Oxford 2008) p4

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The choice of a tax structure, to effectuate this power to tax, therefore depends on the

constitutional constraints of the monopoly of force. At the same time, the function of the tax

structure is to raise revenue to meet the expenditures to finance the obligations of the state

towards its citizens. By using this power to tax, however, it is possible to distribute

expenditure and raise revenue at the same time.

The choice of principles that should underlie a tax structure is therefore contingent on two

prior decisions. The first is the trade-off that is to be made between negative and positive

liberties. This trade-off comes down to efficiency and redistribution. The second choice is

how to effectuate that trade-off. To what extent should the power to tax be used as a tool

for distributing expenditure, thus satisfying collective preferences, in addition to raise

revenue?

The objective of this essay is to examine these two questions. The first part of the essay is an

economic view of property rights in the context of taxation. The second part examines the

constitutional trade-off. In the third part the power to tax as a tool is examined. The

conclusion follows in the fourth part.

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An economic view of property rights

From an economic point of view property rights are the assignment of rights and liabilities to

the use of property23. An example of this is the ownership of land, limited by the tort of

nuisance. This example expresses the classical liberal idea that individuals have the right to

enjoy the use of their property to the extent that they do not violate someone else’s use of

property. This idea is the same as that of negative liberties. Not allowing individuals to

impose costs on each other means that they will have to bear the burden themselves. It

follows, that private use will continue up to the point that the marginal cost of use, matches

the marginal benefit of use. The underlying principle of classical liberalism, therefore closely

matches the idea of economic efficiency.

Two problems

There are two assumptions implicit in, or two problems, with this view. First, property does

not exist in a vacuum. To define property rights, some form of governance is necessary to

enforce these rights4. Second, not all property rights can be defined.

First Problem

To define property rights, the existence of a state is necessary and a state requires funding.

To define property rights, their violation is necessary. The question that the design of a tax

system is concerned with is how this violation should take place. Taxation is the violation of

2
Christian Muller and Manfred Tiezel, ‘Property rights and their partitioning’ in
Jürgen G. Backhaus (ed), ‘The Elgar Companion to law and economics’ (Edward Elgar,
Cheltenham 1999) 40-53
3
Armen A. Alchian, ‘Some economics of property rights’ in
Richard A. Posner and Fransesco Parisi (eds) ‘Law and economics’ (Edward Elgar Publishers,
Cheltenham 1999) 493-507
4
Liam Murphy and Thomas Nagel, ‘The myth of ownership’ (OUP, Oxford 2005) p4

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property rights, through the expropriation of the benefits that their users derive from them.

By expropriating the benefits, the point at which the marginal costs of use will match the

marginal benefits of use, drops. The difference in use, before and after taxation is imposed,

is the distortionary cost of taxation. It is the minimizing of these costs that underlies much of

the optimal tax theory. Minimizing these costs, would therefore increase the use, and thus

the overall benefit of property. Framed like this, this seems a goal worth pursuing. Property

rights however are invested in people and maximizing the use of property and thus the

overall benefit of property is something different than maximizing the overall benefit to

people. The former is maximizing efficiency, whilst the latter is maximizing societal welfare.

It is the maximization of societal welfare that is done through the political process by

expressing the collective preferences through expenditure. Maximizing efficiency, or

maximizing societal welfare, is the constitutional trade-off between negative and positive

liberties.

Second Problem

The second problem is that not all property rights are defined. The situation wherein

property rights are not defined is called the tragedy of the commons. This tragedy comes

down to that because nobody incurs any marginal costs for the use, everybody’s marginal

benefits come at no cost to themselves. In the end everyone does pay the price, indirectly,

but it is the disconnect between cost and benefit that causes this problem. The best current

example of this problem is global warming. One of the solutions that is proposed to this

problem is a carbon tax. By imposing a tax, costs will be incurred for use. In doing this, it is,

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as if, property rights have been defined and assigned. The tax system therefore in part

defines property rights5.

Positive and Negative Liberties.

The constitutional trade-off between positive and negative liberties comes down to choosing

between maximizing efficiency and societal welfare. In choosing the former over the latter

economic growth is maximized. The result of an increased economic growth is that this will

make future generations wealthier. An economic growth rate over 70 years at 2% would

mean that the people then would be four times as wealthy as the people now. By lowering

economic growth to 1% the future generation would be twice as wealthy as the present

generation is now. Depending on how the trade-off is made, wealth will be transferred, to or

from future generations, from or to the present generation. The effect a tax system has on

economic incentives is the effect it has on the wealth of future generations. The trade-off is

therefore twofold, the other being between individual liberties and the satisfaction of

collective preferences. There are two types of positive liberties. One is the fairness as

between persons of similar capacity, or horizontal equity. The other, concerns the

distribution between rich and poor, or vertical equity. By expressing the tax system’s effect

on economic incentives as two trade-offs, an examination is now possible as to what is

traded in. This however does not explain what it is traded for.

It is evident, that these two principles of equity, by definition, satisfy a collective preference

that is to be expressed by the political process in the design of a tax system. The question

that remains to be answered is a preference for what. Both principles implicitly assume that

5
Liam Murphy and Thomas Nagel, ‘The myth of ownership’ (OUP, Oxford 2005) p8
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there is a right and a wrong answer to what is fair between similar persons and what a just

distribution between rich and poor should be. Not expressing the right answer in the tax

system, therefore means that the people concerned will be wronged. These people

concerned, will be wronged from the collective perspective by not having been given what

from the collective is preferred to be given to them. The collective preference here is a

preference for a form of justice to be dispensed by the state. The question then that

immediately arises is what form should that justice take? In the usual case that justice is

dispensed by the state, there has been a perpetrator and a victim. The victim has been

wronged and the perpetrator is to be punished. Here, there are only ‘victims’. The wrong

outcome is the result of a process of people pursuing their self-interest in the use of their

property6.

The substance of this justice is thus essentially concerned with changing these outcomes.

What the substance of this justice is, however, is either a question of fact or principle. What

characterizes justice is that it is based on principle. The collective preferences, however, are

a question of fact. The constitutional trade-offs, between individual liberties and the

satisfaction of collective preferences, and between present and future generations, thus can

be based on either principle or fact. This distinction disappears, when the question is asked,

as Rawls, did, behind a veil of ignorance. The collective preferences, then still is question of

fact, but the fact is now a principle. At a specific time, there will be one particular collective

preference for justice. When the specific time is unknown a principle to guide decisions will

have to be chosen.

6
Friedrich A. Hayek, ‘law legislatation and liberty: the mirage of social justice’ (Routledge
and Kegan Paul, London 1976)

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The problem with this solution, apart that it is difficult to put into practice, is that after the

trade-off has been made, there will be pressure to abandon the principle in favour of a

particular substance of justice, beneficial to the decision makers then. This is something that

has to be anticipated behind that veil of ignorance.

The power to tax as a tool

The power to tax, as stated earlier, is derived from the state’s monopoly of force. This

monopoly of force is constrained by a constitution of negative liberties and expanded by

positive liberties. This means that the power to tax is not only a method to raise revenue; it

is also a tool to effectuate the former. In the case of negative liberties, the power to tax can

limit the exercise of property rights on the one hand, but it can create fictional property

rights as would be the case with a carbon tax. At the same time it is possible through the tax

structure to distribute expenditure. By distributing expenditure the tax structure effectuates

the positive liberties. The right to education, the right to healthcare and the right to a

minimum income were named as examples of positive liberties. By making the cost of

healthcare and the cost of education tax-deductable, the tax structure can give effect to

these two. The right to a minimum income can be effectuated through a negative income

tax. One way of doing this, is by refunding the unused deductions and allowances to the

taxpayer. If there is a threshold before income taxes are paid, then the difference between

that threshold and the taxpayer’s income is refunded at a discount rate.

The result of this, necessarily is, that the tax system expands and it structures becomes

complicated. This decrease in simplicity increases the cost of compliance and thus the cost of

taxation. This however does not imply that the cost of raising revenue has increased. As is

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shown above, the raising of revenue is not the sole function of the tax system. The increase

in complexity has to be weighed against the expenditure it saves. The choice of effectuating

policy through the tax structure is only made when the power to tax can effectuate it at a

lower cost than the other tools that are available.

The choice of principles that should underlie a tax structure therefore are contingent on the

relative effectiveness of tax as a tool to effectuate policy that result from the choice of

positive and negative liberties.

Conclusion

What I have hoped to show through this brief examination is that the choice of principles is

the result of a two-stage process. The first choice is a constitutional trade-off to define the

monopoly of force i.e. the role of the state. This choice between negative and positive

liberties can be split into two separate choices. The first choice is that of individual liberties

versus the satisfaction of collective preferences. The second choice is between choosing

between present and future generations. Implicit in this choice is a form of a justice. The

substance that this justice should, should be based on a principle behind a veil of ignorance,

in making this choice, it should be taken into account, that after the veil is lifted, there will

be considerable pressure to abandon that principle in favour of the people making the

decisions at that time. The second choice is how to use the power to tax. The power to tax

being derived from the monopoly of force is but one way to effectuate the constitutional

trade-off. The choice of using the power to tax depends on its relative effectiveness

compared to the other tools derived from the monopoly of force.

Based on this two stage analysis, the principles underlying a tax system are not traded-off

against each other; they are the result of an earlier choice. The tax system expresses part of

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that choice by implementing it; the extent to which it expresses that choice depends on its

relative effectiveness as a tool. In order to therefore judge a tax system by comparing it to

alternative arrangements, it is important to take into account the context in which it exists.

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Bibliography

Books

Brian M. Barry, A treatise on social justice (University of California Press, Berkeley 1989)

Richard A. Posner, Economic analysis of law (6th edition Aspen Publishers, New York 2003)

Friedrich A. Hayek, ‘law legislatation and liberty: the mirage of social justice’ (Routledge and

Kegan Paul, London 1976)

James M. Buchanan, ‘Fiscal theory and political economy’ (University of North Carolina Press,

Chapel Hill 1960)

John Tiley, ‘Revenue Law’ (6th edition Hart Publishers, Oxford 2008)

Liam Murphy and Thomas Nagel, ‘The myth of ownership’ (OUP, Oxford 2005)

Articles

Christian Muller and Manfred Tiezel, ‘Property rights and their partitioning’ in

Jürgen G. Backhaus (ed), ‘The Elgar Companion to law and economics’ (Edward Elgar,

Cheltenham 1999) 40-53

Armen A. Alchian, ‘Some economics of property rights’ in

Richard A. Posner and Fransesco Parisi (eds) ‘Law and economics’ (Edward Elgar Publishers,

Cheltenham 1999) 493-507

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