The end of taxation?

FOR A PEOPLE so ready to cast off ancient customs, Americans have been strangely reluctant to question the practice of taxation. Begun millennia ago, taxation developed as a method of exploitation. Instead of massacring defeated peoples, or taking them as slaves, conquerors realized that they could make a regular income by demanding wealth--with the threat of massacre as a prod. Of course the methods of taxation have been refined since those early days, but they still rest on the ugly foundation of force and the threat of force.

Yet philosophers and idealists, so eager to liberate the human race in other ways, have all but ignored taxation. Our culture's two outstanding thoughts on the subject are Benjamin Franklin's aphorism that "nothing is certain but death and taxes," and Supreme Court Justice Oliver Wendell Holmes's dictum that "taxes are what we pay for civilization." In other words, either you simply can't do away with taxes, or if you did, civilization would collapse. In the thrall of this received wisdom, generations of earnest reformers have accepted taxation, the legacy of Roman tyrants, as the only workable way to raise money for public purposes.

Growing strains

There are signs that this intellectual free ride is coming to an end. Sophisticated new research has begun to document what common sense long suggested, namely that taxation, far from being an efficient money machine, is an extremely wasteful way to raise money.

Since Adam Smith, scholars have known that taxation hurts the economy: It denies workers, entrepreneurs, and investors some of the fruits of their creativity and thus discourages their contributions. Only recently, however, have economists gotten around to measuring this disincentive effect. The first serious attempt appears to have been made by Michael Boskin in 1975. Since then, quite a number of studies have been done, both on specific taxes and for the tax system as a whole, and they show in all cases a significant depressing effect of taxation. One estimate for the entire tax system by Charles L. Ballard of Michigan State and his colleagues, published in the American Economic Review in 1985, found the disincentive effect to be 33.2 percent. That is, to raise $100 in taxes causes the waste of $33.20 in lost production. Another study, reported in 1990 by Harvard economists Dale W. Jorgenson and Kun-Young Yun, put the disincentive effect for the tax system even higher, at 38.3 percent of tax revenues.

Another area where research has revealed hitherto unmeasured burdens is compliance costs: recordkeeping, studying tax regulations and instructions, making calculations, and filling out forms and supplementary documents. It was not until the 1980s that systematic surveys were conducted to discover how much time taxpayers spent on these compliance activities. The most comprehensive of these surveys, which included both individual and business taxpayers, was released by the Arthur D. Little company in 1985. It found that the nation was wasting 5.4 billion man-hours a year in federal tax compliance work. This is the equivalent of having 2,900,000 people working all year long just to figure out and comply with federal tax regulations. In monetary terms, this burden amounted to $159 billion in 1985, or over 24 percent of tax revenues collected.

Further burdens of the tax system include the time and energy citizens spend grappling with IRS enforcement actions. There are some 20 million of these every year, including levies, liens, seizures, underreporter notices, non-filing notices, audits, and penalty assessments. Then there is the cost of tax litigation (190,000 cases in 1990), as well as the waste of resources devoted to tax avoidance and evasion devices (which range from investment tax shelters to offshore tax havens and money laundering schemes). When estimates of these costs are combined with the findings about compliance and disincentive costs, the conclusion emerges that, all told, the overhead cost of running the federal tax system appears to be about $65 for each $100 in tax collected (see table).

Costs of operating the U.S. federal tax system(*)

                                     Cost to raise $100

Compliance costs                           $24.43
Disincentive costs                          33.20
Uncertainty costs                            1.84
Enforcement and litigation costs             1.97
Evasion and avoidance costs                  2.96
Governmental costs (IRS and
other agencies)                              0.61

Total                                      $65.01

* Adapted from James L. Payne, Costly Returns: The Burdens of
the U.S. Tax System (ICS Press, 1993), p. 150.

What's worse, these costs are heading upward. Tax systems in the modern era have a natural tendency to become more complex. This is partly because economic life becomes more complex, with more nooks and crannies to be defined, reported, and controlled. Another cause of complexity is the politician's desire to undo the hardship of taxation and tax enforcement. In the good old days, tax collectors came to your farm and took which cows they wanted and maybe even your daughter--and burned down your barn if you didn't give them a drink of whiskey.

Today, the trend is away from the arbitrary application of force, but toward an ever-growing mass of rules, regulations, and opportunities to protest. This may make taxation less cruel, but at the same time it makes it more complicated and more costly.

Take just one small illustration of this process. In 1976, Congress gave taxpayers the right to be informed when witnesses were being summoned to testify against them, thus ending the IRS's medieval power to coerce testimony secretly. However, the flip side of this new right was higher costs, as taxpayers used the court system to challenge IRS summonses. The number of cases of summons-enforcement litigation doubled after passage of the 1976 provision, going from 1,900 in 1975 to 3,700 in 1977--and has since climbed to over 8,000 cases.

The 1980s saw dramatic increases in the complexity and burdens of the U.S. tax system. The number of tax court cases nearly tripled (to 28,000 in 1990); the number of liens placed on property doubled (to 1.1 million); and the number of levies (IRS actions to seize paychecks and bank accounts) quadrupled (to 2.6 million). In an effort to keep with a complexity of economic life that was making the tax system ever more porous, Congress approved a mass of highly complicated measures, including the alternative minimum tax and the passive loss provisions. Grappling with this new burden cost Americans millions more hours of work. A study by University of Michigan economist Joel Slemrod found that the time spent on tax compliance for the average household increased 26 percent between 1982 and 1989; the increase of the compliance burden on businesses and corporations was undoubtedly even larger.

The voluntary alternative

We have reached the point where everyone familiar with the facts--including IRS officials themselves--agrees that the current tax system is an appallingly wasteful arrangement. But most people can't see any alternative. They assume that we must endure the tax system, whatever it costs, sacrificing our prosperity to stave off the end of civilization.

Fortunately, this logic is spurious. There is another way to raise public funds. It has been around for thousands of years, and until the twentieth-century love affair with government, it was the principal way money was raised for social purposes. It's called voluntarism. Instead of using force, one collects money on a voluntary basis by offering donors a positive satisfaction in return for their contributions. In many cases, the satisfaction is that of fulfilling a high religious ideal or social duty. But voluntary giving can operate with mundane, personal motives as well. Vanity, for example, is a common impulse behind charitable giving. In ancient Greece, the desire to stand out and be well-thought-of undergirded an extensive philanthropic system called "liturgy." Wealthy, prominent citizens made public gifts of buildings, military equipment, bridges, plays, and festivals. It was, according to tax historian Charles Adams, "the voluntary alternative to progressive taxation."

The free rider fallacy

Voluntary giving is not only ancient; it is widespread. The FFFROC Trust for Philanthropy, an association that keeps records of charitable giving, reports that in 1991, charitable giving in the United States exceeded $124 billion. Still more remarkable is the fact that charitable giving, in spite of the growing bite of government taxation, is increasing, showing a 2.8 percent yearly increase in real (inflation-adjusted) terms over the past decade.

Despite its importance, and its great potential, voluntary giving is routinely ignored, especially in academia. While the theory of taxation is expounded in thousands of books, articles, and college courses, there are hardly any books, articles, or courses on the theory of voluntary giving.

One reason for this neglect is the academic preoccupation with the "free rider problem." Whenever people can enjoy something without being made to pay for it, this argument goes, they will do so. Take, for example, a charitably supported library. Since people can take out books without paying, the natural result--say the theorists--is that everyone will attempt to "freeload," and the library will collapse. Therefore, the only way to have free libraries, or any other public service you don't want to charge for, is to force everyone to pay using a tax system.

The flaw in this argument is that it assumes that everyone is narrowly selfish, always trying to maximize wealth. This kind of simplifying assumption is widely used as a starting point for social science theories, but it overlooks the complexity of human behavior. Human beings can be generous as well as selfish, and this generosity makes possible the hundreds of thousands of voluntary giving arrangements that we see all across the country.

Zero-cost fundraising

A serious look at voluntary fundraising reveals that it has some impressive advantages. For one thing, voluntary fundraising can avoid the overhead costs that plague modern tax systems.

First of all, the disincentive effect disappears. Whereas a tax system discourages work, a voluntary system of giving encourages it. The voluntary donor says, "I want to work overtime this week so I can earn extra money to send our scout troop to the jamboree." In effect, a voluntary contribution is a consumption item. It is no different from a stereo, a ticket to a ball game, or anything else a person earns money for.

Another cost that disappears in a voluntary system is the compliance burden. Since donors are not forced to give any particular amount, there is no need to prove anything to anyone: no recordkeeping, no regulations to study, no forms to fill out. Just whip out a dollar, if you want, or a hundred dollars, if you'd rather. It's your own business.

Just as compliance costs fall to zero in a voluntary system, so do enforcement costs, litigation costs, and avoidance costs. Since no one is being pinned to the wall, no one has to waste energy resisting or evading the pinning.

The overall result, then, is that in a voluntary system, fundraising costs can fall to zero. This is not just a theoretical prediction. Thousands of voluntary groups in the United States actually achieve virtually zero fundraising costs. Take the First Lutheran Church of Sandpoint, Idaho, of which the author happens to be a member. The church is, in effect, a public service organization, operating a free soup kitchen, a free clothing program, youth activity programs, a sewing circle, a choir, counseling services, prayer groups, as well as worship services and Sunday school. The church also forwards over 19 percent of its income to local, national, and international charities. All church activities are open to members and non-members, to those who contribute and those who do not.

Despite the obvious potential for freeloading, this system of voluntary giving does not collapse, as the academics say it should. Instead it thrives. In 1991, it raised $153,893, or an average of over $650 for each of the 230 family members. This voluntary contribution is considerably higher than the average Idaho state income tax payment of these same families.

What was the overhead cost of collecting this $153,893? A close inspection of church accounts and procedures reveals only two fundraising expenditures. In the fall, the church has a potluck stewardship dinner. The supper itself is a social and culinary occasion (the best home cooking in Sandpoint), so it can hardly count as a cost or burden. However, at the dinner, pledge cards are distributed to encourage each family to decide on its yearly contribution. Second, each family gets a box of dated and numbered offering envelopes. Like the pledge cards, the envelopes help motivate and organize giving. The cards and the envelopes cost $419.73, making the total fundraising costs 0.27 percent of the funds collected. In other words, this church has fundraising costs less than one two-hundredth those of the IRS.

This figure is characteristic of most churches and many locally based clubs, like Rotary or Kiwanis. The key to their success is the idea of "stewardship giving": Donors themselves are convinced of the need to give. Other voluntary groups, which do not have such a committed membership, have to expend resources on advertising and mass mailing. But even organizations that depend on these inferior methods still do better than the IRS. For example, the fundraising costs of the American Cancer Society are 23 percent of income; the United Negro College Fund's costs are 21 percent; the American Red Cross's, 7.7 percent.

Give at the office

Voluntary payroll deductions provide another approach. A good example of such an arrangement is the Combined Federal Campaign in the Washington, D.C. area. The federal employees who join the plan are given a booklet detailing nearly two thousand charities vetted by the campaign's organizers. They then fill out a card, stipulating the amount they want deducted from their pay and naming the groups they want their money sent to. The cost of running the entire system--which includes approving the charities, publishing the booklets, collecting the deductions, and disbursing them to the respective charities--is less than 4 percent of the entire sum collected ($35.3 million in 1991).

This system, like all systems of voluntary giving, empowers individuals. Each person gets to choose the charities and public services he wants to support. Governments pay lip service to this ideal, but they never come close to implementing it. In a governmental system, your money is taken away from you whether you want to donate or not, and then spent as decided by a massive, tangled network of administrators and legislators. Unless a citizen is prepared to mount an exhausting and costly lobbying campaign, he is helpless to affect the allocation of his funds. In a voluntary system, on the other hand, the donor can vote agencies up or down with a stroke of his pen. The result is a genuine free market in which consumer choice can reward effective charities and punish those that are unnecessary, wasteful, or corrupt.

In addition to its practical advantages, voluntary giving also has an idealistic advantage. Tax collection is a depressing process. Acting under the gun of coercion, donors can take no satisfaction from their contributions. Instead, they experience anger at having their privacy invaded and their funds "ripped off." Those who operate the system--tax collectors--don't feel good about the arrangement either. Throughout history, they have been resented and friendless. Taxation breeds cynicism, with donors suspecting tax collectors, and tax collectors suspecting donors.

A voluntary system, on the other hand, brings out the best in everyone. It provides inspiration for donors, recipients, and observers. One man who noticed this win-win feature of voluntary fundraising was Booker T. Washington, founder of the Tuskegee Institute, the first black college in Alabama. Washington sought voluntary contributions from everyone, black and white, and often received in-kind donations:

I recall one old coloured woman, who was about seventy years of age, who came to see me when we were raising money to pay for the farm. She hobbled into the room where I was, leaning on a cane. She said, "Mr. Washin'ton, God knows I spent de bes' days of my life in slavery. God knows I's ignorant an' poor; but I knows what you is trying to do. I know you is tryin' to make better men an' better women for de coloured race. I ain't got no money, but I wants you to put dese six eggs into de eddication of dese boys an' gals.

The moral power of this kind of voluntary transaction can never be achieved with a tax system based on force.

A needed policy debate

As noted earlier, taxation is a deeply embedded social institution, woven into the fabric of modern life by generations of indoctrination and usage. It is the vested interest to end all vested interests, supporting scores of millions of people, from pensioners to professors. As such, it is probably neither possible nor desirable to do away with it in a stroke--no matter what its flaws may be.

But what we can and should debate is our future direction. Do we want to depend ever more heavily on taxation as the fundraising system for addressing public problems, or should we start to de-emphasize it and instead promote voluntarism?

Voluntary giving receives little formal encouragement these days. The public has been imbued with the idea that taxation is the way community services are supposed to be funded. Our school children are taught the mechanics of political finance; they are taught to vote and to form pressure groups to lobby for government grants and benefits. They are not trained in the theory and practice of philanthropy.

Voluntary giving, disparaged in our statist culture as a whimsical distraction, nevertheless yields scores of billions: dramatic evidence of its inherent potential. It is worth speculating how such giving might thrive in a society that decided to emphasize it, in a society where children were taught, from their earliest days, that voluntary giving is needed to sustain civilization.

COPYRIGHT 1993 The National Affairs, Inc.
COPYRIGHT 2004 Gale Group