An Immodest Proposal - Taxation by Inflation

When Jonathan Swift wrote his famous essay lampooning the attitude of some towards the poor, he was essentially writing a satire. I originally tried to find a similar way to help people to understand the idea of how our tax system and the management of the wealth of our nations is totally outmoded, but failed to find a persuasive theme. Instead, I will simply present the idea, and hopefully people with intelligence and an open mind can find some merit in it.

Before the advent of fiat currencies, taxes were collected in goods and gold or silver. Tax collectors originally had many means of determining how a person should be taxed. Sometimes it was by their perceived wealth, sometimes by the accounts of their companies or employers, and sometimes by strange rules such as the width of their dwelling.

Today, we continue to collect taxes by the same methods as those used for thousands of years.

The thing that has changed since the turn of the century is the introduction of fiat currencies. A national fiat currency is used instead of gold. The word fiat means that the governments can essentially create as much of this currency as they wish. To an economist, the total value of a fiat currency is equal to the total value of all goods and services in exchange at any moment.

In reality, governments don’t create currency. The banks create currency by borrowing from the central banks and lending, including to the government. All monetary inflation comes from this process.

Currently monetary inflation for most fiat currencies ranges between 5% and 20% depending on the currency and the markets. This means that every dollar in your pocket depreciates in value by this much every year. This is essentially a form of taxation. This implicit tax benefits the banks and investors.

When governments exceed their tax revenue, they must borrow from the banks or the public (via savings bonds). In any case, for every dollar borrowed by a “responsible” government, a bond is created. Over time, governments must pay the principal and interest on this debt and as well pay for the services the government must provide.

My proposal is twofold.

1. Aggregate the implicit inflation tax in with all other taxes and place strong (i.e. constitutional) statutory limits on the amount of this total tax. Declare the real taxation.
2. Reduce collected taxes and replace with un-bonded fiat currency to cover government operations.

The implications of such a system are interesting. Just to name a few:

1. Taxation becomes much simpler. All users of the currency are taxed the same. It is essentially a flat tax. This has both positive implications (such as fairness), and negative implications (such as taxation of revenue instead of profit).
2. Governments cannot make significant budgetary errors. Since the implicit tax consumed by issuing fiat currency to cover government operating expenses is shared with the inflation allowed for banks and investing, failures to curb expenses by the government impact private investment and the overall economy.
3. The public can see the implicit taxation of inflation. Currently most people do not understand monetary inflation and so it is not governed by consensus.
4. Banks do not benefit from public debt. Banks will have an interest in ensuring the governments do not over-extend themselves.
5. Investors are discouraged from holding currency (since it will more obviously lose value). This might improve the rate of exchange of currency - normally a positive economic indicator.

Just to comment on my own entry here. I did a bit of calculation and realized the idea wouldn't work. We'd just have too much inflation.