prior probability

“There is no art which one government sooner learns of another than that of draining money from the pockets of the people.” (V.ii.h.12; my emphasis)

At this point in The Wealth of Nations — i.e. between Articles 2 and 3 of Part 2, Ch. 2, Book V of his magnum opus, for those keeping score at home –, Adam Smith includes an intriguing appendix on “Taxes upon the Capital Value of Land, Houses, and Stock” (available here; scroll down to “Appendix to Articles I and II”). Here, Smith draws a temporal distinction between the ownership and the transfer of property, such as land, houses, and capital or “stock”:

“While property remains in the possession of the same person, whatever permanent taxes may have been imposed upon it, they have never been intended to diminish or take away any part of its capital value, but only some part of the revenue arising from it. But when property changes hands, when it is transmitted either from the dead to the living, or from the living to the living, such taxes have frequently been imposed upon it as necessarily take away some part of its capital value.” (WN, V.ii.h.1; my emphasis)

In plain English, when the government imposes a tax on property such as land (L), houses (H), or capital (C), that tax should not be based on the value of L, H, or C. Instead, the government should only tax any revenue streams produced by that property, i.e. the revenue generated by L, H, or C. But when the ownership of L, H, or C is transferred to another person — either by agreement (e.g. purchase and sale), by death (a will), or by a donation inter vivos (a gift) — any tax imposed on the transfer of L, H, or C will be bad in an economic or wealth-maximization sense because such a tax will “necessarily” reduce “some part of [L, H, or C’s] value.”

Next, Smith draws a secondary — but no less important — distinction between transfers of L and H (land and houses) on the one hand and transfers of C (other capital assets) on the other:

“The transference of all sorts of property from the dead to the living, and that of immovable property, of lands and houses, from the living to the living, are transactions which are in their nature either public and notorious, or such as cannot be long concealed. Such transactions, therefore, may be taxed directly. The transference of stock, or movable property, from the living to the living, by the lending of money, is frequently a secret transaction, and may always be made so. It cannot easily, therefore, be taxed directly.” (WN, V.ii.h.2; my emphasis)

In brief, it is easier to tax transfers of L and H than transfers of C because such L and H transfers “are in their nature either public and notorious, or such as cannot be long concealed.” Does this mean the government won’t try to tax transfers of C? Of course not! The government can tax all types of property transfers in one of two ways: “stamp-duties” (stamp taxes) and “duties upon registration” (registration fees). In the words of the Scottish tax scholar:

“The transference of stock, or movable property …. has been taxed indirectly in two different ways; first, by requiring that the deed containing the obligation to repay should be written upon paper or parchment which had paid a certain stamp-duty, otherwise not to be valid; secondly, by requiring, under the like penalty of invalidity, that it should be recorded either in a public or secret register, and by imposing certain duties upon such registration.” (WN, V.ii.h.2; my emphasis)

In other words, because transfers of capital assets and other moveable property are easy to conceal, the government can try to flush out these underground transfers, forcing them to the surface, so to speak. How? By refusing to enforce or to otherwise recognize the legality of those transfers unless they are recorded in a government registry — with the government charging you a hefty registration fee for this privilege — or recorded on a piece of official paper sold to you by the government. Smith then makes two additional points about these two types of property-transfer taxes. Although registration fees and stamp taxes “are of very modern invention”, they are now — in Smith’s day as well as ours! — “almost universal”:

“Those modes of taxation, by stamp-duties and by duties upon registration, are of very modern invention. In the course of little more than a century, however, stamp-duties have, in Europe, become almost universal, and duties upon registration extremely common.” (V.ii.h.12)

It is here, after the words “extremely common”, that Smith adds the following snide — though no less true! — remark: “There is no art which one government sooner learns of another than that of draining money from the pockets of the people.” (V.ii.h.12; my emphasis) In other words: don’t steal; the government hates competition! Nota bene: I will have more to say about Smith’s appendix on stamp taxes and registration fees in my next post.

“In general there is not, perhaps, any one article of expence or consumption by which the liberality or narrowness of a man’s whole expence can be better judged of than by his house-rent.” (WN, V.ii.e.7)

Thus far this week, we have seen Adam Smith’s four maxims of taxation (see here) and his tax treatment of agriculture (here), but what about residential real estate? That is, what about houses? Should one’s primary residence be taxed, and if so, by how much? As it happens, Smith explores “Taxes upon the Rent of Houses” in the third and last subsection of Article 2 of Chapter 2 of Book V of The Wealth of Nations (WN, V.ii.e). But Smith’s tax treatment of houses is not just about housing; it’s really about taxing the rich, making them pay their fair share of taxes:

“The luxuries and vanities of life occasion the principal expence of the rich, and a magnificent house embellishes and sets off to the best advantage all the other luxuries and vanities which they possess. A tax upon house-rents, therefore, would in general fall heaviest upon the rich; and in this sort of inequality there would not, perhaps, be any thing very unreasonable. It is not very unreasonable that the rich should contribute to the public expence, not only in proportion to their revenue, but something more than in that proportion.” (WN, V.ii.e.6)

Simply put, “house-rents” should be taxed, and since the rich devote a greater share of their income to housing — i.e. because the rich have bigger and fancier houses than the common people — it is “not very unreasonable” that the rich should pay more in property taxes. In addition, Smith argues that to the extent high property values are the result of good government, it is only fair that the direct beneficiaries (the rich) pay more in taxes:

“Ground-rents, so far as they exceed the ordinary rent of land, are altogether owing to the good government of the sovereign, which, by protecting the industry either of the whole people, or of the inhabitants of some particular place, enables them to pay so much more than its real value for the ground which they build their houses upon; or to make to its owner so much more than compensation for the loss which he might sustain by this use of it. Nothing can be more reasonable than that a fund which owes its existence to the good government of the state should be taxed peculiarly, or should contribute something more than the greater part of other funds, towards the support of that government.” (WN, V.ii.e.9; my emphasis)

But how would property taxes be calculated? What if a rich family already owns the house they live in? How would their “house tax” (so to speak) be calculated? The Scottish scholar addresses these logistical questions as follows in Paragraph 8 of this subsection:

“The rent of houses might easily be ascertained with sufficient accuracy by a policy of the same kind with that which would be necessary for ascertaining the ordinary rent of land [i.e. a formal public registry where leases are recorded]. Houses not inhabited ought to pay no tax. A tax upon them would fall altogether upon the proprietor, who would thus be taxed for a subject which afforded him neither conveniency nor revenue. Houses inhabited by the proprietor ought to be rated, not according to the expence which they might have cost in building, but according to the rent which an equitable arbitration might judge them likely to bring if leased to a tenant.” (WN, V.ii.e.8)

In other words, house taxes should be based on fair market values, on the rent a house would have obtained if it were put on the market.

Now, before proceeding any further, however, a crucial clarification is in order. Although Smith is clearly in favor of taxing the rich, he would probably be strongly opposed to a “wealth tax”. To see why, recall from my previous post Smith’s opposition to property taxes based on land values. I could be wrong, but I suspect that Smith’s critique of property taxes based on land values applies with equal force to most, if not all, proposed “wealth taxes” of our day: a wealth tax would have bad incentive effects, would invite government corruption, and would be arbitrary and unfair.

Nota bene: I will proceed to Adam Smith’s appendix for Articles 1 and 2 of Part 2, Chapter 2, Book V in my next two posts.

“The attention of the sovereign can be at best but a very general and vague consideration of what is likely to contribute to the better cultivation of the greater part of his dominions. The attention of the landlord is a particular and minute consideration of what is likely to be the most advantageous application of every inch of ground upon his estate.” (WN, V.ii.c.18)

Nota bene: Today (25 March) is the Feast of the Annunciation!

Remember Adam Smith’s stinging critique of landlords way back in Book I, Chapter 6 of The Wealth of Nations: “Landlords, like all other men, love to reap where they never sowed, and demand a rent even for the natural produce of the earth.” (WN, I.vi.8)? Well, landowners are not just economic parasites; they are also an important group of potential taxpayers — so important that Smith begins his substantive survey of taxation in Article 1 of Part 2, Chapter 2, Book V of his magnum opus with landlords.

(As an aside, Smith’s general emphasis on landowners should come as no surprise, especially since agriculture was still the most important economic activity of his day. Today, I will explore the first two subsections in this article: “Taxes upon Rent” (WN, V.ii.c) and “Taxes which are proportioned, not to the Rent, but to the produce of Land” (WN, V.ii.d). I will turn to the third and last subsection of Article 1, “Taxes upon the Rent of Houses” (WN, V.ii.e) in my next post.)

But instead of asking, How much taxes should landowners pay?, Smith asks a different question. He asks, How should a landlord’s overall tax liability be calculated? (a) On the actual amount of rent the landlord is able to collect from his farmer-tenants, (b) on the overall value of his land, or (c) on the amount of crops his land is able to produce? Smith’s general answer to this key question is crystal clear: don’t tax the crops or value of his land; tax the rent instead. (The meme pictured below is therefore false and misleading.) More specifically, Smith provides three reasons why land taxes should be based on the landlord’s stream of income or rents:

REASON #1: INCENTIVE EFFECTS [1]

To begin, Smith explores the incentive effects of land taxes. His verdict is that a tax on the value of one’s land might be counterproductive because such a tax might deter the landlord from making any improvements to his land:

“The discouragement which a variable land-tax [i.e. a tax based on the value of land] might give to the improvement of land seems to be the most important objection which can be made to it. The landlord would certainly be less disposed to improve when the sovereign, who contributed nothing to the expence, was to share in the profit of the improvement.” (WN, V.ii.c.18)

Ditto taxes on crops, such as tithes:

“The tythe … is always a great discouragement both to the improvements of the landlord and to the cultivation of the farmer. The one cannot venture to make the most important, which are generally the most expensive improvements, nor the other to raise the most valuable, which are generally too the most expensive crops, when the church [or the government, in the case of a tax on the produce of land], which lays out no part of the expence, is to share so very largely in the profit.” (WN, V.ii.d.3)

In other words, if a landlord or one of his tenant-farmers invests extra money and labor to increase the yield or output of their crops, the tax collector (or the church in the case of tithes) will take a share of this increased output without having contributed to the landlord or tenant-farmer’s initial investment.

So, what about a tax on rents? Although Smith throws some shade on the famed Physiocrats of France for their “metaphysical arguments” (WN, V.ii.c.7) in favor of taxing rents, the Scottish scholar devotes most of Article 2 explaining why a tax on rent is “less bad” (so to speak) than the alternatives. See below.

REASON #2: INVITATION TO GOVERNMENT CORRUPTION [2]

According to Smith, a tax based on land values or on the amount of crops (i.e. the produce of the land) would invite government corruption in one form or another. Consider, for example, a tax on crops, especially one that must be paid to tax officials “in kind”:

“The servants of the most careless private person are, perhaps, more under the eye of their master than those of the most careful prince; and a public revenue which was paid in kind would suffer so much from the mismanagement of the collectors that a very small part of what was levied upon the people would ever arrive at the treasury of the prince.” (WN, V.ii.d.7)

Ditto a tax on land values:

“A land-tax assessed according to a general survey and valuation, how equal soever it may be at first, must, in the course of a very moderate period of time, become unequal. To prevent its becoming so would require the continual and painful attention of government to all the variations in the state and produce of every different farm in the country. The governments of Prussia, of Bohemia, of Sardinia, and of the duchy of Milan actually exert an attention of this kind; an attention so unsuitable to the nature of government that it is not likely to be of long continuance, and which, if it is continued, will probably in the long-run occasion much more trouble and vexation than it can possibly bring relief to the contributors.” (WN, V.ii.c.26)

In other words, a tax based on land values would require tax officials to conduct a general survey and valuation, but how accurate would their valuation be? If you were an 18th-century landowner, would you really trust the government to accurately assess the value of your land? Why wouldn’t the government inflate its value in order to squeeze more tax dollars from you?

REASON #3: FAIRNESS [3]

But Smith saves his best argument for last: a tax based on the value of land would, in the end, be arbitrary. Why? Because the Herculean task of trying to figure out the true value of all the land in a kingdom inevitably requires the exercise of discretion by government officials, and this discretion is likely to be abused. (See WN, V.ii.c.27.) A tax on the landlord’s rent, by contrast, is much more easier to figure out and is not subject to the whims of government officials.

Likewise, although a flat land tax or tithe (e.g., 10% of crops) appears to be equal and fair, the effect of such a tax would have an unequal impact on landowners. Why? Because the cost of cultivation varies wildly between land plots. On rich land, a farmer can easily pay a portion of the produce and still make a profit, while on poor land, that same land tax could wipe out his profit. (See WN, V.ii.d.2)

THE BIG PICTURE

For Smith, the main job of the government is not to micromanage the activities of landlords and their farmer-tenants. In two words, its role is to legalize freedom, to allow landlords and farmers “to pursue their own interest in their own way and according to their own judgment”:

“The principal attention of the sovereign ought to be to encourage, by every means in his power, the attention both of the landlord and of the farmer, by allowing both to pursue their own interest in their own way and according to their own judgment; by giving to both the most perfect security that they shall enjoy the full recompense of their own industry; and by procuring to both the most extensive market for every part of their produce, in consequence of establishing the easiest and safest communications both by land and by water through every part of his own dominions as well as the most unbounded freedom of exportation to the dominions of all other princes.” (WN, V.ii.c.18)

In short, the role of the government is to open markets and promote production. The tax system should therefore be consistent with these goals, not undermine them! (To be continued …)

[1] Cf. Adam Smith’s first maxim of taxation: “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.” (WN, V.ii.b.3)

[2] Cf. Smith’s insightful discussion of transaction costs in Paragraph 6 of Part 2 of Chapter 2 of Book V of The Wealth of Nations. According to Smith, a given tax is bad if “the levying of it may require a great number of officers, whose salaries may eat up the greater part of the produce of the tax, and whose perquisites may impose another additional tax upon the people.” (WN, V.ii.b.6)

[3] Cf. Smith’s second maxim of taxation: “The tax which each individual is bound to pay ought to be certain, and not arbitrary.” (WN, V.ii.b.4)

Alternative title: Adam Smith’s Maxims of Taxation

What does ICE and the IRS have in common? Broadly speaking, the main job of the IRS is to collect federal taxes; ICE’s job, by contrast, is to deport taxpayers! [1]

For his part, Adam Smith introduces four general principles or global criteria that all good tax systems should satisfy in Part 2 of Chapter 2 of Book V of The Wealth of Nations (available here; scroll down to “PART II”). Moreover, this is Adam Smith at his finest, for his maxims of taxation are still relevant and foundational today, for they explain why the IRS should not be run like ICE. (See my conclusion below.) But first, for reference, all four of Smith’s maxims are reproduced below:

MAXIM #1: EVERYONE MUST PAY THEIR FAIR SHARE OF TAXES (EQUALITY)

“The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state…. Every tax, it must be observed once for all, which falls finally upon one only of the three sorts of revenue above mentioned [i.e., rent, profit, and wages], is necessarily unequal in so far as it does not affect the other two….” (WN, V.ii.b.3; my emphasis) Notice how Smith does not distinguish between citizens and illegal aliens here; instead, he refers to the subjects of every state.

MAXIM #2: THE TAX SYSTEM SHOULD BE CLEAR AND SIMPLE (CERTAINTY)

“The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person. Where it is otherwise, every person subject to the tax is put more or less in the power of the tax-gathered, who can either aggravate the tax upon any obnoxious contributor, or extort, by the terror of such aggravation, some present or perquisite to himself. The uncertainty of taxation encourages the insolence and favours the corruption of an order of men who are naturally unpopular, even where they are neither insolent nor corrupt. The certainty of what each individual ought to pay is, in taxation, a matter of so great importance that a very considerable degree of inequality, it appears, I believe, from the experience of all nations, is not near so great an evil as a very small degree of uncertainty.” (WN, V.ii.b.4; my emphasis)

MAXIM #3: THE PAYMENT OF TAXES SHOULD BE SIMPLE AND EASY (CONVENIENCE)

“Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it. A tax upon the rent of land or of houses, payable at the same term at which such rents are usually paid, is levied at the time when it is most likely to be convenient for the contributor to pay; or, when he is most likely to have wherewithal to pay. Taxes upon such consumable goods as are articles of luxury are all finally paid by the consumer, and generally in a manner that is very convenient for him. He pays them by little and little, as he has occasion to buy the goods. As he is at liberty, too, either to buy, or not to buy, as he pleases, it must be his own fault if he ever suffers any considerable inconveniency from such taxes.” (WN, V.ii.b.5; my emphasis)

MAXIM #4: TAXES SHOULD BE AS LOW AS POSSIBLE (EFFICIENCY)

“Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.” (WN, V.ii.b.6; my emphasis) More importantly, right after describing his fourth and final general maxim of taxation, Adam Smith identifies four ways that taxes distort the economy:

1. Collection and enforcement costs: “First, the levying of it may require a great number of officers, whose salaries may eat up the greater part of the produce of the tax, and whose perquisites may impose another additional tax upon the people.” (WN, V.ii.b.6) In two words, transaction costs: we need tax officials to collect taxes and enforce tax law, and these collection and enforcement costs further increase the amount of taxes the government must impose on taxpayers.
2. Bad incentive effects: “Secondly, it may obstruct the industry the people, and discourage them from applying to certain branches of business which might give maintenance and unemployment to great multitudes. While it obliges the people to pay, it may thus diminish, or perhaps destroy, some of the funds which might enable them more easily to do so.” (ibid.) Simply put, some taxes might discourage people from working, investing, or engaging in other productive economic activities.
3. Tax evasion: “Thirdly, by the forfeitures and other penalties which those unfortunate individuals incur who attempt unsuccessfully to evade the tax, it may frequently ruin them, and thereby put an end to the benefit which the community might have received from the employment of their capitals. An injudicious tax offers a great temptation to smuggling. But the penalties of smuggling must rise in proportion to the temptation. The law, contrary to all the ordinary principles of justice, first creates the temptation, and then punishes those who yield to it; and it commonly enhances the punishment, too, in proportion to the very circumstance which ought certainly to alleviate it, the temptation to commit the crime.” (ibid.) In plain English: when taxes are too high people will be tempted to join the underground economy or engage in black market activities.
4. Government overreach and intrusion: “Fourthly, by subjecting the people to the frequent visits and the odious examination of the tax-gatherers, it may expose them to much unnecessary trouble, vexation, and oppression; and though vexation is not, strictly speaking, expence, it is certainly equivalent to the expence at which every man would be willing to redeem himself from it.” (ibid.) Imagine, in other words, if the IRS were run like ICE: imagine heavily-armed and masked IRS agents run amok chasing down tax evaders the same way masked ICE agents pursue criminal aliens.

What would Adam Smith have to say about illegal immigration? Although the Scottish scholar himself does not discuss immigration directly in his magnum opus, one thing I can say for certain is that Smith would not want the IRS to be run like ICE, the government agency in charge of deporting taxpayers! (Again, see Note #1 below.) But that said, Smith’s maxims of taxation pose two open questions: (A) which of Smith’s four criteria is the most important one, and (B) does the U.S. tax system, with its multiple levels of onerous and complex taxation, satisfy Smith’s four maxims?

Nota bene: I will proceed to Article 1 of Part 2 of Chapter 2 of Book V of The Wealth of Nations (V.ii.c) in my next post.

[1] Even illegal aliens — as well as full citizens in the underground economy! — pay some form of taxes, such as sales taxes, tolls, etc. See here and here, for example.

We now turn to Part 1 of Chapter 2 of Book V of The Wealth of Nations. Here, Adam Smith surveys the two major “Sources of Revenue which may peculiarly belong to the Sovereign or Commonwealth” (WN, V.ii.a.1): capital and land. Moreover, in the course of his superlative survey Smith, yet again, makes a number of timeless observations:

1. ADAM SMITH’S EVERGREEN CRITIQUE OF DEMOCRACY

First off, the Scottish scholar compares and contrasts in passing “the orderly, vigilant, and parsimonious administration of such aristocracies as those of Venice and Amsterdam” with “the thoughtless extravagance” of parliamentary democracies like England:

“The orderly, vigilant, and parsimonious administration of such aristocracies as those of Venice and Amsterdam is extremely proper, it appears from experience, for the management of a mercantile project of this kind. But whether such a government as that of England—which, whatever may be its virtues, has never been famous for good œconomy; which, in time of peace, has generally conducted itself with the slothful and negligent profusion that is perhaps natural to monarchies; and in time of war has constantly acted with all the thoughtless extravagance that democracies are apt to fall into—could be safely trusted with the management of such a project, must at least be good deal more doubtful.” (WN, V.ii.a.4)

2. SMITH’S LIMITED DEFENSE OF “MERCANTILE PROJECTS” LIKE THE POST OFFICE

Although Smith is very critical of the mercantile system in general (see especially Chapters 1 to 8 of Book IV of The Wealth of Nations), he is, above all and as we have seen time and time again, a pragmatist, so he is willing to tolerate — and even praise — certain mercantile projects when the benefits of those projects are great enough and benefit the public at large:

“The post office is properly a mercantile project. The government advances the expence of establishing the different offices, and of buying or hiring the necessary horses or carriages, and is repaid with a large profit by the duties upon what is carried. It is perhaps the only mercantile project which has been successfully managed by, I believe, every sort of government. The capital to be advanced is not very considerable. There is no mystery in the business. The returns are not only certain, but immediate.” (WN, V.ii.a.5)

3. “NO TWO CHARACTERS SEEM MORE INCONSISTENT THAN THOSE OF TRADER AND SOVEREIGN” (WN, V.ii.a.7)

Why? Because the government is a monopoly, so it doesn’t have to worry about competition:

“No two characters seem more inconsistent than those of trader and sovereign. If the trading spirit of the English East India Company renders them very bad sovereigns, the spirit of sovereignty seems to have rendered them equally bad traders. While they were traders only they managed their trade successfully, and were able to pay from their profits a moderate dividend to the proprietors of their stock. Since they became sovereigns, with a revenue which, it is said, was originally more than three millions sterling, they have been obliged to beg extraordinary assistance of government in order to avoid immediate bankruptcy. In their former situation, their servants in India considered themselves as the clerks of merchants: in their present situation, those servants consider themselves as the ministers of sovereigns.” (WN, V.ii.a.7)

4. THE OPPORTUNITY COSTS OF PUBLIC OWNERSHIP OF LAND

Last but not least, Adam Smith has this to say regarding government ownership of land:

“The revenue which, in any civilized monarchy, the crown derives from the crown lands, though it appears to cost nothing to individuals, in reality costs more to the society than perhaps any other equal revenue which the crown enjoys. It would, in all cases, be for the interest of the society to replace this revenue to the crown by some other equal revenue, and to divide the lands among the people, which could not well be done better, perhaps, than by exposing them to public sale.” (WN, V.ii.a.19; my emphasis)

But at the same time, the Scottish scholar makes a pragmatic exception for “parks, gardens, public walks, &tc.”:

“Lands for the purposes of pleasure and magnificence—parks, gardens, public walks, &c. possessions which are every where considered as causes of expence, not as sources of revenue—seem to be the only lands which, in a great and civilized monarchy, ought to belong to the crown.” (WN, V.ii.a.20)

On this note, recall Adam Smith’s discussion of “publick diversions” in Paragraph 15 of Article 3 of Part 3 of Chapter 1 of Book V of The Wealth of Nations (WN, V.i.g.15), one of my favorite passages in Smith’s entire magnum opus. For me, Smith’s call for “publick diversions” and his public-spirited defense of communal spaces go hand-in-hand: a great society is one in which the people are able to choose from many different forms of entertainment [1] in many different communal and private spaces.

Nota bene: I will proceed to Part 2 of Chapter 2 of Book V of The Wealth of Nations in my next post.

[1] Alas, as I mentioned in a previous post, a potential blind spot bedevils Smith’s call for “publick diversions”, for Smith says that the market for entertainment should be free so long as the forms of entertainment being offered are “without scandal and indecency.” (WN, V.i.g.15) The blind spot, then, is this: Smith’s anti-scandal caveat appears to necessitate some form of censorship. After all, who decides what is scandalous or indecent?

Happy spring! We now turn to the next-to-last chapter of Adam Smith’s Wealth of Nations: Book V, Chapter 2, which is available here. This chapter has two parts. Part One, consisting of 21 paragraphs, surveys “the Funds or Sources of Revenue which may peculiarly belong to the Sovereign or Commonwealth” (WN, V.ii.a). Part Two, by contrast, is much more lengthy and detailed than Part One. It contains a combined 204 paragraphs, spans 139 pages of the Glasgow edition of Smith’s magnum opus, and is further divided into six subsections as follows:

1. A general introduction (“Of Taxes”, WN, V.ii.b.1-7);
2. Article I: “Taxes upon Rent; Taxed upon the Rent of Land” (WN, V.ii.c.1-27), “Taxes which are proportioned, not to the Rent, but to the produce of Land” (WN, V.ii.d.1-9), and “Taxes upon the Rent of Houses” (WN, V.ii.e.1-20);
3. Article II: “Taxes upon the Profit, or upon the Revenue arising from Stock” (WN, V.ii.f.1-14) and “Taxes upon the Profit of particular Employments” (WN, V.ii.g.1-13);
4. Appendix to Articles I and II: “Taxes upon the Capital Value of Land, Houses, and Stock” (WN, V.ii.h.1-18)
5. Article III: “Taxes upon the Wages of Labour” (WN, V.ii.i.1-7);
6. Article IV: “Capitation Taxes” (WN, V.ii.j.1-9) and “Taxes upon consumable Commodities” (WN, V.ii.k.1-80).

Nota bene: We will jump into Part One of Chapter 2 of Book V starting on Monday, 23 March.

Chapter 1 of Book V of The Wealth of Nations (available here) contains a two-page conclusion consisting of six paragraphs (WN, V.i.i.1-6), but this short recap is pure gold. Here, Adam Smith lays down two general rules for public finance, three exceptions to his rules, and to top it all off, an exception to the exceptions(!):

A. TWO GENERAL RULES

RULE #1: LOCAL PUBLIC GOODS SHOULD BE PAID FOR BY LOCALS

Public goods that benefit a local community (e.g. police and fire departments) should be paid for by the taxpayers in that local community and not by anyone else:

“Those local or provincial expences of which the benefit is local or provincial (what is laid out, for example, upon the police of a particular town or district) ought to be defrayed by a local or provincial revenue, and ought to be no burden upon the general revenue of the society. It is unjust that the whole society should contribute towards an expence of which the benefit is confined to a part of the society.” (WN, V.i.i.3; my emphasis)

RULE #2: EVERYONE SHOULD PAY THEIR FAIR SHARE OF TAXES IN ORDER TO FINANCE PUBLIC GOODS THAT BENEFIT THE SOCIETY AS A WHOLE

Public goods that benefit everyone, by contrast, should be paid by everyone. Examples of public goods that benefit everyone are national defense and the cost of “supporting the dignity of the chief magistrate” (e.g. the president, the king, the governor, etc.):

“The expence of defending the society, and that of supporting the dignity of the chief magistrate, are both laid out for the general benefit of the whole society. It is reasonable, therefore, that they should be defrayed by the general contribution of the whole society, all the different members contributing, as nearly as possible, in proportion to their respective abilities.” (WN, V.i.i.1)

B. THREE EXCEPTIONS

Next, after establishing his general rules of public finance, the Scottish scholar then makes three specific exceptions: one for the administration of justice; another for roads and communication systems; and a third for education. These three types of public goods should be financed by user fees — not by the taxpayers — to the greatest extent possible:

EXCEPTION #1: ADMINISTRATION OF JUSTICE

Although everyone benefits from the rule of law, the costs of the administration of justice (e.g. the construction and maintenance of courthouses and the salaries of bailiffs, judges, clerks, etc.) should to the greatest extent possible be paid by the people who benefit the most from the court system, i.e. the litigants:

“The expence of the administration of justice, too, may, no doubt, be considered as laid out for the benefit of the whole society. There is no impropriety, therefore, in its being defrayed by the general contribution of the whole society. The persons, however, who gave occasion to this expence are those who, by their injustice in one way or another, make it necessary to seek redress or protection from the courts of justice. The persons again most immediately benefited by this expence are those whom the courts of justice either restore to their rights or maintain in their rights. The expence of the administration of justice, therefore, may very properly be defrayed by the particular contribution of one or other, or both, of those two different sets of persons, according as different occasions may require, that is, by the fees of court. It cannot be necessary to have recourse to the general contribution of the whole society, except for the conviction of those criminals who have not themselves any estate or fund sufficient for paying those fees.” (WN, V.i.i.2; my emphasis)

EXCEPTION #2: ROADS AND COMMUNICATIONS

Smith’s second exception are public goods like roads and the post office. Everyone benefits from good roads and from a reliable and fast communications system, but the costs of these public goods should be paid by user fees, e.g. tolls and stamps:

“The expence of maintaining good roads and communications is, no doubt, beneficial to the whole society, and may, therefore, without any injustice. be defrayed by the general contribution of the whole society. This expence, however, is most immediately and directly beneficial to those who travel or carry goods from one place to another, and to those who consume such goods. The turnpike tolls in England, and the duties called peages in other countries, lay it altogether upon those two different sets of people, and thereby discharge the general revenue of the society from a very considerable burden.” (WN, V.i.i.4; my emphasis)

EXCEPTION #3: PUBLIC EDUCATION

Again, although everyone benefits from a good education system, schools and sermons should be financed by the people who attend them (or by their parents in the case of children) or by private charity (e.g. alumni donations):

“The expence of the institutions for education and religious instruction is likewise, no doubt, beneficial to the whole society, and may, therefore, without injustice, be defrayed by the general contribution of the whole society. This expence, however, might perhaps with equal propriety, and even with some advantage, be defrayed altogether by those who receive the immediate benefit of such education and instruction, or by the voluntary contribution of those who think they have occasion for either the one or the other.” (WN, V.i.i.5; my emphasis)

C. THE EXCEPTION TO THE EXCEPTIONS

When user fees are insufficient to pay for the full costs of justice, roads, schools, etc., then then taxpayers as a whole must make up the difference:

“When the institutions or public works which are beneficial to the whole society either cannot be maintained altogether, or are not maintained altogether by the contribution of such particular members of the society as are most immediately benefited by them, the deficiency must in most cases be made up by the general contribution of the whole society. The general revenue of the society, over and above defraying the expence of defending the society, and of supporting the dignity of the chief magistrate, must make up for the deficiency of many particular branches of revenue….” (WN, V.i.i.6; my emphasis)

Nota bene: We will proceed to Chapter 2 of Book V of The Wealth of Nations in my next post.

Adam Smith concludes his general survey of public duties in Chapter 1 of Book V of The Wealth of Nations (available here; scroll down to “Part IV”) by pointing out one last major outlay or “expence” that every government must incur:

“Over and above the expence necessary for enabling the sovereign to perform his several duties [i.e. the duties of national defense, justice, and public works], a certain expence is requisite for the support of his dignity.” (WN, V.i.h.1; my emphasis)

Moreover, even here, Smith has something important and insightful to say. To the point, he observes that the size or magnitude of this particular expense — what he calls “the Expence of supporting the Dignity of the Sovereign” — is a function of two variables. One is the general level of wealth of society:

“In an opulent and improved society, where all the different orders of people are growing every day more expensive in their houses, in their furniture, in their tables, in their dress, and in their equipage, it cannot well be expected that the sovereign should alone hold out against the fashion. He naturally, therefore, or rather necessarily, becomes more expensive in all those different articles too. His dignity even seems to require that he should become so.” (WN, V.i.h.2)

In other words, the more wealthy a society is, the more it will cost to maintain “the dignity of the sovereign.” The other key variable is what type of government a country has. The majesty of a Versailles (pictured below), of a royal court of an absolute monarch of a great nation, will be more expensive to maintain than that of, say, a governor’s mansion of a small or upstart state:

“As in point of dignity a monarch is more raised above his subjects than the chief magistrate of any republic is ever supposed to be above his fellow-citizens, so a greater expence is necessary for supporting that higher dignity. We naturally expect more splendour in the court of a king than in the mansion-house of a doge or burgo-master.” (WN, V.i.h.3)

Although this is one of the shortest subsections of Smith’s entire magnum opus — it contains a mere six sentences spread across three short paragraphs — here, the Scottish scholar is making a deeper point: appearances are as important as reality, form is just as important as substance, for in addition to the fundamental duties of national defense (see Part 1 of Ch. 1 of Book V), the administration of justice (see Part 2), and the provision of public goods (see Part 3), the government also has an implicit duty to conduct itself with a certain decorum and majesty (Part 4).

Nota bene: I will conclude my general survey of Chapter 1 of Book V of The Wealth of Nations in my next post.

Nota bene: For my readers who are overseas, the “SAT” or “Scholastic Aptitude Test”, a rite of passage for most high school seniors in the U.S., is a high-stakes college entrance exam administered by a private company called the College Board. The SAT has two main sections: Math and Reading & Writing.

Thus far this week, we have been exploring Smith’s survey of religion in Book V, Ch. 1, Part 3, Art. 3 of The Wealth of Nations. To recap, Smith’s stance toward religion reveals a tension. On the one hand, he defends religious liberty: people should be free to choose their own religion. But at the same time, Smith also concedes that a lot people will make bad religious choices: they will join religious sects that are too strict!

Smith’s solution to this strictness problem reveals his overall commitment to freedom, for his proposed remedy is not to restrict people’s liberty or regulate their behavior. Instead, his proposed solution is to widen people’s horizons through “the study of science and philosophy” (WN, V.i.g.14) and to give people more choices in the form of “publick diversions” (WN, V.i.g.15). Let’s explore these Smithian remedies in greater detail below:

Remedy #1: Science and Philosophy

First off, why does Smith champion “the study of science and philosophy”? Because, in the immortal words of the Scottish Enlightenment philosopher, “Science is the great antidote to the poison of enthusiasm and superstition; and where all the superior ranks of people were secured from it, the inferior ranks could not be much exposed to it.” (WN, V.i.g.14; my emphasis) But how exactly would Smith promote “the study of science and philosophy”? Would he use taxpayer funds to subsidize instructors of science and philosophy? No, he would not. Instead, Smith would require aspiring professionals and future office holders to pass a sort of entrance exam before they could join a profession or hold public office:

“… the state might render [the study of science and philosophy] almost universal among all people of middling or more than middling rank and fortune; not by giving salaries to teachers in order to make them negligent and idle, but by instituting some sort of probation, even in the higher and more difficult sciences, to be undergone by every person before he was permitted to exercise any liberal profession, or before he could be received as a candidate for any honourable office of trust or profit. If the state imposed upon this order of men the necessity of learning, it would have no occasion to give itself any trouble about providing them with proper teachers. They would soon find better teachers for themselves than any whom the state could provide for them.” (WN, V.i.g.14; my emphasis)

Say what? Alas, the devil is in the details, and Smith does not provide us any additional details about this proposed universal entrance exam. What subjects or topics would this entrance exam cover? Who would administer it? (By way of comparison, the College Board, the private company that offers the SAT college entrance exam, is a de facto monopoly; see here, for example.) What would the format of this exam be — e.g. short answer, essay, multiple choice, or some combination thereof — and how high a grade or score would one need to pass? In any case, however these logistical questions are answered, notice the limited scope of Smith’s proposed entrance exam: only “people of middling or more than middling rank” would be required to take the exam.

Remedy #2: Publick Diversions

In addition to Smith’s proposed entrance exam, Smith also proposes an even more creative, surprising, and far-reaching solution to counteract the strictness of small religious sects:

“The second of those remedies is the frequency and gaiety of public diversions. The state, by encouraging, that is by giving entire liberty to all those who for their own interest would attempt without scandal or indecency, to amuse and divert the people by painting, poetry, music, dancing; by all sorts of dramatic representations and exhibitions, would easily dissipate, in the greater part of them, that melancholy and gloomy humour which is almost always the nurse of popular superstition and enthusiasm. Public diversions have always been the objects of dread and hatred to all the fanatical promoters of those popular frenzies. The gaiety and good humour which those diversions inspire were altogether inconsistent with that temper of mind which was fittest for their purpose, or which they could best work upon. Dramatic representations, besides, frequently exposing their artifices to public ridicule, and sometimes even to public execration, were upon that account, more than all other diversions, the objects of their peculiar abhorrence.” (WN, V.i.g.15; my emphasis)

Before proceeding, I want to confess that this is one of my favorite passages in the entire Wealth of Nations. Why? Because Smith presents a cheerful and joyous picture of commercial society, one full of entertaining spectacles and “gaiety and good humour.” Notice how Smith specifically singles out “painting, poetry, music, dancing” as well as “dramatic representations and exhibitions,” and to this laundry list of public diversions, we could also include today’s movie industry (Hollywood) and other spectacles or forms of play, such as professional and college sports. In a word: entertainment.

My main takeaway from this passage — and from Smith’s treatment of religion more generally — is that Smith is not only a true champion of religious liberty; he is also a champion of culture and freedom more generally. Both markets — the market for religion and the market for entertainment — should be free. But that said, as the crucial phrase “without scandal or indecency” in the passage above hints at (V.i.g.15), there is a potential blind spot in Smith’s call for “publick diversions”: who decides what is scandalous or indecent? Smith’s anti-scandal caveat would appear to necessitate some form of censorship!

On this note, I wonder what Adam Smith, were he alive today, would have to say about today’s forms of popular digital entertainment, such as single- and multi-player video games like Grand Theft Auto, Fortnite, and Roblox; or so-called “reality TV” shows like Cops, Real Housewives of Atlanta, and Love Island; or popular social media platforms like TikTok, Substack, and Instagram? Which of these forms of entertainment, if any, do more harm and good? Wouldn’t we all be better off without them? Or is a plethora of 24-hour news outlets and social media addiction the price we must pay to live in a free society? However my questions to Smith are answered, I will conclude my survey of Chapter 1 of Book V of The Wealth of Nations in my next post.