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”). This is Adam Smith at his finest, for his maxims of taxation are still relevant and foundational today. 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.