Capitalism and taxes

“What in France is called the personal taille is, perhaps, the most important tax upon the profits of stock employed in agriculture that is levied in any part of Europe.” (WN, V.ii.g.5)

How should business firms and self-employed workers (e.g. people engaged in particular trades) be taxed? Adam Smith surveys these two types of taxes — “Taxes on Profit, or upon the Revenue arising from [Capital] Stock” (V.ii.f) and “Taxes upon the Profit of particular Employments” (V.ii.g) — in Book V, Chapter 2, Part 2, Article 2 of The Wealth of Nations (available here; scroll down to Article II). Here, Smith makes five timeless observations about business and income taxes, five points that are still relevant to us today:

1. CAPITAL IS MOBILE

First off, Smith explains why business taxes are such a tricky enterprise compared to land taxes: unlike land, capital is mobile. If business taxes are too high, then the owners of capital will simply pack up and move to a lower-tax jurisdiction:

“The proprietor of land is necessarily a citizen of the particular country in which his estate lies. The proprietor of stock is properly a citizen of the world, and is not necessarily attached to any particular country. He would be apt to abandon the country in which he was exposed to a vexatious inquisition, in order to be assessed to a burdensome tax, and would remove his stock to some other country where he could either carry on his business, or enjoy his fortune more at his ease. By removing his stock he would put an end to all the industry which it had maintained in the country which he left. Stock cultivates land; stock employs labour. A tax which tended to drive away stock from any particular country would so far tend to dry up every source of revenue both to the sovereign and to the society. Not only the profits of stock, but the rent of land and the wages of labour would necessarily be more or less diminished by its removal..” (WN, V.ii.f.6; my emphasis)

2. WHY BUSINESS FIRMS ARE UNDER-TAXED

Secondly, Smith explains why most business firms are under-taxed and thus end up paying hardly any taxes at all. Simply put, because capital is mobile and responsive to tax rates (see point #1 above), those countries that have tried to tax revenue or profits tend to under-estimate the tax liability of business firms:

“The nations, accordingly, who have attempted to tax the revenue arising from stock, instead of any severe inquisition of this kind, have been obliged to content themselves with some very loose, and, therefore, more or less arbitrary, estimation. The extreme inequality and uncertainty of a tax assessed in this manner can be compensated only by its extreme moderation, in consequence of which every man finds himself rated so very much below his real revenue that he gives himself little disturbance though his neighbour should be rated somewhat lower.” (WN, V.ii.f.7)

3. BUSINESS TAXES HURT CONSUMERS

Next, Smith surveys “Taxes upon the Profit of particular Employments” (V.ii.g), where he explains why business taxes are ultimately paid for by consumers:

“A tax, however, upon the profits of stock employed in any particular branch of trade can never fall finally upon the dealers (who must in all ordinary cases have their reasonable profit, and where the competition is free can seldom have more than that profit), but always upon the consumers, who must be obliged to pay in the price of the goods the tax which the dealer advances; and generally with some overcharge.” (WN, V.ii.g.3)

4. WHY FRANCE’S INCOME TAX SYSTEM (THE TAILLE) SUCKS

Fourthly, Smith explains why France’s tax system — the taille — is one of the worst tax systems imaginable. By way of background, the taille was a direct tax levied by the monarchy on peasants and non-nobles (clergy and noblemen were exempt) from the late Middle Ages until 1789. Although the monarchy in pre-Revolutionary France levied two types of taille — a tax on land value (taille réelle) and a tax on personal income (taille personnelle) — Smith’s focus here is on the personal income tax. For Smith, the main problem with the taille personnelle is that it changed so frequently and was riddled with so many exemptions that no one knew ahead of time what their tax liability was! Or in the immortal words of Adam Smith:

“No man subject to such a tax, it is evident, can ever be certain, before he is assessed, of what he is to pay.” (WN, V.ii.g.7)

Sound familiar?

5. BADGE OF LIBERTY OR BADGE OF SLAVERY?

Lastly, amid a digression on “poll-taxes” — i.e. direct taxes (or “head tax”) levied on every able-bodied man rather than on his property or income — the Scottish scholar makes the following surprising observation — “surprising” given everything else he has already said about taxes in the rest of this chapter:

“Every tax … is to the person who pays it a badge, not of slavery, but of liberty. It denotes that he is subject to government, indeed, but that, as he has some property, he cannot himself be the property of a master.” (WN, V.ii.g.11)

What are we to make of this sentence? Is it pure hyperbole? Is it meant to be read with a sense of irony? Or is it just plain bullshit? Whatever the case, the French Revolution would occur 13 years after Smith wrote those words, and for what it’s worth, in an appendix to this chapter, Smith also writes: