Hobbes and Kaldor on Taxing Expenditure
The alternatives of taxing income versus spending is a fallacy of the excluded option.
April 24, 2016
Fred Foldvary, Ph.D.

Thomas Hobbes was an English political theorist and philosopher. His main work was Leviathan, published in 1651, in which Hobbes defended the legitimacy of imposed government. Without such government, thought Hobbes, society would be in eternal violent conflict.

Hobbes wrote, in chapter 30, that a tax on spending is more equitable than a tax on income: “... the Equality of Imposition consisteth rather in the Equality of that which is consumed, than of the riches of the persons that consume the same. For what reason is there, that he that laboureth much, and sparing the fruits of his labour, consumeth little, should be more charged than he that, living idly, getteth little and spendeth all he gets; seeing the one hath no more protection from the Common-wealth than the other? But when the impositions are laid upon those things which men consume, every man payeth equally for what he useth; nor is the Common-wealth defrauded by the luxurious waste of private men.”

Two arguments that have been proposed for why a tax on spending is better than a tax on income are: 1) a tax on the gains from savings reduces savings and therefore reduces economic investment and growth; 2) as stated by the economist Nicholas Kaldor in his book An Expenditure Tax, “It is only by spending, not by earning or saving, that an individual imposes a burden on the rest of the community in attaining his own ends” (p. 53).

When consumption is subsidized by the force of government, then indeed this consumption is at the expense of productive society. But with voluntary consumption, in general a person  consumes what he produces, and so he does not burden society.

As for savings, indeed an income tax is at the expense of investment and economic growth, but a tax on spending is imposed also on expenditures paid from borrowing. For large purchases such as a car, a person who borrows has to borrow an extra amount to pay the tax, and then has to pay extra interest on the borrowing. The borrower is double taxed, taxed on the goods he buys, and taxed by paying more interest. The same applies to a person who uses up savings; he must use up even more savings to pay the purchase tax, and therefore with less savings, he then gets less interest income.

There is no good economic reason to favor savings over borrowing. The economy runs on credit, as much of production and consumption is financed by borrowing. For the whole economy, savings equal borrowing, and during a typical lifetime, a person saves as much as he borrows and uses up savings.  

Another problem with taxing spending versus income is that when analyzed down to the core, income and savings are much the same thing. Consider a barber who gets $20 for a haircut. The $20 is spending by the customer and earnings for the barber. A $5 tax on the haircut service is equivalent to a $5 tax on the income of the barber. The amount of tax that falls on the barber versus the customer does not depend on whether the income or spending is the source of the tax, but on how a customer responds to a change in price, and on how a barber responds in work effort to a change in his net income. If a customer refuses to pay more than $20 including tax (and instead gets fewer haircuts or has his hair cut by a friend), then the sales tax is absorbed by a lower income for the barber, as is an income tax. And if the barber decides to quit the business, both the income and the sales tax results in less labor and less production.

Indeed, economists Haig and Simmons analyzed pure income, hence called Haig-Simmons income, as consumption plus a change in net worth. An increase in net worth implies greater future consumption, hence your real economic gain is your consumption, not your money inflow.

The claimed alternatives of taxing income and taxing spending fall into the fallacy of the excluded middle. It is the logical falseness of thinking there are only these two alternatives, when in fact there is a third, unexamined, option. For taxation, the third option is to not consider whether the tax is on income or spending, but whether the tax is on income or consumption that is earned versus unearned.

Earned income includes all gains that ultimately come from labor. Earnings include wages and gains from savings that originates in labor, such as interest income from bonds paid for from wages. As the ultimate inputs are land and labor, unearned income is land rent, including the implicit rent generated by land value. Interest from savings obtained from rent is also unearned.  

If one insists on taxing consumption, then the best source is consumption which comes from unearned sources, and consumption that does not deplete its source. The most efficient and equitable tax is on the consumption of land services. Real estate provides the services of being able to live and work in a location, including all the advantages of that location.

Land provides spatial service. Space itself is not used up, but space is consumed as a flow of site services over time that generate a market rent. For example, garden offers a continuous flow of service as a place to enjoy the outdoors. The user consumes that flow over time, a service that is gone as soon as that time passes.  As a flow, like other services, the spatial service is simultaneously generated and consumed. The rent does not come from the efforts of the land user (as such efforts are labor, and produce capital goods) but from the natural features of the site, the exclusion of others, and the value of the surrounding community demands and services.

Nicholas Kaldor (p. 33) also argued in favor of “an annual tax on capital wealth.” As this would best be an annual (or monthly) tapping of land value, and since the public revenues would be more than sufficient for the public goods desired by the people (per empirical studies as well as the Henry George theorem of public finance), the case for a tax on consumption collapses other than on the consumption land services.

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Fred Foldvary, Ph.D.

FRED E. FOLDVARY, Ph.D., (May 11, 1946 — June 5, 2021) was an economist who wrote weekly editorials for Progress.org since 1997. Foldvary’s commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and San Jose State University.

Foldvary is the author of The Soul of LibertyPublic Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary’s areas of research included public finance, governance, ethical philosophy, and land economics.

Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.