Close Close

Financial Planning > Tax Planning

Democracy’s Price

Your article was successfully shared with the contacts you provided.

The Founding Fathers understood that democracy — “government of the people, by the people, for the people” as Abraham Lincoln put it four score and seven years later — presupposes that people shoulder a set of responsibilities to govern themselves.

The Constitution limits the President’s ability to conduct wars and support a standing army. It explicitly leaves citizens with the responsibility to defend their country, as the Second Amendment sets forth the need for a well-regulated militia. The notion of a plowman-soldier was central to the American Revolution. George Washington was called Cincinnatus of the West, after a Roman farmer who twice led the Republic on the battlefield, subsequently returning to his plowshares.

Taxation = Representation

Naturally, early Americans were also finely attuned to the connection between taxation and self-rule. They had to be: the new nation effectively grew out of the Boston Tea Party with its battle cry “No Taxation without Representation.” Even earlier, British constitutional law was shaped by English monarchs’ need for a steady tax flow to pay for the Royal Navy (rather than relying mainly on manpower as Europe’s continental powers did). This required the crown to cooperate with wealthy barons and ultimately devolve power. That’s why Britain had the Magna Carta back in the 13th century, whereas France stayed absolutist.

The payment of taxes is an important responsibility of free citizens and a way of bringing them into the political process. He who pays for the music ultimately calls the tune.

Governments that rely on citizens to pay the bills tend to be more democratic. Industrialization led to democratization among Pacific Rim Tigers, countries such as Taiwan, South Korea and, more recently, Malaysia and Indonesia. Wealthier societies provide a more secure safety net, with more education, health care and other public benefits, which requires more taxes. Since taxes have to be collected from citizens, citizens get greater leverage vis-à-vis their rulers.

Countries that do not have a substantial industrial base but rely instead on the export of natural resources tend to be far less democratic, even if they grow quite wealthy from such exports and coddle their citizens. The list of oil exporters, from A for Algeria to V for Venezuela, is filled with oppressive regimes. Venezuela is a glaring example. While other Latin American countries have gotten rid of military juntas and charismatic leaders, Venezuela is ruled by a buffoonish strongman. It’s also the region’s largest oil exporter.

The problem is that oil exporters don’t have to ask their citizens for money. They tax their oil exports instead. Oil is a national resource, which ostensibly belongs to everyone but in reality allows governments to pay their bills without sharing power or accounting to their citizens. They don’t need their citizens’ cooperation, only obedience.

Russia is another case in point. During the 1990s oil prices were very low. After the collapse of the Soviet Union, industry was in shambles, citizens had no money, the government collected puny tax revenues and the country was poor. But it was moving toward democracy. Then, in 1999, oil prices began to climb, eventually reaching over $100 per barrel in recent years. In 2011, Russia is drowning in petrodollars and its Forbes list of dollar billionaires continues to expand. But Prime Minister Vladimir Putin, who initially maintained a fairly democratic system bequeathed by predecessor Boris Yeltsin, gradually throttled Russia’s nascent democracy and set up an oil-exporting kleptocracy in its place.

Freeloading Americans

Listening to our politicians in Washington railing against taxes, you might think that ordinary Americans are severely overtaxed. But we pay a considerably smaller portion of GDP in taxes than we did in the 1950s, when American industry ruled the world. Federal taxes as a percentage of GDP, after peaking at around 20 percent in the second half of the 1990s, have been declining steadily over the past decade and a half and are now below 15 percent. This is the lowest proportion of GDP since around 1950. Personal income taxes alone, subtracting corporate taxes, peaked at 10 percent of GDP in the 1990s and are now closer to 7 percent of GDP. Our overall tax revenues are the lowest in the OECD, the rich industrial nations’ club, except for Chile and Mexico, hardly the richest of its 34 members.

That wouldn’t have been such a big deal — and in fact would have probably been a positive — had government spending also declined at the same time. It did decline in the late 1990s and early 2000s, and measured around 18 percent of GDP for all levels of government. But in recent years it rose once more to over 20 percent of GDP, the same level as in the late 1980s.

Ronald Reagan, when he came to power, was a determined opponent of Big Government and profligate public spending. He had an idea of starving the government of money. He passed a number of steep tax cuts and at the same time embarked upon a substantial military buildup. Sooner or later something would have to give — and Reagan was sure that it is government entitlement programs that would be eventually cut, because Americans liked their tax cuts.

Indeed, Americans did love their tax cuts, so much so that tax cutting mantra became a national ideology. “Read my lips — no new taxes” was a campaign slogan that got George H.W. Bush elected in 1988. His son cut taxes twice and got reelected. But, it turned out that Americans also loved their free-spending government. They just didn’t want to pay for it.

What Reagan didn’t realize was that the government could continue to spend and avoid paying its bills. How? By borrowing. The country’s gross debt, after staying stable at around $2 trillion throughout the 1950s, 1960s and 1970s (and falling steadily as a share of GDP, from 120 percent immediately following World War II to under 40 percent in 1980), began to escalate in the 1980s. Congress is currently debating whether or not to raise the debt ceiling once again, since debt has now punched through the previous limit of $14.2 trillion.

Wrong Solution

The American government, then, is no longer spending our money. Rather, it is spending the money of those Americans who do not vote — our children and grandchildren, most of whom have not even been born yet. In the end, it is to them that we’ll bequeath our debts.

Since the government has not been spending our money, it doesn’t feel the need to be accountable to us. Nor do we really care about the way the government spends its money — since it is not ours, anyway. It’s not our treasure that has been wasted over the past decade in Iraq and Afghanistan, nor is it our money that was given to the financial services industry to bail it out in the wake of the 2008 financial meltdown. Nor will our money be spent on a national health care system. Why should we even bother to go to the polls?

The Tea Party is correct when it states that doing business as usual will eventually put the U.S. into bankruptcy. The problem is that it doesn’t have the right solution. Slashing government spending won’t do: we all like our entitlements, our Social Security, our Medicare and other programs, especially since we don’t have to pay for them. A far better way would be to pass a balanced budget amendment and to raise taxes across the board — on the rich, the poor and the corporations — enough to fund the current level of government spending.

You’d be surprised how taxpayers would swamp the polls in the next election to kick the bums out and elect a president and Congress that will institute genuine public finance reform.