1 Central Government Taxation

1.1 Requisitioning and Dutch Auction; Competitive and Restraining Components

Due to the unitary (monopolistic) nature of central government, special care has to be taken in constructing a confederate fiscal system. While the states will be restrained from excessive taxation by inter-state competition, the unitary nature of the Confederation prevents this mechanism at the central level. Accordingly, the proposed solution has a competitive component and a restraining component. Thus the issue of the level of taxation is separated from the mode of taxation. The competitive component applies only to what is taxed and how it is taxed, given a particular level of taxation. The restraining component only deals with the level of taxation, irrespective of collection.

To achieve competitive behavior in collection, funds are requisitioned from each state. This leaves each state free to decide what is to be taxed, and how to tax it with the minimum economic dislocation. (In case of non-compliance/non-cooperation by state authorities, the Confederation is empowered to make up the shortfall by direct taxes on the citizens.)

The level of taxation on the other hand, is decided directly by all confederate citizens by Dutch auction. By reducing the level of taxation to one figure (i.e. an annual per capita charge) and separating the level of taxation from collection, the level of taxation can be determined directly by the ultimate payees, i.e., ordinary people.

Dutch auction is an auction in which an item is initially offered at a high price that is progressively lowered until a bid is made and the item sold. In the context of confederate taxation, "the bid" would be that amount that a majority of the citizens would accept as an annual per capita charge. Each citizen would indicate an individual "acceptable" charge, and the tallying would consist of finding that annual charge carrying a majority. (It has to be a Dutch auction because of the necessity of starting from the top; i.e. very high taxes would only attract few citizens, as the taxes are lowered, they become progressively more acceptable, until a majority is reached.)

This method together with measures designed to balance the budget, is intended to force the politicians to live within their budgetary means. The proposed method is able to raise any amount of money for the confederate budget, provided the charge is approved by the people. Unlike present procedures related to taxation, it is unable to raise funds contrary to the wishes of the population.

1.2 Disadvantages of traditional measures for raising public revenue

There are four possible alternative methods of Confederate fundraising:

Specific revenue sources
Concurrent revenue sources
State appropriations
Traditional requisitioning

Specific revenue sources

Specific revenue sources has 3 distinct disabling features: It doesn't provide for the raising of enough money in times of extraordinary requirements; It doesn't provide a mechanism for the deflation of the confederate budget after the formerly limited powers have been breached; and; It provides no incentive for collecting taxes with the least amount of distortion to the economy.

The first two objections really go together. Since the only way the central government can garner more funds is by expanding its taxing authority there will be continuing pressures to breach the revenue straitjacket. Over long periods there will always be occasions where this does make sense from a short term point of view; typically for instance, there is a war or threat of war and the central government needs funds to arm. Once the barrier is breached, central government grows until the new revenue sources are exhausted, and at the next moment of crisis, it is the same story all over. The author does not know of a single instance where revenue sources once ceded to central government have been returned to local authorities.

The third objection is a little bit different. Since specific revenue sources leave the central government without any choice as to what to tax, by definition it cannot design its taxes to minimize economic dislocation. But other factors tend to make this objection less important than the others.

The mildest consequences of specific revenue taxation probably will be encountered with import duties or tariffs. This source is also the most common. Import duties or tariffs will essentially act as protective tariffs, but this is less important if domestic competition is sufficiently fierce. If the Confederation is very large with varied living standards, ample domestic supplies of raw materials and a diversified industrial structure, the negative consequences will be limited. Imports will be substituted by domestically manufactured goods at a moderate cost differential. On the other hand, this also puts a limit on how much revenue can be collected by the Confederation, and whets the appetite for other more substantial revenue sources.

Concurrent revenue sources

Concurrent powers of taxation exist when the central government and the states may lay and collect taxes independently of each other. Concurrent taxation is often combined with specific revenue sources so that some taxes are concurrent and some specific to the central body. The typical mix, is a combination of central import duties combined with concurrent vat or sales tax(es) or income tax(es). Indirect taxes, like value added taxes are simply added up. If the central government lays a tax of 5% and the state lays a tax of 10%, the total tax is 15%.

Concurrence has the great advantage that it avoids unnecessary conflict. The issue of taxation becomes one of convenience. How can revenue be gathered with the least effort by the government and inciting the least opposition from taxpayers? There is little or no haggling between governments to get access to the most attractive sources of revenue. If there is a need at a particular level, it can be fulfilled as the citizens and the government at that level sees fit. Contrary to specific revenue sources, concurrent powers are flexible. They can fit increasing central needs in times of crisis (war), and increasing local needs in times of peace. Thus at least from a revenue point of view, governmental tasks may be carried out at the most effective level. Indeed, flexibility and independence when it comes to revenue may often be seen as a prerequisite for independence of action.

Concurrent taxation: restraint and competition

Concurrence is however, inconsistent with inter-governmental competition, as it will be impossible to escape monopolized central taxation.

The major problem with concurrent taxation is how to restrain the confederate government. Since the money doesn't come out of their pockets, the states will have little incentive for acting as catalysts in restraining the confederate government. The state government's interests may in fact be the exact opposite. Due to competitive pressures there will be definite limits to how much each state can raise its own taxes, but if it can persuade the central government, with its monopoly powers, to raise enough money and then transfer money back to the state, this "problem" will not arise. In effect the federal or central government is co-opted into an arrangement whose sole purpose is to defeat the interests of ordinary people. Concurrent taxation is a recipe for disaster in the field of fiscal restraint.

Traditional requisitioning

In a system of traditional requisitioning the Confederation chooses an amount that is payable by each state. This alternative has the advantage of being clearer, shorter and simpler to express than the concurrent taxation alternative. It also makes the flow of funds more visible, by that making it easier for the people to decide whether the flow of funds into confederate coffers corresponds to their wishes. And it does provide the states with an incentive to monitor confederate spending and present alternatives. But since it allows the traditional bundling of spending decisions, and the traditional coupling of revenue and spending measures, it is likely to lead to traditional runaway governmental budgets. Its most immediate disadvantage is risk of non-compliance by individual states and instability due to the low legitimacy of central institutions. Decisions taken directly by the people are likely to have a much greater authority than requisitions enacted by a central legislature.

State appropriations

State appropriations has the advantage that it restrains the centralizing powers of the Confederation. It has the disadvantage that by itself it doesn't insure the Confederation sufficient funds to carry out its tasks.

If voluntary contributions are to work, there has to be a fixed method of finding each state's share, and there has to be a mechanism for compelling payment. In effect, this would be a requisitioning system where the charge was determined not by the institutions of the Confederation, but by the states collectively.

Such a system has the disadvantage of being susceptible to state collusion. See also decoupling and unbundling.

1.3 Additional comments on fiscal restraint

The proposed mechanisms for confederate spending and taxation has 3 important characteristics: a) taxation is decided freely and directly by the citizens through Dutch auction, b) taxation is decoupled from spending decisions, and c) spending decisions are unbundled. These 3 elements act together to restrain the confederate share of the total economy, and they tend to produce spending decisions beneficial to the general welfare of the inhabitants.

The chief advantage of a Dutch auction system is that it allows citizens to decide the level of taxation without artificial restraints. A simple popular approval does not suffice since it presupposes someone making a prior judgment as to what to put on the ballot; a process that is also likely to be confrontational. Dutch auction decisions on the other hand, are non-confrontational and may not be prejudiced. The proposed system ensures that each vote is equally important.

Decoupling and unbundling

Decoupling and unbundling is essentially the same mechanism applied to two different decision. With unbundling it is two or more spending or legislative decisions that are separated, with decoupling taxation is separated from individual spending decisions. Prerequisites for both decoupling and unbundling are: a) secret balloting making it impossible to enforce agreements that seek to exploit the minority, and b) plenty of participants to make it difficult to form coalitions and even more difficult to enforce them. Decoupling and unbundling take place in markets characterized by independent action and low concentration.

Decoupling taxing and spending allocations simplifies information gathering by the electorate just as standards simplify market decisions. Also, decoupling restrains governmental taxation.

In a decoupled and unbundled spending/taxation environment, each proposal has to pass two hurdles. First, the money must be available as taxation, secondly given availability, each project will be ranked according to its support in the entire population. As each spending project is unbundled, it must meet with the approval of at least 51% of the voters, but since it also competes with other projects for a fixed sum of money, the actual required approval rating may be considerably higher. The uncertainty introduced by decoupling lowers total governmental spending.

1.4 Summary

There are two sets of difficulties in designing a system to raise confederate revenues: a) The system has to be compatible with inter-governmental competition, and b) the system has to reflect the people's opinions about the wanted level of taxation at any point in time.

The two traditional central revenue measures in a federal system: specific revenue sources and concurrent taxation both have severe shortcomings. They don't provide an appropriate answer to either of the two concerns listed above.

The proposed solution ensures inter-governmental competition by separating the issue of how much tax from the issue of how to collect the tax. Collection is left to the states according to their own preferences. Tax level responsiveness is ensured by giving the people the right to decide the appropriate level of taxation by Dutch auction.

All procedures are eased by standardizing confederate taxation decisions to per capita figures.

Revised: 2004-07-02