A friend of mine once asked me this question: why do we have to pay a part of our income every month to the State? And why, if we are in any case left with a smaller income than is shown in office accounts, should not the salary itself be fixed at a lower level? What and this was my friend’s dilemma is the fun in our signing a book which shows a salary higher than what we actually receive at the end of the month?
The question seemed a naive one it was indeed naiveyet in answering it, I remember, I had to cover a whole gamut of problems connected with public finance. For the purpose of taxation, in the broad sense, is coterminous with the finance of a government. So economic development is important.
If the government of a country has to operate as an agency charged with certain functions involving expenditure, it has to have command over a part of the real income of the country. The functions of the government may consist in the maintenance of law and order, security and defence; they may also extend to other spheres, social and economic, depending upon the degree of State interventionism that the society is prepared to accept. Maintenance of internal order and protection against external aggression are of course the minimal function of the State. But no civilized government can stop at this; health and education and certain essential amenities to those sectors of a society which cannot by themselves make provision for these are also part of the responsibilities of a civilized State. In the purely economic sphere, too, awareness is being increasingly felt nowadays of the need for the State to step in to supplement private enterprise not merely to cover up excess capacity where it exists, as in a mature economy, but also to create additional capacity where it is needed, as in an under-developed economy.
To perform its various functions the State needs goods and services which have to be paid for. To have command over a part of the real income of the society, the State needs to appropriate a corresponding part of the money income. And since it is the sum total of the money incomes of individuals that constitutes the aggregate money income of the society, the State has necessarily to encroach upon individuals’ money incomes, in so far as such encroachment is deemed appropriate. In a totalitarian society, where production is more or less centralized, it is possible for the State to appropriate the resources which it needs straightaway before incomes reach the hands of individuals. But in a predominantly free enterprise economy, it is after incomes reach their destination through a certain process of distribution that the State comes forward to snatch away a portion, either in a direct way via income tax or in an indirect way via commodity tax. So economic development is important.
The crucial point in any case is that the entire money income of the society cannot be left at the disposal of the so-called income earners; a part has to be given over to the State for it to dispose of it in a manner dictated by the functions that it assumes. This is irrespective of the level of money income of the society. If all of us were wage-earners and if all production were in the hands of the private sector, then a general cut of 10 per cent of our wages would only mean, the real income of the society in terms of physical output remaining the same, a fall in the general price level; it is this reduced money income that would now purchase the whole of the output.
If, on the other hand, the wage-earners were asked to pay out to the State 10 per cent of their wages in the form of tax, and if the tax receipts of the State were also spent on the purchase of goods, then the wage earners would be denied 10 per cent of the output of the society; their disposable income would be lower than their so-called earned income by 10 per cent, the balance being transferred to the State. A tax on money income deprives the income earners of a part of the real income of the society and enables the State to have command over it; a general cut in money income does not.
This, in a nutshell and abstracting from complications arising out of the mixed character of most economies, is the answer to the question with which we started. But then there is an alternative way in which the State can get round this straight method of taxation it can sell securities and thereby obtain funds. When these securities are sold to individuals and held by them, the loans behave in a manner similar to a tax so far as their impact upon the economy is concerned; they result in a transfer of income to the State. When the securities are sold to the Central Bank, new money is created with which the State can surreptitiously in a way, take away a part of the real output of the society.
An intermediate case is one in which the securities are sold in the first instance in the market, but they are made negotiable and are permitted to pass on to the Central Bank via the general banking system. In either case the State receipts are an addition to the money income that is generated in the normal course of production. So economic development is important.