REVIEW #12: Meaning of Taxation: Effects of Various Taxes (Labor, Capital, Consumption) on the Economy

As Thomas Jefferson once said, taxes along with the death are inevitable. We know that scientists are trying to challenge the inevitability of death. Avoiding taxes is, like death, one of the biggest problems most people face. And I do not mean as the problem for the government in raising money for spending, which is obvious, but for the economy as a whole. Put differently, taxes are problematic for the economy because they are avoidable.

Taxation is an involuntary payment levied on various entities in order to finance the state budget1. Clearly, the tax burden is heavily influenced by the philosophy of the role of the state in the public life, as well as quantity and quality of public services rendered.

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Here, the level of corruption, cronyism, and efficiency of the bureaucracy constitute important factors.

As a result, how much money is available for public policy is dependent on not only the sheer amount of taxes collected, but also on how much is going to be stolen or wasted along the way. As such, it is not so much about the philosophy of public spending and how large the budget should be.

According to some schools of economic thought, like Modern Monetary Theory, this is completely irrelevant as budget could be financed with created money, whereas taxation is only a means of stabilizing money supply2. Leaving such ideas aside, let us take revenue needs of the government as given and discuss only the means of taxation – not its level.

What Is Taxed and Why?

The governments can be very creative as regards taxes and what is the base of taxation. From the economic point of view, taxation concerns mostly two categories: stocks and flows.

Taxation of flows concerns transactions or exchanges including purchases, donations, earning income, etc. Taxation of stock is done chiefly through property taxes with the most important being real estate tax and inflation.

There are many other variations of stock taxes where any other type of property is taxed including: dogs, horses, TVs, wells, fruit bearing trees, chimneys, or even one’s own head3.

Here, we will deal mostly with the taxation of labor and capital. Taxation of labor is an income tax, which constitutes a flow. Taxing capital might be more difficult to classify, as government sometimes taxes flow (income) and in other cases stock.


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1 The state is understood here broadly, including the local government as well as various state and state related agencies (such as social security and health insurance). Therefore, all such contributions are included under the term ”taxes”. As such, any academic debate on whether social security and similar contributions are technically taxes or not will not be discussed.

2 In fact, MMT relies heavily on an untypical but a very common tax, which is inflation. Also, it leads to distortion of the structure of the economy and, therefore, is not advisable in any real-life policy.

3The poll tax is also called a “head tax”, as everybody in a possession of a “head” needed to pay it.