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There Are Four Ways To Pay For Government Services

11/8/2018

 
By Bill Haley 11/8/2018   slight update 4-16-2022 

There are four ways to pay for government services.  The most common is a tax.  Taxes include income, and sales, among others; however, all are a percentage of the transaction.  Borrowing and monetizing are the second and third ways and are used too often.  The fourth is a government mandate that citizens purchase the service directly, however rarely used.  
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Because economics is very complicated with hundreds of factors, it is wise to simplify the situation to see the actual effects.  Let us go to a very simple economy of 10 people going to the market every Saturday.  Each person brings ten items and $10.  All items are $1.  Everyone trades.  Everyone leaves with $10 and ten different items.  Money is used to simplify trade.  Everyone buys 2 items from at least one person.​
Everyone agrees that there is a need for a policeman and a soldier.  Everyone agrees that two of them should take on those full-time roles for the price of $10 a week each, and all 10 of them should contribute money to those government services valued at $20.  
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If they choose an income tax, everyone’s tax rate will be 20%.  8 people will bring ten items to market, thus 80 items.  The cop and soldier would not bring items to the market because cop and soldier are their full-time jobs.  All 10 people bring their $10, thus $100.  All 10 people buy 8 items.  Therefore all 80 items are sold.  The 8 people bringing items to market now have earned $10 each, plus kept the $2 they did not spend.  
The eight people pay $2 from the 20% tax, thus $16 to the government.  The government pays the cop and soldier $10 each.  The cop and soldier now pay their $2 tax each and even out the government books.  All 10 people come with $10 and purchase eight items for $8.  The other $2 from everyone was taxed to pay for government services to which everyone benefited. 
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With this tax rate of 20%, people must be willing only to take home $0.80 for each item versus the full $1.  It is likely that 10% to 20% of purchases are not worth it, and the tax rate will have to rise to about 25% to attain the $20 needed for the cop and soldier.  Higher tax rates lower taxable economic activity.  
A sales tax rate of 25% would be necessary on the eighty items selling for $80, thus attaining the $20 needed for the cop and soldier.  People would now need to be willing to pay $1.25 per item and only attain $1 per item they sell.   It is likely that 10% to 20% of purchases are not worth it, and the tax rate will have to rise to about 32% to attain the $20 needed for the cop and soldier.  It is important to note that there is no sales tax on government services compared to government workers paying income tax. 
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Whether an income tax or a sales tax, the government increases the cost of a trade.  Regardless of who collects the tax, the earner or seller, the tax is on the transaction.  During negotiations, both sides share in the tax burden.  The higher the tax rate, the less taxable activity will occur.  People will go without, do it themselves, do it under the table or do it outside the taxing authority.  
Taxes take a percentage of a transaction.  The nature of a two-person agreement of a transaction means sometimes both sides do not meet on price.  If both sides barely overlap on agreeable terms of the transaction, a small tax rate stops the transaction.  A significant overlap in price can withstand larger tax rates.  However, increasing tax rates yield ever-decreasing transactions.  A discouraged transaction yields $0 in taxes and no benefit to either side of the would-be transaction.
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If everyone/government chooses to borrow to pay for the government services of a cop and a soldier, the government will have to develop a repayment tax plan.  Therefore, maintaining the harmful effects of the tax.  On top of the adverse impact of the tax, the government debt uses part of the capital needed for capitalism.  

Bringing in additional capital or having a lower level of capital increases interest rates.  Some business plans make sense at 5% or 6% but not 7%.  An increased interest rate lowers the number of business plans that make sense; thus, get started.  Additional government debt can raise interest rates from 5% to 7% for borrowers.  If the government takes 30% of the total capital for government debt, that money is not available for business creation.  ​
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Let us explore the effects of the ten people in our small town deciding to monetize the $20 needed for government services.  8 people still bring 10 items each to the market, making 80 items for sale.  All items are still $1.  All ten people come with their $10.  Everyone buys eight items and has $2 leftover.  All eight people bringing items to sell earned $10; thus, they leave with $12. 
The government creates 20 new dollars by simply printing 20 new pieces of paper with the government seal.  The government pays the cop and soldier $10 each.  They also walk away with $12 and eight items.  Everyone comes back every week and buys all 80 items for $80.  Government creates $20 more every week and pays for government services.  Everyone always walks away with eight items.  In the following weeks, people walk away with $14, $16, $18, $20, etc.  
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The unwritten agreement to keep all items at $1 each and stop after one buys eight items will quickly vanish.  People will start to bid up prices because they have money left over.  They will get to the market early while the product is still on the shelves and buy more than their share of eight items.  As market prices go up, the cop and soldier will demand higher pay to keep up.  Every time the government prints up more money, prices rise. 
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Money is a service that helps people trade.  Monetizing government services destroys the nature of money, which is a medium of exchange and a store of value.  The two-sided agreement of trade allows money to perfectly regulate services provided and services received into the economy.  Monetizing government services spread the value of money over a greater quantity of dollars, thus devaluing each dollar.  A constantly changing value of a dollar ruins the service of money
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One way to pay for government services is to have the government mandate each person purchase the service the government decides needs to be done.  All 10 people bring $10 to the market.  8 people bring 10 items to market.  The cop and soldier stand behind a counter with 10 cards stating cop and soldier services.  These cards are now items to sell.  Therefore, 100 items are for sale at the market at $1 each. 
As people shop the market, the government mandates that everyone buy one cop card and one soldier card for $1 each, every week, including the cop and soldier.  All ten people now sell ten items and buy ten items, two of which are government service cards.  Everyone buys items for $1 and keeps $1 when they sell an item.  Thus, there is no tax-discouraged trade.  Everyone came with $10 and ten items.  Everyone leaves with $10 and ten items.   
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There are some real practicality concerns why all government services cannot move from taxes to the mandate; however, there should be significant movement in that direction.  Taxes having a minimum base on the tax also help to keep tax rates lower.  The purpose of this reform is to increase the level of beneficial transactions by decreasing the tax discouragement created from high tax rates.​
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