If I pay Less Will You Pay More?

A scholarly analysis of the IRS penalties versus the excessive fines clause of the Constitution concluded with the statement (in part) that

"When one taxpayer pays less, we all pay more."

This is also an often used comment by various IRS officials. But is it true?

If it is true, it means that the government somehow arrives at some budgeted amount that is somehow divided among all taxpayers. Furthermore, if the full amount that is budgeted isn't collected in the current year, it must somehow be picked up in a later budget year.

And what happens when a lot of taxpayers lose their jobs and end up paying less taxes? Do the rest of us have to somehow make up for that lost tax revenue?

If that's true then every time the government introduces some kind of new targeted tax incentive (aka special interest tax expenditure), all of the taxpayers who are not part of the favored group must have to somehow make up for the shortfall. And what about the fact that roughly 50% of the households in the U.S. don't pay any income taxes at all? Clearly, the other half must make up for the shortfall.

However, it doesn't really work that way.

First of all, this cliche' presumes that the expense side of the budget can't be changed. Is that the way things are in your household or business? If there is a shortage of revenue, don't you make up for the difference by either borrowing (if you can) or by cutting back on expenses if borrowing is not an option? And if the loss in revenue persists (or is expected to persist), you start cutting some expenses, like the cruise you wanted to take or the new car you were going to buy. In extreme cases, you might even downsize by moving to a smaller home and selling some stuff.

With the federal government, there is a lot more opportunity to borrow the funds, which are rarely repaid. The annual deficit is just added to the accumulated national debt which results in having to pay more interest. But the debt isn't repaid -- it is just rolled over from year to year. And if the debt gets to be too much, we pay off some of it with new money courtesy of the Federal Reserve. Of course we try to do that gradually because if we print too much too fast, it would upset all of our trading partners around the world. (Because our money would lose value.)

Back to the question. If I somehow pay less taxes by not working or by getting a cut in pay or by using some sort of obscure tax break, do you have to pay more? The answer is no! There is no connection because the government has an almost unlimited ability to borrow money.

But I can hear a few readers asking, "O.K., if that's true why do they need to collect taxes at all?" And my humble two cents on the question is that they don't have to collect taxes as long as they have the Federal Reserve available to create new money in exchange for new treasury obligations. But doing that would make it obvious that inflation is actually a substitute for taxes.

Vern