Government Beneficiaries Don’t Pay Taxes –

The Tax Pie

By Hans Sherrer

(July 23, 2010)

An interesting anomaly about taxation is that no state or federal employee, contractor or beneficiary pays income, sales, use or other taxes to the state or federal government that pays them.

This is easy to understand if you think of tax revenues as forming a pie shape. The tax revenue pie is created and expanded by the individuals and businesses who produce the wealth that is taxed. Government employees, government contractors, and beneficiaries of government programs are paid from the pie created by that tax revenue.

The returning of tax money by government employees, contractors or beneficiaries to the pie of tax revenues does reduce the amount the recipient has, but it doesn’t increase the tax pie from which they are paid. So it is redundant and somewhat deceptive for people and organizations to “pay” income, sales, VAT or other taxes on money the government pays them. It is similar to an Indian giver situation: When a person asks/demands something back and they get it, they don’t have any more than they had before giving it away. But they can use it themselves or give it to someone else. That is the situation between the government and those who return part of the money they receive from it in “tax” payments.

If all government employees, contractors and beneficiaries were exempt from “taxation” on what they were paid by the government and their payments reduced by that amount, the charade of them returning a certain amount in “taxes” to the government could be dispensed with. It would also eliminate the bureaucratic overhead involved in processing their “tax” payments, or refunds of pre-paid or withheld taxes. However, it would expose the true situation that only producers of wealth are taxed – and they are financially supporting the government structure.

Since the tax pie is created and enlarged to the degree “tax” payments by people and organizations are not made from money paid to them from the tax pie, a tax recipient can pay taxes on money they earn from non-government related activity. A government contractor such as Boeing or Microsoft does not increase the tax pie by “paying” taxes on its revenue from government contracts. But it can pay taxes on its non-government commercial sales that increases the tax pie.

A recent study found that 47% of households in the U.S. paid no federal income taxes in 2009. [1] Adding in the number of government employees and beneficiaries not included in that 47%, and contractors paid wholly from tax revenue, reveals that a minority of people and companies produce the wealth that comprises federal tax revenue. Without those wealth producers there would be a small pie of tax money for the consumers of federal revenue to draw from. [2]

That is why “real” wages and the standard of living is so low in countries where the government is the primary employer, and there is little private wealth creating financial activity that is taxed. Cuba is one of those countries. In 2008 the average monthly wage in Cuba was the equivalent of less than $20 (U.S.). [3] Soviet Russia imposed a high income tax on its citizens, but those people who mostly lived well below the poverty line by U.S. standards merely returned to the government money that had been paid to them from the tax pie. China had an abysmal overall standard of living and there were periodic famines until Mao-tse-tung died and the government changed its policies to permit wide-scale profit-seeking wealth creating activity that could be taxed to dramatically expand China’s tax pie. North Korea is a modern day example of the dire economic consequences of a country following policies similar to Maoist China.

Producers of wealth actually pay taxes, while those who obtain benefits from those taxes are tax consumers, not tax payers. Government employees, contractors, and beneficiaries are paid other people’s money – not their own. This is also true of Social Security and other government entitlement payments to non-government workers. Those function as pay as you go programs, so money a person paid into them was spent before payments are made to them.

The imposition of taxes regardless of whether its source is private wealth creating financial activity or government payments, masks the reality that the former adds to the pool of tax revenue, while the latter doesn’t. In fact, the pie of tax revenue would be the same size if the government did not pay any money to those people and organizations, and they didn’t pay any taxes from receipt of that money.

Endnotes:

1. “Nearly Half of U.S. Households Pay No Federal Income Tax,” Fox News, April 7, 2010, citing a report by the Tax Policy Center. A family of four making $50,000 per year will pay no federal income taxes based on standard deductions.

2. The federal government is constitutionally empowered to levy a duty on imported goods, but the tax is paid on the domestic importer of the goods, not the foreign exporter. So the tax on imported goods is directly paid by domestic wealth producers.

3. “At 50, Cuba’s revolution showing its age,” CNN.com, December 31, 2008. The primary source of wealth creation in Cuba is trade with other countries and forms of foreign aid, such as oil for below market prices from Venezuela.