What taxes pay for

Why collection exists at all

Every state that has ever existed has had to answer the same question: how does a body that produces nothing pay for the things everyone is assumed to want? Roads and courts and defence and record-keeping do not fund themselves, and they are difficult to sell individually because nobody can be easily excluded from them. A person who refuses to pay for a court system still benefits from living somewhere contracts are enforceable.

That difficulty, rather than any particular political theory, is the practical reason taxation is compulsory. Voluntary contribution works for things people can be excluded from. It works badly for things nobody can be excluded from, because the rational individual choice is to let someone else pay. Compulsion is the mechanism that makes the collective purchase possible, and the argument in every country is about how much, from whom, and on what.

Taxes on income, on spending, and on holdings

Almost every tax in the world attaches to one of three moments. It can attach when money is earned, when money is spent, or while something is simply held. Taxes on earning include income tax and the various contributions deducted from wages. Taxes on spending include sales taxes, value-added taxes, and the older duties on particular goods. Taxes on holding include property taxes and the levies that fall on estates when they pass on.

The three moments behave differently, and that is why systems use all of them. A tax on earning follows a person's capacity to pay closely but collapses when employment collapses. A tax on spending keeps producing revenue during a downturn, because people continue to eat and heat, but it takes a larger share from those with little left over at the end of a month. A tax on holdings is the steadiest of the three and the hardest to assess, because value has to be estimated rather than observed.

Where the money goes, and the myth of the labelled coin

In most systems, collected money is not labelled. It goes into a general fund and is spent according to a budget decided separately from the collection. This surprises people, because the language of politics is full of sentences that suggest a particular tax buys a particular thing. Very occasionally a levy is genuinely earmarked for one purpose, a practice called hypothecation, but it is the exception and it tends to be unwound the moment the earmarked revenue and the earmarked need stop matching each other.

The practical effect is that no individual can trace their own payment to an outcome. What can be traced is the aggregate: the published budget of a government shows what proportion of total spending goes to health, to pensions, to education, to servicing debt. Those proportions, rather than any single tax, are the honest answer to the question of what taxes pay for.