Journal of Economics 7 (1981):
FISCAL ILLUSION I N CLASSICAL ECONOMIC LITERATURE
Robert A. Blewett, Western I l l i n o i s University.
I.
INTRODUCTION
F i s c a l i l l u s i o n r e f e r s t o the a b i l i t y
of c e r t a i n f i s c a l i n s t i t u t i o n s t o a l t e r t h e
perceived c o s t s and b e n e f i t s of t h e public
s e c t o r . Buchanan [ 2 , 1960, pp 59-66; 3. 1967,
Chapter 101 i s the f i r s t modern economist
t o w r i t e d i r e c t l y on t h e concept of f i s c a l
i l l u s i o n . He t r a c e s t h e concept's o r i g i n s
back through the w r i t i n g s of Mauro F a s i a n i
i n t h e 1940s t o those of another I t a l i a n ,
Amileare Puviani, a t the t u r n of t h e century.
However, f i s c a l i l l u s i o n i s not a concept
,
f i r s t borne by Continental minds. C l a s s i c a l
economists of t h e l a t e 18th and e a r l y 19th
Centuries incorporated f i s c a l i l l u s i o n i n t o
t h e i r a n a l y s i s of public finance. This paper
w i l l provide t h e reader with evidence of f i s c a l
i l l u s i o n i n c l a s s i c a l economic w r i t i n g s .
Readers who a r e unfamiliar with t h e concept
of f i s c a l i l l u s i o n may find the pap-er enlightening s i n c e each major i l l u s i o n - g e n e r a t i n g i n s t i t u t i o n i s discussed.
The next s e c t i o n w i l l d i s c u s s t h e r e l a t i o n s h i p between t a x a t i o n and f i s c a l i l l u s i o n .
The b e n e f i t s of public s e r v i c e s and f i s c a l
i l l u s i o n w i l l then be analyzed. The f o u r t h
s e c t i o n w i l l explore public debt and how
C l a s s i c a l economists believed t h i s method
of finance hid t h e c o s t of government.
11.
TAXATION
I n d i r e c t t a x a t i o n i s an e x c e l l e n t example
of an i n s t i t u t i o n which generates f i s c a l
i l l u s i o n . An e x c i s e tax nominally paid f o r
by a producer i s j u s t one example of i n d i r e c t
t a x a t i o n . J . B . Say noted f i s c a l i l l u s i o n
generated by e x c i s e taxes i n h i s a n a l y s i s
of t a x incidence:
[The s e l l e r ] frequently does no more
than advance t h e tax e i t h e r wholly o r
s o t h a t a g r e a t many
partially;
persons a r e paying p o r t i o n s of t h e tax,
a t a time when they l e a s t suspect i t ,
e i t h e r i n t h e shape of the advanced p r i c e
of commodities, or of personal l o s s ,
which they can f e e l but cannot account
f o r [12, 1844, p. 4711.
...
Adam Smith [13, 1971. p. 3551 observed
t h a t g r e a t e r f i s c a l i l l u s i o n i s generated
when t h e tax is c o l l e c t e d gradually and i n
small amounts. I n h i s d i s c u s s i o n of the e x c i s e
t a x on s a l t , Smith observed " t h a t nobody could
f e e l very s e n s i b l y even a p r e t t y heavy t a x
upon it."
John S t u a r t M i l l [ 7 , 1936, p. 8651 a l s o
recognized t h e i l l u s i o n accompanying i n d i r e c t
t a x a t i o n . He believed t h e burden of d i r e c t
t a x a t i o n was t h e only burden t h e taxpayers
were s u r e they bore. The d i r e c t t a x a t i o n
made c i t i z e n s aware of t h e c o s t s of p u b l i c
s e r v i c e s . This awareness would a c t a s a
159-161
c o n t r o l t o l i m i t public expenditures which M i l l
f e l t was absent with i n d i r e c t taxation.
Thomas Cooper was the foremost American
economist during the f i r s t h a l f of the 19th
century. He noted [5. 1971, p. 2601 t h a t p u b l i c
o f f i c i a l s r e s o r t e d t o i n d i r e c t t a x a t i o n so a s
t o h i d e t h e c o s t s of government and he considered
such financing t o be "taxes on ignorance."
P i e r c y Ravenstone [ l o , 1966, pp. 21-22],
a Ricardian S o c i a l i s t , believed t h a t t h e i n c i dence of t a x a t i o n was d e l i b e r a t e l y obscured
i n o r d e r t o gain p o l i t i c a l acceptance. The
incidence theory t h a t t a x e s f e l l u l t i m a t e l y
on "property" was nothing more than a r a t i o n a l i z a t i o n intended t o generate i l l u s i o n s .
Thus i t was recognized by C l a s s i c a l w r i t e r s
t h a t i n d i r e c t taxes a s w e l l a s t a x e s c o l l e c t e d
o f t e n and i n small amounts, f o s t e r e d f i s c a l
i l l u s i o n . These taxes lowered t h e r e s i s t a n c e
of t h e p u b l i c t o t h e financing of p u b l i c expenditures.
111.
EXPENDITURES
Taxpayer-voters may n o t be f u l l y aware
of t h e b e n e f i t s of p u b l i c s e r v i c e s . Such benef i t s may be i n d i r e c t and q u i t e d i f f i c u l t t o
evaluate. M i l l thought t h e r e was a systematic
underevaluation of the p u b l i c b e n e f i t s of p u b l i c
s e r v i c e s . He believed t h a t i n d i r e c t t a x a t i o n
was j u s t i f i e d s i n c e t h e i l l u s i o n on t h e tax
s i d e would o f f s e t t h e underestimation of t h e
b e n e f i t s of govemment s e r v i c e s :
..
. I f our p r e s e n t revenue of about seventy
[I8621 m i l l i o n s were a l l r a i s e d by d i r e c t
taxes, an extreme d i s s a t i s f a c t i o n would
c e r t a i n l y a r i s e a t having t o pay s o much;
so g r e a t an aversion t o t a x a t i o n
may n o t be an unqualified good.
[The
financing of public s e r v i c e s h a s ] again
and again been prevented by t h e r e l u c t a n c e
which e x i s t e d t o apply t o Parliament f o r
an increased g r a n t of p u b l i c money.
[ 7 , 1936, 855-661.
...
..
...
John R. McCulloch was a l s o aware of t h e
a b i l i t y of i n d i r e c t t a x a t i o n t o d i s t o r t t h e
perceived burden of t a x a t i o n . He believed t h a t
taxpayer-voters would underestimate t h e b e n e f i t s
of government s e r v i c e s and j u s t i f i e d h i d i n g
t h e amount of t a x a t i o n v i a i n d i r e c t t a x a t i o n
because of t h e f a i l u r e of taxpayer-voters t o
f u l l y appreciate public service benefits.
The burden of d i r e c t t a x a t i o n is palpable
And t h e b e n e f i t s derived
and obvious.
from government, though of t h e h i g h e s t
importance, being n e i t h e r so very obvious
nor s t r i k i n g a s t o be r e a d i l y f e l t and
appreciated by the bulk of t h e people,
t h e r e i s i n t h e g r e a t majority of c a s e s
a s t r o n g d i s i n c l i n a t i o n t o t h e payment
of d i r e c t taxes. For t h i s reason governments have g e n e r a l l y had recourse t o those
t h a t a r e i n d i r e c t . [6, 1968. p. 1471
...
Public o f f i c i a l s can c o n t r o l o r manipulate
t o some degree the s t o c k of information held
by v o t e r s . C l a s s i c a l economists r e a l i z e d
t h e unique positons of bureaucrats allowed
them t o a f f e c t the perceptions (1.e.. generate
i l l u s i o n s ) of voters. Henry P a r n e l l noted
t h i s a b i l i t y of government o f f i c i a l s when
he wrote concerning the p r a c t i c a l i t y of t r l m i n g
t h e government budget:
It i s almost impossible f o r persons,
not themselves in o f f i c e , t o have s u f f i c i e n t knowledge of d e t a i l s t o be a b l e
t o expose the f a l l a c i e s on which t h e
p l e a s f o r expense a r e enforced; and t h e
absence of such an exposure produces
o f t e n a b e l i e f t h a t the expense i s necess a r y [9. 1968, p. 991.
C l a s s i c a l economists were f u l l y cognizant
t h a t c i t i z e n s were not f u l l y informed concerning
t h e b e n e f i t s of the public s e c t o r . Some j u s t i f i e d i n d i r e c t t a x a t i o n on t h e grounds t h a t
f i s c a l i l l u s i o n on t h e t a x s i d e may balance
t h e i l l u s i o n on the b e n e f i t s i d e . Our C l a s s i c a l
precursors were a l s o aware t h a t information
concerning p u b l i c s e r v i c e b e n e f i t s could be
manipulated by p u b l i c o f f i c i a l s .
IV.
Buchanan presented one hundred and f o r t y y e a r s
l a t e r concerning the burden of t h e debt.
Modem economists accept t h e b a s i c Ricardian
equivalence theorem t h a t equated a once and
f o r , a l l t a x with t h e issuance of debt. However,
c l a s s i c a l economists, including David Ricardo
himself, d i d not b e l i e v e t h a t i n d i v i d u a l s would
consider t h e two a l t e r n a t i v e s q u i t e equivalent.
After explaining h i s equivalence theory, Ricardo
went on t o o f f e r an important q u a l i f i c a t i o n
which was based on f i s c a l i l l u s i o n :
From what I have s a i d , i t must not be
i n f e r r e d t h a t I consider t h e system of
borrowing a s t h e b e s t c a l c u l a t e d t o d e f r a y
t h e e x t r a o r d i n a r y expenses of the s t a t e .
I t is a system which tends t o make us
l e s s t h r i f t y - - t o b l i n d us t o our s i t u a t i o n
111, 1973, pp. 162-631.
The propensity of public debt t o generate
f i s c a l i l l u s i o n was almost u n i v e r s a l l y accepted
by c l a s s i c a l economists. One can s c a r c e l y
f i n d a scholar of t h a t period who was not opposed
t o t h e excessive use of debt because of i t s
a b i l i t y t o "blind" taxpayers. After explaining
t h e Ricardo Equivalence Theorem, Thomas Chalmers
wrote:
PUBLIC DEBT
A major s t r a n d of modern p u b l i c finance
l i t e r a t u r e concerns i t s e l f with p u b l i c debt.
Buchanan's e a r l y work [ I , 19581 on t h e burden
of the public debt s e t off a now famous and
q u i t e f u r i o u s debate which l a s t e d most of
a decade. A s E.G. West [15, 19751 pointed
o u t , t h i s debate was primarily t h e r e s u l t
of economists using "burden" t o d i s c u s s two
d i f f e r e n t concepts.
A t the aggregate l e v e l t h e r e i s no burden
of i n t e r n a l l y held debt. Money i s merely
passing from one hand t o another.
Other
than t h e Ricardo-Pigou e f f e c t of reduced c a p i t a l
formation, no burden is placed on f u t u r e genera t i o n s because t h e debt revenues take resources
out of c u r r e n t p r i v a t e consumption and investment.
However, a t t h e i n d i v i d u a l l e v e l , taxpayers
can c u r r e n t l y avoid t h e f i n a n c i a l burden of
public expenditures by having t h e government
borrow in the c a p i t a l market. A t a f u t u r e
d a t e , f u t u r e generations of taxpayers would
bear a burden when t h i s debt was r e t i r e d .
Even though i n t h e aggregate t h e lenders and
taxpayers a r e the same people, a t t h e i n d i v i d u a l
l e v e l t h e i r functions can be separated.
C l a s s i c a l economists were well aware
of both the aggregate and i n d i v i d u a l burdens
of t h e public debt. One such c l a s s i c a l econom i s t was Count D e s t u t t Tracy, whose T r e a t i s e
on P o l i t i c a l Economy had i t s t r a n s l a t i o n e d i t e d
by Thomas J e f f e r s o n i n 1817. Tracy [14. 1970.
p. 2411 demonstrated the Ricardo-Pigou e f f e c t
and acknowledged t h a t resources obtained by
public debt were u t i l i z e d i n t h e period borrowed. He a l s o summarized the argument
Notwithstanding, however, l o a n s a r e more
The people
popular than taxes
do n o t f e e l t h a t governments a r e [ s i c ]
taking t h e money out of t h e i r pockets
by borrowing, though t h i s i s v i r t u a l l y
done, and a t t h e time too, i n t h e shape
of higher p r i c e s , i f n o t i n t h e shape
of higher taxes. They think t h a t a loan
only e n t a i l s a d i s t a n t calamity, although
t h e f u l l weight of i t i s f e l t i n a p r e s e n t
calamity. But t h i s is not perceived,
and blindness r e c o n c i l e s them t o a s o r e
i n f a t u a t i o n [4. 1968. p. 4951.
....
But Adam Smith had previously i n s t r u c t e d
everyone on t h i s s u b j e c t and i n t h e s t r o n g e s t
and c l e a r e s t terms. Discussing t h e means of
r a i s i n g a l a r g e amount of revenue t o support
a war, he wrote:
They [government] a r e unwilling f o r f e a r
of offending t h e people, who, by so g r e a t
and s o sudden an i n c r e a s e of t a x e s , would
soon be disgusted with t h e war; and they
a r e unable from not w e l l knowing what
t a x e s would be s u f f i c i e n t t o produce t h e
revenue wanted. The f a c i l i t y of borrowing
d e l i v e r s them from t h e embarrassment which
t h i s f e a r and i n a b i l i t y would otherwise
occasion [13. 1971, p. 4021.
Smith believed t h a t government f o o l s t h e
people by not d i r e c t l y taxing them. Sovereigns
c r e a t e public debt because i t s e f f e c t s a r e
f e l t only i n d i r e c t l y . The expense of the war
i s only d i r e c t l y f e l t when t h e public debt
i s t o be paid o f f .
J . B . Say [12, 1844, p. 4831 a l s o noticed
t h a t n a t i o n s f e e l "stronger" because of t h e
,
n a t i o n a l d e b t o r r a t h e r because of t h e i r a b i l i t y
t o s o e a s i l y r a i s e revenues. They were more
l i k e l y t o a t t e m p t g i g a n t i c and w a s t e f u l p r o j e c t s and more l i k e l y t o wage war. Tracy [14,
1970. p. 2451 echoed a s i m i l a r c o n c l u s i o n and
a l s o noted t h a t n a t i o n s o f t e n placed themselves
i n p o s i t i o n s deemed n e c e s s a r y t o c a u s e an
i n c r e a s e i n p u b l i c d e b t . Without t h e d e b t
c r e a t i o n p o t e n t i a l t h e y would b e l e s s prone
t o a l l o w themselves t o be p u t i n such p o s i t i o n s .
Henry P a r n e l l [ 9 , 1968, p. 1031 observed
that
t h e [Napoleonic] war d e s t r o y e d a l l
p r e v i o u s l y e s t a b l i s h e d systems of c o n t r o l and
economy [ i n government]."
T h i s was due t o t h e
government's
f a c i l i t y of g e t t i n g money
by loans."
He noted t h a t a l l t h e e x t r a o r d i n a r y
expenses t h a t a r o s e d u r i n g t h e war were having
t h e i r e f f e c t f e l t by o t h e r t a x p a y e r s o n l y
a f t e r t h e war was over. P a r n e l l was probably
n o t t h e f i r s t nor t h e l a s t w r i t e r t o n o t i c e
t h a t temporary e x p e n d i t u r e s have a tendency t o
though
become permanent when he w r o t e ,
t h e war i s over t h e s p i r i t of p r o f u s i o n
survives
P u b l i c d e b t and i t s a b i l i t y t o b e g e t
i l l u s i o n on t h e p a r t of t a x p a y e r s was noted
by most c l a s s i c a l economists. Taxpayers would
f e e l l i b e r a t e d from t h e burden of e x p e n d i t u r e s
f i n a n c e d by p u b l i c d e b t . Also noted was t h e
tendency of government t o overexpand i t s o u t l a y s
due t o t h e d e b t ' s f a c i l i t y i n r a i s i n g revenue.
Money c r e a t i o n was s e e n a s a method of a v o i d i n g
d e f a u l t on t h e p u b l i c d e b t . The r e s u l t a n t
i n f l a t i o n was viewed a s an i n d i r e c t form of
t a x a t i o n which g e n e r a t e d f i s c a l i l l u s i o n .
". . .
". . .
". . .
."
C l a s s i c a l economists were aware t h a t
p u b l i c d e b t removed some p o l i t i c a l l i m i t a t i o n s
on e x p e n d i t u r e s and t h a t a u t h o r i t i e s may overextend t h e p u b l i c s e c t o r w i t h p u b l i c d e b t .
The expected r e s u l t would be a d e f a u l t on
t h e debt.
Adam Smith [13, 1971, p. 42) was w e l l
aware of t h e tendency of s o v e r e i g n s t o i n c r e a s e
t h e d e b t i n o r d e r t o avoid d i r e c t l y t a x i n g
t h e i r s u b j e c t s . He was a l s o aware of how
t h e s e s o v e r e i g n s could avoid a "bankruptcy"
o r a d e f a u l t on t h e p u b l i c d e b t . They could
a l s o f o o l t h e i r s u b j e c t s and c r e d i t o r s by
r e s o r t i n g t o an e a r l i e r form of money c r e a t i o n :
r a i s i n g of t h e denomination of t h e c o i n .
T h i s money c r e a t i o n and i t s accompanying
i n f l a t i o n i s a c t u a l l y a v e r y i n d i r e c t method
of t a x a t i o n . T h i s type of t a x a t i o n makes i t
v e r y d i f f i c u l t indeed f o r an i n d i v i d u a l t o
i d e n t i f y h i s s h a r e of t h e burden of t h e c o s t s of
government goods and s e r v i c e s . I n f a c t , a n
i n d i v i d u a l may n o t be a t a l l c e r t a i n how
government i s t o blame f o r h i s d e c r e a s i n g r e a l
income.
V.
CONCLUSION
F i s c a l i l l u s i o n r e f e r s t o t h e a b i l i t y of
certain fiscal institutions to a l t e r the
p e r c e i v e d c o s t s and b e n e f i t s of t h e p u b l i c
s e c t o r . The concept is g e n e r a l l y thought
t o have been o n l y a n a r e a s t u d i e d by modern
economists. Hopefully, t h i s paper h a s d i s p e l l e d
t h a t n o t i o n . C l a s s i c a l w r i t e r s were aware
of such i l l u s i o n - p r o d u c i n g d e v i c e s a s i n d i r e c t .
confusing and complex t a x a t i o n . The a b i l i t y
of t h e government t o e x p l o i t f i s c a l i l l u s i o n
concerning t h e b e n e f i t s of government programs
was a l s o observed. M i l l and McCulloch observed
t h a t consumers o f t e n undervalued t h e s e r v i c e s
of government--another form of i l l u s i o n .
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