Evan Osborne



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The Keys to the Kingdom: Income Tax and the State

Evan Osborne


Wright State University
Department of Economics

3640 Col. Glenn Hwy.


Dayton, OH 45435

937 775 4599 (Phone)

937 775 2441 (Fax)

evan.osborne@wright.edu

May, 2002



"Congress will have to go slow in making appropriations unless the President is to be put in an embarrassing position. He will not want to increase the income tax, and if he had to do it would not hesitate ... to put the blame where it belonged. The provision will be a whip in the hands of the president to keep Congress toeing the mark of economy."
- From a Washington Post editorial supporting the imposition of an income tax, 1909 (?)

One of the most striking economic phenomenon of the last century has been the substantial growth, across a wide variety of jurisdictions, in the size of government. This phenomenon has of course not gone unobserved. What has become known as “Wagner’s law” states that all types of societies over time devote more resources to state activity. An extensive empirical literature has developed on this topic, for which the canonical paper is often said to be Peltzman (1980).

The focus of this literature has generally been to explain the rise of government spending through measures of outputs – generally, examining the size of government spending relative to the entire economy or population. However, thus far scholars have not paid attention to the means of the ever-expanding state. Which measures taken by governments to facilitate a more extensive public sector are the most effective enablers of this seldom-disputed outcome? Answering this question would help to better understand the precise dynamics of government growth, which would in turn enable citizens in a particular society to understand where they are on that timeline.

This paper examines the relation of one particular method of revenue extraction to such growth: the taxation of income. The widespread use of such taxation is relatively new, and yet its existence has coincided strikingly with the dramatic growth in government activity that occurred in the twentieth century. Despite this stylized coincidence (in the literal sense of the word), no study of this relationship has been conducted. To do so, this paper presents a brief history of income taxation in Section I. In order to illustrate the tradeoff in choosing taxation instruments, it then presents in Section II a model of endogenous taxation choice by a sovereign. Sections III and IV contain empirical investigation of the relation between government size and introduction of income taxation, and Section V interprets the results.





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