What is the power of direct taxation? How does federal taxation rely on direct tax revenue?
Direct taxation is the power to assess taxes on indviduals. The federal government doesn’t have to go through the states to collect revenue.
See how the power of direct taxation was an essential change when moving from the Articles of Confederation to the Constitution.
The Power of Direct Taxation
The management of public finances is another core function of any government. As we explored in the previous chapter, the Articles of Confederation had failed badly on this score because they made federal taxation revenue dependent on the fulfillment of quotas and requisitions of the state.
The federal government itself only had a few revenue streams, like imposts on imported goods, that it directly controlled; for everything else, it had to rely on the states functioning as intermediaries. This left the government unable to meet basic fiscal obligations and led to rising costs in the financing of the national debt and a collapse in public confidence.
Publius feared that a national emergency like a war would expose the dire condition of public finances. The federal government, unable to raise adequate revenue, would be forced to rely on loans at usurious interest rates, which would only compound the debt crisis. Because it acted directly on individuals, not states, the new Constitution gave the government powers of direct taxation. Thus, it could directly assess taxes on land and people, without relying on the states as intermediaries.
Concurrent Jurisdiction: State and Federal Taxation
Fears of federal encroachment on state revenues under this arrangement were unfounded. In the first place, the Constitution did not prohibit states from also levying direct taxes. This was a core principle of federalism—on many issues, especially those related to revenue, the states and the federal government exercised concurrent or coequal jurisdiction.
Concurrent jurisdiction over revenue was the only logical way to put the government on sound financial footing. If the states held the exclusive power of direct taxation, this would be a gross misallocation of resources, diverting revenue to where it was least needed. After all, the greatest public expenses were those related to the national defense, a power reserved to the federal government under the new Constitution. Giving it the lion’s share of revenue was appropriate.
The Benefits of Direct Taxation
Giving the federal union the power of direct taxation wouldn’t just benefit public finances; it would also be good for the broader economy. If the federal government had to rely solely on customs duties and excise taxes (taxes on manufactured goods levied at the point of manufacture) for its revenue, it would have to tax these items at an extraordinary rate.
This would have distortionary and unequal effects on the different states. States with large manufacturing sectors would be able to produce more of their own goods instead of relying on imports, while passing the costs of the excise taxes onto consumers. States without a manufacturing base, however, would be forced to pay much higher prices for manufactured goods, either from abroad or produced domestically.
The high rates would encourage the growth of tax evasion and black markets, while undermining general respect for the law. In general, giving the federal government a broad tax base would encourage modest tax rates, which would be good for both producers and consumers.
Better Revenue Collection
A strong Union would also provide better and more efficient means of revenue collection than would a series of independent or semi-independent states. Given the difficulty and cost of assessing and collecting direct taxes (like income taxes) in the 18th century, most states raised revenue from indirect taxes, mainly in the form of duties on imported goods.
Moreover, any direct taxes levied by Congress (in the 18th century these taxes would have applied chiefly to real estate) were required by the Constitution to be proportional. As per Article 1, Section 2, the tax burden assessed in each state was to be tied to that state’s population according to the decennial census.
(Shortform note: The requirement that direct taxes be levied proportionally according to the census was effectively nullified by the passage of the Sixteenth Amendment in 1913, which allowed the federal government to levy an income tax without regard to apportionment among the states.)
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