Milosz Pawlowski and Ion Lucian Sterpan

Just TaxesFree Choice in Public Sectors

Abstract

The main aim of the paper is to present a novel vision of the management of taxes. We start with a discussion explaining the moral and economical reasons for the search of an alternative to the currently existing taxation systems.

The mainstream view is that the prisoner’s dilemma and the free rider problem apply to the provision of a number of public goods and to the provision of equity. These provisions require an external coercive political process, superimposed on a market process. At the same time however, it also has to be recognized that state agencies enjoying a legal monopoly in collecting and administering the amount of tax-money are facing a perverse incentive structure generating pressure group, rent-seeking and financial indiscipline problems.

Our project is based on the idea of the free tax, and gives a central role to the new type of tax: the semi-free tax. The proposed system of individual tax-management gets rid of the problems which make the current system unjust and ineffective. The project involves also a vision of substantial institutional reforms, empowering citizens, reducing the scope of the governmental powers and strengthening the civil society.

I. Introduction

Taxes are always with us. They are are ubiquituos to the point of being well-nigh invisible (just how many taxes do we pay when we buy an imported liquor?). But should we take this part of our lives for granted?

The liberals since long fight a battle for decreasing taxation. Their reasons are not only economical but also moral. Taxation – at least taxation in its current forms – is not justified. To better see the point, let us turn for a while to the most radical liberal position: libertarianism.

Libertarians think that the existence of taxation and state is unjustified. Some of them advance a very strong moral claim:

(O1) The coercive collection of taxes is a transgression against the natural rights of property1.

This objection is not to be taken lightly. All the more so, as perhaps the most widely shared justification of taxation also appeals to natural (positive) rights.

1 The natural rights invoked are of the Lockean variety, see Locke, Second Treatise on Government. The authors which make such claims include M. Rothbard, The Ethics of Liberty, New York University Press, 1998; and H.-H. Hoppe, The Economics and Ethics of Private Property, Kluwer, 1993.

Now, the language of rights is notorious for its tendency to generate irresoluble moral conflicts. But many libertarians would agree with supporters of taxes about the legitimacy of at least some aims of taxation. Why do we want there to be taxes? The most serious moral answer is: because they are meant to guarantee social welfare and security. These are certainly important objects of our moral concerns. But all libertarians would claim that taxes are very poor means to achieve these goals. Now, it would be a mistake to assume that the disagreement about means is no longer moral, but purely economical. Even here we are likely to stumble upon moral disagreements. For example, the libertarians are likely to claim that the state system of redistribution makes people irresponsible, dependent and slavish.

Thus the disagreement about the justification and permissibility of taxation seems to involve genuine moral disagreements. Luckily, moral conflicts can sometimes be avoided rather than be resolved. That is, it might be possible to reach a practical solution which will be reasonably satisfactory for both sides. While it is not a moral compromise, as each side can retain its beliefs and attitudes, it is a practical compromise.

II. Objections to Current Solutions

Let us then look at the fundamental objections which can be raised against the libertarian and against the mainstream solution.

There are two principal arguments against the libertarian rejection of taxation. Obviously, it can be maintained that the state is needed for many reasons; or that its existence is inevitable and hence that the libertarian project is a mere utopia. But the state needs to be financed by taxation. Secondly, there is a more direct concern about people’s welfare. There is no guarantee that private charity will meet all the needs of the poor or otherwise afflicted people. There is a danger that without coercive taxation there will not be enough of equity, social security, and real (not only formal) equality of chances. The friends of taxes can express their concerns with these issues in a variety of ways. They can put their point in terms of the virtue of social solidarity. Or they can resort to positive rights-and-duties rhetoric. If there are positive rights, there are also corresponding duties. And it can be argued that it is at least sometimes permissible (or mandatory) to coerce people to do their moral duty.

What then is wrong with the taxation-system in its current shape? It is inherently unjust. To better see the point, let us compare charity and taxation. In the case of charity, every individual can freely decide (a) how much money to give and (b) whom to give and for what purpose. In the case of taxation the power to decide about both (a) and (b) is taken from the individual. In the mainstream approach, taxes are coercively collected and monopolistically managed. The institution which makes the decision about (a) and (b) is the state. Let us suppose that we deal with a democratic state, where an individual is not simply a subject, but has some influence on the state policy.

We have already mentioned one reason to think that taxation in the current form is unjust – (O1). This objection focuses on the very collection of taxes. This objection, however, at least at this level of elaboration, is not likely to carry much force against

anyone who does not have strongly liberal intuitions. But there are serious reasons to think that the way taxes are actually managed is wrong.

Suppose that I think taxation is justified because it helps us fight poverty and makes available health-care and education to everybody. In general, the basic moral aim of taxation is to provide a desirable redistribution of goods. Redistribution means that some people contribute more and gain less from the system, while others profit from it. The problem is that wrong people profit from the system.

(O2) Tax-payers are unjustly exploited by pressure groups and the state administration.

A monopolistic institutional environment provides incentives for obtaining financial privileges by means of group lobbying activities. Collective action and visibility to politicians is needed for a group in order to be effective. The free rider problem of collective activity (the organizational costs) is more easily overcome by smaller and concentrated groups since they are easier to form. Therefore smaller groups with obvious interests are capable to push their demands more effectively, while larger and diffused groups with relatively more complicated reasons and interests are not so fortunate in making themselves heard. This is why producers and workers in a more concentrated industry are more successful at lobbying than larger and more geographically diffused “groups”. This is why the unions in steel industry get subsidized and why people who smoke cigarettes don’t get subsidized, nay, they are heavily taxed. Or why the miners are more effective in obtaining economic privileges than nurses, high-school teachers, or single parents, to give a notorious example from the recent history of our region.

The argument explaining the efficacy of pressure groups applies to bureaucracy as well: it is a homogenous special interest group whose problem of collective action (the free rider/lobby problem) is already solved. No less importantly, the growth of the administration follows from the growth in the powers and the scope of activity of the state. Even in contemporary democracies, where legal conditions of transparency are fulfilled the state still grows because the cost of every new piece of regulation / redistribution is less visible than the benefit. Though higher, the marginal cost of every new increase is less visible or more dispersed than the benefit.

Thus from the perspective of the individual tax-payer, the fundamental problem is that she has insufficient visibility and control over the management of public resources. In effect, a large part of the resources are appropriated by pressure groups instead of being used for the original purposes. But that means that the would-be beneficiaries of the system – the poor – are also losers or, to the extent to which the poor are tax-payers themselves, even wronged. Consider David Friedman’s argument2. He asks: How does redistribution work? His answer: Perversely! Why?

(1) The rich start working later than the poor because they afford to stay home or to stay in school more. The result is that the poor are paying taxes for more years than the rich. (2) The rich have a longer retirement period than the poor, because they afford a healthier and thus longer life. The result is that the poor are receiving help for fewer years than the rich.

2 D. Friedman, The Machinery of Freedom, La Salle, Illinois, Open Court, 1989

(3) The payments made by the poor in his earliest years have more time to accumulate interest than the payments made later by the rich. The result is that the effective value of the poor man’s early savings is higher when he reaches his retirement age.

(4) The sum of these 3 reasons is great enough to reverse the effect of redistributionist policies. (5) Therefore, the overall effect of redistribution is to take wealth from the poor and transfer it to the rich.

There are many other examples to show that it is often precisely the poor which lose in the game of redistribution3. This is not what we wanted.

The third problem is engendered by the existence of the central budget which is a natural tool of the monopolistic system of administration. Now, the melting-pot of a central budget creates a peculiar moral problem involved in supporting questionable policies. Suppose that the government decides that the country should go to war – and we might assume that it is supported by the majority (although in reality it is often not the case). Yet I am morally opposed to this war. Consider then the following argument:(1) It cannot be my duty to support what I regard as immoral actions. (2) My moral integrity demands that I do not support what I regard as immoral actions.(3) If I pay taxes, I support what I regard as an immoral action. (4) If I don’t pay taxes, I face legal punishment. (5) Therefore, I am coerced to support immoral actions. (6) The current taxation-system thus inweighs against my moral integrity.

Now, civil disobedience seems a fair thing. But if I try to be truly consistent and I stop paying taxes, I thereby neglect my duty to contribute to the upkeep of health-care system, public education etc. Therefore:

(O3) In the current taxation-system which supports questionable policies, I am likely to compromise my moral integrity, whatever I do.

The system which yields such outcomes can appropriately be called unjust.

The last objection to the current approach to taxation invokes inefficiency:

(O4) The monopolistic management of resources is economically inefficient.

This is different from the charge of injustice. Of course, injustice and inefficiency most often go hand in hand when there is always someone to appropriate a share, but whenever total losses exceed total gains we can also speak of pure waste. In the public choice literature the phenomenon bears the name of rent-seeking. Rent seeking is devoting resources for obtaining through the political process special privileges in which the injury

3 Beautiful parks are more open to those who live near them (oftentimes the rich). Security agents are again more present in central areas, not in the infamous neighborhoods hosting precisely those who can't afford private protection.

to the injured is greater than the gain to the people who gain4. Let us call the amount available at the center a “rent”, the competitors “bidders” (whatever form the bidding may take), their efforts “rent seeking” and the resources devoted to win the competition “rent-seeking costs”. The total cost of rent-seeking wasted in the process of bidding for the rent, once the rent is available is hard to measure but we can make some idea about its magnitude from the following example: Assume that every bidder knows his probability of getting the resource. If there is a rent of $ 1 million available at the center and 10 bidders each guessing a ten percent probability of their getting the money, then each bidder will spend close too 100 000 in lobbying activities / rent seeking. Leaving aside the obvious cost born by the taxed and other transfer / transaction costs we observe that only rent seeking can easily consume out an amount of social resources roughly equal to the value of the available rent.

Thus the practice is not only unjust on the grounds we have exposed in writing about pressure group, but it also yields an economic result which is bad overall. Resources can also be wasted simply being frozen, unused and thereby losing value; or since taxes are a disincentive to investment, and all costs are opportunity costs, then a waste is also what could have been done by the market with the resources taken from it. Everybody loses (or at least unknown actors lose), so no one is wronged in particular. Hence injustice and inefficiency need not have the same scope.

Yet by far the most widely recognized is the problem of financial indiscipline. Those who spend other people’s money in other people’s interest, as opposed to spending one’s own money in one’s own interest are more prone to recklessness. Incentives for reaching the best deals are low when the administrator’s income does not depend on the marginal utility of her work but on some other standardized rules – fixed wages from the budget. At the same amount of benefit workers will choose the least amount of work possible. For an artificial monopoly the incentive is to be as large and as complicated as possible. In the absence of competition, the logic is to lobby that what it does is not easy, that it needs more staff and equipment, without any apparent upper limits. A monopolistic agency not only has an additional incentive for inefficient transactions but also for opacity in transactions (offering preferential credit, for subsidies, bail-outs, etc). In the case of bureaucratic monopolies, it is easier to take opportunities such as taking bribes to change the order in which and the quality by which the clients are served.

We have seen that both the libertarian and the mainstream solution face formidable challenges of moral and economic nature. Is it possible to find a middle-way practical solution which could withstand these challenges? How to provide for a desirable redistribution of goods, and the existence of the state as its guarantor, and make sure that the operation of the system will be more just and efficient than what we see today? We believe that our proposal of the reform of the individual income tax makes all this possible.

III. A Practical Compromise: The New System of Tax Management

It is necessary to distinguish two steps involved in taxation. The first is the collection of resources from the tax-payers. The second step is management and

4 G. Tullock, Rent Seeking, Aldershot – Vermont, Edward Elgar Publishing Ltd., p. 22.

distribution of the collected resources. Assume that as individual tax-payers we believe that there are legitimate purposes of taxation, i.e. coercive collection of money. Our problem can now be put simply: how can we ensure that the collected money is indeed effectively spent on these purposes?

There already exists a tool which does this job to a small extent. This is the free tax, first introduced in 1997 in Hungary. The idea is beautifully simple: some part of the tax-money –first voted to be 1% then raised in most Central European countries to 2 % – is allocated by tax-payers themselves to NGOs5 of their own choosing. With regard to this tax, the problems of pressure groups and questionable / opaque policies are sidestepped since the tax-payers have a much more direct control over their money, and the danger of inefficiency is significantly alleviated, due to the virtues of competition. If an NGO – which operates on the free market – is accused of inefficiency, the tax-payers which supported it are positively free to relocate their money.

Now, the essence of our proposal is that the overwhelming part of the tax-money can and should be managed by individual tax-payers. We tentatively suggest that up to 90-95% should be so managed. How can this possibly work?

Let us start by asking again what the point of taxation is. What do we really want to sponsor with the money we pay? The following list is probably not exhaustive, but is sufficient to figure out the celebrated idea of public goods:

1) government and public administration2) army3) police and secret services4) judicial system5) public health-care system6) education and science7) social care8) the development of infrastructure (roads, airports etc.)9) ecology10) culture (including religion)

Let us use the label ‘public fields’ for these items. The list can perhaps be expanded or presented in a different manner. What emphatically should not be included in the list of items we wish to sponsor, however, are the costs of such things as covering public debts. These are just means used in the current system, and obviously not its aims.

There are four categories of second order decisions to be made with respect to taxation.(D1) Who decides the total level of taxation / public funds?(D2) Who decides as to which are the public fields?(D3) Who decides what part of the total public funds should be spent on each field?(D4) Within every public field, who decides the provider of the public service?

5 We take NGOs to be associations / organizations under civil law that try to take over part of the governmental duties without being subordinated to the government. The syntagm “under civil law” is here to ensure the lawlessness of organized instigation to any negative discrimination of any kind.

We are already familiar with two types of taxes: the ordinary tax, which we shall call central tax, and the free tax. In the case of the central tax, all four decisions belong to the central government: the money is amassed in the central budget and the state officials decide to which field and to which provider to allocate the money. In the case of the free tax, (today within the limit of 2 percent of the individual income tax) decision 3 and 4 is left to the individual tax-payer and the money is allocated directly to the recipients. We propose to create a new type of tax: a semi-free tax and extend its limit in the detriment of the central tax. That is, the tax-payer will be required to allocate a pre-defined percentage of his tax-money to a field pre-defined as public, but will be free with regard to choosing an institution within the field6. The idea is to shift the decision number 4 from the central authority to the individual taxpayer in an overwhelming proportion. To give an example: Say that 10% of the individual tax should be allocated to education. But it will be up to the individual to choose one or more schools, university or institute to sponsor.

Now, we postulate the following division of the tax sum (percentage is again tentative):

Table 1.

Division of the tax-sum

Central tax Semi-free tax Free tax

percentage 10% 80 10%the target-field 1) 2)-10) * arbitraryrecipients central government public institutions,

NGOs, private agencies

public institutions, NGOs, private agencies

* The subdivision of the semi-free sum should be fixed and is to be specified by the law.

The idea behind this proposal should be clear by now: individual management of taxes makes possible significant cuts on the costs of the maintenance of the central budget and the central administration.

Which taxes are amenable to this method of management? We propose two taxes: the personal income tax and the corporate tax. The first case is easy. After calculating the amount of relevant types of taxes, the tax-payer simply gives orders to his bank to transfer the money to the chosen recipients. The case of the corporate tax is only slightly more complicated. The actors who should decide about the allocation of the takings are the owners. In the case of stockholders, there can be thousands of them. We take the profit of the company as the basis for the tax. Let the level of the tax be n%. Now, the executive of the company has to calculate the overall amount of the tax. Then he sends the money to special bank accounts belonging to the individual shareholders. The formula for division is simple. If a shareholder’s share is m%, the amount of money allocated to his account equals:

6 In fact we have an existing example of such ‘tax’: the compulsive insurances.

Company’s Profit ´ n% ´ m%

With regard to the money on his special account, the individual shareholder has to take the same decisions as in the case of the personal income tax. The division into tax-types and fields should be the same in both cases.

This is the outline of our proposed reform of taxation. We now turn to the questions of what political, institutional setup is coherent with such system of taxation. And why is it desirable?

IV. Institutional Framework

§ 1.Our proposal is naturally bound up with a move towards the minimal state. If

almost all important purposes can be served by means of the semi-free tax, what is the point of retaining a significant central budget? But if the central budget is reduced, so is the central administration which occupies itself with the distribution of resources from the central budget. Moreover, the administration cannot grow indefinitely, as the amount of money for its upkeep is to be severely limited (in § 2 we address the issue of how to prevent the increase of taxation). Finally, the possibilities of government’s intervention in economic matters will also be drastically reduced. But that is just another important advantage of the proposal. The monopolistic character of the state will be preserved only for those agencies necessary for the maintenance of such a competitive system of NGOs (policing the community hard enough as to ensure that everybody pays their taxes irrespective as to which NGO they choose for the usage of the tax-money from them). The governmnet should also retain some essential minimal functions: conducting the foreign policy and supervision over security sectors. We leave it as an open question, whether and to what extent the central government should supervise other sectors and whether it should take some part in the development of infrastructure. Most of these tasks could be carried out by local governments. Finally, the central budget can function as a reserve, from which resources can be taken to balance the operations of the free part of the taxation system in urgent cases.

Now, aren’t we proceeding a bit too quickly? So far, we have been speaking only of the income tax and the corporate tax. But apart from these, there are many other taxes:, VAT7, excises8, customs duties. And such practices as introducing inflation9, budget deficit10 and price increases for services monopolized by the state, like natural resources or public utilities, can also be thought of as a covert collection of taxes. Obviously, the large part of the central budget derives from these sources. What should become of them? The liberal answer is sweet and simple: they should be abolished en masse. This will leave the resources in the hands of individual tax-payers. But then, the level of the

7 Tax on the estimated value added to a product at each stage of manufacture and distribution.8 Tax on some particular type of goods.9 Increase in the amount of currency and credit to the immediate effect of benefiting the first wave of clients still confronted with the old prices, but to the mediated effect of a decline in the purchasing power of other waves of buyers.10 Spending more than collected; to collect more, the government sells bonds to the banks; but the demand for money makes the interest rate rise, thus depressing private investment

income tax and the corporate tax can be set at a relatively high level, which would guarantee the financing of public sectors. If some of the aforementioned taxes are nonetheless retained, they can be used to increase the financing of the army or the police for example or kept as a reserve for unplanned catastrophes.

The essence of the semi-free tax is the guarantee that the money will be used for a given purpose. Now, let us assume for the time being that at least the strategic institutions dealing with security (the army, the police and secret services, courts of law) will remain public. Then, there are two ways in which the semi-free takings can be administered. We could retain the central budget, albeit rigidly divided into fields. The single pot will be there, but the ingredients won’t be mixed. Or, these institutions can be set up as constitutionally defined agencies with independent budgets to which the relevant semi-free takings would directly flow. This fits much better the spirit of our proposal, as it keeps the flow of money simple and direct, and allows for further important moves (see § 3).

§ 2.Having sketched the limited role of the central government and the central budget,

we must now address the issue of the legal framework of the proposed system. Constitution is obviously the key element. It specifies and delimits the functions of state institutions – most importantly, those of the government and of the central budget. More specifically, the constitution can define the range of economic instruments which can be used by the government and other institutions. For example, it can place precise limits (or complete ban) on inflation, budgetary deficit etc. Finally, with regard to taxes it should specify first, the level of the central tax and secondly, the overall level of taxation.This does not allow the vicious spiral of the rise of taxation and growth of the public administration to get off the ground. Even the most capricious democracies cannot afford to change their constitution every year or two if it takes a public referendum to change one11.

Public referendum is the second most important tool in our repertoire. Having the level of taxation and the level of the central tax decided by the constitution, we still need to make the decisions about the division of takings into the remaining two types of taxes and among fields (see (D2) and (D3) above). These decisions should be made by a national referendum. Constitution should of course place some commonsensical constraints on the frequency and form of the referenda with regard to each of the first three second order decisions; say, it should take place no more often than once in two years, the initiators should gather 100 000 signatures, every new proposal presented for choice in the referendum should be supported by 50 000 signatures etc. Now, why the referendum? The answer points back again to the pressure groups problem. What was ostensibly lacking in the list of ‘fields’ we gave in the preceding section, were subsidies for many particular branches of economy: farming, steel industry, mining etc. A significant part of actual budgets is consumed by such subsidies. But do the majority of individual tax-payers really want to sponsor and privilege the groups in question? Nothing is simpler than a referendum to check it. Now, if it turns out that the majority is ready to allocate their tax-money to such fields, one can only bow before a truly democratic decision (whether it would be rational is another matter). But we strongly

11 Obviously, one can also place constitutional limits on the frequency of the change of the constitution.

suspect that the results would be quite different. And that would clearly expose the nature of the involved groups as pressure groups.

At this point there might arise a worry that our proposal does not guarantee enough flexibility in public finances. How frequent should be public referenda on decision number 3? Perhaps it should be easier to change a division of resources between the fields. And might not there arise a real and urgent need of an overall rise of taxes (D1)? These are legitimate worries about financial instruments. But we have already proclaimed that it is not the central government’s business to regulate and manage the country’s economy. So if this task is abandoned, the worry about financial instruments necessary for performing this task is quite pointless. Furthermore, real and urgent needs of tax-rise are usually due to the uncontrolled increase of budget deficit. Yet we have already dismantled the central budget, and put constitutional limits on the deficit, so this need not worry us either. Insofar as we retain the minimal central budget, its rigidity is an advantage, as it enforces financial discipline.

So the remaining genuine problem concerns the potentially unbalanced distribution of resources among the fields and providers. Perhaps one year it would be better to shift resources to education and next year to health-care for example. Putting aside the question whether such rapid moves are really needed (instead of being a result of the play of forces between political parties and pressure groups), we think that the system is flexible and efficient enough. Surely it is cheaper to have a referendum every two years12 instead of keeping a standing army of state officials. And surely the result would much better reflect the real preferences of citizens than arbitrary decisions of a group of officials prone to all sorts of human weaknesses. Furthermore, there is always the free-tax part – nothing would prohibit the tax-payers to direct this part to those purposes which need more support in a given year. Finally, we have allowed the central budget to provide an additional balance.

The power to decide about the division of tax-money is thus distributed among the public, expressing its decisions in the form of constitutional or ordinary referenda, the government and the individual tax-payers:

Table 2.

Division-decisions Central-Tax Semi-free tax Free taxtax-type the public

(constitution)the public (referendum)

the public (referendum)

field within the tax government the public (referendum)

individual

provider within the field

government individual individual

§ 3.

12 Especially if an electronic-based system of voting could be established.

The institutional solutions presented so far answer mostly to concerns about the overall level of taxation, about its division into tax-types and about the general purposes (public fields) to which the tax-money should be allocated. But at the heart of our proposal lies also the concern with empowering individuals to choose the actual provider of public services. The possibility of choice is obviously incompatible with the existence of a monopoly on a given service. In our age, however, many sectors tend to be controlled by monopolistic state institutions. How can some degree of free choice be introduced into these fields?

Let us start with security and law-enforcement: the army, the secret services, the police and judicial institutions.

The most radical solution is the wholesale privatization of these sectors. It is a fascinating intellectual enterprise to argue for the feasibility of this idea, but we cannot attempt to undertake it in the confines of this article. Instead, we will present a set of much more limited solutions.

In the case of the army it is possible to separate the tasks of control and commandment form that of the management. For the first task one needs some kind of Central Headquarters under the control of the civil Ministry of Defense. The actual armed forces can, however, be divided into several constitutionally defined agencies. Let us imagine The Army, The Navy and The Air Forces for example. The three would have independent budgets, independent structure of management and could have independent projects of development. This provides a measure of competition which ensures a better quality of services and better financial discipline. Analogous solution can apply to secret services.

One problem with this proposal is that individual tax-payers cannot have access to all confidential information which can be needed for distributing resources rationally. The solution to this problem is twofold. Firstly, general financial reports can be made public. Secondly, Members of Parliament, who represent the citizens can have access to relevant confidential information and publish reports and opinions framed in sufficiently general terms.

The police can remain at the basis of the system of internal security. Yet the tax-payers should have an option of supporting municipal guards instead. And it should be possible to allocate at least some part of the money within the field to private security agencies.

Even within a monopolistic judicial system, some courts operate more efficiently than others. Instead of being ascribed to a local court, as is now often the case, the citizens should be able to subscribe to the court of their own choice. If a case should arise, the ancient formula applies: the plaintiff presents the case at the court of the defendant.

One public field which still seems troublesome is the development of infrastructure. It is precisely in this area that inefficiency, opacity, and criminal affairs abound. On the other hand, for many people it is difficult to imagine how the whole sector could be managed solely by private corporations and NGOs. Yet perhaps the competition for tax-money between the central government, local governments and non-

governmental institutions would prove sufficient to alleviate the problems, since individuals could always leave the semi-free tax to go the central government just as today, the 2 percent free tax goes by default to the central budget.

All the remaining fields should be left entirely to the free market and the NGO sector. While this is one of the central parts of our proposal, we will not go into the details of the functioning of these sectors – there are many widely known tools which can be used. Vouchers may be introduced. The costs of services can be covered by publicly sponsored insurance companies. Finally, some institutions eligible for public support, like hospitals or schools, could be bound to provide a specified range of services for free.

§ 4.What we want to address now is the issue of how institutions competing in the market of the relevant services become eligible for public sponsorship via the semi-free tax13. Can the entry be altogether free? It rather seems that we need a monopolistic public institution to make a selection and create a publicly accessible list of the eligible NGOs14. First of all, the NGOs which propose to further objectionable goals – for example, the removal of minorities from the country – should be eliminated. But there is also an economic problem. The non-profit organizations acting for public benefit obviously should not be taxed15. But then, we can imagine that everybody would create a personal NGO and allocate the semi-free tax sums to themselves in order to avoid taxation.

There are simple measures which would effectively block this process. First, NGOs eligible for public funding should specialize and operate only within one field. Secondly, to retain eligibility for further funding, each NGO would have to attract a minimal number of donors/ customers – say, 100 – per year. It does not matter whether the support would have the form of vouchers, allocated semi-free or free tax-money, or charity. The law needs only specify the minimal amount of donation possible. Thus a phoney NGO which would not provide real services to anybody could not obtain enough support even if a whole family and a circle of friends were involved.

The threshold of customer support ensures that only serious NGOs would remain as providers of quality public services and tax-evasion is precluded without need of complicated or arbitrary legislation. This does not mean of course that very small or narrowly specialized NGOs could not exist. On the contrary, the free tax would help the whole NGO sector flourish.

To sum up, ee offer a whole set of interrelated solutions. We propose the new way of managing public funds through the direct financing of recipients by the tax payers, far-reaching reduction of the size and functions of the central government and public administration, introduction of competition and decentralization into almost all sectors of public services, preferably by entrusting them to directly sponsored non-governmental institutions with a free entry into the market of public services. We have already observed why these measures provide a solution to some of the gravest problems inherent in the 13 We will speak of NGOs for the sake of brevity.14 Again, the Internet would be an indispensable tool in the operation of the whole system.15 The NGOs income resulted from investments in other companies is deductible just as a normal corporate tax.

centralized way of spending public funds (pressure groups problem, financial indiscipline, growth of bureaucracy), but only hinted as to the alleviation of the rent seeking problem. One could complain about that mere presence of rents or taxes in our proposal on economics grounds. Indeed, the mere possibility of transfers attracts rent seeking and rent protection spending. Once there is a rent available we cannot avoid the rent seeking problem. But the problem would be greatly alleviated in a direct system in which the taxpayers pay directly their preferred NGOs, since instead of having one gainer and nine losers for any period of time, all agencies that would be of any worth to anyone would always gain something. No rent seeking outlays will be completely wasted anymore.

Let us now add a more detailed exposition of further advantages involved in our proposal.

V. Advantages

We claim that out proposal responds to the two basic demands: one for justice and the other for efficiency.

A more just provision of services with social utility:A centralized decision as to which and how great the social priorities are, is bound

to represent rather the value judgments of the representatives than the value judgments of the individuals as taxpayers. Insofar as a more direct link with the social needs than by the intermediation of a team of central representatives is practically possible, continuing to allow public spending according to decisions from the centers is arbitrary. In a free market for NGOs and under conditions of transparency of the lobbying activity, the value judgments on the part of the representatives cannot provide a better criterion on public utility than the sponsoring choices of individuals qua taxpayers. The institution of competition carries the necessary and sufficient incentives for a more accurate search for those services that have public utility. Decentralizing entrepreneurship for services of public utility makes possible the use of local knowledge on the part of NGOs in detecting preferences.

A more cost-effective provision of services: In a competitive environment, entrepreneurs satisfy as high a demand as possible using the least amount of resources possible to the best of their knowledge. Once competition is employed as a discovery procedure of the precise services of public utility, it is still competition that carries the incentives for the provision of qualitative services at a smaller price. Incentives for financial discipline and continuous innovation will decrease the total cost of public administration.

Efficiency in monitoring the performance:Local organizations are more exposed to the eye of the interested public than a

central organization. Thus, bringing the spending closer to the individual taxpayers enables contributors to better check the way their money is spent, breaking the public

problem of transparency into locally manageable bits. The monitoring system becomes much cheaper since it utilizes the dispersed monitoring capacities of individuals and their incentives to check whether their invested trust was cheated.

Higher degree of independency from the central institutions and pressure groups:Enabling dispersed individuals to finance their preferred organizations eliminates

the collective action problem and cancels the unfair advantage of compact groups as sources of finance for NGOs. A large and open range of sources of financing eliminates the ideological or political dependency of an NGO upon few sources of financing (from the central budget as from any interest group)

Solution to the problem of questionable policies: With regard to this problem, we might note that our proposal makes civil

disobedience incomparably easier. Since we know which part of our money goes to which field, we can cease to pay only a part of our taxes, without lapsing from our duty to contribute to noble purposes. In some cases, one could even contemplate the legalization of such a move – in the case of out-border military intervention, for example. But even if we do not go so far, abstaining from payment of, say, 10% of your tax is a much lighter offence than not paying taxes at all. This could be punishable by a fine, which would go to the upkeep of the judicial system for example. Thus the conflict between the state and the individual would be resolved without significant losses for either side.

Encouragement of participatory civil behaviour and strengthening of civil society:The feature that makes democracy attractive as an institutional option is self-

government. However, we have witnessed an increasing lack of participation and alienation of the citizen from the central government due to the continuous increase in the numbers of the represented relative to the representatives and the continuous proliferation of complicated special interest legislation. Our institutional solution eliminates the central government as an intermediary and brings the citizens in a direct relation with the organizations that carry out the public functions. Informed participatory civil behaviour and a higher degree of civic culture is more easily developed.

Furthermore, the direct financing of NGOs and the subsequent growth of this sector implies a double increase in the involvement of citizens in the operation of the civil society and of their local communities. As tax-payers, people would have to take interest in the activities of NGOs and of their local governments. Secondly, as the existence of the free and the semi-free tax would encourage establishing NGOs of all sorts, we could hope for a wide participation of citizens in such organizations.

Guarantee of representation for all groups:Due to the elimination of the collective action problem, all groups, however diverse and dispersed, can support their own representative organizations.

Puts an end to the unnecessary growth of public expenses and the growth of bureaucracy:

The securing in the constitution of a ceiling on the total level of taxation roughly equal to the present level would bring no danger of under-spending in sectors of social

utility. If it is true that the more competitive-based the public spending is, the more efficient, then, if there is a danger with regard to the size of the public sector relative to the private, that is over-spending not under-spending since the more efficient the administration of public funds, the better the social needs (as defined by the list) are satisfied.

While we thus ensure that public expenses would not be unduly low, we also preclude the possibility of the expansion of the apparatus of public administration which would unnecessarily rise the costs of public services. We place a constitutional ceiling on the size and uses of its budget, on the rise of taxation, growth of inflation and budget deficit. Taken together, these measures should prove effective.

VI. Open questions

In this paper, besides proposing a new vision of the tax-system, we have sketched a set of related institutional reforms. But that is no more than a very rough and tentative sketch, meant to show that the implementation of the new system is possible. We have hinted at different possible solutions, some more, some less radically liberal. There is a space for debate and for drawing much more detailed projects. One of the most pertinent questions concerns the stability of our general project. Would the proposed system collapse into anarcho-capitalism? Or to the contrary, would it erode back to something like the current system? How far can we go in both directions while retaining the virtues of the new system of taxation?

The flexibility of our proposal, which gives rise to these questions, gives us hope that we propose something more than an eccentric utopian project. For it allows for a cautious and gradual implementation. With the introduction of the free tax in Hungary in 1997 the first step in the right direction has been taken. So perhaps we can go from one to ninety – or even 100 percent?

Milosz Pawlowski Ion Lucian Sterpan