This is a piece on taxation and expenditure in the United States. My goal is to provide you with an accountant’s view on the financial condition of our Government. We’ve heard from the politicians, economists and media outlets, but what can an accountant add to the fray? This will be a two-part blog, with the second part containing an analysis of the Federal budget.

This part is a circuitous and whimsical look at governments, taxes and accountancy.

Poets and Scholars
What kind of perspective can an accountant provide? Well…accountants, don’t you know, invented writing and are the original poets. Who better to turn drab columns of numbers into a coherent literary analysis? P.G. Wodehouse put it best when he observed that poets must have a firm grasp of accounting principles:

Poets, as a class, are business men. Shakespeare describes the poet’s eye as rolling in a fine frenzy from heaven to earth, from earth to heaven, and giving to airy nothing a local habitation and a name, but in practice you will find that one corner of that eye is generally glued on the royalty returns.

But surely I jest and gibe when I claim accountants invented writing?

The oldest discovered pieces of writing are found on clay tablets dating back to 3300 BCE. The hieroglyphic writings on these tablets were found in the tomb of the Egyptian King Scorpion and primarily represent tax records. In Georges Ifrah’s The Universal History of Numbers, it is noted that “[w]riting was invented by accountants faced with the task of noting economic transactions which, in the rapidly developing Sumerian society, had become too numerous and too complex to be merely entrusted to memory.” Surprisingly, over ninety percent of the known cuneiform documents from ancient Mesopotamia are about economic and tax matters. Symbols on these documents representing grain, animals and labor indicate settlement of business transactions or payment of taxes.

The World’s Second Oldest Profession
For millennia, taxes were assessed on the produce of the land and paid in kind. The income tax is a modern invention. Those without means paid taxes in the form of compulsory labor service. In A History of Taxation and Expenditure in the Western World, Carolyn Webber and Aaron Wildavsky observe that “[c]orvée, the mandatory contribution of personal labor to the state, was the earliest form of taxation for which economic records exist; indeed, in the ancient Egyptian language the word “labor” was a synonym for taxes.”

From Mesopotamia to Rome, kings, temple priests and governments outsourced the collection of taxes to prominent businessmen or elders who usually had some form of wealth. These “tax farmers” were responsible for paying the tax to the government whether or not they collected it from the citizens. You can imagine someone going from Palermo to Naples, collecting little brown envelopes….

However, throughout most of history, taxpayers received very little in exchange for their tax dollar, franc or pound sterling. Governments were not in the business of looking after the welfare of its citizens. It was Adam Smith, who in the Wealth of Nations (1776) wrote…

Wherever there is great property, there is great inequality…Civil government, so far as it is instituted for the security of property, is in reality instituted for the defence of the rich against the poor, or of those who have some property against those who have none at all.

Yet, some form of government is necessary, and debate about the proper role and function of government is nearly as old as, well, the invention of writing. Thomas Hobbes wrote that legitimate political power must be representative and based on the consent of the people. He imagined a world without government and in 1651 observed that:

In such condition, there is no place for industry; because the fruit thereof is uncertain: and consequently no culture of the earth; no navigation, nor use of the commodities that may be imported by sea; no commodious building; no instruments of moving, and removing, such things as require much force; no knowledge of the face of the earth; no account of time; no arts; no letters; no society; and which is worst of all, continual fear, and danger of violent death; and the life of man, solitary, poor, nasty, brutish, and short.

So, to keep us at our best, some form of government is necessary. The nature of society, and consequently its expectations from government, began to change during the Industrial Revolution (1750-1850). Prior to this time, mass poverty had been the norm. But as people broke their long connection with the land and moved to cities, a host of new demands were made on governments. From Webber and Wildavsky again:

Changes in patterns of life and work during the nineteenth century converted individual problems of personal welfare into social issues…In an environment of widening franchise, governments no longer served only to protect the rights of the wealthy: they began to take action to improve the lives of the poor…Pushed by continuing unrest associated with depression-induced unemployment, nineteenth-century legislatures slowly responded to reformers’ demands…

It took a bothersome colony some distance away from Hobbes’ native England to pick up on his “representation” theme. You could argue that the United States declared its independence as a result of a tax dispute. England needed funds to pay for troops stationed in its various colonies around the world, and the English Stamp Act of 1765 was designed to provide that revenue. It also started all the fuss about taxes in the colonies. Ben Franklin  reflected that the colonies would need to be represented in Parliament if they were to be taxed…but, since we were essentially good English men and women, it took a disagreement about tea in 1774 to really put the kettle on.

The United States was able to finance and win its Revolutionary War thanks to heavy lending from France. The French figured they could keep England bogged down in an overseas war (just like the Americans felt they could do to the Soviet Union in Afghanistan – sorry, I couldn’t resist) and not only provided credit but also ships and troops.

How did we repay France? We defaulted. According to Simon Johnson and James Kwak in White House Burning:

Less than six years after the Treaty of Paris ended the American Revolutionary War, the new nation was deeply in debt and already in default. The United States had missed interest payments owed to France for several years in succession, as well as principal payments due in 1787 and 1788.

So not only were the French no longer able to eat their cake, some of them got le guillotine and the rest got the French Revolution which began in 1789, to be followed by the Reign of Terror in 1793, and Napoleon in 1799.

With French funding no longer available, how did the U.S. pay for its government? Except for a short time during the Civil War, the United States derived its revenue almost entirely from tariffs on imports. One of the first federal income tax laws was signed by President Lincoln in 1862 to help finance the Civil War, but it was repealed several years later.

Income taxes did not become widely utilized until the early 1890s when several nations adopted various forms of income tax. Up until World War I, financial policies of most Western nations incorporated elements of taxation and expenditure that were holdovers from the nineteenth century: minimal government supported by a few low but productive indirect taxes; and small spending for welfare, defrayed from insurance funds and the proceeds of progressive income and inheritance taxes paid by the rich.

In the United States, the Wilson-Gorman Tariff Act of 1894 imposed the first peace time income tax which was equal to 2% of incomes greater than $4,000. This represented less than 10% of households at the time. The following year, the Supreme Court held the tax to be unconstitutional, because it violated the Constitution’s prohibition against unapportioned direct taxes.

But, since you can always change what you find disagreeable in the Constitution, and with war looming again, the ratification of the 16th Amendment to the U.S. Constitution in 1913 famously did away with the apportionment requirement:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

This means that next year will be the 100th birthday of the modern income tax in the United States. Since that time, two World Wars, and a surge in global population from 1.6 billion in 1913 to a projected 7.0 billion in 2013, have created vast cradle-to-grave welfare societies with a dependency on governments never known before.

So how are we to avoid a Malthusian budgetary catastrophe? Read on in Part II – Tea Time.

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Reverend Thomas Malthus felt that populations would continue to grow until they exhausted available resources at which point havoc and mayhem would sweep the land until population size reduced back to a sustainable level. I am of course, paraphrasing.

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Some accountancy from Monty Python –

…our experts describe you as an appallingly dull fellow, unimaginative, timid, lacking in initiative, spineless, easily dominated, no sense of humour, tedious company and irrepressibly drab and awful. And whereas in most professions these would be considerable drawbacks, in charted accountancy they are a positive boon.