Tag Archives: Margaret Levi

Taxation and Conflict

17 Saturday Dec 2022

Posted by in Economics, Politics, Politics for Worldbuilders, State Formation, Writing

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Worldbuilders often have settings in which tax policies are key drivers of conflict. This is as it should be, given that taxes often drive conflict in the real world, for very good reasons. But typically, the decisions that a fictional ruler face are boiled down to “Do I want money? If so, tax everything that moves.” In the real world, things are more complex. And introducing a bit of carefully chosen complexity into your stories can make the conflicts a lot more interesting.

Our current discussion is based on the seminal model of Margaret Levi. Based on a deep review of the history of governments, Levi starts from the assumption that in general, sovereigns want to maximize their tax revenue. (You can read a nice summary of the model here.) But this does not simply mean jacking taxes up as high as they can go.

First of all, the more you tax, the more opposition you get from those being taxed. This is obvious, but it has some notable consequences. A weaker regime will be able to tax less, because serious opposition could bring it down. Additionally, taxes will tend to fall more heavily on social groups that are less able to resist the government (often because they are poor!), or who depend on the government more, or who would benefit directly from the additional government projects that the tax revenues would fund and are thus more willing to bear the burden. In any event, the rulers will have to limit their taxation if they don’t want to antagonize the people.

Second, the higher the tax rate, the more that economic activity becomes depressed as many businesses simply become unprofitable. Moreover, it becomes worth it for people to rearrange their businesses to pay less tax, or even cheat on their taxes altogether. As a result, if you increase taxes by ten percent, say, your tax revenue will rise by somewhat less than ten percent. And at a certain point, tax collection actually goes down with higher taxes. (This concept is popularly known as the Laffer Curve.)

So a ruler will have to figure out the optimal tax policy for generating revenue. This is a difficult problem, especially if you don’t have a lot of data about the economy. Often, rulers get it wrong and set the tax rate too high for the amount of revenue they want to collect. (It is much less common to set the tax rate too low!)

This basic issue also functions across time periods; collecting lots of taxes this year will often mean that the economy’s growth will slow down in the future, reducing tax collection later. As a result, Levi notes that a major factor in the taxation decisions of sovereigns was their discount rate—that is, how willing they are to forego money today in exchange for more money tomorrow. 

(A quick example: suppose you have an opportunity to invest $100 today, and in a month you’ll get back $110 guaranteed. If you have money in the bank and won’t miss $100, you’ll happily invest the money for a good return. If you only have $100, on the other hand, and you need to spend it on food, it’s another matter entirely. Still, you might be willing to invest the hundred dollars if you would get back a thousand; for that much money, you’ll find some way to last the month. In the first case, you have a relatively low discount rate; you can afford to be patient. In the second case, you have a relatively high discount rate; you need money today, and it would take a massive amount of money in the future to get you to give up what you have.)

Levi notes that sovereigns facing a crisis—particularly a war—needed lots of money today, and were more willing to raise taxes for current revenue even if it harmed future growth, and even if it provoked domestic opposition (to a point). In other words, these rulers had a very high discount rate.

Next, certain types of taxes take different types of bureaucratic infrastructure; if you don’t have the infrastructure, you can’t levy the tax. For example, to tax incomes, you need a way to monitor how much money people make. This is tremendously hard, which is why direct income taxes across all of society were nearly unknown until the early 1900s. And some kinds of taxes would cost more to administer than you would actually raise!

A sovereign will then want to invest in new bureaucracy, to be able to collect more taxes in the future. But such investment takes money and time, and it usually provokes opposition from society—people resent intrusions into their privacy, and know that higher taxes are going to result in the future.

Levi’s model thus has a number of moving parts, including:

  • the discount rate of the sovereign;
  • the capability of the tax-collection apparatus;
  • transaction costs for commerce, and for tax collection (which include information/monitoring costs, and fees, operating expenses, and other forms of friction); and
  • the relative bargaining power of the state versus different classes in society.

Levi’s entire discussion includes many other complex facets, including the concept of quasi-voluntary compliance which I already touched upon in Beyond Kings and Princesses in the discussion of bureaucracy; I hope to write about more from Levi in future posts. But even this starting overview provides some useful tools for worldbuilders looking to juice up their political conflicts.

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(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth [Commerce?] for Worldbuilders. No idea when it will be finished, but it should be fun!)

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Tax Farming

17 Sunday Jun 2012

Posted by in Better Fantasy, Economics, Finance, History, Politics, State Formation, Writing

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April 15th is a date seared into the brains of most Americans—being the due date for us to turn in our tax returns to the Internal Revenue Service. In the modern era, most governments have wide-ranging powers to tax their populaces. Yes, you have problems with tax evasion here and there, but most urban dwellers are used to paying taxes as a matter of course (though we certainly aren’t happy about it).

When you think about it, though, the smooth collection of taxes requires a vast infrastructure of information processing, bureaucracy, and coercive enforcement if necessary. All of that came about very late in historical terms. In the United States, tax withholding from our salaries was only instituted during World War II, for example. (In a delicious bit of historical irony, the concept was developed in part by famed free-market economist Milton Friedman, when he worked for the Treasury in the early days of the war. For the rest of his life, he hoped that tax withholding would eventually be abolished.) The first income tax in the United States was a temporary measure enacted during the Civil War.

In other countries, the story was similar. The seminal work on this subject, at least in comparative politics, is Margaret Levi’s Of Rule and Revenue, a study of taxation systems throughout history. Levi’s basic argument is that rulers are constrained in how they can tax populations by their ability to coerce the people, the ease with which money can be hidden, and limitations in measuring technology. (I previously wrote of similar concerns behind the institution of English nobility.) In short, early rulers had a very hard time raising taxes directly, simply because it was next to impossible to extend their control over the populace.

So what did they do? The strategies of rulers were many, but in this piece I want to focus on a particular practice called “tax farming.” In its basic form, the ruler created some sort of tax or tariff—a 10% tax on salt, for example—but rather than collecting the taxes itself, the ruler would sell off the right to collect the tax to some private party. This was the tax farmer. The tax farmer would pay a large sum up front to the government, and in exchange would gain the right to ruthlessly apply the salt tax to anyone within his jurisdiction and pocket the proceeds.

This is not the same as modern privatized tax collection, where the private party must transmit collected taxes to the government. Here, the tax farmer is the direct beneficiary of tax revenue. In general, tax farming was incredibly lucrative for the farmer, while the state was forced to sell the future revenues at discount prices, simply because it lacked the capacity to collect taxes itself. (Here, we see another example of a principal-agent problem.)

A nice (free!) overview of tax farming in the 18th century can be found here, by the eminent scholar Eugene White. The French monarchy, for one, was heavily dependent on tax farming for revenue. This dependence was a major contributor to the French Revolution, for two reasons. First, royal revenues were always rather stunted because the tax farmers absorbed much of the take, weakening state power. Second, the tax farmers of France were notorious for harshly oppressing the populace in order to squeeze every last sou that they could. (Similar concerns were at play with the Publicans of ancient Rome; a nice overview can be found here.)

This is all very interesting, but why is it worth knowing? In fact, it is surprising just how relevant the principle of tax farming can be, even in modern society. Take casinos, for example. They pay a large sum of money to local and state governments, and in return gain the right to siphon vast amounts of money from willing gamblers. The voluntary nature of the transaction makes it more palatable, of course, but even then the addictive nature of gambling muddles things.

Even more striking is the history of the banking system. That subject is so fascinating that it deserves its own post, but for now, suffice it to say that for decades, many U.S. states raised nearly half of their revenue by selling monopoly banking charters. In return, a particular bank would be given exclusive control of its town, free to earn considerable profits from its residents.

Neither casinos nor early banks are really the same as tax farming, of course. But they are both indirect means of collecting revenue, in which private parties gain outsized profits compared to the government’s take. Other examples can be seen with only a little effort, and the idea of tax farming is a useful lens for viewing much government policy.

Aside from that, this is another opportunity to bang my hobby horse of more realistic fantasy writing. As noted, tax farming was often the cause of massive oppression of the people, and resulting political unrest. I’d bet my last cent that some budding fantasy author could spin a much more interesting story using tax farming as an ingredient, than the typical “Evil Overlord wants to oppress the peasants for the lulz.”

The key thing to remember is that a king turns to tax farming when he needs more money that he can easily extract with his own efforts. It is the hallmark of lands with difficult travel, poor communication, and weak and divided political loyalties. In time, the tax farmers can become extremely powerful in their own right, perhaps even rivaling the established authority in the same way that Italian mercenaries would often overthrow their employers. If that isn’t fertile soil for a good story, I don’t know what is.