Thesis Number: #4 (Page 6 of 8)

The Making of the Weak State

Taxpayers are intuitively aware that there is something fundamentally wrong with public finances. In England a thousand years ago, the State’s revenue was exclusively from rent; 500 years ago, the land grabbers got to work. The chart that records the reduction of rent as a proportion of public revenue tracks the making of a weak, dishonest State. Evidence of this weakness surfaces at many levels. Some examples:

  • Rent seekers exercise the power to manipulate governments to secure preferences that enhance their privileges.
  • The fiscal State is ultimately responsible for creating problems like mass unemployment which creates funding obligations that cannot be met out of current revenue. Budgets cannot be balanced, so the State has to borrow, rendering it vulnerable to creditors. Today, the US Federal government is in dangerous debt to China.
  • Distress caused by land speculation is addressed with palliatives. This fosters social chaos, which appeared most visibly among the southern members of the European Union after the financial crisis of 2008.

Europe’s weak States were responsible for two world wars. And yet, the knowledge needed to avoid such outcomes was available to statesmen in the 18th century, at the dawn of the Industrial Revolution when a generalised prosperity was a practical option. What went wrong may be illustrated with the work of Wilhelm von Humboldt (1767-1835), a polymath civil servant responsible for the establishment of the University of Berlin. He delayed publication of The Limits of State Action, which appeared in 1852. In this, he sought to describe how the State could be tamed.

Individual freedom, von Humboldt argued, was achieved by education that treated people as ends, not means. The State had to be confined to functions that helped people to realise their potential. But how can citizens constrain the State which commanded the instruments of coercion? Revenue was the key.

Box 3

The Money-soaking Sponge

Taxes that can be avoided will be dodged by those with the resources to conceal their incomes. What happened when the Italian government announced an amnesty for people who repatriated income back from tax havens is revealing. Land owners in the Veneto region captured a significant slice of the inflow of funds. The price of property soared, which at the time was celebrated as evidence of a vibrant economy. Why did the money end up in the land market? Unlike labour and capital, land is fixed in supply. Its owners exercise extraordinary bargaining power. The land market works like a sponge: it soaks up the rents that governments fail to collect for the public purse.

The State must have revenue to fund its functions, von Humboldt noted. But on what terms would that revenue be raised? Who decided how the revenue would be raised, and how much would be handed over to fund public services? The answers lay in the unique character of rent, and the social function performed by the land market. Through that market, the people themselves would negotiate the rents they were able to pay for the use of services available at each location. By this process of free negotiation, who paid, and how much they paid, would be settled by citizens, not their politicians or the servants of the State.

In the 18th century, the Physiocrats in France explained that rent was the correct source of revenue for the State. Adam Smith concurred in The Wealth of Nations (1776). But while von Humboldt confessed his “ignorance of everything concerned with finance” (1993: 134), he felt free to pronounce on tax policy. The Physiocratic rent-revenue policy was “unquestionably the simplest”, he wrote, but “human power” must also be “subject likewise to direct taxation” (1993: 135).

If people like von Humboldt, who contributed to Germany’s zeitgeist, had helped to confine the State to Physiocratic finance, might that nation have traversed a different evolutionary path? Might heightened prosperity and a benign financial system have led to the unification of the people of the various principalities on terms that avoided the need to engage in colonial land grabbing in Africa? That muscle-flexing mission was ultimately responsible for luring a weak German State into war with its neighbours in 1914.

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