Government Employees Should Not Be Taxed


One of the things I find to be humorous about mainstream economics is the inclusion of government spending in the GDP metric. When government spending is included in this metric, it makes the assumption that government spending adds to the real wealth of the nation. Since "real" wealth translates into actual material goods and services that benefit humanity, which have been produced under the guidance of a profit and loss test by consumers, there is hardly anything the government does which meets the criteria of new "real" wealth creation. In the same vein, the taxation of income that comes from government jobs hides the destruction of wealth that is occurring when government spends money. So let's go over a few examples to demonstrate my point.

Assuming the state operates on a balanced budget, in order for the state to create one job that is funded from the tax rolls, it must first forcibly take enough money from the private sector to fund the public sector job and the infrastructure necessary to support that job. Looking at this situation from a microscopic point of view, does it make any sense for the state to then tax the income of the coercively funded job?

Let me put this another way. Would it be possible for the state to only tax publicly funded jobs in order to pay for the creation of publicly funded jobs? Let's say the state has a police force; could the state only tax police officers to pay for additional police jobs? Clearly this would be impossible. Because in order to have any police force in the first place, resources must first be confiscated from private productive jobs.

The taxation of public sector jobs is nothing more than an accounting gimmick. From a logical point of view, it would cost far less administrative overhead if the state simply paid its workers a tax-free salary.  For example, if a public sector employee would normally be paid $50,000 a year gross salary, the state would instead pay them $40,000 a year and simply not tax their income.  This would create a situation where a private sector employee who earns $50,000 a year would receive the same net take-home pay as a public sector employee being paid $40,000 a year, assuming a 20% marginal tax rate and both are doing similar types of work.

Clearly it is ridiculous to tax a salary that is entirely funded from taxes, especially when one considers the administrative overhead costs that a payroll tax creates. The state could potentially shave billions from its budgets if it simply stopped taxing state employees and paid them a tax free wage. Obviously this begs the question of why does the state bother to jump through all the accounting hoops of taxing its own employees?

I think the answer to that question is as obvious as the question itself. It does so to hide the fact that it is destroying resources. When the state taxes its own employees, it creates the illusion that state funded jobs are actually productive jobs. It hides the flow of money and resources streaming out of the private sector from the public eye and obfuscates the value of the jobs the state creates. If the state did not tax its own employees, it would be much more clear to the public just how destructive each new public job is to the overall economy.

Assuming the state maintains a balanced budget, and assuming the state did not tax jobs that are funded from the tax rolls, as the size of government grows, people would be able to easily measure just how much of a burden those new government jobs are imposing on private enterprise. In order for a private employer to pay a worker a salary of $50,000 a year, the revenue that employee generates must be greater than, or at least equal to, the salary he is paid. Thus, as taxes on private employers increase in order to accommodate expanded state spending, private employees must become ever more productive if they simply wish to maintain their standard of living. As tax rates increase, private employees must meet each new increase with a matching increase in productivity if they wish to simply maintain what they were previously taking home in salary.

From this perspective, it becomes clear that each dollar government spends is accompanied by a marginal decrease in the real wealth enjoyed by that society. It doesn't matter if the taxes take the form of expanded debt or direct taxation, nor does it matter if balanced budgets are maintained or not, the effects of the spending are the same. However, when a state operates on a balanced budget and only imposes direct taxation of private sector jobs, it is much more obvious to the public just how destructive state spending is to the citizens' overall well being.