Why do we pay taxes?
At first glance, the question “why do we pay taxes?” seems straightforward. Mainstream economic textbooks offer a clear answer: governments collect taxes to (1) correct market failures, (2) promote equity, and (3) stabilize the economy [1].
But that explanation is what governments claim to do, not necessarily what they achieve. In practice, governments often fail to meet these lofty objectives. In fact, government failures are frequently larger and more damaging than market failures they are meant to solve.
One reason for this is that “the government” isn’t a single, unified entity with consistent goals. Instead, it’s a collection of individuals—politicians, bureaucrats, and administrators—each pursuing their own interests. Another reason is that governments don’t operate under the same financial constraints as households or businesses. Government officials spend money they don’t earn and borrow without being personally liable for the debt. This financing structure allows—perhaps even incentivizes—irresponsibility in ways that private actors cannot afford. As a result, the mainstream textbook purposes of taxation rarely align with the messy reality of politics.
So if governments don’t (or can’t) truly maximize efficiency, equity, or stability, the question remains: why do we actually pay taxes?
To answer that, we must first understand what money is—the very instrument we use to pay our taxes. Contrary to what many believe, money is not a commodity with intrinsic value, nor is it merely pieces of paper or digits on a screen. Money is debt, an IOU (I owe you). Digital money represents debts owed by commercial banks, while paper currency represents debts issued by the central bank. On its own, money has no inherent worth. Yet, people treat money as valuable. We use it to buy food, clothes, and countless other goods and services. This raises an important question: why does anyone accept money as payment in the first place?
The answer is taxes.
Think about it. Nobody wants to pay taxes. We pay them because the government forces us to do so under threat of fines or imprisonment. But this very coercion is what gives money its value. When a government requires taxes to be paid in its official currency (like the dollar, peso, or rupiah), everyone living under that government needs that currency to settle their obligations and stay out of trouble. Because I need rupiah to pay my taxes, I will accept rupiah from you as payment for my work. You, in turn, will accept it from others for the same reason. This shared need, driven by the tax mandate, creates a society-wide demand for the currency.
Without a tax system to enforce its use, your bank balance would be just digits in a computer, and your paper bills would be as worthless as Monopoly money. The value of money doesn’t come from the metal it’s made of or the paper it’s printed on, but from the taxes that must be paid with it.
So, why do we pay taxes? At the most basic level, we pay because we are forced to. In doing so, however, we participate in the system that transforms otherwise worthless pieces of paper and digital entries into an acceptable medium of exchange. This system is controlled by the central bank and commercial banks, which create money out of thin air when they lend and profit from the interest they collect. If that sounds like a form of servitude, that’s because it is.
Footnotes:
- Known as Richard Musgrave’s “Three Functions of Government” which consists of allocation, distribution, and stabilization.
- Read “What is Money?” and “The Credit Theory of Money” by Alfred Mitchell-Innes.