Public Finance in Democratic Process: Fiscal Institutions and Individual Choice

Differences between behavior in the face of ignorance and/or uncertainty and behavior in the presence of illusion are subtle. In either case, behavior would not be the same in the absence of the phenomena. If the chooser does not possess adequate information about alternatives and if he is uncertain, he conceptualizes the alternatives
imperfectly. If he is affected by an illusion, he conceptualizes the alternatives
falsely. The effects on his choice behavior may, however, be identical. Initially, it seems reasonable to suggest that probabilistic elements are more important in the first of these situations than in the second. This need not be of assistance in distinguishing results, however, for several reasons. First, an illusion itself may take the form of an expectation of greater or less certainty than “real” facts warrant. Secondly, and more importantly, the probabilistic elements that must be considered are necessarily subjective and nonobservable. And, finally, illusions may be both optimistic and pessimistic.
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Behavior under illusion is not necessarily irrational. The individual who behaves irrationally makes inconsistent choices; he does not behave in such a way that an external observer can make predictions, even should his utility function remain unchanged. By contrast, the individual who behaves in the presence of an illusion will act consistently; given the same choice situation on two separate occasions he will tend to make the same decision, provided that “learning from experience” does not dispel the illusion and provided that his utility function does not shift in the interim. Conceptually, the external observer can make predictions here if he knows the effects of illusion on choice behavior. This amounts to saying that “theorizing” about individual behavior under illusion is possible, whereas “theorizing” about individual behavior that is genuinely irrational is not possible.
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Illusion arises because of the characteristics of the alternatives as these are perceived by the individual; irrationality is a characteristic of the “mind.” Thus, we can “explain” why an individual “sees” water in the desert mirage. The artist can create illusion deliberately out of his knowledge of ordinary sense perceptions.
*38 It is evident that the institutions of social choice can create illusions, and that this aspect of such institutions is worthy of study.

The Italian Setting for Fiscal Analysis

It is surprising that the “fiscal illusion” has not been more thoroughly analyzed. Institutions in which the individual must participate in making fiscal choices can exert illusion-creating effects, and these may be sufficiently important to modify behavior. However, the concept remains largely outside the community of discourse that makes up modern public finance. A fundamental contribution was made by an Italian scholar, Amilcare Puviani, who published his major works at the turn of this century. These works were neglected, even by other Italians, until Mauro Fasiani reintroduced them in his widely acclaimed treatise, first published in 1941.
*39 Only during the decade of the 1950’s was Puviani’s contribution more widely recognized, and, in 1960, a German translation of his basic book was published.
*40 The discussion of Puviani in my own essay on the Italian tradition remains, to my knowledge, the only available summary of his views in English,
*41 although plans are currently underway for the completion of an English translation.
*42

The theory of public finance as it has developed in Italy is much more closely related to the structure of political institutions than has been the case with its English-language counterpart. The Italians have traditionally been explicit in their statements about the political models within which their discussion of fiscal organization takes place and for which their analysis applies. This has produced two parallel branches of fiscal theory. Some of the major figures, such as Francesco Ferrara, Antonio de Viti de Marco, and Mauro Fasiani, extended their own work to cover at least two political models, one of which is “democratic,” “co-operative,” “voluntaristic,” or “individualistic” (these terms being used variously by separate writers) and the other of which is “tyrannical,” “monopolistic,” “elitist,” or “monarchist.”

Other scholars have worked largely in one or the other of these two broadly contrasting models, and aside from those major figures who did make the attempt to develop both models simultaneously, the various Italian works in public finance can be classified in these two sets. Puviani’s approach to public finance is based on an assumption that the State is “monopolistic.” In order to appreciate fully Puviani’s contribution some discussion of this political model is required. The State, or the political unit, is not conceived here as an independent, supra-individual entity, in any Hegelian sense. To this extent, even the “monopolistic” model remains individualistic, as opposed to organic in basic content. The political unit is not, however, conceived to be democratic in the sense that universal participation is assumed. Instead, the State represents an agency through which one group of persons, those possessed with power, exerts its will upon persons in another group, those who are dominated. This is essentially a force theory of politics, a “ruling-class” model. As such, it is akin to the Marxian conception, although it is not specifically Marxian in content. The ruling class need not possess particular economic characteristics, and economic reality need not determine the demarcation between the rulers and the ruled. The political conception is that developed more fully by both Pareto and Mosca, who observed that, as of any moment, the citizenry can be divided into two groups, the dominant and the dominated. The conception is based, fundamentally, on a denial of the possibility of effectively democratic political order.

It is relatively easy to see that, if one looks at the political process with this “vision,” the theory that he constructs may be significantly different from that which he might construct should he possess the “vision” of effectively working “individualist” democracy. The hypotheses would be different, and the explanations offered for the same set of facts would sharply diverge, as is indeed demonstrated in some of the contrasts between the Western and the Marxian interpretations of current events.

Under the ruling-class conception, the fiscal structure is an institutional means through which this class, who are the decision-makers for the whole community, can exact funds from the dominated or ruled group, for providing, or financing, those goods and services that the first group wants to see provided. The ruling group may or may not be narrowly self-interested. The members of the dominated or ruled group can only react to the conditions within which they find themselves; they can never initiate action in a direct sense. This group will, predictably, resist efforts by the ruling class to impose charges upon them, and they will, understandably, be conscious of little or no “co-operation” with the rulers. The objective of the rulers becomes that of arranging or organizing the fiscal structure so that the resistance of the dominated class is effectively minimized, consistent with the securing of adequate revenues.

In this setting, the task of the fiscal theorist becomes that of explaining the behavior of the ruling class in organizing the system, in making the fundamental decisions on the public economy, and also in explaining the behavior of the dominated or exploited class in reacting to and resisting the imposition of tax charges. One means of explaining the behavior of the ruling class is that of placing one’s self, conjecturally, in their position and asking: What actions should be taken if the objective is that of minimizing resistance or discontent on the part of the dominated groups? This approach is in the tradition of Machiavelli’s
Il Principe, an approach that has been widely employed (and widely misunderstood). Puviani approached the theory of fiscal organization with the question:
If the ruling group desires to minimize taxpayer resistance for any given level of revenues collected, how will it set out to organize the fiscal system? He made it quite explicit that he did not assume that the ruling group actually asked such a question or that it aimed directly at accomplishing this objective. Puviani argued perceptively that action on behalf of the ruling, decision-making authorities would probably be motivated largely by the short-run goal of taking the path of least resistance in each particular instance of choice. But the whole pattern of action can often be explained by a model which incorporates some
as if objectives. All economists are familiar with such models. It is in this way that Puviani looked at the fiscal process. His answer to the question was put in the form of a general hypothesis. The ruling group attempts, to the extent that is possible, to create fiscal illusions, and these have the effect of making taxpayers think that the taxes to which they are subjected are less burdensome than they actually are. At the same time, other illusions are created that make beneficiaries consider the values of public goods and services provided them to be larger than may actually be the case. The various institutions of taxing and spending are so organized as to create this set of illusions. Puviani then proposed to examine existing fiscal structures to test his basic hypothesis. How much of the evolution of real-world fiscal institutions can be explained?

Puviani’s Institutional Array

Puviani made his hypothesis too general, and in some instances he seems to stretch it almost out of recognition. Nevertheless, it is useful to look briefly at some of the institutions that he discussed and to see how he interpreted these in terms of the illusion hypothesis. Both sides of the budget were included; illusions are created through taxes and through public spending programs. The tax side is more important, however, and it will be discussed in somewhat more detail.

Fiscal Illusion in the Imposition of Taxes.
*43  Illusion in the imposition and the collection of taxes can be introduced in several specific ways, not all of which are equally important and relevant, especially in a modern setting. These several ways may be listed and discussed in turn.

1. The connection between the total amount of resources actually utilized in producing or supplying public services and any individualized share in this total may be obscured to the taxpayer. In other words, the individual shares in the opportunity cost of public spending may be hidden. Illusions of this sort can be generated in at least five separate institutions of taxation.

The first involves the use of income from the
public domain to finance government operations. In this case, the individual taxpayers will fail to realize that, were the income not so employed, it could be returned to them in reduced levels of ordinary taxation. This institution need not be discussed in detail here. Historically, the public domain has provided a major source of public revenues, but in the last century this source has become relatively unimportant in nonsocialist states. In socialist states, of course, the profits from state enterprises are used to finance public services, and the illusion mentioned here by Puviani again takes its place as a factor promoting general acquiescence in the expansion of such services.

The second institution that falls within this broad grouping is more significant for our purposes. Illusion arises when the tax is actually absorbed in the payment that an individual makes for private goods and services. This situation is characteristic of
specific excise taxes, where the tax is nominally included in the price of a private good or service. Here the individual must adjust his purchases so that the price, including the tax, stands in the same proportion to any other price as the ratio of the relative marginal utilities of the two
private goods. No explicit recognition of the payment for a public good or service enters into the individual adjustment here. Hence, the individual is likely to be quite ignorant of the amount of tax that is paid, and he may, in some cases, be unaware of the tax altogether. The illusion is more complete, said Puviani, when a tax has been in existence for some time. Initially, when a private-goods price increases as a result of a tax, the impact may be evident to the purchaser. But as the institution remains in being for a succession of periods, the opportunity cost is not sensed by the taxpayer.

The
public debt is the third institution that Puviani included in his first broad category. He accepted the basic Richardian proposition that the payment of a single once-and-for-all tax and the payment of a certain percentage of this sum through an annual tax in perpetuity are, in some real sense, equivalent. But, said Puviani, individual taxpayers do not act as if the two alternatives are the same. Somewhat surprisingly, he did not discuss fully the possible failure of taxpayers to discount, to capitalize, the future tax payments that public debt issue involves. He seemed to accept, at the outset, that such capitalization did take place. Even with this, however, Puviani argued that the flotation of loans, with these loans to be serviced by the payment of an annual tax, would not be resisted to the same extent as would the levy of a single once-and-for-all tax. The illusion stressed by Puviani arises because, under the public-loan scheme, the individual retains “control” over a capital value which, even though fully offset by the liability stemming from the capitalized value of future taxes, remains desirable. Because of this control over assets, the individual prefers to pay the tax in perpetuity. Such an “asset illusion” may, of course, be extended to private debt as well as public debt.
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A fourth, and clearly relevant, institution that Puviani included in his first category is that which involves the financing of public goods and services through
inflation, that is, through currency creation. It seems evident that this means of financing makes it very difficult for the individual to identify his own share in the costs of the services being financed and supplied through government. Puviani stated correctly that currency inflation was similar in effect to indirect taxation under full employment.

A final means through which the ruling group, in control of the fiscal machinery, can generate an illusion that obscures the individual’s share in the total costs of governmental services is the making of false promises. These take the form especially of making the individual think that various spending programs are temporary and short-lived when, in fact, these programs, once started, will be maintained in being. In this way, the taxpayer will be subjected to a considerably higher cost than he may have originally anticipated. And once a program has been commenced, it is relatively easy to present the taxpayer with the traditional “sunk costs” argument for its continuation.

2. Obscuring the real costs of public goods and services is not the only means of introducing a fiscal illusion, although it is perhaps the most important one. A second category includes those institutions of payment that are designed so as to tie the obligation to a time period or an event which the taxpayer seems likely to consider “favorable.” Puviani’s ingenious idea here is based on the recognition that isolated individual decisions can be influenced by temporary circumstances, and that the attitude of the individual may vary significantly with such circumstances. Common to poker games is the slogan, “big winner buys the drinks,” despite the fact that, outside of the particular circumstances of the evening’s play, the winner may be less able to buy the refreshments than his colleagues. “Impulse buying” is, of course, an important phenomenon in marketing behavior, but its significance for ordinary consumer choice is reduced by the repetitiveness of the marketing process. There is less impulse buying of staple commodities than there is of dollies at the county fair. The individual does not “buy” government services voluntarily and surely not on impulse. However, Puviani sensed that if the institutions of taxation could be so arranged that individuals are confronted with the necessity of paying taxes only during periods when some complementary event takes place with a highly favorable outcome, the real costs of government goods and services will seem less onerous. Several institutions of taxation lend themselves to partial “explanation” through this extension of the Puviani hypothesis, although there seems to be some question as to whether this effect can be due to “illusion” in any strict sense.

Taxes on transfers, on inheritances and gifts, levied on the donee fit well under this rubric. Assume that a rich uncle dies and leaves an estate of a million dollars to a nephew who did not anticipate the inheritance. It seems clear that, on the moment of the announcement, the levy of a tax against this inheritance will not be “felt” by the legatee in the same sense that an ordinary tax of equivalent amount would be “felt,” say, five years after he had secured the inheritance.

The same reasoning applies, however, to all taxes on transfers of assets. Any exchange, except those made strictly at the margin, involves net gains, presumably to both parties to the transaction. Hence, a tax levied at the moment of completing a transaction, in the presence of the apparent gain, tends to be less severe, in the minds of the taxpayers, than a tax of like amount levied at another time.

3. A third means of introducing a fiscal illusion, and one that is closely related to the one previously discussed, is found in the charging of explicit
fees for nominal services rendered upon the occasion of memorable or pleasurable events. Puviani brought in marriage license fees, hunting licenses, entertainment licenses, fees for diplomas, etc. Slightly different, but similar reasoning led him to “explain” such taxes as those on playing cards, pool tables, and lottery tickets. Business licenses that are charged only on the opening of an operation can be explained on the generally optimistic attitudes of all prospective managers.

4. The dominant class will also take advantage of shifts in public attitudes on social issues, said Puviani, and will use these shifts as the basis for imposing taxes. If a particular attitude is pervasive in the community, an opportunity is provided to levy a tax that will capitalize on such sentiment, making the burden appear less than might otherwise be the case. Puviani seemed to overextend his provocative hypothesis here when he suggested that taxes aimed at redistributing incomes to the poor were more readily accepted when rich groups were made to fear the uprising of the poorer classes. On the other hand, there is some legitimacy in his argument that certain taxes are explicitly introduced as means of securing the acquiescence of certain groups to other social changes. For example, taxes on business profits are often introduced, and justified to business groups, as political sop to labor groups aimed at securing political support for other measures. While Puviani’s comments on these aspects of tax policy are interesting, as indeed most of his work is, they do not lend themselves readily to specific results in terms of his own illusion hypothesis. He does not seem to have distinguished properly between “explaining” how certain taxes come into existence, given the political activity of several social classes, and in “explaining” individual responses to taxation. It is only in the second of these that the fiscal illusion, as such, may be observed.

5. Puviani was on somewhat more firm ground when he argued that the governing class will, in order to secure the general acceptance of a tax, threaten the body politic with the direst of consequences if, in fact, the tax levy is not approved. These “scare tactics” tend to make the alternatives to particular tax proposals appear worse than they are, and it seems evident that, to the extent that such tactics are effective, a fiscal illusion is created which can influence individual reactions. In modern fiscal settings, such tactics are probably more familiar on the expenditure side than on the tax side, and it is now more or less anticipated that the bureaucracy will threaten the representative assembly and the citizenry with disastrous consequences if specific spending programs are not implemented and continued.

6. To the extent that the total tax load on an individual can be fragmented so that he confronts numerous small levies rather than a few significant ones, illusory effects may be created. If, for example, all taxes paid by an individual are concentrated into a single levy on personal income, the individual would surely be more conscious of the sacrifice that he undergoes, presumably, in support of government services. Hence, according to Puviani, fiscal systems in monopolistic states tend to be complex and to rely relatively little on general, broad-based taxes.

7. A final, and important, means of creating illusion on the tax side lies in the levy of taxes under situations where the individual cannot really know who finally pays; that is, in situations where the incidence of the tax is unknown. This illusion is clearly akin to that discussed under the first category, and also to some of the discussions in previous chapters. It is clear that the uncertainty that is involved in tax institutions of uncertain incidence does exert an influence on fiscal choice, whether or not this be classified as an illusion.

Fiscal Illusions in Public Spending.  The basic Puviani analysis was also extended to the spending side of the fiscal account, although it seems somewhat less applicable here. Several of the points made with respect to the imposition of taxes can be applied in reverse to spending programs. Puviani stressed, however, the prevalence of more general practices on the spending side. One of the most important of these was the tendency of governments to conceal from public view the extent and true nature of budgetary programs. Tracing the evolution of fiscal systems historically, Puviani noted that for centuries there was no distinction made between the account of the State and the personal account of the Prince. Even when this essential separation was finally accomplished, the right of the sovereign to expend tax revenues secretly was maintained. Gradually, of course, accountability to the representative assembly was established, but, even here, the governing class tends to exaggerate the spending needs and to conceal the true state of affairs in order to secure the levy of additional taxes.

In earlier epochs, the possibilities of creating illusions in this way were greatly enhanced by the absence of systematic accounting and budgetary techniques. And even under the most modern of budgetary systems, the sheer complexity of the budget makes detailed examination impossible. At best the citizen remains poorly informed concerning the allocation of public monies. Given this necessary ignorance, governments find it relatively easy to manipulate budgetary items in such a manner as to make it appear that larger sums are devoted to the more “popular” programs.

An Evaluation of Puviani’s Contribution and Its Extension to a Democratic Setting

No attempt has been made to present Puviani’s discussion in great detail. Many of his notions seem out of date in the 1960’s. Nevertheless, the modern critic cannot fail to be impressed by the relevance that the basic conception seems to retain. The Puviani hypothesis offers an essentially new perspective from which to look at the fiscal structure, and it can be of some assistance even as applied to a modern governmental setting.

Puviani operated on the assumption that the fiscal system was organized by a ruling class, an elite, within a larger, more inclusive, political society. In his modern extension of Puviani’s ideas, Fasiani discusses the fiscal illusion in that part of his treatise called “Public Finance in the Monopolistic State.” We have, in this study, deliberately adopted an opposing political framework. We have assumed that the political structure is fundamentally democratic and that fiscal decisions are made, in some ultimate sense, by all members of the political group in a sort of voting process, whether this be direct or indirect. This difference in political assumptions need not, however, imply that the Puviani analysis is without value. As Fasiani points out, all traces of an elitist model are rarely removed, even in the most “democratic” of states, and to the extent that these remain, the Puviani analysis has relevance on its own terms. I should go considerably further than Fasiani here and say that, even in a fully democratic setting, fiscal institutions, regardless of the motivation behind their original organization, can be analyzed and arrayed in terms of their tendencies to generate fiscal illusions. This essentially positive approach, which does not get involved with the “why” of institutions but which takes them as they are and then attempts to analyze their effects, is the one followed in this book. For such an approach, the political setting is not so important as it may have been made to appear in earlier chapters. Just as the Puviani analysis can be appended as supplementary to that of this study, which has presumed a democratic setting for fiscal choice, so our own study could be appended as supplementary to the Puviani analysis in a monopolistic setting. It would not be difficult to modify the discussion of earlier chapters to develop a theory of “fiscal reaction” rather than a theory of fiscal choice.

Fiscal Illusions in Modern Systems

Puviani looked at the whole fiscal process through a “different window” from that which has been used by English-language critics. The institutions were to be explained, in his vision, by the unconscious motivation of the ruling class to exploit the ruled. Upon closer examination, however, we see that Puviani did little more than make explicit some of the norms for fiscal organization that were also widely accepted by the utilitarians. Interestingly enough, a theory of public finance applicable to a democratic setting was not developed at all in the English tradition. Out of neoclassical economics and utilitarian ethics there came, instead, the tax principle of “least aggregate sacrifice,” as developed primarily by Edgeworth and Pigou. This principle, if it merits attention at all, must be recognized as closely akin to Puviani’s fiscal illusion as a norm, for what is the purpose of creating illusion other than that of minimizing aggregate sacrifice for the taxpayer, and, through this, minimizing taxpayer resistance? Puviani was a political realist, and he made no pretense of assuming government to be both despotic and benevolent. The Edgeworth-Pigou principle, by contrast, can be applied only in a despotic setting where the despot is both wholly benevolent and all powerful. It is clearly irrelevant to a democratic setting, and since the despot need not worry explicitly about taxpayer reaction, he must be all powerful. In either conception, Puviani’s or Edgeworth-Pigou, the tax side is viewed independently from the expenditure side, which of course implies a nondemocratic framework. In a democratic setting neither “least aggregate sacrifice” nor “minimization of felt burden through illusion” is appropriate as a norm for fiscal organization. Instead, the norm must be that of allowing individuals, through the structure of collective decision institutions, to “purchase” public goods and services in such a way that their choices as between these goods and services and those produced via private market process can remain as “neutral” and “nondistorted” as is possible.

If we go back to the classical economists and look at the canons of taxation laid out by Adam Smith, we find that “convenience” to the taxpayer is one norm. Taxes should be so levied as to make the payment as convenient and as commodious as is possible. This norm has been repeated in many manuals. It is not surprising that this norm of convenience should come close to that which motivates the ruling class in the Puviani conception. If we look at those institutions which have come to be accepted primarily because of the convenience criterion, these lend themselves to examination under the Puviani model.

Puviani’s ruling class attempts to promote optimistic illusions; the taxpayer is made to feel that he pays “less” and receives “more” in return than he would under alternative institutional arrangements. If we drop all considerations of motivation, however, and simply examine institutions as they exist, there is no necessary presumption that the fiscal illusions present shall always be optimistic ones. Pessimistic illusion is also possible.

Withholding of Income for Tax Payments.  Since World War II, in the United States, a large proportion of the personal income tax has been collected through the withholding of tax from payments of salaries and wages to employees. The employer acts as the tax collector, and the employee does not receive directly that proportion of his salary or wage that is withheld at the source for tax purposes. This widely hailed “reform” in the American income tax system was almost exclusively supported on the argument of increased convenience for the taxpayer. If Puviani’s ghost were present, he would surely point to the withholding feature as a likely source for the generation of illusion in an almost classic sense.

Withholding would fit neatly under Puviani’s first category of institutions which tend to obscure from the taxpayer his opportunity cost of supporting public services. The individual who does not have possession of income before paying it out cannot “sense” the real cost of public services in a manner comparable to that experienced in a genuine act of outpayment. In this respect, withholding affects individual behavior in much the same way as an indirect tax.

Does this imply that “convenience” to the taxpayer should not be one of the criteria for tax reform? Should the taxpayer be made to pay taxes in the most onerous manner that can be devised? The answers to these loaded questions are obviously negative. Prior to the introduction of withholding and pay-as-you-earn, the individual taxpayer was forced to pay the full amount of his annual tax liability at one time, at the springtime settling of accounts. This practice probably generated a pessimistic illusion and made the cost of government appear excessive in some appropriate relative sense. Conceptually, an “ideal” institutional arrangement might be that of allowing individuals to “pay for” governmental goods and services in a manner analogous to that which they have found most convenient for financing consumer durables. The quarterly payments of tax on declarations of income above or outside withholding probably tend, on balance, to promote “logical” response to the income tax structure. It is the absence of any conscious sense of transfer, the absence of any monthly or quarterly bill, that represents the questionable feature of withholding, and one that may tend to create a Puviani-type illusion.
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Progression in the Rate Structure of an Income Tax.  As suggested, pessimistic illusion may be generated as well as optimistic ones, especially when no specific design-for-illusion in the Puviani sense has guided the organization of the system. It seems intuitively plausible that the institution of progression, per se, tends to create an excess feeling of tax burden on the part of the taxpayer. The effect here stems from the divergence between the average and the marginal rate of tax, and the observed tendency of persons to think in terms of marginal rates. This illusion, if present, is supported by discussions of the rate structure in the popular press and in political debates.

For some purposes, the marginal rate of tax is the relevant one for analyzing individual choices. In adjusting his behavior in the private sector, in deciding how much taxable income he will earn, the individual should act in response to the schedule of marginal rates. However, in trying to choose the quantity of public goods to be supplied, in matching the benefits of public services against the tax-costs that are imposed upon him personally, the individual should think in terms of average rates, and of the schedule of these rates as the total revenue requirements vary. He may, however, be led by the progressive structure to think and act falsely
as if public goods and services are available to him at some schedule of “negative quantity discounts,” that is, at some increasing marginal price.
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One implication of the hypothesis here is that an individual would tend to choose a larger quantity of public services under proportional income taxation than under progression, even though his own liability under the two schemes is identical. This implication is at least subject to conceptual testing.

Social Security Taxes.  The modern American system of old-age and survivors “insurance” seems ready made for the Puviani criticism. It is apparent to almost everyone, without detailed analysis or knowledge of the system, that the effects of promoting the institutions under the “insurance” rubric, which implies actuarial independence and integrity, tends to conceal from participants the real flows of costs and benefits. Whether or not such was the deliberate intent of the founders of the system need not concern us here. The facts are that the system, as an independent trust-fund account outside of the regular budgetary procedures of the federal government, is not actuarially sound by private financial standards, and that the plan will depend for its continued existence on the Treasury’s willingness to finance currently claims made against the system. Contributors to the system finance only a relatively small share of the benefits that they receive, especially to this date (1966), and the remaining funds must be secured from current taxes collected from prospective beneficiaries. To the extent that the current contributor accepts the regular increases in his own taxes, as well as those nominally levied on his employer, under the assumption that, on balance, these are to be accumulated for support of his own retirement benefits, he will be less resistant to such increases than if he knew that such tax increases were simply required to meet current outpayments to beneficiaries. He operates under an illusion of the Puviani sort. If future claims against the system should be properly discounted, along with future taxes that are required to meet these claims, the entrant into the system would recognize that, in the net, the costs significantly exceed the benefits, both computed in present-value terms. The fact that there is no widespread resentment or resistance against entering the system supports the hypothesis that illusion is present, and is effective. Even for the employee who may recognize the actuarial bankruptcy of the present system, who is able to dispel the fiscal illusion, it may not, however, be rational to reject the scheme when he predicts that, during his own period of retirement, other prospective entrants can still be attracted by illusory claims of “insurance.” The system in this manner provides a continuing means through which income transfers can be made to the aged from the currently productive elements of the population, which can be “explained” or “rationalized” to many taxpayers on the basis of contributory schemes of retirement protection. There seems little question but that, if the same fiscal transfers were proposed openly and without attempts at illusion, there would be significantly greater political resistance. This conclusion can be attained, regardless of one’s own value position on the quite separate question as to whether such transfers should be decreased, kept the same, or increased.
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Corporate Income Taxation.  Taxes imposed on income of corporations tend to create major uncertainty for the ultimate taxpayer, as we have previously noted, and this in itself is sufficient to allow this important modern institution to be added to Puviani’s last category. The additional feature that warrants special mention lies in the tax status of the separate legal entity, the corporation. This device lends itself to an even further obscuring of the real costs of public services from the individual, who must be the final taxpayer.

Averaging in the Personal Income Tax.  Among academic specialists in public finance in the United States almost universal support has been voiced for the introduction of additional averaging features under the progressive income tax. The substantial reforms in this direction embodied in the 1964 tax legislation have been widely acclaimed. Puviani, from his wholly different approach—and unconcerned about equity—could “explain” the failure of previous attempts at such reform, and he would not have been able to predict 1964 changes by his hypothesis. If the only consideration is the minimization of taxpayer resistance, averaging would not be a reform that commands the widespread attention of Puviani’s “rulers.” The man who receives windfall gains, who hits it lucky, now and then, whose income fluctuates is, psychologically, more willing to pay taxes than is his neighbor who may possess the identical “permanent income.” The nonaveraged progressive income tax becomes, under this explanation, one device for introducing illusion. The 1964 reforms clearly refute Puviani’s illusion hypothesis in its normative sense.

Capital Gains Taxation.  The treatment of capital gains under the income tax is closely related to the problem of averaging, and one reason for the continued favorable treatment of gains is held to be the absence of effective averaging provisions in the regular income tax. In the context of Puviani’s model, taxes should clearly be imposed on gains, perhaps more severely than on ordinary income. As with the 1964 averaging reforms, the favorable treatment of gains tends to refute the basic Puviani notion that the motivation behind fiscal evolution is the creation of illusion.