Is money we make completely taken away by taxes?

Question

In my opinion, any money we make will be completely taken away by taxes. Here is my logic.

When I earn some money (x), I have to give some as tax to the government. For example, let it be 10% of my income. After taxes, I have х - х * 10% = 0.9x of the money I earned. I will spend this money on my needs, and it will become someone's profit. Therefore, this person will also pay 10% to the government. In this way, the initial amount will remain 0,9х - 0,9х*10%=0,81x. Here is my calculation table:

As we can see, after 30 steps, only 4% of the initial amount will remain from this money. And this happens with any salary. In the next tax period, I will earn new money and the whole cycle will repeat itself.

My friends told me that I am wrong, and taxes don't take 100% of our money because after taxes we still have 90% of the money we earn. In my opinion, such a view is wrong, because it reflects only 1 present moment, not taking time into account. The money that remains in the hands of a specific person is just a temporary advance.

I also want to pay attention to the fact that our salary was also someone's income, therefore, compared to the employer, we are several steps down when it comes to money movement. In any case, the government with the help of taxes will take all 100% (close to 99.99% to be very precise) of our money, just not immediately, but a few steps later. So tax rate shows the speed with which the money will be withdrawn. For example, when tax rate is 30%, then money completely disappears in 10 moves.

Mathematically, everything seems to be true, but is everything like that in reality? People told me that I am wrong, but don't explain why, so where am I making a mistake?

Answer 1

No, this will not happen.

Government does not tax people just for 'shits and giggles'. Governments do not hoard money at some pile as a some sort of dragon from a fantasy novel. Taxes are levied so government can spend that money on some public goods or to use them as transfers to alleviate poverty or inequality. As you correctly point in your question, your spending is someone's else income. Government spending works the same way. When government spends money on a new bridge it creates profits for the contractor, wages for the workers, rents for landowners and interest to capital owners. When it comes to transfers, transfers are not income per se but then spending of the people who receive transfers will create incomes for whatever business and its employees and investors the people getting transfers choose to patronize.

Sure if the government would keep all the money they tax, and if money supply would be kept constant by central bank, then at some point all the money would be eventually siphoned out of the economy and government would get 'all the money', while the economy would be in ruin because people would have to revert to barter and there would be no provision of basic public goods such as police etc. However, in real life governments rarely if ever avoid spending money they tax. In fact most real life governments are running relatively large debts (e.g. see OECD statistics) showing that most governments spend usually more than they even tax.

Answer 2

Wind the clock back in the other direction: where did this money come from in the first place? The government issued it. Render unto Caesar that which is Caesar's, etc.

You've also chosen to stop your analysis at the point where you pay into government. The government will promptly pay a lot of that straight out again as salaries, benefits, bond repayments, purchases of everything from office supplies to weapons.

Or you could make the same argument for some other provider of essential services: if everyone spends (say) 10% of their income on energy bills to keep the lights on, at some point the energy provider gets all the money. Yes .. but they spend it again?

It's a bit like arguing that eventually all the water in the world will have passed through the urinary tract of some animal: it may or may not be true, but it's not as exciting as it sounds either way.

Answer 3

Your calculation is fundamentally wrong because you are forgetting an important factor - the money that government spends.

In your calculation you seem to think that the 10% the government takes in taxes vanishes into a black hole. But what actually happens is that it get paid to a teacher, or a soldier, or a road construction firm, and it enters the economy again.

So if you track all the individual dollars: yes, every one will eventually become a tax dollar and go to the government. But every one will also come out of the government and go to a person and start the cycle again.

(Incidentally you could make exactly the same calculation for Jeff Bezos - some fraction of all spending goes to Amazon and some of that gets taken as profit for Jeff Bezos; and so as money keeps circulating eventually all money will go to Jeff Bezos - although of course it will also be spent by him.)

Answer 4

A distinction must be made, as also other answers suggest, between money and income.

If you speak of money, meaning the amount of money you have at some instant of time, and with which you pay taxes and buy consumption goods, giving this money to other people, you are right. Calculations similar to yours can say that at the end of the process all the money would come back to government as taxes.

We can show it formally.

Suppose that you have a dollar coming, for example, from a helicopter drop: a helicopter drops $1$ dollar and you take it. Suppose that the tax rate is $10 \% $.

You pay $\frac{1}{10} $ of taxes and spend $\frac{9}{10} $, giving it to another person to buy goods. This person has now $ \frac {9}{10} $ dollars, pays $ \frac{1}{10} \frac{9}{10} $ taxes and buys $\frac{9}{10}\frac{9}{10} $ of goods. The process continues infinitely, the government at each step takes $\frac{1}{10}$ of taxes from each person. The process of levying taxes can be described as follows:

$ T= \frac{1}{10} +\frac{1}{10} \frac{9}{10}+ \frac{1}{10} (\frac{9}{10})^2+...+ \frac{1}{10} (\frac{9}{10})^n+...=$

$= \frac{1}{10} [ 1+\frac{9}{10}+ (\frac{9}{10})^2+ (\frac{9}{10})^n+...]= $

$= \frac{1}{10} \sum_ 0^\infty (\frac{9}{10})^n \qquad (1)$

where $T$ is the total amount of taxes the government levies.

The sum in formula $(1)$ is a geometric series of ratio $\frac{9}{10}$, and the theory of series says us that it converges to $ \frac{1}{1- 9/10}$.

Therefore we can write $(1)$ as:

$T =\frac{1}{10}\sum_ 0 ^\infty (\frac{9}{10})^n = \frac{1}{10} \frac {1}{1-9/10}=$

$=\frac{1}{10} \frac {1}{1/10}= \frac {10}{10}=1$.

As you can see, the amount of taxes levied by government at the end will be $1$ dollar, exactly the dollar you had at the beginning.$^1$

$\;$

Things are different if we speak of income: at each step, when a person buys goods, this expenditure becomes the income of another person, and it is counted as income. At each step, therefore, the overall income increases.

Economic theory says that in this case the total income increases by $ \frac {1}{t}$, $^2$ where $t$ is the tax rate, $\frac{1}{10}$ in our case.

So, at the end of the process the increase of overall income, generated by the initial dollar, call it $\Delta Y$, is

$$\Delta Y= \frac {1}{1/10}=10$$

Therefore, you can see that the total amount of taxes, $1$ dollar, is paid out of an overall income of $10$, so that the overall tax rate will be still $10\%$.

$$***$$

Obviously, all that holds ceteris paribus. If the government, at the same time, increases the money supply, through government spending, or the money supply increases through other means of money creation (including banks and foreign sector), it is of course possible that the total amount of money doesn’t decrease, it can remain the same or also increase.

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$^1$ ^{More rigorously, as we have an infinite process, we say that the sum converges to $1$ as the steps of the process approach infinity.}

$^2$ ^{This formula in economics is called the keynesian multiplier. More specificcally, in general the formula is $\frac{1}{1- (1-t)c}$, where $c$ is the rate of disposable income (income after taxes) we spend in consumption goods, that in our case is $1$, because we are supposing we don't save anything, we spend all our disposable income.}

Answer 5

Let's look at this from a more theoretical point of view.

Consider Government G, Company C and Yourself Y.

Company C is a Monopolist for everything (or an aggregate of all companies, same thing), so the only company in existence.

Y is employed by C. (Y is doing all work or an aggregate of all workers)

Y receives 1 per period from C for providing work. Y spends all money on taxes and necessities (let's ignore savings). Say taxes are 10%.

C receives 0.9 from Y (necessities) and pays 0.09 in taxes.

G receives 0.19 in taxes from C and Y.

However, G also pays C for doing some work. As G may also not generate savings, G pays 0.19 * 1,11... to C and recovers 0,11... in taxes.

What you got now is an equilibrium. Now, you may ask, if G doesn't spend money, wouldn't all money be collected by G eventually and therefore all money go to taxes?

Yes!

Same if C or Y doesn't spend any money. Over time, they'll accrue all money in the system. But: none of C, G and Y can actually do that. Spending is necessary.

Therefore, the government doesn't have any more possibilities of gathering all money than you do. Actually, look around, companies and individuals are better at gathering money ;).

P.s. if you add savings you get the same thing but with an equilibrium over several periods unless someone saves forever, in which money actually does leave the cycle (money sink). However, that money sink can be anyone, not just the government.

Answer 6

I will be in partial opposition to other answers here, because I think that, technically, you are completely right!

Yes, government takes all your money... (back!)... The thing, which I find wrong in your reasoning is the statement that this money were even yours in the beginning. You actually do not own any money! You only temporarily hold it. Money is a government's product, which government lends to its people to make transactions (through Central Banks). Of course that, eventually, the government takes all this money back through taxes, because the government is the reason why money even exist in the first place (right now I mean those goverment's ones!). I would say it is like a central repository through which all the money flows and must flow.

If you have centralized money they will flow through the central.

That is my perspective of the problem.

Answer 7

TL;DR The fact that all money "gets taxed away in some sense" is uninteresting. How fast that process happens is interesting and whether you want it to be fast or slow depends on how much you believe that what the government does is value building.

I think pjc50's answer is really good in that it sums up

1. all (fiat) money "belongs" to the government (in as much as that is a thing). They create it so that they can use it to collect tax and than use it to buy things.
2. a similar argument can be made for any essential commodity (food/energy) if every person needs the commodity at some percentage then as the money gets passed between people you get "all" the money being used for the commodity.
3. the government doesn't hoard it, it just goes ahead and gives it back to "the people" in the form of paychecks, infrastructure, defense, healthcare, etc.

But there is a little more to it than that. For one taxes are much more ubiquitous, many/most transfers of money between private and even state actors are taxed in some way. Which does make the government a little more interesting.

Secondly the taxes are distributed based on the governments interests.

This is the real crux. Because money as such, isn't particularly useful. I can have many million Deutsche mark but their value will be rather negligible now they can't be converted. What is useful is the perceived value of the money by other people. Money is used to obviate the need to write a piece of code for your grocer when you want to buy two apples.

And the perceived valued of money is something that the government can and does influence based on how it spends the money it gets. If it creates things that are useless or destroys stuff, we all get poorer. If it uses the money to create and support useful things we might even get richer.

Since governments are universally pretty bad at managing money, how fast the money they give out gets back to them, is interesting and does have an effect on the economy and the "value of money".

So the fact that all money "gets taxed away in some sense" is uninteresting. How fast that process happens is interesting, and whether you want it to be fast or slow, depends on how much you believe that what the government does is value building.

PS: Value building in all kinds of sense by the way, maybe you want pro-abortion advocacy or you want healthcare for everyone or you want lot's of guns, or good family values, or even all of that. It might be lowering the actual amount of food you can afford, but if you've always been able to eat way more than you needed it to, you're happy now your neighbour can also afford to eat.

Answer 8

Money will not be completely taken by the government as long as government spends the money. Basic macroeconomic identity is GDP equation:

$Y=C+I+G+NX$

Where $Y$ is aggregate income, $C$ consumption spending, $I$ investment spending, $G$ government spending and $NX$ spending on net exports. Consumption spending is further function of disposable (after tax) income $C(Y-T)$. What is important here is that aggregate income also depends on government spending $G$, if government spends all money it gets $T=G$, then aggregate income won't change.

Answer 9

Your calculation is correct, but your interpretation is not.

You are correctly calculating how much of the money from your paycheck will eventually flow to the government. But your interpretation, "any money we make will be completely taken away by taxes", is not the right conclusion.

Think of money like water flowing around in pipes.

There is money flowing from your employer to you, flowing from you to the government, flowing from you to the stores you shop in, and so on. The money flows around and around these pipes. This is how the economy works. Even the government is both receiving and spending money, so all the money flowing into the government is also flowing back out in other pipes.

We can also think about savings accounts as water tanks, and think of banks as more complicated tanks that can make loans, etc., but for now let's ignore the tanks and just think about the pipes, like your calculation, which also assumed nobody is putting any of their money into savings. And even if we include all these water tanks, water is still flowing all around the system if we take a long-term view where money flows both into and out of the savings accounts.

Does all water flow to the government?

Now, if we look at a molecule of water in this giant pipe network, what is the chance that it will flow to the government? This is what you are calculating. After you receive it, there is a 10% chance it will continue directly to the government, and a 90% chance it will flow somewhere else. But of course, after flowing somewhere else, there is still a 10% chance of flowing to the government, and so on. As you correctly see from your calculations, it is basically inevitable that sooner or later it will flow to the government.

Of course, it doesn't stop when it reaches the government. It will keep flowing around and around the economy, and sooner or later it will visit every part of the economy. It will even eventually come back to where it started (but it won't stop, it will just keep flowing around and around).

A negative view of taxes

If the government were a giant sinkhole where money would just disappear (so the water would just empty out of the pipes and not return), then your conclusion would be right: all the water would eventually drain out of the network because of taxes. But of course that is not what happens. The government spends the money (on salaries, army weapons, etc.), so the water keeps flowing around the economy.

A more positive view

For a more positive perspective, remember that as long as you are receiving and spending money, all the water in the system will eventually flow through your bank account, because it is part of the giant pipe network. So if you believe that "any money we make will be completely taken away by taxes", you should also believe that "all the money anybody makes will be completely paid into your personal bank account". It will just take a much much longer time for it to find its way there, because your bank account is much much smaller than the government's!

Answer 10

In step 1, you made \$1 as income.

In step 2, you paid a tax of 10% and kept \$0.9

Now that money is yours. You don't pay taxes on that \$0.9 again.

Eventually there is a cycle, if you see for some time.... where the governments directly and indirectly pump the money back to the people and then folks pay them back and the governments again get a percentage off that.

Like you said governments are going to keep getting the money more and more, and people lose money. People would be having lesser money to buy stuff. This means governments keep getting lesser chunks. They want people to make more, so that they get more (as a percentage). They print more money and pay folks even more, so that people pay even more to the government back. (I am not an expert. This is just my take on this.)

Answer 11

Most answers don't seem to be getting to the core of the question.

Is money we make completely taken away by taxes?

In a world without saving, yes!

Imagine an economy where aggregate production is sufficient to allow everyone everywhere to spend all their income as and when they get it.

In this economy, you get paid your monthly salary or a company gets a monthly revenue and proceeds to purchase goods and services immediately afterwards equal in value to this income. You place nothing in a pension savings or bank savings account.

In aggregate, the non-government sectors (domestic (incl. local government) and foreign) will have no net saving. The result will be as many spending rounds as necessary to return all government spending back to it via taxes.

The following schematics demonstrate how the government spends and how it collects taxes.

The net result is reserve balances have swelled by 1 Trillion and deposit accounts have also swelled by 1 Trillion (both domestic and foreign).

The reverse process occurs when all these deposits get immediately spent and taxes are collected. Several rounds are combined into one in the following:

However, this is an unrealistic model. Clearly, at the end, the non-government sectors have no money left.. that's not ideal!

What happens is the non-government sector has a certain demand for net saving. This forces the government to be in a deficit because in every spending round, some money is held back and not spent. This means less tax is ultimately recollected than was initially spent by the government. These saving streams represent "leaks".

One such leak is if your country has a trade deficit with the rest of the world. In this case, you export fewer goods and services than you import so there is a net outflow of your currency abroad which is not returned to the government in taxes.

Before this gets too long though, I'll include bank credit. The majority of deposits held with commercial banks are created by the banks themselves when they make loans. Spending behaviour effects the demand for bank credit and so the level of spending in the economy not only impacts the tax returned to the government but also the amount of new deposits created by the commercial banks.

This interplay means that there will always be money on deposits that could be spent in the future. The long-run money supply in terms of net financial assets increases solely due to government deficits since all bank loans have corresponding liabilities.

As an example, using the same diagrams as above, this is how bank credit is created:

I have assumed in the above diagram that a government has run a 50 Billion deficit (i.e. a non-government surplus of 50 billion).

Here, you can see how bank credit creation is solely the domain of deposit accounts and has no effect on reserve balances. Also, the commercial bank total net balance sheet position is zero in aggregate in these examples since I've ignored government bond purchases and loan interest payments.

Answer 12

What I think you're missing is that businesses are taxed on their net income, not their entire revenue. (I'm simplifying greatly.)

So if you buy something for \$100, their cost to make that product would probably have been at least \$90, and their net income would be less than \$10. Then they pay less than \$1 in tax on that.

As you keep going further along the supply chain, the amounts of taxes that come from your original payment get smaller and smaller. They'll never add up to the full \$100 you paid.