This chapter is largely based on Plug, Van Praag, and Hartog (1999).
There is no country without taxation. The raison d'être of the state as an organization is that there are a number of needs which citizens have in common and which can be met only at much higher cost or not at all if citizens do not associate into a state or a community. We mention the army, the police, justice, education, the road system, etc. We call the products state services. The production of those services requires human resources and capital, which cannot be used for the production of other commodities and services. The state has to buy these production factors or the finished products from the market at market prices. For instance, workers have the choice of working for a private firm, being self-employed, or becoming a civil servant. They only choose the civil service if the state is competitive with the private sector on the labor market. Similarly, the state has to pay the market rent if it wants to rent an office building.
Let us assume that via a parliamentary decision process the choice has been made that 30 percent of the national product must be spent by the state for the production of state services; then this implies that 30 percent of total national income has to be spent by the state and consequently that 30 percent of the factor earnings, that is salaries, profits, interest revenues, etc., has to be taxed away from the citizens. The ratio of 30 percent in this example we shall call the national tax ratio. Banknotes have to be seen as vouchers which stand for rights in a specific part of the productive efforts of the country. If we want those vouchers to be used for state production, it follows at the same time that the vouchers cannot be spent by citizens on food, housing, and other private purchases. In fact, the situation is very comparable to that of a football or golf club where the club provides fields, trainers, a club house, etc., which is paid for by contributions from the club members. The club members are the citizens and the contributions are the taxes the citizens are paying to the state.
We shall call the decision on the national tax ratio and on the distribution by the state of the tax revenue on various state services like army, police, and