Why does the government collect taxes?

By DAVID MOON, Moon Capital Management, LLC
November 29, 2009

My nine-year-old son brought home a social studies exam last week. Here is one of the questions:

What is the main reason that the United States government collects taxes?

a. To pay for the military
b. To pay for the cost of running the government
c. To pay to rebuild after natural disasters
d. To create more jobs

“All of the above” was not a choice. He chose D. According to the teacher, the correct answer was B.

Are you smarter than a 4th grader?

In the past couple of years, a better answer might have been E: to assume every financial risk in the U.S.

Depending on your politics, that mission might be laudable or laughable, but there is no debate that it creates terrible unintended consequences.

Less than a year after receiving $10 billion in U.S. taxpayer funds, Goldman Sachs posted its highest profit ever. Goldman would not have been eligible for the bailout, except that it was allowed to convert to a bank – specifically to receive funds earmarked only for banks.

When Goldman earned these record profits – with the federal government implicitly guaranteeing against the failure of the company - the employment contracts for its employees called for billions of dollars in bonuses.

When the U.S. Treasury provided bailout funds to Goldman, I suspect no one ever considered this possible outcome – except maybe some people at Goldman.

When the federal government declares you “too big to fail,” they have implicitly assumed the risks for any failures you might have.

What kind of risks would you take in a poker game if you didn’t have to pay when you lost?

This “heads-I-win; tails-you-lose” business model hasn’t even created more lending. Goldman Sachs doesn’t even make loans. Neither do many other recipients of TARP and associated bailout funds. Many of these companies are making huge profits by buying and selling securities – that is, speculating – while enjoying a federal government backstop.

Unintended consequences occur at the individual level, too. The IRS tax-rebate program for first-time homebuyers is about to be expanded to include buyers who trade-up.

These, and other subsidies, encourage people to buy more expensive homes, with less of their own money at risk. FHA insurance was originally designed for low-income families who didn’t have an old fashion 20 percent down payment. It now extends to loans as large as $934,200, allowing people to buy million dollar homes using practically none of their own capital.

One 27-year-old investor who purchased a $1 million apartment building with the assistance of this low-income insurance program was quoted in the Wall Street Journal: “It was kind of crazy we could get this big a loan.”


The House Financial Services Committee recently passed a measure that would subject the Federal Reserve to Congressional operational audits of its monetary policy, extending politicians reach into the area of setting interest rates. Representative Barney Frank (D-Mass.) rightly opposed the move. While the move sounds good on paper, Frank at least realizes the risks of unintended consequences in this dangerous area.

So what is the main reason government collects taxes?

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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