Why we pay taxes

Photo by Mikhail Nilov, Pexels

I’ve been genuinely curious about attitudes towards taxation. Decades ago, I got a stern look from a Swiss colleague. I’d just found out about their keenness for having a referendum and wanted to know why they didn’t have one to abolish tax. He just looked at me in a very disappointed way and just said it would be highly irresponsible. Now, no-one likes paying tax. But I think we all know why we pay tax. However, I’ve been thinking that it’s not a simple transaction. It’s not just that I need medical support now and again, or quite like having a few roads around the place. What I’ve never been able to articulate is that taxation is so much more than a club membership. And certainly, as some would have it, it is most definitely not a confiscation of private wealth, instead, it the price of having a functioning currency, a working legal system, and a stable economy in which private wealth can exist at all.

We pay taxes to a state taxes because:

• they give the currency its value and help keep inflation in check;
• they fund the legal and institutional framework that makes markets, companies, and property rights possible;
• they redistribute risk and income, supporting stability and opportunity;

Then we get the most usually discussed reasons for taxation:

• they steer behaviour towards socially desirable outcomes;
• they underpin state capacity and accountability.

Taxes give the currency its value

Now, I don’t read enough on economics to bluff my way around Modern Monetary Theory (MMT), and I wouldn’t be qualified to give an opinion in any case. However, even without adopting a belief in MMT it seems clear that when a state declares a unit of account (in our case the pound) and insists that tax liabilities must be settled in that unit that creates baseline demand for the currency. In other words, if you owe tax in pounds, you need pounds (it’s not as strange a counterexample now that we have so much cryptocurrency kicking around). But it’s this tax demand that ensures the currency is widely accepted in private transactions too, not just for taxes. In other words, the state’s power to tax in its own currency underpins demand for that currency. Without a state willing and able to impose and enforce tax liabilities in pounds, the pound would be just another private token with no guaranteed role in settling obligations.

In addition to this, the state’s fiscal and monetary framework (which includes taxation) helps keep inflation and default risk in check, protecting the real value of nominal savings. In other words, my savings have value because we are taxed in that currency and that currency is managed somewhat responsibly.

Taxes fund the legal and institutional infrastructure of markets

I guess this is one of the least visible powers of the state. Just because we have to pay to enforce property rights doesn’t mean the state had no role in defining the legal frameworks. There are a number of structures and institutions that make markets possible.

• Property rights: the law defines what you own, how you can use it, and how you can transfer it.
• Contract enforcement: courts and legal processes let you enforce agreements with suppliers, customers, and employees.
• Corporate form and limited liability: the state creates and maintains legal entities like “My Company Ltd”, enabling you to build reputation, raise finance, and limit personal risk.
• Dispute resolution: civil law, tribunals, and enforcement mechanisms (bailiffs, charging orders, etc.) back all of this up.

All of this costs money: judges, courts, registries (Companies House, Land Registry), insolvency practitioners, enforcement officers, and the wider legal infrastructure. Taxes pay for that backbone, even if much of the cost appears to be borne privately.

Taxes control inflation and stabilise the economy

Taxes aren’t just about raising revenue; they’re a macroeconomic stabiliser. By withdrawing money from circulation, they help control aggregate demand and thus inflationary pressure. Progressive tax systems automatically dampen booms and cushion slumps (you pay more tax when incomes are high, less when they’re low), smoothing the economic cycle. Governments can also use targeted tax changes to cool overheating sectors or support demand in downturns.

In other words, taxes aren’t just a bill; they’re a thermostat. By withdrawing purchasing power from the economy, they help keep inflation in check and smooth out booms and busts. That stability is part of what protects the real value of savings and wages.

Redistribution and social insurance

This is the most familiar argument, but it’s worth setting out. Taxes fund public services (health, education, infrastructure) that raise the economy’s productive capacity. They finance social insurance (pensions, unemployment benefits, disability support), which reduces extreme insecurity and allows people to take risks such as retraining or starting a business.

Progressive taxation, which redistributes income and wealth, can also:

• reduce social tension and political instability;
• support aggregate demand (lower-income households tend to spend a higher share of their income).

Redistribution isn’t just about fairness; it’s also about limiting the concentration of economic and political power that enables rent-seeking. A highly unequal economy tends to produce more lobbying, regulatory capture, and entrenched incumbents. I think this is the area we argue about the most, the reason I wanted to write the blog post is not that I think we should argue about priorities in this regard. It’s just that this is only one part of the iceberg, not the whole iceberg.

Shaping behaviour: “sin taxes”, pigouvian taxes, and incentives

Governments use tax not only to raise money but to steer behaviour. (Full disclosure: I only wrote this section because I didn’t know what Pigouvian meant, to be honest.)

• Pigouvian taxes: taxes on negative externalities (carbon, congestion, pollution) aim to make private costs reflect social costs. In principle, this could push innovation and investment towards low-carbon technologies rather than rent-extraction.
• “Sin taxes”: on tobacco, alcohol, sugar, etc., to discourage harmful consumption.
• Incentives: tax reliefs for R&D, investment, pensions, green technology, etc., to encourage socially desirable activity.

State capacity, accountability, and the social contract

Finally, taxation is central to state-building: a government that can raise revenue reliably can also enforce laws, provide services, and maintain order. There’s a reciprocal relationship: citizens who pay taxes tend to demand better governance, accountability, and representation (“no taxation without representation” in modern form).

A functioning tax system reinforces the social contract: we contribute to shared institutions, and in return we get security, infrastructure, and a rule-based order. Taxation isn’t just a technical revenue tool; it’s part of how a state earns legitimacy. A government that can tax effectively can also govern effectively, and citizens who pay taxes have both a stake and a voice in how that power is used.