You know the rules. Death and taxes—the two certainties of life, as the saying goes. Benjamin Franklin supposedly said it first, though the idea is older than that. And there’s a certain amount of truth in it. Taxes are everywhere. Here in the United States, we have taxes on income, taxes on spending, taxes on businesses, taxes on property. If we invest our money and it makes a return, that gets taxed, too. Certain items get taxed at higher rates than others. There are taxes on imports. And if we’ve managed to accrue a bit of property and savings to pass along to our families after we die, there’s a tax on that as well.

There is functionally no part of everyday life that doesn’t have some tax touching it somewhere.

Taxes, as many people like to say, are the price we pay for living in a civilized society. They’re the portion of whatever they’re being applied to that a government—federal, state, or local—demands be turned over to it. The government then uses this money to fund various services.

But taxes exist outside the framework of capitalism. They’re neither voluntary nor a true form of trade. So why are we talking about them in a series about capitalism?

While no tax is truly an aspect of capitalism, taxes do contribute to the incentives—or disincentives—that shape economic decision-making. Further, Milton Friedman himself acknowledged that while he favored reducing taxes in all circumstances, a certain level of taxation is inevitable and even necessary.

Think about what governments exist to do. At a minimum, they need to protect the rights of their people. Police and law enforcement need salaries. So do courts with their judges, bailiffs, and clerks. National defense requires funding. Civil infrastructure needs maintenance. Elections must be held. Legislatures must function.

Friedman acknowledged these purposes and conceded that taxation is the simplest way to pay for them. Nobody likes paying taxes, and there are very real consequences of those taxes on the broader economy. The trick is keeping taxes as low as possible and confining them to the sorts of economic activity that have the smallest negative impact.

Here’s where things get complicated.

Every tax changes behavior. When you tax something, you get less of it. Tax income, and you discourage earning. Tax investments, and you discourage saving and risk-taking. Tax property, and you discourage ownership. This isn’t a moral judgment. It’s simple economics. People respond to incentives.

The question becomes: which taxes do the least damage while still funding necessary government functions?

Some taxes are more destructive than others. Income taxes, for instance, directly discourage productive work. The more you earn, the more you pay, creating a disincentive to work harder or take on additional responsibility. Progressive income taxes amplify this effect by taking larger percentages as income rises.

Capital gains taxes discourage investment and risk-taking. When entrepreneurs and investors face the prospect of paying substantial taxes on successful ventures, some opportunities that would have been worth pursuing become marginally not worth the effort. The economy loses innovations and business growth that would have occurred otherwise.

Corporate income taxes get passed along to consumers, employees, and shareholders in ways that are rarely transparent. A company doesn’t actually pay taxes. It collects money from customers, pays employees less, or returns less to investors. The tax obscures who’s really bearing the cost.

Tariffs, as we’ve explored previously, are taxes on imports that raise prices for consumers while protecting inefficient domestic producers from competition.

Estate taxes penalize saving and wealth accumulation, encouraging people to spend rather than build capital that could be invested productively.

Each of these taxes not only extracts money from the economy but also distorts the decisions people make about work, investment, consumption, and saving.

But here’s the reality Friedman recognized: governments need funding for their legitimate functions. The question isn’t whether to have taxes. It’s how to structure them to do the least damage.

One approach is to favor consumption taxes over income taxes. When you tax consumption rather than income, you don’t discourage earning and investing. You only discourage spending. This preserves the incentive to work and save while still generating revenue.

Another principle is simplicity. Complicated tax codes with countless exemptions, deductions, and special provisions create opportunities for manipulation. They reward those who can afford expensive tax lawyers and accountants while punishing those who can’t. Simple, flat tax structures reduce these distortions.

Transparency matters, too. Hidden taxes—like inflation or tariffs buried in product prices—prevent people from understanding the true cost of government. When citizens can’t see what they’re paying, they can’t make informed decisions about whether government programs are worth their cost.

The broadest possible tax base with the lowest possible rates tends to do the least economic damage. When everyone pays something, and rates stay low, the distortions to economic decision-making stay minimal.

All of this brings us back to a fundamental tension. Capitalism is voluntary exchange and individual decision-making. Taxes represent the opposite—mandatory transfers enforced by government power. They’re inherently anti-capitalist in that sense.

Yet nearly every ardent capitalist recognizes that some government functions are necessary. Property rights mean nothing without courts to enforce them. Voluntary exchange isn’t truly voluntary when it happens under threat of violence from criminals or foreign invaders.

This creates what might be called capitalism’s necessary compromise. We accept a limited amount of government activity, funded through taxation, to create the framework within which capitalist exchange can flourish. The keyword is limited.

When taxes grow too high, they begin undermining the very prosperity they’re meant to protect. Government spending crowds out private investment. Tax distortions redirect resources from productive uses to tax-advantaged ones. The bureaucracy required to collect and spend all that money consumes resources without creating value.

There’s also a psychological element. High taxes change how people view their relationship with government. Instead of seeing government as a neutral arbiter protecting rights and enforcing rules, people begin viewing it as a competitor for their resources. Political battles increasingly focus on whose taxes will be raised and whose favorite programs will be funded, rather than on what government should actually be doing.

This is where understanding trade-offs becomes critical. Every dollar spent by government is a dollar that can’t be spent or invested privately. That wouldn’t necessarily be a problem if government spending were obviously more valuable than private spending. But government operates without the profit-and-loss signals that guide private decision-making.

When a business invests poorly, it loses money and eventually changes course or goes bankrupt. When government invests poorly, it typically requests more funding. The feedback mechanisms that make capitalism effective at allocating resources don’t apply to government spending.

None of this suggests that zero taxation is possible or even desirable. Courts, police, national defense—these serve genuine purposes that markets alone don’t efficiently provide. But it does suggest that every expansion of taxation and government spending should be viewed skeptically.

The burden of proof should fall on those proposing new taxes or higher rates to demonstrate not just that some goal is worthwhile, but that government can pursue it more effectively than private individuals and organizations acting voluntarily.

Friedman had it right. Reduce taxes in all circumstances. Like medicine, they should be taken in the smallest effective dose.Learn more about capitalism here.