Religious Liberty and Tax Exemptions (Part 1)

What is the correct legal position with respect to religious beliefs and practices in a liberal democracy? Should there be a right to religious liberty? Should religious organisations be granted tax exemptions? Should such exemptions be withheld if they engage in activities that are contrary to the laws of the land?

To non-believers and secularists like myself, the answers to these questions are straightforward: (i) religious beliefs and practices should be granted no special legal protections over-and-above those granted to other beliefs and practices of all citizens; (ii) there should be no tax exemptions for religious organisations; and, of course, (iii) religious organisations should not be rewarded (through tax exemptions or otherwise) for doing things that are contrary to the secular legal system.

These answers sound fine at a theoretical level. In practice, things are little more difficult. In practice, most liberal democracies do afford some special legal status to religious beliefs and practices (i.e. rights to free exercise and conscience). In practice, secularists would like to avoid excessive intolerance or oppression of religious believers. And so, in practice, convoluted balancing acts are undertaken.

In this brief series, I want to take a more in-depth look at some of the issues arising from the special status of religious belief and practice in liberal democracies. I do so by examining an argument from the libertarian legal theorist Richard Epstein relating to religious tax exemptions. I then use that argument as a springboard for questioning the law relating to religious liberty.

The series comes in two parts. In this first part, we develop a basic theoretical conception of the social contract and derive from it a principle for assessing governmental tax policy. In the second part, we will see how the application of this principle to cases involving tax exemptions for religious organisations highlights the implausibility of a robust right to religious liberty. 

1. Bargaining in General

Epstein’s argument concerning tax exemptions and religious liberty occurs in his book Bargaining with the State. The book develops a general theory of the social contract, and then applies that theory to a series of practical legal issues. Although I do not share Epstein’s libertarian sentiments, I do share his basic theoretical vision of the state. This vision is built on the notion of bargaining. This is something I have covered in detail in previous entries but I’ll summarise its essential elements here.

There are occasions on which two or more people can coordinate their activities and create a social surplus. In other words, they can gain more of something than they could if left to their own devices. But in order for this to take place, a bargain must be struck which determines the distribution of the surplus. 

Here’s an example, one of many which could be adduced. Suppose there are two people, A and B. Suppose A is the producer of some good X and that she values (perhaps due to production costs) X at $7. Suppose B is a potential consumer of X who would be willing to pay up to $15 for X.

Given these conditions, any negotiated exchange of X at a price between $7 and $15 would lead to the creation of a social surplus. Why so? Because A would get something more valuable to them than X, and B would get something more valuable to them than any cash-sum up to $15. The bounds of $7 and $15 represent the baselines or status quo over which the surplus is calculated. 

The bargain thus creates a larger pie of assets that is divided among the parties in different proportions.

2. The Creation of the State

The basic idea of the bargain can be used to build a theoretical model of the state. The picture is, roughly, the following: Rational actors left to fend for themselves without the option of cooperation could achieve a certain degree of personal welfare and security. This would be the “pie” or “surplus” that can be achieved in stateless society.

According to some classic theories, the size of the pie in the stateless society is exceptionally small. Thomas Hobbes, for example, argued that in the state of nature man’s life would be “nasty, poor, brutish and short”. He did so because he believed that without a state with a monopoly on the use of violence there is an unending state of war. The deeper reasons for this are explored in the diagram below (click to enlarge).

Whether Hobbes is right in his pessimism, most would agree that the creation of the state does, in general, enlarge the size of the pie (raise the baseline) compared to the stateless society. This enlarging of the pie would make it mutually advantageous (rationally acceptable) for people to agree to be bound by the regulations imposed by the state. In other words, it would be rational to negotiate a social contract that legitimates the state.

What kind of state would be required to enlarge the pie from what it is like in the state of nature? There are different suggestions. 

A libertarian like Epstein would argue that a very minimalistic state is all that is required. Such a state would have basic legal institutions, legal rules on freedom of contract and property, and some sort of police force and army. Hobbes himself argued that a maximal, authoritarian state (the Leviathan) was needed to lift us out of the war of all against all. The liberal democratic state probably falls somewhere between these extremes.

We do not need to engage with the arguments for and against these different possibilities. We assume that a liberal democratic state is required. This state comes with certain rights and entitlements including, usually, a right to freedom of speech and religion. It will also come with some sort of taxation policy because the state needs to raise revenue to perform its basic functions.

3. Bargaining with the State

Now we come to the crux of the issue. Once the state has been created, it becomes an agent in future bargains and negotiations with its citizens. This is because the situation arrived at after the implementation of the social contract is not some stable, unchangeable state of affairs. Changes in government policy could help to enlarge the size of the pie once again. 

If the government chooses to change its policies in order to enlarge the pie, it enters a new round of bargaining with its citizens. The citizens will be operating within the status quo (or baseline) that has been established by the social contract. Given that the working assumption is that government is the product of rational agreement, the government must ensure that its policy changes do not make people worse off than they are under the existing status quo. This requires just compensation for any losses suffered, and equal relative shares of the new surplus.

What are the implications of all this for changes in tax policy? Most forms of taxation are selective. That is to say, they target certain activities (e.g. work and consumption). But some forms are obviously more selective than others. For example, governments often impose higher taxes on the consumption of certain types of goods (alcohol or cigarettes). The same goes for policies relating to tax exemptions, e.g. exemptions for start-up companies but not established companies.

The crucial point here is that selective changes to tax policy, even if they do enlarge to social pie, necessarily involve the redistribution of assets from one group of citizens to another. This means that those changes constitute a deviation from the status quo. Any such changes must be rendered mutually advantageous by some form of just compensation and equal relative share of gains.

We will be considering examples in the next entry in the series.

4. How to Evaluate Tax Policy

There are a lot of ideas embedded in the preceding paragraphs. In the interests of clarity, we can restate them as a formal argument.

• (1) A legitimate government is one that is mutually advantageous for its citizens, i.e. it creates a social surplus and distributes it fairly.

• (2) Any change in government policy from the existing status quo must be assessed in terms of its ability to satisfy the requirements of mutual advantage (from 1).

• (3) One way to satisfy the requirements of mutual advantage is to ensure that there is just compensation for any losses suffered and equal relative shares of gains.

• (4) So changes in government policy from the existing status quo should be assessed in terms of just compensation and equal relative gain (from 2 and 3).

• (5) Selective changes in taxation are deviations from the status quo because they involve the redistribution of assets.

• (6) So selective changes in taxation must be assessed in terms of just compensation and equal relative gain (from 4 and 5).

This argument, working from a principle for legitimate government based on rational assent, gives us a principle with which we can assess the legitimacy of changes to tax policy given their impact on the status quo. We will put this principle into action in the next entry when looking at the topic of tax exemptions for religious organisations.