We have a government, and we want it to do things for us, so we need to give it money to accomplish whatever goals we assign to it. Where should that money come from?
Currently, our answer is the income tax. Before exposing the income tax as a farce or endorsing an alternative, I will attempt to outline the various paths money can take through our economy so that we may easily identify the best way to apply a tax to fund government activity.
First, money comes from a mint. Money is not itself a thing of value, it is just exchanged for things of value, goods and services. Through the medium of various banks, this money enters the economy. This step is only important for the purpose of pointing out that money only represents potential wealth.
Lets begin our consideration with a person who does some work in exchange for wages. These wages are paid in the form of money. It is unimportant what that work was, be it construction work or investment banking, so long as it is paid for with money. From there, this person has four options. He can 1) spend the money on some good or service, 2) save the money in some financial institution, 3) invest the money, or 4) keep the money.
If the money is spent (1), then it is either spent on 1) necessities, or 2) luxuries. Either way, someone else receives money for a good or service that was produced via work. Though we can easily see a reason to treat these differently, for the purposes of the economy, they function almost identically, with the exception that demand for necessities is more stable than for luxuries, so we will label them the same.
That spent money (1) is handed over to either 1) an individual or 2) a company.
If the money is handed over to an individual (1.1) then we return to our original four options. At this point, it is useful to understand that a company is not the same as a person. A company is a financial intermediary; it does no actual work and consumes no goods or services, but only facilitates the interaction between one person or group of persons and another. It holds money to pay for the production of a good or service and collects it when that good or service is sold. It also collects money from investors, who are actual people or groups of people, to invest in creating a greater capacity to produce goods or services, and pays out profits back to those investors. Therefore, if the money is handed over to a company (1.2) the company has only two options, although one of those can play out in a variety of ways. The company, when receiving money, can 1) pay wages or repay investors, or 2) purchase goods or services. If the company pays out the money (1.2.1), either to workers or investors, whoever receives the money has our original four options. If the company instead purchases goods or services (1.2.2), whether those are materials the workers need in order to produce goods or services, or improvements to the company's capacity to support the production of goods or services, then we return to our second step, with the money being either paid to an individual or another company.
If our original money is saved (2), then it ends up in the hands of a financial intermediary, a bank. The bank only has two real options. To ensure a return on the money left in its hands, the bank either 1) lends it to a person or 2) lends it to a company. Lending it to a person (2.1) is a service, and the interest paid on that loan can be considered the price paid for that service. Lending the money to a company (2.2) is an investment, which places the bank as the intermediary between the company receiving the investment and the original holder of the money. The bank receives a return on that investment and pays a small interest rate to the individual who deposited the money, and pays the rest in combination to its employees and its own investors, since it is itself a company. All three of those results revert back to the original array of four options.
If the money is invested (3), the result is that the money is either 1) lost, totally or partially, or 2) gotten back with an increase. If the money was lost (3.1), someone got it, they just failed to return the expected increase in the potential supply of goods or services in the economy. Investors in companies assume this risk because they expect to make more than they lose. This is a reasonable assumption, so long as the total economy, the supply of goods and services, continues to grow. Companies cannot starve. They pay their employees and insulate them from some of the risk of producing a good or service. If no one buys whatever was produced, the employees do not immediately starve, they just have to look for another job when their previous employer, the unlucky company, dissolves. Neither can companies become rich. They cannot consume anything, so wealth is of no use to them. If they have extra money then we're back to what a company can do with money (1.2.1 or 1.2.2), which basically amounts to giving it away to someone else, a real person, who has our original options. This is the situation when our investor gets his money back with an increase (3.2); he again has to decide what to do with his money.
If the original holder of this money decides to keep it (4), then we're at a dead end. That money does nothing at all, and at every moment represents a decision between our first four options. This is the worst situation from both the perspective of the individual, he could be getting at least a small return on it from a bank or wealth, goods or services, from an individual or company, and from the perspective of the economy, which does not receive the benefit of this added exchange.
Or, to put it another way:
-I) Spend the money, on either necessities or luxuries
---A) Given to an individual
-----1) Start over
---B) Given to a company
-----1) Pay employee wages
-------a) Start over
-----2) Repay investors
-------a) Start over
-----3) Purchase goods or services from outside the company
-------a) Purchase from and individual, start over
-------b) Purchase from another company, return to B
-II) Save the money, money given to a bank
---A) Bank lends to an individual
-----1) Start over
---B) Bank invests in a company
-----1) Return to IB
-Note: A bank is itself a company, so any profits can be treated as from IB. Returns from a bank, in the form of capital plus interest, are money, and we start over.
-III) Invest the money
---A) Money lost, either totally or partially
-----1) A company received the money, but failed to return the expected output
-------a) Return to IB
---B) Money gained
-----1) Start over
-IV) Keep the money
---A) Start over So there we have a very basic outline of the economy.