1. Introduction

Luigi Einaudi prolifically contributed to theoretical and applied economics, covering a vast array of topics from the late 19th century through to the birth of the European Community—a project he staunchly supported.

The theoretical foundations and guidelines of his extensive work rests upon the principles of free trade and the theory of capital as the driving force of economic development, as espoused by classical British economists since Adam Smith. In his 1944 work La società liberale, Einaudi declared:

"Abolish without fail, and immediately, and with no claim for compensation (…) all types of protective tariffs, of constraints on foreign and domestic trade”

Einaudi’s advocacy against protectionism extended beyond customs fees to include all forms of monopolistic restriction, as reflected in his writings on free enterprise, federalism, and globalisation.

Einaudi also emphasised the role of wealth creation as pivotal to societal progress:

"To improve the well-being of the working classes, there is no other means but to increase the amount of wealth produced in our country." (L. Einaudi, "Il programma economico del partito liberale", La Stampa, 12 October 1899).

Capital, he argued, is the fruit of savings—a principle that underpinned his interest in savings , he main subject of his writing on financial theory, monetary policy, and social policy.

Einaudi’s approach was further distinguished by his adherence to method, reflecting a deeply rooted tradition in Italian economic thought. He defined this as a “sense of reality,” which required the patience to criticise individual facts analysed in their intertwining with the broader social and historical context:

"The more our representation of reality transitions from a photographic snapshot to a moving picture extended over time, from statiticity to dynamism, the better past, future, and expected choices—being consequences of preceding actions and foundations for future ones—intertwine. This renders the isolated treatment of any single aspect of a problem monolithic and often illogical." (L. Einaudi, 1943, Ipotesi astratte ed ipotesi storiche, e dei giudizi di valore nelle scienze economiche, in L. Einaudi, 1973, Scritti economici storici e civili, a cura di R. Romano, Milano, Mondadori, p. 404).

2. Freedom and Competition: Liberal Society and Liberal Economy

Einaudi’s conception of liberalism is intrinsically linked with free trade and economic development, whose primary consequence is the principle of competition. This, he posited, served as a guarantee of freedom for individuals and institutions in both the private and public spheres:

"Any producer, given the choice, would avoid lowering prices or improving quality if free from the constraints of competition. To work as little as possible while earning as much as possible is an inherent human tendency, not unique to producers." (L. Einaudi, 1944, I problemi economici della federazione europea, Lugano, then published in L. Einaudi, 1986, La guerra e l'unità europea, edited by G. Vigo, Bologna, Il Mulino, p. 114).

Similarly, he argued that the same freedom of competition had to be given to:

"Workers and peasants must be afforded full and absolute freedom of association—a school of responsibility and a tool for moral and material progress. However, any attempt by such associations, alongside employers' associations, consortia, cartels, or trusts, to monopolise the market of goods and labour to the detriment of society must be energetically repressed." (L. Einaudi, 1944, La società liberale, Turin).

The principle of competition extends beyond private economic activities characteristic of market dynamics to encompass a wide range of public functions, particularly the provision of public services to Men living in society. According to Einaudi, this responsibility rests not solely with the State but also with

"all kinds of public bodies: (…) more than on the State, on the regions, jurisdictions, municipalities, public charity institutions, moral bodies, and private foundations" (L. Einaudi, 1944, La società liberale, Turin, pp. 7–8),

reflecting a framework rooted in the principle of subsidiarity.

In this context, Einaudi underscores the importance of local autonomy while expressing caution regarding the risks of financial irresponsibility. He asserts:

"Cantons, regions, municipalities, territorial entities, whatever their name, cannot lead a healthy and productive existence without autonomous revenues, generated, endorsed, and initiated by local taxpayers—complementing, rather than substituting, national taxation. Nor should they rely on handouts from the central State or on shares of national tax revenues" (L. Einaudi, 1962, Prediche inutili – "Che cosa rimarrebbe allo stato", Turin, G. Einaudi, p. 364).

Luigi Einaudi regarded the principle of competition as an extension of the principle of freedom, which itself stems from an ethical foundation that renders competition indispensable in the social, political, and economic spheres. He asserted: "In economic matters, the first commandment is the same that applies in spiritual matters. (...) [any free man] cannot enjoy an economic privilege to the detriment of the equal freedom for all, to work, to undertake, to save" (L. Einaudi, 1962, Prediche inutili – "Concludendo", Turin, G. Einaudi).

Further elaborating on this idea, Einaudi observed:

"The guarantee of the freedom of citizens lies in the existence of different powers, of various forces of attraction: thanks to which the ordinary man need not depend on a single force in order to earn his bread" (L. Einaudi, 1962, "Politici ed economisti", in Il Politico, XXVII, no. 2, p. 249).

In opposition to Benedetto Croce, Einaudi argued that a competitive market economy was integral to the survival of a liberal society:

"Freedom of thought is thus necessarily connected with a certain amount of economic liberalism (...). The historical conception of economic liberalism states that freedom cannot exist in an economic society where there is not a varied and rich fortune of human life. Freedom thrives on its own virtues, independent of each other, and not enslaved by a single will" (L. Einaudi and B. Croce, 1988, Carteggio (1902-1953), edited by L. Firpo, Turin, L. Einaudi Foundation, Part II, IV).

3. The State and the Market

Luigi Einaudi’s perspective championed the principle of competition while maintaining a keen awareness of the functional limitations of markets and the necessity of public intervention. His approach to economic issues was rooted in pragmatism, focusing not on an abstract delineation of the roles of the market and the state but on ensuring that both function effectively to uphold freedom and foster economic and social progress.

Einaudi, in particular, rejected the notion that consumer choices driven by habit, inadequate information, fashion, or the influence of advertising could be considered inherently rational. He thus questioned the dichotomy often drawn between the rationality of individual decisions and the irrationality of public ones:

"Is it improbable that illogical actions are far more numerous and more far-reaching in private life, and the expense such choices determine absorb a far greater share of income than do the overt illogical public spending?" (L. Einaudi, 1941, Saggi sul risparmio e l'imposta, ed. 1958, Turin, G. Einaudi, p. 194)

Luigi Einaudi identified an additional limitation of the market: the negative environmental impacts of production. He specifically referred to the external diseconomies caused by industrial activity, such as the fumes and dust generated by steelworks and cement factories. These externalities distort the price formation process to the detriment of consumers and the benefit of producers, "because in the calculation of the cost (...) the cost of eating back smoke and dust produced by the chimneys is not taken into account" (L. Einaudi, 1961, "La predica della domenica", Corriere della Sera, 30 July).

Market mechanisms are further skewed by monopolies, which often arise from ideological biases or the pursuit of group interests. Moreover, Einaudi acknowledged that certain services—such as defence, law and order, education, and public infrastructure—can only be efficiently provided by the State, or at a significantly lower cost than private entities. For Einaudi, the State itself is a factor of production, and the principal role of taxation is to remunerate the State for its contribution to production and the overall growth of wealth. The State is also tasked with combating monopolies and cartels, even when these are occasionally the by-products of public intervention.

In addition to championing individual freedom, Einaudi recognised the interdependence of individuals within society. His vision of economic liberalism was distinct from liberism (laissez-faire economics):

"Liberalism (...) does not mean the absence of state constraints, of coercive regulations. It should by now be useless to repeat once again that 'economic liberalism', as it is commonly, or rather vulgarly, repeated, is a funny puppet, which no economist (...) of those who have even a certain insight into the content and limits of the discipline they cultivate has ever made his own. Economic liberism is a shameless invention of the socialists, of Dirigistes, interventionists, and the commandment of laissez-faire, laissez-passer has a limited content proper to certain circumscribed fields of human activity" (L. Einaudi, 1962, Prediche inutili – "Concludendo", Turin, G. Einaudi).

Einaudi’s pragmatic sensibility compelled him to reject the constraints of ideological labelling:

"How (...) can one reconcile (...) the profession of a liberist, notoriously attributed to the author's public reputation, with the exaltation of the work of the State, which he considers beneficial even if it has come to leave the taxpayers penniless? Not even the interventionists, not even the dirigistes, not even the planners can be so foolish; and he claims to be taken seriously! On this point (…) I am now resigned to thinking that the game is lost, for it is clear that those who judge men after attaching a nickname to them (liberalist, socialist, interventionist, planner, and the like) are incapable of making economic judgements which provide evidence only when it is demonstrated that a given choice is relatively more convenient or less harmful than any other imaginable; and it may well be that the worst tyrannical or foreign state is preferable to disorder and anarchy (...). Choices are made by reasoning, not by labels. But politicians do not like to reason and prefer labels" (L. Einaudi, 1950, Essays on Savings and Taxation, Preface, p. XVII).

Einaudi’s distinction between dirigistes and liberals lies in their fundamentally different approaches. For the former the State actively directs the choices of individuals, while for the latter:

"The state intervenes to fix the framework norms within which men's actions can freely move; it does not order how men should behave in their daily conduct" (L. Einaudi, 1962, Prediche inutili – "Concludendo", Turin, G. Einaudi, p. 399).

Einaudi further emphasised the necessity of regulating market operations, particularly by imposing transparency obligations on financial market players. He observed that antitrust enforcement in the United States was supported by the ability to conduct investigations and trials,

"on the basis of the information that companies and entities are required to prepare and communicate by virtue of federal and state laws, stock exchange regulations and instructions from the Commissions on Interstate Commerce and the Federal Reserve Board" (L. Einaudi, 1962, Prediche inutili – "Concludendo", Turin, G. Einaudi, p. 399).

Einaudi’s departure from a strict laissez-faire approach in advocating for freedom of initiative and competition aligned his vision with the theory of conformist interventions developed by the economist and sociologist Wilhelm Röpke. Einaudi expanded upon this concept, defining compliant interventions as:

"all economic plans or policies that are compatible with the existence of a market where consumers go equipped with the means available to them in order to buy goods to satisfy their desires and on which the same men, in their capacity as producers, go to buy production factors and sell manufactured goods" (L. Einaudi, 1937, “Sulle origini economiche della grande guerra, della crisi e delle diverse specie di piani”, Rivista di Storia economica, II, no. 3).

This encompasses any measure designed to safeguard the mechanism of competition mechanism, including adjustments to the distribution of resources, provided such actions do not disrupt the proper functioning of the pricing system.

4. The Market and Socio-economic Policy Institutions

Einaudi’s conception of a liberal economy, which acknowledged the necessity of governmental constraints and regulatory interventions, underpinned his interest in studying institutions through the lens of a market economy supported by appropriate state measures. His focus extended beyond taxation and fiscal policy to encompass the institutional structures of the agricultural economy, social and labour policies, and industrial organisation.

Einaudi’s engagement with the economic and institutional challenges of land and agriculture began with his early works, such as La distribuzione della proprietà fondiaria in Dogliani (1893) and L'azione del Partito Socialista nei paesi di piccola proprietà terriera (1894). In these papers, he argued that the concentration of land ownership was not an inevitable outcome of agricultural development. He advocated for interventions to support agricultural property, including the establishment of rural credit banks and cooperatives dedicated to the processing and marketing of farming products.

For Einaudi, the agricultural sector embodied the ideal model of an economy. In this sphere, the individual entrepreneur persisted as a figure characterised by industriousness, thrift, and autonomy. Regarding inheritance laws, Einaudi opposed proposals to diminish the discretionary share in favour of the reserved share for descendants (later enshrined in Article 537 of the Civil Code). He contended that such measures would undermine the ability of the family head to select the most capable successor. This would, in his view, hinder the natural corrective process by which:

"the silent work that the land does by itself, refusing its fruits to those who do not deserve them, expelling the incapable or ignorant owners and attracting, with the promise of larger fruits, the willing and hard-working men" (L. Einaudi, 1938, L'unità del potere e la storia catastale delle famiglie, Rivista di storia economica, December).

It is no coincidence that Einaudi’s arguments for the benefits of open markets and the principle of normal income taxation as the cornerstone of the tax system were inspired by the example of land.

The centrality of individual merit formed the basis of his concept of justice within the market, where individuals are rewarded in proportion to their contribution to production. For this principle to function effectively, Einaudi recognised the necessity of social policy interventions aimed at reducing inequality at its roots.

To ensure that market mechanisms yield a fair distribution aligned with the principle of merit, competition among individuals must be equitable. This requires, among other measures, equal access to education for developing and enhancing human capital, the provision of a guaranteed minimum income for all, the elimination of barriers to entry into professions and economic activities, and the active prevention of monopolistic dominance.

Einaudi saw human capital formation as serving two vital purposes: advancing general economic progress through individual development and securing basic equality. He advocated for competition between public and private schools, viewing such rivalry as a means to ensure diversity in educational programmes and to drive continuous improvement. In his view, this coexistence would be best supported by abolishing the legal recognition of educational qualifications, thereby fostering a more dynamic and meritocratic educational landscape.

Nonetheless, Einaudi firmly believed that education should be funded by the State:

"Among other things, the public body shall gradually provide children with elementary education, school meals, suitable clothing and footwear, books and exercise books. Willing youth who show a sufficient disposition to study must have the possibility to attend free of charge secondary schools and universities of their choice" (L. Einaudi, 1958, Lezioni di politica sociale, Turin, Boringhieri, par. 124).

From the perspective of ensuring basic equality, Einaudi regarded a guaranteed minimum income not as a conclusion, but as an ethical foundation for progress:

"Our idea should be different and namely that a basic level of existence is not a point of arrival, but of departure; an assurance given to all men so that all can develop their aptitudes" (L. Einaudi, 1958, Lezioni di politica sociale, Turin, Boringhieri, par. 35).

Einaudi applied a similar rationale to old-age pensions, which he saw as motivated by moral considerations preceding economic ones:

"The foundation of the old-age pension is the moral advantage coming before the economic advantage. Only the man who is confident in himself and in his future saves and elevates himself. The one who is uncertain about his future (...) does not even try to provide for the future with his own strength (...). Whereas, on the other hand, he is aware that a minimum standard of living is assured to him in old age, he is not only driven to work with tranquillity during his best years, but he is encouraged to add something to what he already possesses" (L. Einaudi, 1958, Lezioni di politica sociale, Turin, Boringhieri, par. 40).

The principle of wealth redistribution aligns with Einaudi’s strong opposition to large concentrations of wealth. Such redistribution should be understood as the reduction of privileged positions, which often serve as breeding grounds for monopolistic abuses.

For Einaudi, trade unions were fundamental institutions for both economic and social development, and they should operate on an equal footing with employers' associations. However, these institutions cannot fully perform their intended function if they contribute to the creation of monopolistic power. As Einaudi stated:

"Let workers and entrepreneurs establish, if they can, a monopoly on labour and enterprise. What is only denied is that the state legally sanctions the monopoly itself (...). This is the fixed point, not that of the advantage of the monopoly" (L. Einaudi, 1973, Scritti economici, storici e civili - "La bellezza della lotta", edited by R. Romano, Milan, Mondadori, pp. 837).

5. Monopoly

Luigi Einaudi articulated his opposition to restrictions on competition, particularly in his discussions concerning the institutions of the industrial economy. His focus was on the establishment and enforcement of anti-monopoly regulations in goods and services markets.

At the core of Einaudi’s stance was a resolute fight against customs tariffs and any regulatory framework that facilitated monopolistic practices:

"The first and safest anti-monopoly legislation is the one that will avoid to create monopolies (...). Now one of legislations most certainly responsible for promoting monopolies is precisely the customs tariff" (L. Einaudi, Intorno alla tariffa doganale. Nota redatta ad occasione della lettura del "materiale di studio" per la nuova tariffa doganale e delle istruzioni alla delegazione italiana alla conferenza di Annecy, in L. Einaudi, 1956, Lo scrittoio del Presidente (1948-1955), Turin, G. Einaudi, p. 118).

Customs duties, by weakening international competition, enable either a dominant domestic firm to extend its market power or multiple domestic firms to form cartels and manipulate prices. This, Einaudi argued, undermines production efficiency and harms consumer welfare.

For similar reasons, Einaudi supported corporate intellectual property rights, such as patents, but only when these rights were strictly time-limited, ensuring they did not evolve into enduring monopolistic privileges.

Einaudi’s analysis underscored the intrinsic connection between economic freedom, competition, and the rights of those not yet participating in the market but who may enter it in the future. This theme is evident in his discussions on business licences and agrarian contracts, where he affirmed the rights of future generations over the privileges of current players:

"By 'living' is meant, on the one hand, traders who are holding licences today, and on the other, agricultural contracts, sharecroppers and tenant farmers who have a contract; by 'not yet born' is meant not only those who are not physically born at the present moment, but also those who could aspire to carry out a trade or cultivate farms with sharecropping or tenancy contracts" (L. Einaudi, 1956, Lo scrittoio del Presidente, book VII, 'I vivi e i non nati').

For Einaudi, freedom of trade was closely aligned with the expansion of the market’s scope, which he regarded as the second key measure to counter monopoly power. Referring to the example of the United States, he noted that the vast size of the American market limited the prevalence of monopolies dangerous to healthy market functioning:

"Because the size of the market is so large that the monopolists cannot, despite customs duties, put totally down competition; nor can monopolistic profit margins expand too much without the decision from new competitors to access the market" (L. Einaudi, 1962, Prediche inutili - "Concludendo", Turin, G. Einaudi).

Einaudi’s final remedy against monopolistic distortions was direct public intervention. Public enterprises, he argued, should operate particularly in the provision of essential commodities and infrastructure (e.g., urban and rail transport, electricity, gas, and water), especially in cases where individual profit drive diverge from collective benefit. A notable example is the postal service, which he envisioned as ensuring universal access, even in areas where providing such services might be economically unprofitable but essential for societal equity.

6. The General Theory of Taxation and the Issue of Depreciation

Luigi Einaudi advocated for substantial public intervention to stimulate economic development, necessitating a correspondingly high level of taxation to fund it. However, he insisted that taxation, like all public interventions, must remain market-compliant—that is, it should not distort competition while generating revenue to finance state-provided services. According to Einaudi, optimal taxation is achieved when:

"It provides—with the minimum friction and with the greatest possible immediacy—the tax revenue necessary to maximise the economic power of society, including that of the State" (L. Einaudi, 1941 and 1958, Saggi sul risparmio e l'imposta, Turin, Einaudi, Fourth Essay: "Contributo alla ricerca dell'ottima imposta," Section Four: "Connotati dell'imposta equa e stabile" par. 32).

Einaudi’s contributions to the science of public finance, stemming from this theoretical foundation, earned him international renown as an economist. His analysis explored themes such as the capitalisation of taxation, the double taxation of savings, and taxation on normal income, which he examined and interwove over four decades.

The concept of capitalisation, or depreciation of tax, refers to the contraction in the value of a capital asset when the income it generates is subject to taxation. Traditional economic theory had concluded that such capitalisation occurs when a special tax is levied on specific types of capital income, but not when a general tax applies uniformly to income from all forms of savings.

Consider an asset that generates a perpetual, time-constant annual income of 50. With a market interest rate of 5%, the asset's market value will be 1,000. If a special tax rate of 20% is imposed on this income, the net income will decrease to 40. At the same 5% interest rate, the asset’s value will fall to 800, as buyers will not pay 1,000 for an asset yielding a lower return than comparable assets unaffected by the special tax. Under this scenario, the burden of the tax is borne entirely by the current owner of the asset, whose capital value diminishes by an amount equivalent to the present value of the future tax. Future buyers, however, remain unaffected in practice, as they purchase the asset at a reduced value of 800, with its net income of 40 aligning with market expectations.

This inequity does not arise if the tax is general, i.e., applied uniformly to all forms of capital income. In this case, all income is reduced by 20%, and the effective return on capital is uniformly adjusted to 4%. The asset’s net income of 40 is then capitalised at the reduced rate of 4%, restoring the capital value to 1,000, as it was prior to the tax introduction. In this scenario, the effect of the tax shifts from a depreciation of capital value to a reduction in the interest rate, which introduces a different inefficiency: a disincentive to save.

Einaudi criticised the traditional theory that drew a distinction between general and special taxes. He argued that taxation cannot directly lower the interest rate, as the interest rate is merely a ratio. Instead, he contended that a reduction in capital income diminishes the available pool of savings, which in turn causes a rise in the net interest rate—though this increase is smaller in proportion to the decline in income. Consequently, Einaudi concluded that even a so-called general tax would lead to capital depreciation.

Einaudi’s analysis extended beyond these technical considerations, observing that—even with the refinements outlined above—traditional theory regarded taxation solely through its negative dimension as a levy. He likened such taxation to hail:

"Without cost and without compensation for men, [it] takes away the fruits of the earth [and thus destroys] a share of the income from the fields and gives nothing back" (L. Einaudi, Osservazioni critiche intorno alla teoria dell'ammortamento dell'imposta e teoria delle variazioni nei redditi e nei valori capitali susseguenti all'imposta, reprinted in L. Einaudi, 1941, Saggi sul risparmio e l'imposta, Torino, G. Einaudi, p. 183).

However, Einaudi argued that if the term "taxation" is reframed as compensation paid to the state in exchange for public services provided to citizens, the levy must then be assessed in tandem with its positive effects. Taxation that funds services capable of enhancing the productivity of existing factors—provided it is cost-effective and consistent with market principles—will tend to increase the income generated by assets and thereby augment their capital value. This dynamic reduces the relative value of present goods compared to future goods, thereby lowering the interest rate. The resultant psychological adjustment reflects the re-evaluation individuals make when choosing to defer consumption and save, compared to their ultimate decision to consume.

This principle applies equally to general and special taxation. The distinction lies in the fact that, under general taxation, the income of all assets tends to rise net of tax, whereas under specific taxation, the positive effects are confined to a subset of assets from which the tax is deducted.

7. Double Taxation on Savings and Taxation of Ordinary Income

The theory of market-compliant taxation serves as a foundation for Einaudi’s concept of the double taxation of savings. As with his analysis of tax depreciation, the starting premise is the equivalence between the capital value of an asset and the income it generates—the former being the present value of the latter. Einaudi explained this equivalence succinctly:

"These two things, capital and income, are not just one function of the other. They are two sides of the same thing; they are the same thing viewed from two different perspectives. If we consider 40 lire per year for an ongoing figure, we can say we are observing ‘income.’ If we compress this timeline, so to speak, into the present moment, we can say we are observing ‘capital.’ Yet we are always observing the same reality" (L. Einaudi, 1938, Miti e paradossi della giustizia tributaria, reissued in L. Einaudi, 1959, Opere di Luigi Einaudi, Turin, G. Einaudi, ch. II, p. 55).

From this perspective, it follows that capital and the income it generates cannot be taxed simultaneously, as they represent two facets of the same entity.

Similarly, the portions of earned or produced income allocated to consumption and to savings—where the latter forms income-generating capital—should not be subjected to identical taxation. If treated alike, savings would be taxed first as produced income that is saved (capital) and again as the yield from those savings (income), effectively taxing the same economic resource twice.

To prevent what Einaudi termed “double taxation,” it becomes essential to exempt either capital income or the savings that generate it. However, exempting capital income entirely was impractical, especially for business income, which represents a composite of both capital and labour income. The alternative—exempting savings—required presumptions about the allocation of income. To address this, Einaudi proposed taxing at a reduced rate the income of individuals for whom a higher propensity or necessity to save could reasonably be presumed, such as recipients of labour income, those with uncertain or fluctuating incomes, and those earning minimal incomes.

More broadly, Einaudi observed that the necessity to save diminishes as income rises, leading him to conclude that taxation on earned income should be progressive, thereby exempting presumed savings.

This justification for progressivity did not rely on the traditional principle of sacrifice, which posits that the loss of utility from the withdrawal of a unit of income decreases as individual income increases, due to the diminishing marginal utility of additional income.

Instead, Einaudi offered a technical rationale grounded in his rigorous approach to economic analysis.

In his view, savings could be effectively excluded from taxation by adopting normal income as the tax base:

"The taxation of normal income is the largest and probably the most perfect approximation recognised to the approach which excludes savings from the taxable base" (L. Einaudi, 1929, Della fonte del risparmio e della tassazione del reddito normale come approssimazione alla esclusione del risparmio dalla materia imponibile, in Contributo alla ricerca della ottima imposta, reprinted in Saggi sul risparmio e l'imposta, 1958, Turin, G. Einaudi, p. 465).

In La terra e l’imposta (1924), Einaudi traced the tradition of normal income taxation in Italian economic thought and fiscal policy. He began with the 1718 Land Register introduced in Lombardy, which assigned a fixed value to landholdings. Under this system, any future increase in land value attributable to the entrepreneurial efforts of landowners was exempt from taxation, a measure designed to incentivise land improvement and stimulate agricultural development. This approach to land income assessment, rooted in the cadastral method, was extended across Italy in 1886.

Einaudi observed that this system arose directly from the challenge of distinguishing between land income (the landowner's return) and agrarian income (the farmer's profit), compounded by the existence of diverse production regimes. For taxation purposes, this approach suggested disregarding the specific income-generating entity and the type of enterprise. Instead, taxation would shift to a category-based system, focused on ordinary income rather than actual income produced. Ordinary income was defined as the typical yield derived from land of comparable fertility for a specific crop, under normal conditions. Any surplus income exceeding this typical amount would be exempt from taxation.

In La scienza italiana e l'imposta ottima (1940), Einaudi proposed extending the application of this method, with land serving as a model for designing an entire taxation system.

More broadly, Einaudi's first argument in support of the theory of an optimal tax—measured against normalised category income rather than actual income—was the inherent difficulty in accurately determining real income. As he explained in Miti e paradossi della giustizia fiscale (1938), these challenges stemmed from discrepancies between the taxation period and the production cycle, inaccuracies in calculating the costs of generating income, and other complexities.

This approach implied that the taxable base for individual income would effectively be the average individual income. If the taxable base were determined by the income that a taxpayer could normally earn given the resources and conditions available, the system would eliminate uncertainty in assessment and, most importantly, reward those who outperform the average while penalising those who fall short.

Such a system represents an optimal, market-compliant form of taxation that incentivises production, saving, and capital accumulation.

In the context of agriculture, for example, doubling land fertility through labour and investment would be more beneficial than owning unproductive land. More broadly, taxpayers earning below the average would deplete their capital by consuming their savings, while those earning above the average would accumulate savings. As a result, the taxation of normalised income provides an effective approximation of an ideal tax that exempts savings.

8. Currency, Stabilisation, and Development

In the post-war period, Luigi Einaudi served as both Minister of the Budget and Governor of the Bank of Italy. In these dual roles, he spearheaded an effective campaign against inflation through a monetary stabilisation strategy.

By early 1947, wholesale prices had risen by 50%. Einaudi was deeply concerned about the risks of inflation to the production and distribution system, particularly for goods where precise pricing was difficult to calculate. To counteract this, he implemented measures to tighten liquidity in the banking system and raised the discount rate from 4% to 5.5%.

These measures proved effective: over the following six years, the price index increased by only 12%.

The theoretical foundation of this strategy lay in the equation of exchange. Einaudi rejected the simplistic assumptions of the quantitative theory of money, which posits a direct, proportional relationship between the money supply and the price level, assuming a constant real GDP. According to this theory, given a real income (R) the price level (P) is proportional to the money supply (M): M:P = M/R. Instead, Einaudi endorsed the more exact equation of exchange, which accounts for the velocity of money (V)—the frequency with which money circulates among economic agents within a given period. According to this model, the price level is expressed as P=(MV)/R, highlighting the dynamic interaction between money supply, its velocity, and real income.

The velocity of money circulation can vary due to technological advancements, regulatory changes imposed by the central bank—such as adjustments to the relationship between bank deposits and loans—or shifts in the liquid deposits held by market operators. For instance, during inflationary periods, the velocity of circulation tends to rise as individuals and businesses avoid holding liquid deposits whose purchasing power is steadily going down. Given fixed values for R (real income) and M (money supply), a decrease in V (velocity) leads to a corresponding decrease in the price level, P.

Einaudi’s stabilisation strategy targeted this dynamic by imposing stricter reserve requirements on banks than previously.

While inflation was successfully curbed, the initial contraction in monetary circulation was accompanied by stagnation in industrial production. Nonetheless, the long-term benefits of monetary stability were evident: Italy experienced a real economic development with a sustained GDP growth in the years that followed. This raises a critical question: Could anti-stagnation measures be implemented to enhance existing production capacity, and to accelerate economic development even in the immediate aftermath of the manoeuvre?

This query leads to an exploration of the relationship between Einaudi’s ideas and Keynesian theories. According to Einaudi, savings and investment represent identical values. However, this is precisely where his views diverged from those of John Maynard Keynes and the latter’s revolutionary insights. Einaudi recognised the discrepancy between savings and investment and engaged with the Keynesian analysis of underinvestment equilibria. He acknowledged that Keynes’s multiplier theory was relevant in contexts of widespread underutilised production capacity, but he argued that this was not the case in post-war Italy.

Instead, Einaudi believed that Italy’s economy in the post-war years faced conditions of resource scarcity or, at the very least, sectoral imbalances that distorted economic activity:

"If there are unemployed factors; if they can be combined economically; if merely the impetus of credit is insufficient to achieve this, then credit expansion is welcome (...). But do such unemployed production factors currently exist, waiting to be economically combined? The answer is undoubtedly uncertain. The only definitive assertion that can be made concerns the presence of numerous bottlenecks through which the unemployed factors must inevitably pass to combine with those trapped in corresponding dead-ends" (L. Einaudi, 1965, Lo Scrittoio del Presidente (1948-1955), Chapter XIV, “Risparmi e investimenti”).

The sustained and robust GDP growth that followed the initial years of stagnation proved Einaudi’s approach to be correct. Monetary stabilisation fostered savings, encouraged capital accumulation, and laid the groundwork for long-term development. This progress was further augmented by increased public expenditure, which expedited the reorganisation of production in response to competitive pressures. It also facilitated Italy’s integration into international trade and European economic frameworks.

9. International Opening and European Confederation

The recognised importance of capital accumulation in driving market growth, coupled with his unwavering support for free trade, made Luigi Einaudi a steadfast advocate of an open economy and a European federation.

He first proposed the idea of European federation as early as 1897 and reiterated it consistently from 1920 until the Treaty of Rome formalised its establishment in 1957.

Einaudi believed that technological innovation would inevitably propel the world towards economic unification. He argued that the expansion and development of markets would foster labour specialisation and strengthen the rules of competition. To illustrate his vision, he frequently turned to examples from agriculture. Reflecting on fruit cultivation, he described its initial stages:

"Where the good Lord had caused the seed to fall and take root (...) the farmer allowed it to grow haphazardly (...) and what did not rot on the ground or remain stored for winter family use was taken (...) to market (...). The proceeds from fruit did not count in the farmer's budget...."

However, he observed a transformation over time:

"But at a certain point, everything changed. The market grew, and specialised traders emerged. Fruits were now sold in large cities across northern Italy, Germany, England, and Scandinavia (...). The existence of a sufficiently large market for high-quality products disseminated knowledge of their existence and cultivation and, over time, led to a reduction in production costs. For such products to be sold, what was once offered to the few had to be offered to the many in growing quantities and at lower prices, which nevertheless had to cover costs. Competition, which is far harder to suppress or limit in a large market than in a small one, operates by compelling producers to reduce prices to the level of marginal cost" (L. Einaudi, 1944, I problemi economici della federazione europea, Lugano, reprinted in L. Einaudi, 1986, La guerra e l'unità europea, edited by G. Vigo, Bologna, Il Mulino, pp. 112–113).

According to Einaudi, the drive for market expansion was closely intertwined with the ideological struggle between totalitarianism and democracy, one of the underlying causes of the Second World War. In his view, the solution lay in transcending the confines of nation-states and moving towards a supranational federal state:

"The claim to absolute sovereignty cannot be sustained within the boundaries of a self-proclaimed sovereign state. Men cannot survive in a modern world governed by the division of labour in vast mechanised workshops, by rapid international communications, and by the aspiration for a high standard of living if their lives are confined within the limits of a single state. Autarchy means poverty and will inevitably drive men to conquest" (L. Einaudi, 1945, Il mito dello stato sovrano, in L. Einaudi, 1986, La guerra e l'unità europea, edited by G. Vigo, Bologna, Il Mulino, p. 40).

From an economic perspective, Einaudi believed that a global government would be the ideal solution for a globalised economy. However, he acknowledged that the largest viable political unit would have to be smaller. He therefore advocated for a European confederation of similar scale to the United States, with a single army and unified customs border.

Einaudi recognised that market expansion could give large companies a competitive advantage, especially under conditions of declining production costs. Nonetheless, he believed that the positive effects on competition would prevail. Among these was the observation that the diverging national interests of member states within a federation would make it harder for protectionist pressures to influence the federal government:

"It will be much more difficult to reach an agreement between Danish and Sicilian farmers when asking for protection against Russian, Canadian, or Argentine cereals. If the large Sicilian cereal growers (...) demand protection, the Danish farmers will object because they are interested in obtaining affordable, high-quality cereals for themselves and lower-grade grains for their dairy cattle" (L. Einaudi, 1944, I problemi economici della federazione europea, Lugano, reprinted in L. Einaudi, 1986, La guerra e l'unità europea, edited by G. Vigo, Bologna, Il Mulino, p. 117).

Einaudi did not see these measures as detracting from the Federation's critical role in combating monopolies through consistent and comprehensive policies.

He strongly advocated for monetary unification and the establishment of a European central bank, arguing that these institutions would ensure monetary stability and help reconcile conflicting interests among member states. On one side, some states might push for issuing and monetising public debt, while on the other, public opinion and other nations would resist such moves.

Einaudi maintained that a single currency would not hinder development opportunities for less affluent regions, provided that low productivity corresponded with low wages:

"The low wage of an Abruzzese shepherd cannot compete with the high wage of a Danish cheesemaker; to become competitive, that same low wage must be employed within an organisation similar to the Danish one (...). Similarly, the high wages in Denmark cannot compete with the lower wages in Abruzzo (...). Over time, the example set by better-organised companies will phase out outdated ones; but this process is gradual, leaving room for necessary adjustments to increase productivity and wages in less developed areas" (L. Einaudi, 1944, I problemi economici della federazione europea, Lugano, reprinted in L. Einaudi, 1986, La guerra e l'unità europea, edited by G. Vigo, Bologna, Il Mulino, pp. 156–157).

Furthermore, he argued, "if, thanks to the unification of currency and monetary circulation, the Federal Central Bank exerts considerable influence on credit distribution in a unified Europe, it will become evident and rational that the central bank should direct credit flows from states and regions where savings accumulate due to greater wealth towards those where economic activity is less advanced and new types of investment are more likely. Consequently, capital will flow towards poorer states, where numerous investment opportunities exist due to lower levels of economic development (...). The Federation, by facilitating financial relations between states, enhancing investment security, and guaranteeing adherence to laws through an impartial federal court, will significantly foster this transfer of capital from the richest to the poorest states" (L. Einaudi, 1944, I problemi economici della federazione europea, Lugano, reprinted in L. Einaudi, 1986, La guerra e l'unità europea, edited by G. Vigo, Bologna, Il Mulino, pp. 132–133).

The theoretical and political legacy of Einaudi’s advocacy for a free and open economy represents perhaps his most enduring contribution to the development of Italy and Europe.