What drives people to pursue a political career? Is it idealism, ideology or the pursuit of power? I like to think that they want to help society and believe they have a better capacity to do so than most of their fellow citizens. And yet the Law of Unintended Consequences does not usually allow politicians to correctly forecast the ultimate impact of their well motivated actions. A prime example was Prohibition, which sought to rid America of the scourge of alcoholism and public drunkenness. Widespread disrespect of the law generated rampant corruption among politicians and within police forces and gave rise to organized crime to supply booze even as consumption continued at high levels.
Whatever their motivations, politicians at all levels operate through two primary levers; the power to tax and the power to spend. In this post, let’s examine the power to tax. Starting from a base of good intentions, politicians use their power to carve out exemptions, deductions, credits and other tax code distortions to try to achieve their policy goals. While we tend to like our congressional representatives (after all we voted for them), as a body, national approval ratings for Congress are now at 21%.
It is no wonder that this is so. We have arrived at ‘Economic Perdition’, where as a country we lack either the resources to pay for our fiscal extravagances or widespread agreement on how to change the unsustainable path we are on. In large part we don’t think the tax code is fair because some very high income rich people and corporations like GE pay taxes at a low rate or none at all.
The alternative minimum tax (AMT) was passed in 1969 because 115 Americans paid little or no taxes on million dollar incomes derived from municipal bonds, and were vilified for not paying their “fair share”. In 2012, 31 million Americans will be ensnared by the AMT who are not even necessarily “wealthy”. President Obama says that is not enough, so last week he called for the “Buffett tax” of 30% on all income over $1mm. This failed on a Senate vote along largely party lines.
Liberal preoccupations with “fairness” and “social equity” are puzzling to me. Definitions of these terms can be debated endlessly even among well intentioned citizens. Because of income inequality, the “rich” should always pay more. (Of course, we could eliminate income inequality, but that would be known as communism.)
Many of us have no idea just how progressive the tax system already is. The top 1% of income earners already pay 38% of all taxes and that the top 10% pay about 70% of all taxes. With about about half of the population paying no net taxes after credits and transfers, the remaining 49% of citizens, the “middle class” pay only 27% of taxes.
Most Americans have little comprehension as to what manner of trickery and foolishness lurks within the federal tax code, which is now 17,000+ pages. (You can get copies from the GPO, but searching it as a database seems to me much easier than pawing through the 20+ volumes of small text.) As a nation, we spend $300 billion per year on tax preparation, or around 20% of what we pay in taxes because of its mind numbing complexity. And the efficiency cost of the tax system—the output that is lost over and above the tax itself—is between $240 billion and $600 billion per year. Of course, it’s not only tax policy that is so complicated. In the recent Supreme Court oral arguments on the Affordable Care Act (Obamacare), Justice Scalia claimed that the court could not reasonably be asked to actually read the 2700+ page law, claiming that would be tantamount to a violation of the 8th Amendment barring cruel and unusual punishment.
The economy works best when investors and companies can operate under predictable policies that allow them to better judge their risks for the long term. The U.S. economy doesn’t need another tax gimmick. We need tax reform that includes a permanent cut in marginal individual and business tax rates for everyone.
The president and many in his party keep telling us that the government needs more money, but if they believe this, why are they taking charitable deductions? I expect the reason is that most of us implicitly believe (for good empirical reasons) that private charities and other tax-exempt groups spend our money more wisely and carefully than the government.
As a seeker of truth, it seems to Diogenes that the only way to solve this conundrum is to enact fundamental tax reform that does not require a lawyer or accountant to explain to citizens. The Constitution was only about 8 pages. Even complex legislation need not be so obscure. The original Social Security Act was fifty-two pages. By not trying to address every possible contingency, these documents allow a flexibility necessary in the application of good law. Americans are fundamentally open and fair. They are easily capable of understanding the intent of laws if that intent is allowed to be made known.
We should all be easily able to file our tax returns by ourselves because the tax code makes sense. (60% of Americans currently pay someone to prepare their tax returns. Of those that do it on their own, the IRS estimates it takes them an average of 32 hours to do the job.) The best way to do this is to enact “flat tax” reform with one fixed rate above the poverty line. There should be few allowable deductions, perhaps only for charitable contributions and for mortgage interest, up to certain limits. Initially such a tax code seems overly simple, so let’s examine the reasons why this idea would work.
Compliance would be very high, as it would be extremely difficult as well as less profitable to game the system.
Tax collections from the “rich” would actually increase, as it has in most years in most of the 24 countries that have enacted such reforms. None of those countries that have adopted flat tax regimes have returned to progressive taxation.
Everyone above the poverty level would receive relatively equal treatment. Even large charitable donations would not excuse the wealthy from paying taxes.
A flat tax would discourage increased spending by government. Tax increases would affect all taxpayers. In the current tax system, government officials are lobbied for benefits to special interests paid for by all, or try to raise money for new spending by targeting certain groups or industries for taxes . If everyone’s taxes had to go up with any new spending, every new government program would have to be more carefully reviewed. In the long run government should become more efficient.
Businesses and government could better plan and organize their spending, leading to increased economic growth. We would change the discussion from fighting over shares of the pie to increasing the size of the pie. Partisan politics would be immeasurably reduced to discussions of how to spend the tax receipts.