How much is enough?
It's a simple question, and sometimes it has an easy answer. How much gas is enough to fill up my tank? Check your owner's manual. How much lasagna do I need for a dinner party? Ask your mom.
Unfortunately, there's no owner's manual for government, and Mom probably isn't an expert in fiscal policy (unless, like Diane Lim Rogers, she goes by the Internet nom de guerre EconomistMom). So when it comes to taxes, how much can be a hard question.
Consider, for instance, a pressing issue in this election year: How much should we tax the rich?
There are actually two "how much" questions at play here. How much income does it take to be rich? And assuming you qualify, how much should you be forking over to the government every year?1
Lots of politicians are ready to answer those questions. President Obama, for instance, thinks anyone making more than $1 million a year should pay at least 30 percent in taxes (the so-called Buffett rule, after billionaire investor and eager taxpayer Warren Buffett). More broadly, Obama would let the Bush tax cuts expire, pushing the top income tax rate from 35 percent to 39.6 percent.
Republicans tend to disagree with those proposals. Mitt Romney would start by making all the Bush tax cuts permanent. He would then cut rates by another 20 percent, bringing the top rate to just 28 percent.
So who's right, Obama or Romney? Both. Or neither. Take your pick, because when it comes to taxing the rich, there is no single, objectively correct answer. You can talk all you want about asking rich people to pay their "fair share," but don't kid yourself: You're just trying to turn private opinions into public policy.
On the other hand, don't be shy about those opinions, either. They are central to our tax system. It goes without saying that fairness is important to tax politics. Just listen to the politicians blather on about it. What's less obvious, but still true, is the importance of fairness to actual tax policy -- the nuts and bolts of our federal revenue system.
Every major change in federal tax policy over the past 200 years has been prompted and shaped by some sort of argument over fairness. Until the Civil War, for instance, almost all federal revenue came from tariff duties on imported goods. Lawmakers understood that those taxes were regressive, and some political groups (notably farmers) had been complaining about them for decades.
But it wasn't until 1861 that those complaints found traction in the context of wartime sacrifice debates. With objections already afoot that the conflict was "a rich man's war but a poor man's fight," Union lawmakers were at pains to demonstrate that rich men would at least shoulder a big share of the war's cost. As a result, Congress enacted the first U.S. income tax and started the nation down a road we're still on today.
The Civil War tax regime was fleeting. Its marquee innovation disappeared in the 1870s when Congress allowed the income tax to expire. But debate over the income tax did not expire with the levy itself. Instead, Americans continued to argue about tax fairness -- and the relative justice of income taxes and tariff duties in particular -- for the next four decades.
Following an aborted effort to revive the income tax in 1894 (cut short by the Supreme Court's 1895 decision in Pollock v. Farmers' Loan & Trust Co.), Congress brought the levy back in 1913. The tax resurfaced in response to another argument about fiscal fairness. In many respects, it was the same argument that had unfolded in the 1860s; it still boiled down to issues of taxing consumption and income. But since the Civil War, the industrial revolution had fundamentally altered the social and economic context of this argument. Of particular salience in the early-20th-century version of the fairness debate were the increasing concentration of wealth, the reorganization of large-scale business enterprise, and the advent of organized labor.
The income tax of 1913 proved durable, although the first 20 years of its life were tumultuous. World War I revived issues of shared sacrifice, inducing lawmakers to add a variety of very high rates to a tax that began with very low ones. The 1920s saw a retreat from those rates, as a series of Republican presidents successfully argued for tax cuts. But then the 1930s brought a Great Depression and a New Deal to Washington -- as well as heavy new taxes on the rich.
The ups and downs of the 1920s and 1930s were relatively minor episodes in the evolution of the income tax, at least when compared with the watershed of World War II. In the 1940s, war again served as a catalyst for major tax reform, chiefly by thrusting fairness debates to the center of fiscal politics. This time, lawmakers used fairness arguments to justify a major expansion of the income tax. Long the exclusive province of the rich, it took on a distinctly plebeian cast as millions of middle-income Americans found themselves added to the tax rolls.
That transformation of the income tax hinged on a bargain of sorts. Middle-income Americans agreed to shoulder much of the war's fiscal burden. But in return, political leaders offered tacit -- and sometimes explicit -- assurances that rich Americans would be asked to pay their fair share, too.
The terms of that bargain were clearly derived from New Deal debates over taxing the rich, including Franklin Roosevelt's distinctly punitive Wealth Tax Act of 1935. But during the war, heavy progressive taxation on the rich found broad bipartisan support. Even more striking, those rates long outlasted the war. One of the unsolved puzzles of fiscal history is the durability of high marginal tax rates during President Eisenhower's Republican revival.
Eventually, of course, those rates began to come down, especially during the Kennedy and Reagan administrations. But some 60 years after it was made, the wartime bargain around progressive taxation remains at least nominally intact. Statutory rates are much lower, of course, as are average effective rates on the rich. But substantial progression in the rate structure (at least with regard to labor income) remains a key element of the federal tax system. Efforts to curb that progression (through, say, a flat tax or a FairTax) have been notably unsuccessful. Graduated rates seem firmly entrenched in the current tax regime, just as they have been for decades.
But here's the problem with graduated rates, at least for many conservative critics: They are totally and utterly arbitrary.
Scottish economist J.R. McCulloch made that observation while Americans were in the midst of their Civil War:
The moment you abandon . . . the cardinal principle of exacting from all individuals the same proportion of their income or their property, you are at sea without rudder or compass, and there is no amount of injustice or folly you may not commit.2
Modern conservatives tend to agree. "Establishing a graduated rate scale and setting the top marginal rate on that scale are inherently arbitrary tasks," wrote Kip Hagopian in a 2011 article for the Hoover Institution's Policy Review. Talking about anyone's fair share, he adds, is an "invitation to abuse."3
Perhaps. But Americans have been offering that invitation for decades. Fair-share rhetoric has been a fixture of the federal tax debate since at least the 1930s, and somehow -- or at least so far -- the nation has managed to survive.
That may be because pretty much all tax decisions are arbitrary. A flat rate system rests on exactly the same sort of arbitrary intuitions as a system with graduated rates. Especially when that flat rate system includes a large exemption, which every politically viable version of the flat tax actually does. The same is true of the FairTax and most other plans for tax replacement or wholesale tax reform.
Indeed, even the choice of tax base is arbitrary. Sure, economists have insights to offer about the relative efficiency of different tax bases (and rates, for that matter). But the political fairness debates that will eventually determine the shape of federal taxation don't give much prominence to those economic insights. Even champions of single rate consumption taxes -- who have a solid claim to efficiency arguments -- tend to frame their political case in terms of fairness.
Ultimately, all tax systems rest on a variety of arbitrary opinions, intuitions, and prejudices. We rely on the political system to sort out those opinions in some reasonable fashion, avoiding "abuse" and approximating fairness.
Even in a year without a scheduled Taxaclysm (better than "Taxmageddon," no?), the presidential election would guarantee another round in our endless debate about fiscal fairness. But let's be honest as we renew this fracas yet again. The starting point for any discussion of tax fairness should be a confession: We're just making this stuff up.
1 For a briefer exploration of these questions, see Joseph J. Thorndike, "Taxing the Rich: What's Fair?" CNNMoney, June 15, 2012, available at http://money.cnn.com/2012/06/15/pf/taxes/tax-the-rich/index.htm. Some of the comments that follow are drawn from that analysis.
2 J.R. McCulloch, A Treatise on the Principles and Practical Influence of Taxation and the Funding System 1863, available at http://bit.ly/NZ1Cqv.
3 Kip Hagopian, "The Inequity of the Progressive Income Tax," Pol'y Rev., Apr. 1, 2011, available at http://www.hoover.org/publications/policy-review/article/72291.
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