TAXES AND THE RICH
Friday, June 15, 2012
President and Publisher
LEONARD E. BURMAN
Daniel Patrick Moynihan Professor of Public Affairs
Maxwell School of Syracuse University
Principal, National Tax Department
Ernst & Young LLP
JOSEPH J. THORNDIKE
Director of the Tax History Project and Contributing Editor
MR. BERGIN: Good morning. Many old friends, many new friends. Welcome all and welcome to the latest in Tax Analysts series of discussions on key issue in tax policy and tax administration. Today's topic is taxes and the rich. I'm Chris Bergin, the president of Tax Analysts, which is the nonprofit publisher of Tax Notes, Tax Notes Today, State Tax Notes, Tax Notes International, and many other fine print and online products on federal, state, and international taxation.
We are in our 10th year of published discussions on tax policy. If you are new to our discussions, let me first say, it's great to have you here. Also, let me take just a moment to explain our process today. I will open things up with some brief remarks to introduce our topic. I will then introduce our distinguished panel of speakers. Each of them will address aspects of our topic. After that, we will open up the discussion to all of you, and we encourage all of you to participate.
Whether you are seated at the table or just a bit away from it, just wave and I'll find you. We are streaming audio of this event on our website and we will post both the audiocast and a transcript there. We're also tweeting this event as we try to reach more people beyond this room through social media. And obviously, C-SPAN is here. And thank you, C-SPAN for your interest in our topic today.
So for all media purposes, we are on the record. For that reason, when I recognize you, please tell us who you are. Also, please speak into a microphone. For those of you away from the table, we have handheld mics and we will quickly get to you. I will moderate the discussion and we will end just a little bit before 11:00. Now on to the subject at hand: taxes and the rich.
What the rich should pay and why. But first, I want to thank President Obama, House Speaker John Boehner, House Minority Leader Nancy Pelosi, former top Obama adviser Larry Summers, and most of all, former President Bill Clinton for highlighting this very topic in the last couple of weeks. They have made this conference even more timely than it already was. Personally, I'm confused why President Clinton's comments about our topic just a few days ago were so wrong or why they were proved so controversial.
The way I heard what he said, he wasn't questioning if we should raise income taxes on the rich, but when we should raise income taxes on the rich. Seems sensible to me. Actually, there's a lot about the current debate on taxing the rich that confuses me. For example, who is rich? Is a family that makes more than $250,000 rich? Or only those that make at least a million dollars a year as Ms. Pelosi suggested, rich? It seems to be a point of some confusion among the Democrats.
And if you're rich, does that mean that you should never again face an increase in your taxes? Ever? That seems to be a point of some confusion among the Republicans. And can we tax the rich enough to address our problem of surging deficits and debt? You might think so if you follow the budget debate. And how important are the rich when it comes to investment and job creation? You might think that they're more important than anything else based on some of the rhetoric we hear.
In my own defense, I should point out that I'm hardly the only confused person in America. Tax practitioners often ask me what they should tell their high-wealth clients about the future of for instance, the estate tax. Here's the most honest and insightful thing that I can tell them: I have no idea. And they always seem dissatisfied with that answer. So here we are. The Democrats are frantically looking for rich people to tax and Republicans are adamantly refusing to tax anyone, especially the rich.
With the parties largely gridlocked over tax policy, unable to set a long-term course for taxes, we now have a tax code that is increasingly temporary with major provisions due to expire at the end of the year and other provisions that expire on a regular basis. That makes it impossible for practitioners to advise their clients and for businesses and individuals to plan a future. All of that hurts our economy over the long term.
But I think the thing that I'm most confused about is, why our elected leaders don't seem to understand, or if they do understand they don't seem to care, all the problems with this temporary tax writing is creating. We have a wonderful panel here today that I'm sure will help clear up my confusion, at least when it comes to taxes and the rich. I will introduce them in the order in which they will speak. Joe Thorndike is contributing editor at Tax Analysts and director of the Tax History Project at Tax Analysts.
Len Burman is the Daniel Patrick Moynihan Professor of Public Affairs at the Maxwell School of Syracuse University. And Bob Carroll is a principal in the National Tax Department of Ernst & Young. Now, all three of these gentlemen have books. I believe Bob's book is already out. There's Bob's book. Len has a book coming out. I think I have the flyer here. Yeah, I got a flyer here. Taxes in America: What Everyone Needs to Know. And Joe has a book coming out and the title will be?
MR. THORNDIKE: Their Fair Share.
MR. BERGIN: It's only a rumor that I'm getting a commission on this. Having said all that, Joe, would you start us off?
MR. THORNDIKE: All right. Well, you know, I've got to say -- I got to start by confessing that I promised that book at so many events and it's still upcoming. Any minute. But it really is sometime soon, I hope. Chris promised that we're going to clear some stuff up, and I don't know if I'm going to clear anything up actually, because I think what I'm going to do is just confuse the matter and sort of, embrace the confusion. But I can make a few points which are largely historical. Given my historical background, that makes sense.
The first is obvious. When it comes to taxes -- the tax politics, the fairness really matters. You can see that by the fact that C-SPAN is here. I have an article in CNN today. Tax fairness is always the hot issue, at least among voters. What's less obvious but I think is just as true, is that tax fairness is really important to tax policy. Not just the politics, but the actual making of tax law. Every major change in the federal tax system -- and by major change, I mean sort of, enduring change.
Regime change, historians call this. The kind of change that lasts for decades. Every major change in the last 200 years has been prompted and shaped by an argument over what's fair. Our current tax regime dates from World War II, and you know, this was the time when they transformed the income tax from a mass tax to a -- a class tax to a mass tax. It used to be a narrow tax just on the rich. They changed it into a tax that really, all middle-class Americans paid.
The deal here -- there was an implicit bargain and to some degree, an explicit bargain that underlay this change, and that was, we're going to ask you middle-class people to pay a lot of money. You've never paid this tax before; we're going to start asking you to pay it now. We're going to ask you to pay the income tax and increasingly, a lot of payroll taxes. In exchange for that, we're going to tell you that the rich people are going to pay a lot, too.
I mean, there were an awful lot of politicians who made that bargain explicit. So progressive taxation really lies at the heart of what our current tax system is. And opinion polls since World War II have shown really strong and consistent support for the general notion of progressive taxation. But who knows what that might actually mean. You know, the thing about progressive taxes and it's a thing that I think drives a lot of conservatives crazy -- is that they are completely and totally arbitrary in operation.
You can win a lot of agreement, even from conservatives, that the idea of a progressive rate structure is a reasonable one. But you can't win broad agreement on what that rate structure looks like, where the bracket should fall, or anything like that. Conservatives often object to proposed tax increases by saying that the hikes are arbitrary. And there's a great quote from the Scottish economist J.R. McCullough, a long time ago: "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 a compass and there is no amount of injustice or folly you may not commit".
I think that's a statement of truth. There's really not much doubt about that. You don't have any clear standards. But of course the existing rate structure, if we're complaining about, you know, a tax increase -- a rise from where we are, the existing rate structure is just as arbitrary. Even a flat-rate structure would be completely arbitrary. There's no scientific objective, disinterested starting point to talk about rates. Every structure is a matter of opinion.
Even the overall structure of the system -- you know, what sort of taxes do we use? An income tax, an excise tax -- they used to love excise taxes. Some sort of broad-based value added tax? That choice of taxing instruments is also completely arbitrary. The economists have lots to tell us about which they think will work better, which are more efficient. But on the issue of fairness, there's no way to sort it out. So I think the starting point for any conversation about tax fairness has to be an admission, which is essentially that we're just making this up.
We're all just sort of, shooting from the hip. We can develop all sorts of sophisticated theories and Lord knows, the economists and the philosophers have done so about marginal utility and sacrifice and you name it. No one, I don't think, has ever come up with a really convincing theoretical justification for any particular definition of what is fair in tax policy.
Tax fairness really is a social construction, and the only thing that matters is how people feel about it. So let me finish with a quick discussion of tax fairness in American history. I've already touched on it a little, but I think it is fair to say, historically, Americans have felt pretty good about taxing the rich. They've tried to do it in a variety of ways with weird excise taxes on things that only rich people buy like snuff, back in the early Republic.
They've also tried to do it with an income tax. First, in the Civil War. It was an explicit effort to make the tax system more fair. Then again, it goes away and comes back again in World War I. Every time it's an effort to make the system more fair. Now it's not in general about redistributing wealth, and I think that this is a mistake that a lot of progressive voices make. American history doesn't lend a lot of support to the idea that Americans think we should take money from rich people because they just have too damn much.
What that does lend support to, is that they think we should ask rich people to pay their fair share. As ridiculous as that phrase may be, as open to debate, as meaningless in any specific sense, it's very powerful in a political sense. So I think that the issue here is not to simply say, ah, well you can't talk about fairness. That's crazy. And you hear that a lot today, you know, and that doesn't help us at all.
It may not help us at all, but it is also the only thing that matters. I think really we'll find that whatever tax reform we choose going down the road, that issue of fairness is going to move the debate. It will actually, I think, be the key element in moving the debate. So how much is enough? How much do we tax them? What's the right number? I think that's what politics is for.
MR. BERGIN: Thank you, Joe. Len?
MR. BURMAN: Thank you, Chris. And I should point out that my book, which isn't going to be coming out for a while, is with Joel Slemrod who has a coauthor who is kind of slow on his part of the book. So you know, the question is: Should taxes go up on the rich? And the answer is kind of a no-brainer. Taxes are going to have to go up on everybody. Federal taxes are at their lowest level since 1950 and that was before the Interstate Highway System and Medicare and scores of other programs that we rely on.
We've promised all of these programs to take care of senior citizens: Social Security, Medicare, Medicaid, which pays for half of nursing home care. And the population is aging, so the demands on the federal government are going to be unprecedented in coming years. It would be absurd to argue that the wealthy shouldn't pay more. So the real question is whether -- you know, whether we should have a more or less progressive tax system.
And as Joe pointed out, there's no -- you know, you've got two economists on this panel and economics doesn't tell us what the right level of progressivity is. And we can write down these models where you maximize social welfare and then it becomes a trade-off between efficiency -- you know, the economic costs of taxation and progressivity. But the thing that's left out is, what's the social welfare function? How do you value the well-being at the top compared to people in the middle or in the bottom? And that is essentially a value judgment.
As Joe pointed out, polls show that most people favor the idea of a progressive tax system, and recent polls have suggested that people think that high-income people should pay a larger share. In terms of, you know, what the right level of progressivity is, this isn't really -- again, as Joe pointed out, it's not really about punishing the rich. I like rich people. They're successful, they -- you know, we wouldn't have much of an economy without rich people. They're very generous; they support various kinds of nonprofit activities reflected in this room. They support universities.
But the question is, how do you determine what people at different income levels ought to contribute to paying for the government? And in a free market system, a progressive tax system can help to mitigate the inequities that are the Achilles' heel of unrestrained free enterprise. It's not class warfare to argue that the rich should pay a larger share. In fact, I'd argue that it's exactly the opposite.
Because if we can't figure out a way to mitigate the inequities -- the inequities of our capitalist system where a very large and growing share of income goes to people at the very, very top, that system isn't really sustainable. In a democracy, people vote on the rules, and if people think that the system is rigged in favor of a very small share of the population, that's going to change. And there are a lot of -- you know, economists know that taxes entail economic cost, the whole notion of deadweight loss.
And higher tax rates are economically costly. There are two issues. One is that higher tax rates are not necessarily the way that we want to raise more income from a -- more revenue from higher-income people. The other thing is that, things we might do to mitigate income inequality outside the tax system could entail much, much higher economic costs like, for example, putting a lot of restraints on the free market system; very, very high minimum wages; restrictions on executive compensation; and things like that.
There's a question about whether the wealthy are overtaxed. The Congressional Budget Office has compiled income tax statistics going back to 1979, and over that -- from 1979 to 2007, the share of income going to the top 1 percent more than doubled, from 10.5 percent to 21.3 percent, while their average federal tax rate, including individual and corporate taxes, excise taxes, and payroll taxes, fell by more than 20 percent, from 37 percent to less than 30 percent.
During the same period, the share of income going to the middle 60 percent fell by a similar amount. Basically, there was just a shift in income from the middle to the top, and their tax burden also fell, but by much less, from an average of 18.8 percent to 15 percent. Capital gains tax rates have been much in the news because Gov. Romney's tax return, the Buffett rule, all of those things. Capital gains tax rates are at their lowest level since the Great Depression.
And some -- you know, one question is, why are there such large income disparities? And some imply that it's a matter of effort. That the rich work really hard and lower-income people don't. That they're slackers. Clearly, that's not the case. I mean, there are some people who are poor because they don't work very hard, but there are people who work full time at jobs close to the minimum wage or not much above and their incomes have really stagnated.
If you look at a set of charts that were handed out at the beginning, one of the slides shows the median earnings going back to 1970, 1974. And the median earnings for full-time, four-year workers in constant dollars adjusted for inflation, have been basically flat. So the economic gains that have produced huge income growth at the top -- the first chart shows the share of income going to the top one-tenth of 1 percent and the top 1 percent. And I'm sure a lot of you have seen these figures before.
Those are at near-record highs. They declined a little bit in the recession, but they're much, much higher than they've been -- they were through the 1960s, 1970s, and early '80s. At the same time that incomes at the very top have exploded, incomes at the middle have been basically flat-lined. Now the question is, you know, what do you do about that? And there's also a question about how much access that people at different income levels have to those, you know, high incomes at the top.
The data suggested economic mobility in the United States is lower than it has been historically. The children of rich parents are much more likely to grow up rich than the children of lower-income people. Rich kids have access to better schools -- Syracuse University. They live in safer communities, and when they grow up, they have better connections to help them succeed.
A progressive taxation is not the sole solution to extreme economic inequality in the United States, but it can mitigate its effects. We should also invest more in education, for example. But progressive taxation helps and education takes a long time to play out. And we should also care about extreme inequality, even if we didn't care -- even if we didn't feel compassion for struggling middle-class families. There's evidence that very unequal economies grow slower than economies with less skewed income distributions.
This may be because inequality provokes demands for regulations, trade sanctions, and other provisions that are inimical to economic growth. Or it may be that workers in less equal societies are less productive because they feel alienated. There is an issue about, what is the cost in terms of economic growth of higher taxes? People often cite the experience of President Clinton, who raise taxes when he took office and the economy did very well in the 1990s.
President Bush's taxes. The economy didn't do very well in the last decade. Ronald Reagan, who is well known as a tax cutter -- he promised tax cuts when he took office, was convinced to raise taxes in 1982 and 1984. And actually it was because he was concerned that the deficits that resulted from the big tax cuts in 1981 would entail huge economic costs. And that's another fundamental point, that if we can't figure out a way to raise enough revenue to pay for the government, deficits are going to entail much more of an economic cost by raising interest rates, making it harder for people to buy homes, making it harder for businesses to invest, than any of the costs from higher taxes.
Finally, the issue isn't whether we should necessarily raise tax rates on higher-income people. The issue is whether we should make the tax system more progressive. And the best way to do that, I think most economists would agree, is to broaden the tax base. To eliminate as many of the preference items, most of which are very, very skewed -- and they're very, very skewed towards people with higher incomes. To eliminate as many preferences as possible so it's possible to actually lower marginal tax rates at the same time that you make the tax system more progressive.
The bipartisan Bowles-Simpson commission proposed exactly such a plan. The Bipartisan Policy Center which I worked on also proposed such a plan. So you can make the tax system more progressive at the same time that you raise more revenue and help reduce the deficit which is really the big threat to the economy. And with that, I think I'll pass it off to Bob.
MR. BERGIN: Thanks, Len. Bob.
MR. CARROLL: Well, it's a real pleasure to be here, Chris. I appreciate the opportunity to participate in the discussion. It's really nice that Tax Analysts is able to put on these events and have really interesting and deep policy discussions on important issues.
Another thing I want to say is, nothing I say should be construed to represent Ernst & Young, the organization I work for. It's interesting, when I wrote my notes for this talk, I was going to end with a particular point -- it's actually the same point that Len ended with.
And I think that a discussion of whether we should have a more progressive tax system, whether we should tax the rich more is -- and the focus on tax rates I think is where I kind of have -- take issue with that discussion. I think the focus on tax rates is really problematic, simply because the tax rates themselves, the graduated tax rate schedule contributes to the progressivity of our tax system, the progressivity of the tax burden, but it's not a determining factor.
As the president's own fiscal commission showed, the fiscal responsibility commission, or more commonly known as the Bowles-Simpson commission, you can simultaneously lower tax rates very substantially and broaden the tax base very substantially and replicate the current distribution of the tax burden.
I think as we proceed through tax reform and carefully weigh what we want the distribution of the tax burden to be, I think we have to be very deliberate and very understanding of what economic costs come with, higher tax rates on high-income tax payers.
I think, from my own perspective, I really have no idea what the right distribution of the tax burden is, what it ought to be. That's not something, as Len indicated, economists are very good at. That's something, in my own view, that is really best left up to people who are elected to office, to politicians. I think everyone has a view and probably everyone has a different view on how progressive the tax system ought to be.
One thing I will say, however, is that I do know that the current tax system is progressive. I do know that, and some of the charts that Len included, high-income people pay a larger share of taxes than low-income people currently. My recollection of the statistics is the top 1 percent pay about 36 percent of individual income taxes. You don't have -- if you look more broadly at all federal taxes, you don't have that level of progressivity, but you still have a substantial -- a level of progressivity. So we do have a progressive tax system. That's something that should be a starting point for the discussion.
In the sense, the discussion on whether we should tax the rich more -- you really get to the core of some of the conflict in the tax reform debate. Usually when we talk about tax reform, we're talking about, you know, a set of objectives, policy objectives, a simpler system, a system that's more fair, whatever that might mean, and a system that's more pro-growth.
Today there are more issues or objectives that have added to that debate. Having a more competitive system better enables us to compete in a global marketplace, and having a system that is more stable, where we don't have roughly 25 percent of the tax code expiring every couple of years to provide taxpayers with certainty.
But going back to those core objectives of tax reform that usually come up simple, or fair, or pro-growth, the two objectives of fairness and pro-growth are often conflicting, often at odds. And it's important to -- when we talk about fairness, to recognize that some of the policy remedies, more higher tax rates in high-income people, do come with economic cost. This is a point that Len made quite clearly. High tax rates -- higher individual tax rates -- come at an economic cost, welfare loss, the efficiency loss associated with higher taxes related to the square of the tax rate, not the tax rate alone.
As those tax rates get higher, the drag on the economy gets much, much larger, not in proportion to the tax rates, but relative to the square of the tax rates.
Just to put this into perspective, I have a long career working at the Treasury Department, and I was very involved in analyzing changes in individual tax rates when I was there as an economist, and later as a political appointee. When you raise tax rates on high income taxpayers, one way to look at it is, what does the revenue take to the government?
Treasury's own estimates, when they estimate raising the top two rates, they would estimate that the revenue relative to the static revenue gained from raising the top two rates, about 25 percent of that static revenue gain pick up would be lost due to behavioral responses. Other estimates would have that -- those behavioral responses much larger, more like 40 percent of the revenue lost. That just gives you a sense for, from the government's perspective, the cost associated with higher rates. It also gives a sense from the taxpayer's perspective or policymaker's perspective what is the cost involved in raising those rates.
The distortionary effect of high rates is much greater for higher-income people than lower-income people. There's a number of papers that illustrate that point. So high tax rates carry large economic costs.
Another aspect of tax rates is, what are they taxing? Are they taxing the return to labor or the return to capital? Economists generally have a great affinity for consumption taxes that would tax -- that wouldn't tax the return - most of the return to capital or savings at all.
I have a new book, but I didn't get to mention the title of my book. So just in the interest of fairness, Progressive Consumption Taxation: The X-Tax Revisited just released through AEI Press, coauthored with Alan Viard on June 4th, available through Amazon.com.
In any case, taxing capital income, from a, you know, taxing capital income, so one of the arguments for taxing capital income is, there's a perception not a great deal of capital income is disproportionately other returns, disproportionately received by higher-income taxpayers, and thus, if you want a more progressive system, you ought to include the return to capital in the tax case to achieve that objective.
However, taxing capital income does come with an economic cost. It's a drag on economic growth. Some estimates -- by a paper about a decade ago suggests that if you went to a flat rate consumption tax, not something I would advocate, but if you were to go to a flat rate consumption tax, you could increase long run GDP on the order of 6 to 9 percent in the long run. The size of the economy would be 6 to 9 percent larger.
If you had a progressive consumption tax, the estimates would be smaller. And when I say a progressive consumption tax, I mean a progressive consumption tax that replicates the current distribution of the tax burden, something that's just as progressive as the current tax system at a high level. For the top 1 percent, for the top 5 percent, for the top 10 percent, those groups would pay roughly the same amount in taxes as they pay today. Based on Treasury estimates from work related to the 2005 tax reform panel, growth would increase in the two, three, four percent range in the long run. The size of the economy would be that much larger.
Another aspect of our tax system is that an awful lot of flow-through, passthrough income is funneled through and taxed through the individual income taxes subject to the individual tax rates. That's one of the reasons there is a lot of resistance to raising the top rates, because depending on the estimates, 40 or 50 percent of flow-through income is generally thought to be subject to those tax rates, and so that's a consideration in terms of evaluating, you know, the economic costs to the economy of raising the top rates.
How will that affect entrepreneurship? How will that affect the employment -- the hiring decisions of entrepreneurs, the investment decisions of entrepreneurs? How will that affect the growth rate for small businesses? All of those things are considerations and factors that enter into this discussion.
So I think you do really need to think about cost. And I'll go back to the point that I started with and that Len ended with. In terms of thinking about the distribution of the tax burden, I think of much more relevant questions. What is the distributional effect of the federal government, not just the tax side? Len has a paper where he makes the case, as I understand it, that a lot of the tax expenditures, the $1.1 trillion in spending that's run through the tax code, should perhaps be thought of more as spending as opposed to part of the tax system and should be evaluated along the lines of the spending programs.
Those provisions have profound effects on the distribution of the tax burden, just as the graduated tax rate schedule does. They are currently factored into distribution tables produced by Treasury or CBO, the tax expenditures.
I think we ought to also really think very much -- we should think very carefully about how all the spending programs also affect the distributional footprint of the federal government. And I think as we get into tax reform -- it's kind of interesting, because tax reform, you know, there are reasons to do tax reform, really good reasons, but one of the reasons -- I think that tax reform -- there's a very strong focus on tax reform today, it's because there's a perception that in order to do entitlement reform, we'll have to do tax reform also to get it onto the table. And from a distributional perspective, there's a lot at stake through entitlement reform, and there's a lot at stake for the nation in terms of addressing the long-term fiscal imbalance. It's probably a much bigger issue for the nation than tax reform -- addressing the long-term fiscal imbalance -- where the reform of the tax code probably has to be part of that discussion in order to get entitlement reform to work. But at the same time that we're talking about the distribution of the tax system, we ought to also be talking about the distribution of the entitlement programs.
And it would be -- I think the current state of what economists know, it's probably still a bridge too far, but it would be really interesting to see distributional tables factored into both sides of the equation, the spending and tax side.
MR. BERGIN: Thank you, Bob. I'm going to open this up to anybody who wants to comment. Please raise your hand. I'm going to go to Len first, because he's a panelist. And remember to state your name, especially those who know me and I know you, because that's harder for you.
MR. BURMAN: I just wanted to respond to a couple of things that Bob said. First of all, I want to say that people should get Bob's book. You know, people have talked about the national retail sales tax for a long time. Those are ridiculous proposals, from my perspective, because they don't account for the -- I mean they would make the tax system much more aggressive. The national retail sales tax couldn't -- or sometimes it's called the Fair Tax -- couldn't even be administered in any sensible way.
You can write to me at Bob.Carroll@ -- okay. But basically economists have long liked the idea of a consumption tax on efficiency grounds because we don't think we should have a tax penalty to savings. But there is the issue of fairness and the fact that most of the savings is done by high income people, most of the wealth is held by high-income people, and the X-tax, which Bob and Alan Viard write about, takes very seriously the fairness concerns.
The issue about the economic costs of taxation -- and I guess more generally the issue of growth versus fairness -- is, it is a trade-off. I mean sometimes it sounds like when Democrats talk about tax policy, all they care about is fairness, and when Republicans talk about tax policy, all they care about is economic growth. And I think most people who are not drinking water out of the Potomac would say that there is something of a trade-off -- that if all of the economic growth goes to a tiny, tiny sliver of the population, that's not a particularly good thing. And, of course, if you achieve fairness by bringing everybody down, that's not a really good thing either.
The best way to do this is, as Bob mentioned, is by broadening the base. And I should point out that, you know, when you talk about the economic costs of taxation, one conclusion -- this is in a paper by Emmanuel Saez and Peter Diamond -- is that if you broaden the base, you actually lower the economic costs of tax rates themselves, and that the logic is that at a high tax rate, if there are lots of loopholes in the tax code, you have a huge incentive to take advantage of those loopholes.
If you got rid of a lot of the loopholes and preferences, then high tax rates actually entail smaller economic costs because it harder for people to avoid them. At this point, I think Bob and I are in complete agreement. What I'm going to say next might actually provoke a response from him.
The biggest loophole in the tax code is a lower tax rate on capital gains. And that's actually, you know, if you look back to the 1986 Tax Reform Act, if you look a the Bowles-Simpson plan and the Bipartisan Policy Center plan, one way they were able to achieve a high level of progressivity with lower rates was by taxing capital gains the same as other income. And the problem with the lower tax rate on capital gains -- right now the capital gains tax rate -- the top capital gains tax rate is 15 percent, the top ordinary income tax rate is 35 percent.
If you can figure out a way to turn your ordinary income into capital gains, you save 20 cents on the dollar. And this has produced this whole industry of advisers and consultants whose job it is to come up with ways to generally make, you know, deductions to shelter your ordinary income from tax and ultimately pay you back in the form of capital gains. This is a huge waste.
First of all, a lot of the investments that produce these deductions are not -- they don't make any sense from an economic perspective; they only make sense when you consider the tax consequences.
Second, there are a lot of really smart people working on these tax shelters who actually could be doing socially useful work under other circumstances. Remember, right, Bob.Carroll@ -- You probably can't tax capital gains at a 35 percent rate. The Joint Committee on Taxation and Treasury would square that as raising less revenue than say taxing gains at a 28 percent rate. But if you can lower it in our income tax rates and tax capital gains at the same rate, that's a reasonable trade-off. Ronald Reagan agreed to it, even though he didn't particularly want to tax capital gains more because it produced this, you know, it produced a tax system with radically lower rates.
The thing that saved tax reform in 1986 was when Bob Packwood came up with the idea of -- what he called the 27 percent solution. It ended up at 28. But the thing that made it work was taxing capital gains. And it eliminated a lot of opportunities for tax sheltering.
MR. CARROLL: So there's one thing that Len and I will agree on -- that the second or third thing he said would elicit a response. So I wanted to make two points: first to focus on capital gains, and then make a broader point where -- in any case, on capital gains -- I really do take issue with what Len said. I think if one's looking at capital gains and dividends, I think one needs to really think about the entire income tax system in its totality.
I would tend to think that Len would agree with this perspective. You're looking at investment made through corporate solution. You really need to take into account both layers of tax that are imposed on those investments and those returns that flow to investors. And you have to take into account the corporate income tax, as well as the investor-level taxes on gains and dividends.
When you do that, the current integrated tax rate on capital gains -- depending on how you do the math, depending on how you count the corporate income tax, and how you account for a deferral of capital gains taxes at the individual level and step up a basis, but generally if you were looking at the top integrated tax rate -- you would calculate that top integrated tax rate on capital gains to be in probably the mid 40's, including state income taxes, not the 15 percent federal rate on investor-level capital gains.
And so in that sense, when you're thinking about tax reform, I think many economists would agree that, with the comprehensive income tax, you would tax -- if you believe that you should have a comprehensive income tax, which I think is probably where Len would be, whereas I might lean much more heavily towards a consumption tax which would exclude the return to saving and investment all together on an important portion of the return to those flows. But in any case, if you wanted to tax all income -- a comprehensive income tax -- you would still tax income once, not more than once. And so with respect to capital gains and dividends -- where a corporation can choose to retain corporate income, increasing the value of the firm -- it's then realized by shareholders when they sell their shares or if they choose to pay out those corporate earnings as income. As dividends to shareholders, it's taxed a second time.
The integrated tax rates for gains are probably in the mid 40s. The integrated tax rate for dividends is around 50 percent. In 2013, the integrated tax rates on capital gains will rise to probably around 50 percent, if not higher, because the federal capital gains rate is scheduled to rise from 15 percent to 20 percent under the individual income tax and then to rise another 3.8 percent under the Medicare tax and under the [Patient Protection and Affordable Care Act] healthcare legislation.
The capital gains -- the Medicare tax -- will apply to unearned income for the first time in the U.S. The dividends tax rate will rise to somewhere upwards of 68 percent from its current level of, you know, substantially lower than that, around 50 percent on an integrated basis. So again, I think you really, at least for investment made in corporate solution, you really need to think about the double tax and think about the income tax on an integrated basis, and so that's, I think, a very important issue.
As Len indicated, just looking at capital gains tax rates through the individual income tax, Joint Committee, CBO, and Treasury would tend to view the revenue-maximizing rate on capital gains in the neighborhood of 26 to 28 percent. That's generally what they've assumed for the last 15 or 20 years. It's my understanding that that's what they would still assume.
And then the other point that I would make is, I think when you look at the income tax system or the tax system generally, you really need to be careful, I think, to not fall into the trap that it's the cause of income inequality. I think it's an important policy tool to address income inequality, perhaps. But I think it's really also important, when one is talking about these issues, to focus on what we think is the source of the increase in income inequality -- measured income inequality over the last 15 or 25 years.
And it seems to me that that's a very important discussion to have, because then that might lead us down a different path in terms of how to address rising income inequality. So if we think the stagnation of wages for those in the middle is perhaps due to globalization and perhaps due to lower-skilled labor in the U.S. having to compete with low-skilled labor in emerging market countries -- in Southeast Asia and in South America and other places, and when U.S. low-skilled labor is competing in a more global market, it puts downward pressure on those wages -- then I think the high-skilled labor is getting fairly substantial returns to their human capital.
It kind of leads you down a different path. It would tend to point you to the most important thing we could do to address that income inequality -- something that's a long-term investment in education, and trying to raise the skill levels of the bottom two or three quintiles of the U.S. population -- is probably a very, very important thing that we ought to be focusing on.
And to focus on the tax system is important. I think most people in the room would agree that we need to have a progressive tax system, but I think that's an important part of the discussion.
MR. BERGIN: Len, do you want 30 seconds to respond?
MR. BURMAN: Yeah, I could go on for hours, but just I want to point -- I actually agree with Bob that we should just tax capital income once. The lower tax rate on capital gains and dividends is a terrible way to do it. And there's actually an article in a wonderful publication called Tax Notes.
MR. BERGIN: Our publication.
MR. BURMAN: I wrote in 2003, I think, called, "Taxing Capital Income Once." And basically what it says is that I like Bob Carroll's -- I think -- were you the DIS when the capital gains cut --
MR. CARROLL: I was over at the Council of Economic Advisers.
MR. BURMAN: I liked your first proposal better than the one that was actually enacted, which was the lower rates.
MR. CARROLL: I don't disagree.
MR. BERGIN: OK. This gentleman here and then Scott, I'll go to you.
MR. HANKIN: I want to go back --
MULTIPLE SPEAKERS: Name.
MR. HANKIN: Steve Hankin. I was a -- I used to be an attorney with the IRS. I'm retired now. I want to go back to the statement made about fairness and how, you know, that's the major concern. You seem to have accepted the notion that everybody agrees that this income tax system -- and particularly with the progressive rates -- is fair. I would like to submit to you that taxing the rich is essentially taxing a person based on his status.
It would be -- to me it's not much different than taxing a person based on his religion, or his ethnic group. The big difference of course is that the -- it gets the amount of revenue in that if you tax people who are wealthy that's a big source of income, but the fact remains that it is a -- essentially you're taking somebody based on their status -- their wealthy status. And our country never wanted to have these distinctions based on status. So what I submit to you is to say that that's fair to tax somebody on the basis of their status, I don't think that's fair at all. I don't think that we just -- you're just assuming that that's fair. You're starting off from a point of saying that must be fair when it's not fair.
MR. THORNDIKE: I think you are probably talking about me because I said that the fairness was always so central and so I'm going to retreat into what the historians always say, you know, you can not like what I say, but that's the way it was. And I think that is really my answer. I mean, your position is fine and, in fact, fully consistent I think with what my point is, which is that we're going -- people are going to argue about what's fair. And there are plenty of reasonable arguments to be made that the income tax is not fair, that progressive rates are not fair, but the fact does remain that historically Americans have found them to be pretty fair. Assuming that you accept poll data as relevant, or election results as real evidence, Americans have embraced it. I mean, if nothing else the income tax has been with us for a 100 years next year. If people don't think it's fair and it's always had progressive rates in that time. If people don't think it's fair it's sort of remarkable that it lasted so long.
MR. HANKIN: Well, if I could respond to that. I mean, people are always going to want to tax the rich and they're going to say, oh, that's fair because 90, you know, 98 percent of the people aren't rich, so they're going to say, yeah, it's fair for them to tax. I mean, that word fairness is just loaded with all kinds of --
MR. BURMAN: It's certainly true that there's not a universal agreement. There are a lot of people -- I write a blog on Forbes and I hear from these people all the time: "Man, you're punishing the job creators and it's unfair." One question is, so first of all, that it's a value judgment. So to say that this is a matter of fact that more progressive tax is fair. You're right that that's a value judgment, which I think is shared in Joe's point of this -- I've shared it with most Americans, but it's really not all of them. The question is, I mean, do you decide what the fair distribution of tax burdens is based on what your economic status is, or would you -- is the right way to decide, say, based on not knowing where you come out. This is the whole notion behind, you know, John Rawls's Theory of Justice, which is that, you know, when you decide distribution issues it should be behind a veil of ignorance, not knowing whether you're going to come out rich or poor.
I can say from my own experience, I grew up pretty poor and now I'm doing reasonably well and I think from my perspective having people like my parents pay little or no taxes and having me pay a substantial amount of taxes makes perfect sense, but I'm probably not going to change your mind or a lot of other people's but it's also -- it's just a lot easier for me to pay a substantial tax than for my parents who at times might, you know, my mother wasn't eating because she didn't have enough food to put on the table. And saying she should pay more tax when, you know, my decision is about whether to take a second vacation or not, from my perspective it seems pretty easy.
MR. BERGIN: Let me jump in here for a quick second because the theme of the conference is what the rich should pay and why and whether it's fair to tax the rich. So I'm certainly not assuming that it's fair to tax the rich. I'm not assuming anything. That's what we're here to discuss. Let me -- I wanted to go to David.
MR. BRUNORI: That's to my point.
MR. BERGIN: That's to your point, exactly. Exactly.
MR. BRUNORI: I noticed you had Scott.
I know you had Scott up, but I just wanted to ask a follow-up on that question. I wanted to ask Joe something because I sort of agree with you, by the way. And I wanted to ask Joe you said that people -- I think you said that people have long support -- David Brunori, by the way, Tax Analysts. People have long supported the idea of progressive taxation as being fair, I think you said. But isn't true that people support the idea of progressive taxation at income levels above what they make? That it's like, oh sure progressive taxation as long as it's kicking in at more than what I make and whether I make $10,000 or $100,000 or a million dollars, with the exception of Len does not mind paying higher taxes right now. But most people would say, yeah progressive taxation is great as long as it's not me, which then doesn't it turn it into a big redistribution mechanism?
MR. CARROLL: There is a very famous quip: "Don't tax me, tax that man behind the tree."
MR. BRUNORI: Right. So you may be all for taxes as long as it's not me.
MR. THORNDIKE: The nasty way to put that is that it's all envy, right? And that you're going after these guys in punitive way. The less nasty interpretation is that everybody has their self-interest bias and so sure on balance I'd like to keep my money and --
MR. BRUNORI: What? You'd rather keep your money in your pocket?
MR. THORNDIKE: Yeah.
MR. BRUNORI: And if we need money to fund whatever it is we're paying for, let's tax those guys over there.
MR. THORNDIKE: Although increasingly what you also see is an interest in raising tax burdens for people beneath your own economic status as well.
MR. BRUNORI: And that becomes a different question.
MR. THORNDIKE: So it's really everybody -- every tree.
MR. BURMAN: There actually are, I mean, there's a significant group of millionaires who have been arguing for more progressive taxation. So it's not purely selfish, I mean --
MR. THORNDIKE: It's not, although I mean, and I love those guys, but really they are outliers.
MR. BERGIN: Let me get to Scott here just to -- I'm the moderator so I'm supposed to be moderate, but just so -- you're not alone, Len. I'm in the Len camp. You know, when I started out not doing well and I'm happy -- I'm a great believer in progressive taxes. Now I'll go back to being the moderator. Scott.
MR. HANKIN: I just want to make one more
MR. BERGIN: Quickly, please.
MR. HANKIN: OK.
MR. BERGIN: A lot of people want to talk.
MR. HANKIN: In terms of fairness, if you go to the store and you buy a product and they said to you, "we have one price for rich and another price for poor," everybody in this room would say that's ridiculous. That's not -- but yet, when the government taxes you what are they taxing you? The major purpose of a tax is to raise revenue for paying for government services and so why should one person have to pay more for government services because they're rich than another person who's poor? And that's essentially what an income tax and particularly a progressive income tax does.
MR. BERGIN: Scott, you want to jump in here?
MR. HODGE: Sure.
MR. BERGIN: I kept you waiting too long.
MR. HODGE: Scott Hodge with the Tax Foundation. It seems like we haven't really had enough sort of baseline discussion about the progressivity of the current system. And according to an OECD report, the U.S. has the most progressive personal income tax system of any industrialized country. We rely more heavily on the top 10 percent than any other industrialized country. Our poor people have the lowest income tax burden of any industrialized country. In fact, last year we had a record number of Americans who paid no income taxes since 1940. And yet, at the same time the top 1 percent -- 2 percent pays roughly 51 percent of all the income taxes. So I'd like to ask the panel, what do we consider to be least fair, more unjust? The fact that we have roughly half of all Americans who pay no income taxes, or the fact that we have the top 1 or 2 percent that pay 51 percent of all the income taxes?
MR. BERGIN: I'm going to let Bob go first and then Len, but let me point out Scott brought along some handouts from the Tax Foundation and you should all have them and if you don't we'll figure out how to get you some.
MR. HODGE: Thank you.
MR. CARROLL: So I am really happy that Scott made the point about the comparisons to the European economies and, you know, this OECD study has been pretty popularized to some extent, but the U.S. has the most progressive tax system. And it's really kind of interesting and the way I kind of think about that and the way I kind of explain that is that the Europeans don't need to have as progressive a tax system to have as progressive a footprint of their governments -- the government sectors because they have much bigger government sectors and they do a lot more distribution on the spending side. So that's why I think it's so important when we have the discussion on, you know, the income and equality and how the government should address that or not address that. It's so important to not only focus on the tax side. It's critically important that we also focus on the spending side.
The European economies have pretty exclusively public healthcare programs. Ours is split where we have a public program for the elderly and primarily a private system for everyone except -- everyone else except for poor children. You know, we -- they tend to have much more extensive public retirement plans than we do. They run a lot more of their economies through the government sector than the way we do. On the spending side they have a lot more redistribution than we do.
So it's really no -- probably shouldn't come as that much of a surprise that we have a more progressive tax code and they have a less progressive tax code, because they're just doing more of the heavy lifting on redistribution on the spending side. And so, you know, that's at least the way I kind of can reconcile the OECD study, but then I think one of the things you can draw from that is that, where's the discussion that we are having on the distribution of spending programs? You know, and how does that affect how we view the distributional footprint of federal government activity?
MR. BERGIN: All right, Len.
MR. BURMAN: I agree with what Bob said. I mean, the -- on the issue of the progressivity of the tax system there are a couple of charts in my handout showing that the distribution of overall taxes and the income tax is very progressive. That we actually run the largest cash assistance for working-age Americans is the earned income tax credit. It's bigger than TANF. At least in most years it's bigger than food stamps now. But the biggest tax that most Americans pay isn't the income tax, it's payroll tax. And that's actually pretty regressive. It's a flat percentage of earnings and it's capped at about $110,000. People point out that while the benefits paid under Social Security are progressive, it gets back to Bob's point that you should look at benefits as well as taxes, but Americans do pay a substantial amount of taxes.
There's a -- I reproduced a chart based on data from Citizens for Tax Justice where they looked at not just federal taxes but also state and local taxes, which tend to be much more regressive. And when you look at the overall system that the top two -- the tax system is somewhat progressive, but the top two quintiles -- the -- basically from the 60th percentile up to the top basically have a flat tax system. There's actually a decline in the overall effective tax rate at the very top, primarily because of capital gains.
Bob's absolutely right that, you know, we run a lot of our social welfare system through the income tax, much more than European countries do. And actually it would be -- I've argued in a -- I argued in one paper that actually putting in a place a value added tax, which is a regressive tax dedicated to paying for healthcare, would be a progressive trade-off overall. And that wouldn't show up in the distribution tables because we only look at the tax part, but the fact is that we don't do very much on the spending side compared with European countries.
MR. HODGE: The income tax is the primary tax to fund the basic functions of government, like national defense and so forth. And so one could say that when you've got half of all Americans with no skin in the game they really have no stake in the basic functions of government and that's a real serious question facing America. Do we want people to be essentially disconnected from the basic cost of government? They have no sense of what government's costing them. And so you get the fiscal illusion problem, which can lead to greater growth in government because these people bear none of the cost and they're more than happy to tax millionaires to pay for it.
MR. BURMAN: Well, but actually I mean, if you look at what's happened over the last dozen years you say that nobody has any skin in the game because we had two wars, the largest expansion of Medicare its history and the significant expansion of the federal role in education and at the same time we were cutting income taxes. So but in the margin it probably looks like to most people that we can get more government services and we'll never have to pay for it.
I agree with the basic point that the idea the government is free for a significant fraction of the population is problematic. That doesn't necessarily mean that we want to have taxes -- that we want to have burdens go up overall on low- and middle-income people, but we could have a tax system where for example, if we had a value added tax it was dedicated to paying for federal healthcare expenses and people would -- and that is the fastest growing component of spending. That's the one that's going -- if we don't get it under control we'll bankrupt this over time. That if there were this tie-in between a broad-based tax like a VAT and that component spending, then people would see that and they might be more interested in doing sensible things to slow down entitlement spending.
MR. HODGE: But in terms of a baseline discussion, you know, we see these progressivity charts of the top 1 percent and their income share, but we never see a comparable chart showing the amount of income taxes or the percentage of income taxes that that 1 percent pays. And that's been growing considerably over the years. And it's actually double their share. So they earn say roughly 20 percent of the income taxes, but pay 40 percent of -- or earn 20 percent of the income, but pay 40 percent of the income taxes.
MR. BURMAN: But actually taxes as a share of their income has been going down over the last, you know, at least based on OECD data --
MR. HODGE: It's been going down for everyone as you know.
MR. BURMAN: But what's -- but it's been going down more at the top.
MR. CARROLL: What's kind of interesting about some of Len's charts, I mentioned this to him just, you know, in jest as were sitting down, is if you take a slide two, which shows the, you know, the top -- the income and the trend in inequality since the early part of the last century through today. Then you look at the highest-income tax bracket, which is actually if you know the data the top income tax bracket actually is going to be -- it's actually similar to the share of taxes paid by the top 1 percent. And if you were to overlay these two, you would see a high negative correlation. And one conclusion some have drawn, although there some difficulty with, you know, drawing too strongly is, is that the -- as you have the high-income taxpayers paying a much larger share the tax rates on the high end go up, the reported incomes go down.
This kind of goes to the issue that I raised earlier that high, you know, there's a very large behavioral response at the high end. These data are measured as reported incomes and the incomes of high income people are rather sensitive to the tax rates that they pay. When we had tax rates upwards of 90 -- over 90 percent in the '50s and early '60s, you know, those very high-income taxpayers had very strong incentives not to earn an extra dollar -- not to report an extra dollar and so that's again, going back to what are the economic costs of high tax rates, you know, and I think that's a very important part of the discussion.
You know, France I understand is proposing to raise its top individual tax rate to 75 percent and I just kind of wonder if we lived in an economy where we had, you know, just as we did in the '50s, if we had a top tax rate of 75 percent, how would people behave if they only got to keep $0.25 on the dollar when they were deciding to work, or would they retire earlier? Would they take jobs that were -- that paid them less that didn't offer much rewards? Would it affect the professions that they entered into? You know, how would that affect investment decisions? There are a whole range of decisions that would be affected with such high tax rates.
MR. BERGIN: I have three people waiting and I won't forget you. I promise, but I think Joe wanted to respond and you want to respond quickly?
MR. THORNDIKE: Well, I just wanted to go back for a minute to that nonpayers issue, which I think is -- although we're talking about poor people when we talk about them mostly. It is relevant to debate about taxing the rich. I'm not particularly concerned about the free rider issue because I do think that, you know, whether or not Social Security taxes constitute -- what their status is, is up for some debate, you know, whether there are contributions to a program that pays you back, or whether they're just taxes. But I do think that you have a good point. And I think that liberals have missed this point. That the issue of nonpayers is dangerous, it -- because the income tax -- and I think this is important for the politics of the subject as opposed to the economics. It's more than just a way to raise money. It's really about a connection to the government, to the polity, to its -- you know, it's a -- it has a symbolic role in American government that I think is lost there, you know, it's silly. We all think April 15th is this big holiday. We all hate it. And we all, you know, try to rush and get our taxes in, but that's a shared experience for Americans. And to not be a part of that experience I think is a problem. I don't think that we need to expect poor -- the nonpayers to pay much. Most of them can't afford to pay much, but I think the idea of including people in a tax that is almost, you know, that we think of as universal is important and that that's the real cost. So I think liberals missed the boat here. If you want to protect the income tax you need to make it feel like it's a shared burden and this does not make it feel that way. I mean, you know, it's a Republican plot. Most of these things keeping the poor off are Republican ideas originally, but now they're loved by liberals. And I think that's really shortsighted for the left to just respond, you know, on the gut level: "Oh these people pay lots of other taxes." I think that misses the point.
MR. BURMAN: Just to Bob's point about the relationship between tax rates and income inequality, I think he was deliberately overstating the point. If you look at the data, for 30 years the share of income going to the top 1 percent was at about 8 percent, and during that period the middle class was doing very well, that basically their incomes were growing with the economy, and something changed. The tax rates are probably a small part of the story, but the big thing is that the decline in the power of labor unions; increasing internationalization, the fact that a lot of workers now have competitors in Bangalore; the financial innovations which help sink the economy in the last decade, and the financial innovations produced enormous income gains at the very, very top; increased technology; and this whole idea of a winner-take-all society where the earnings are at the very, very top. The top performers get humongous payouts compared with people who are almost as good.
I think when you look at data on labor supply, you look at the data on savings and how it responds to taxes, the real responses to taxes appear to be very, very modest. LeBron James would not decide to sit out the finals if we raised his marginal tax rate. He still would have wanted to play because his next best option is not going to pay him all that much. Corporate CEOs want to be the people earning the very, very top incomes. They're not going to decide to work a little bit less because their marginal tax rate goes up. So, Bob was making a valid point, but I think, probably deliberately overstating it. I think that the rise in inequality is really an issue. That if all of the income gains are going to a very narrow sliver of the population, I think that's politically unsustainable, and I think it's also problematic. If you need to pay for government and income gains aren't widely shared, it's really hard to argue that people who are just struggling to get by would have to pay more in taxes.
MR. CARROLL: Right. And so then from where I sit, I think of that as okay, so that you have this rising income inequality and what should we be doing for that from a public policy perspective? If you think that that's related to the bottom two or three quintiles of lower skilled labor competing on a global labor market with people who make a lot less money in other countries -- emerging market countries, then the issue is really skill level. So, we should be having a continuing discussion on that issue. I think, you know, the tax code -- or I should say the federal government's spending in taxes are a lever, but it's certainly not the problem. It's not going to address the long-term issue of income inequality. You have to think more fundamentally a bit. What is the cause of income inequality? That's really a very important part of the discussion.
MR. BURMAN: I agree but it's also a very hard issue.
MR. BERGIN: Right.
MR. BURMAN: And you say invest more in education. Even that's problematic but there's much more to it than that. I mean there are some people who are just not going to be able to get college degrees or -- and people have -- you know, there's a -- some of us are lucky that we're able to really take advantage of higher education and get big payoffs and other people who aren't. And it used to be that there were good factory jobs that paid those people very, very well, and we sort of have to figure out a new kind of economy where people who have limited skills can still support their families with dignity.
And I should say, the earned income tax credit, which is a significant component of that 50 percent of Americans who don't pay income taxes, on balance I think it's a really good thing because as opposed to raising minimum wages substantially, which would entail an economic cost, this subsidizes wages for people who are working and makes it possible for somebody working full time at more than minimum wage to be able to support their family at a level above poverty. And if you don't want to do it through the earned income tax credit, you've got to think about some other way to make sure that people who are working hard can actually survive.
MR. BERGIN: Right.
MS. ROGERS: Diane Lim Rogers of the Concord Coalition. So, the topic of this event is taxes on the rich, right? And I wanted to just make the point that, obviously, there are economic costs associated with raising taxes on the rich. The panelists have talked about why base broadening would be a lower cost way of raising taxes on the rich, but there would still be economic costs. And I think that this is an issue of where the budget process and our budget constraints can really help tax policy move along because if you give people the choice of raising tax burdens versus not raising tax burdens, they're always going to choose to not raise tax burdens.
So, you're not going to force tax reform or any action on tax policy unless you have a binding budget constraint and it's something different from the budget constraint we've been following. So, I think we have an opportunity in that there is a need for deficit reduction. There is a need for a lot of deficit reduction, and the budget process can help inform the tax reform debate by setting a budget constraint, not necessarily separately on the revenue side versus the spending side, but set an overall budget constraint of how much deficit reduction has to happen. And then it forces us, as policy experts, as policymakers, to weigh costs against benefits on different types of tax policies or spending policies. So, one thing I've repeatedly pointed out is that the current-law baseline is a really good baseline in terms of achieving economically sustainable budget deficits. If we were to stick to the current-law baseline, that doesn't mean going over the fiscal cliff or running into the fiscal cliff or however you want to use that metaphor. It can mean sticking to "pay as you go" on the expiring tax cuts over a 10-year budget window.
And I think a lot of people have the tendency to look at the fiscal cliff and look at the expiration of the tax cuts as it's an all or nothing deal. OK, we've either got to run into the cliff or run off the cliff, or just stop short of it and don't do anything about it. And I think that's a mistake. So, I'm still hopeful. I'm naively hopeful that the fiscal outlook, the budget constraint, the fiscal cliff coming up, that it's all an opportunity to actually let the budget outlook and budget process help make better tax policy.
MR. BERGIN: Do me a favor for the TV audience and explain what you mean by the current baseline?
MS. ROGERS: The current-law baseline assumes that current tax law actually happens. So silly. So, currently, the Bush tax cuts are scheduled to expire at the end of this calendar year. They were previously scheduled to expire at the end of 2010 but were extended. So, we are nearing the end -- at the end of this year, they're all supposed to go away. Alternative minimum tax relief is another tax provision that is going to expire, and the payroll tax cut is going to expire, so those are just the tax portions of the fiscal cliff, which when you throw in some sequestration possibility on the spending side, make for a rather steep cliff in terms of the one-year timing. Current law is literally that the tax cuts would expire at the end of the year, but sticking to pay-go on the current-law baseline just requires that that revenue be made up over 10 years. And that's what the difference is between current law and a current-law baseline.
MR. BERGIN: Thank you. Over here.
MR. THURONYI: Thank you. Victor Thuronyi. Many good ideas here. Let me add one more. So, let's suppose a decision is made in tax reform to lower rates, broaden the base, probably lower the corporate tax rate, I'm skeptical that this is going to satisfy the current-law baseline. You know, come up with the revenues we need, or do enough on the distribution. So, about a year ago I wrote an article in Tax Notes describing the progressive expenditure tax. This would be a supplemental expenditure tax. It's a little different from what's suggested in Bob Carroll's book which I haven't read yet but look forward to. And I think it would be great if we -- we can't do it here but in a subsequent event, to look into these alternatives and to see, you know, how can we actually do it if we decided that we wanted to? Thank you.
MR. BERGIN: OK. Did I see somebody raise their hand in the back, by the way? OK. Two, and then, Joe, I'll get around to you. OK.
MS. WILKINS: I'm Rebecca Wilkins. I'm with Citizens for Tax Justice. I think we need to embrace "taxmageddon" or as Bruce Bartlett calls "taxmagenon." (Laughter) It's really an opportunity for us to push the budget reset button, and let the Bush tax cuts expire, and then do some sensible reforms, come back in January and decide what targeted tax cuts really need to be made. And everybody, like Len said, is going to have to pay higher tax rates to address the budget problems.
But I find it really frustrating for us to focus, as Scott did, on just the federal income tax. When you look at the chart that Len so kindly copied up from my report in April, the taxes that people pay -- people at the low-income range pay huge amounts of state and local taxes. Now, all of us in this room, the federal income tax is the biggest tax we pay so that's what we tend to focus on. But there's a Washington on the other coast where the bottom 20 percent pay 17 percent of their income in state and local taxes. And the top 1 percent pays less than 3 percent of their income in state and local taxes. Now, when you go to the store to buy your kids' school supplies in August and you have a $20 bill in your pocket, if you're in the low-income range, you know that you can't put $20 worth of stuff in your basket. You can only put $17 or $18 worth of stuff in your basket because when you get to the checkout counter they're going to add another 10 percent or 12 percent of sales taxes.
So, we do, as Robert said, need to look at the tax system as a whole and where people pay taxes. And that's including the corporate income tax. In November, we updated our "Corporate Taxpayer & Corporate Tax Dodgers" report. We looked at the Fortune 500. We included only the companies that had been profitable over the three-year period that we looked at. We found an average corporate tax rate of only 18.5 percent, which is almost half the statutory rate of 35 percent. There were 78 companies in our study who paid zero income tax in at least one year, and there were 30 companies that had a zero or lower tax rate in all three years. So, to say that that corporate income is taxed and then taxed again at the investor level is just really not what reality is.
And also looking at the tax system as a whole, you've got to look at the problem that the capital gains lower rate caused us. Not only all those smart people wasting their time figuring out ways to convert your income to capital gains; I think it contributed in a great way to all of the financial innovations that happened that almost brought down the world economy. And look at how much it contributes to inequality. If you have two people making, let's say a nice salary -- $250,000. And one of them, all their income is from salaries and wages; and the other one, all their income is from capital gains and ordinary income. Well, the guy who works for a living is going to pay about $57,000 in federal income tax, but the person who is living off his wealth is only going to pay $38,000 in federal income tax: $20,000 difference. So, at the end of the year, he's got $20,000 more to invest. Here's somebody who already has substantial assets, and we've just given him $20,000 more, so at the end of the year he's going to increase the amount of assets that he has.
So, I think we really have to look at the system as whole and see what makes sense, and the tax -- the wealthy can pay more tax and the threshold should be a lot lower than $250,000. And also, I wanted to give Joe a shout out. I've never heard April 15 talked about as a holiday before.
MR. THORNDIKE: It's more of an anti-holiday. I misspoke.
MR. BERGIN: Keep housecleaning. I've got two in the back that I'm going to go to in a second and then over here and then over here, but David wanted to jump in for a second. That's why he's here.
MR. BRUNORI: I'd like to respond to one thing that Rebecca said. She mentioned the state of Washington having a very regressive tax system, but I wanted to remind her that the citizens of Washington, I think it was two years ago, rejected adoption of an income tax, overwhelmingly, and it was an income tax that was going to fall on the top 1 percent of the population or something. It was only incomes over $400,000. Like, nobody was going to pay it. And it was rejected 70 to 30 or something like that.
MS. WILKINS: We can't explain why people keep voting against their self-interests.
MR. CARROLL: That raises an interesting point and when you include state-level taxes, the 50 states and D.C. -- the citizens in those states are making choices in terms of what they want their state systems to look like. I saw your chart when I was looking through Len's handout and it, you know, it's really a very interesting chart, but then it kind of leads you down the road of whether the folks in Washington should attempt to undo the distributional effects of state level policies through the federal tax code, and I think that's kind of a very problematic path to go down.
MR. BURMAN: But actually it's harder for states to have very progressive tax systems because it's actually easier for high-income people to avoid state taxes. They can move from, you know, Oregon to Washington if they don't want to pay income taxes. Whereas if we decide collectively that we actually want to provide public goods, we want to provide support for lower-income people, it's much easier to do it at the federal level.
MR. BERGIN: Eduardo Saverin.
MR. SCHNEIDER: Les Schneider, Ivins, Phillips & Barker, and I'm a former Treasury official. I guess I'd like to challenge this emerging consensus -- the conventional wisdom that the way to reform the tax laws is by eliminating or reducing tax expenditures and lowering the top rates. I think people have a selective memory loss because we tried that in 1986. We lowered the rate to 28 percent, and most people don't realize it, but when you look at the distribution tables, that tax law change was a tax increase, not a tax cut. And the greatest increase, according to the distribution tables, was to incomes at the top.
But I would say that within three months after the enactment of that statute, more liberal politicians already were screaming that the rate on wealthy people was too low, and they wanted to increase it. And I think that if you buy off on this myth that you'll trade tax expenditures for a lower rate, you're going to end up with no tax expenditures and a higher rate in the end. Now, maybe that's what people want, but on one side of the aisle that's not what they want, but that's what they're going to end up with in the long run.
MR. BERGIN: You had a response to that?
MR. BURMAN: I think most of the base broadening in '86 was actually on the corporate side, and actually a lot of those changes survived. Now, it is true that rates went up. Also, right after tax reform was enacted there was a call to lower capital gains tax rates and to restore the investment tax credit, one of which eventually happened. I mean, for people who are thinking about tax reform, I think the biggest challenge is figuring out how make it stick.
But certainly -- and the other thing is that, you know, we talk glibly about $1.1 trillion of tax expenditures. Most of those would be extremely difficult politically to get rid of. You know, when you're talking about raising -- you know, one of the things that happened in '86 was that corporate CEOs came to Washington and said we kind of like this thing. Even though we were really raising taxes on corporations, they liked the idea that their own personal tax rates were going down to 28 percent. Talking about trimming the mortgage interest deduction, limiting the tax break for health insurance and things like that; both of those, I think, would be a good idea as a matter of policy, but politically they're, if not impossible, extremely difficult.
MR. BERGIN: And to your point, there's another incentive in the tax code that we haven't talked about yet and that's the incentive of the politicians to keep it so they can keep picking winners and losers. And that's the one that I worry about. Do we have somebody else in the back? No? Dave?
MR. KAUTTER: Dave Kautter from the Kogod Tax Center of American University. And I'd like to narrow the discussion maybe a little bit for a minute or two. One of the issues, it seems to me, that muddies the debate on how much the rich should pay or what the rates should be is something that Bob mentioned, which is a large percentage of business income flows through and is taxed at individual rates. And whenever there's a discussion about raising the individual rates, then it's described as a tax on job creation.
I wonder if the panelists have any thoughts about separating the taxation of business income from individual income. In other words, on the existing Form 1040 you have two schedules: one where you have a number for sole proprietorship income, one with S corporation and partnership income. What if the system were to take those two numbers off the individual return, subject them to a business rate schedule, the same rate as a corporate rate schedule, and then deal with individual? And I understand that doesn't deal with integration issues for corporate, but tax business income under one system and individual income under another system.
MR. BERGIN: You both addressed that, so --
MR. BURMAN: So, the idea of taxing flow-through business income at a different rate, I actually haven't heard that suggested before. I think it would be problematic, and the reason is that first is the question about whether you would actually want to do it, and I would say that the progressive tax system actually is good for most businesses. Most businesses are owned by people that actually don't have -- they're not in the top brackets.
Now, it is true that most of the income is earned by people in the top brackets. They're the ones with the large businesses with many, many employees. But basically, business investment is risky and effectively progressive taxation provides a kind of safety net, that if you don't do very well, you're taxed at a much lower rate than if you turn out to be very, very successful. The issue of trying to separate S corporations, partnerships, other sole proprietorships from other kinds of income is problematic just because it would be hard to draw that line. According to income tax returns, I'm a small business. I file a Schedule C. I didn't get an honorarium for this but I sometimes get paid for -- (laughter)
MR. BERGIN: You get our love and respect.
MR. BURMAN: Yes, and that's tax free, and I get a huge benefit just from that. But a lot of the people who look like businesses on tax returns are really just -- they're people who do a little bit of consulting on the side; they're fairly wealthy people who are on corporate boards and get paid for their activities, doing that on Schedule C. And actually the Treasury Department has a very nice study -- Susie Nelson and several other people looked very, very closely at business income reported on individual tax returns. And a very large percentage of that was people you wouldn't actually think of as small business people, people who are hiring other people, creating jobs. The more fundamental problem is that if you said that business income was taxed at a lower rate than other income, a lot of people would be looking for ways to make their wages and salaries actually look like business income, and that would be economically inefficient. And also it would raise fairness issues.
MR. CARROLL: Just a couple of points. The first time I heard of this idea was actually in 1993 when I was a staff economist at the Treasury Department, shortly after President Clinton was elected. And his interest in raising the top tax rates, when the millionaire surtax morphed into the 39.6 percent rate, kicking in at $250,000 at the time. And in any case, there was a hotly contested debate in the Congress. And one of the things, an idea that was broached was having a separate rate schedule for certain types of flow-through or business income. And it was considered and then not -- it was considered on the Hill -- it was considered internally for a very short while before it was rejected.
I think one of the problems with this issue is the corporate income tax is really a tax on investment returns, on equity finance investment returns primarily. And corporations tend to pay everyone who works for the corporation wages, and those wages are subject to the individual income tax. With flow-throughs it works a couple of different ways. S corporations are required to pay the owner some reasonable compensation, while partnerships are not. For sole proprietors there's no distinction between wage income and the return to capital from the investment in the enterprise.
So if one wanted to have something that was parallel to the corporate income tax, one that some thought might need to be given to how to separate the returns from the capital investment to the return to labor, it's kind of related to a point that Len was making. Some of the Nordic countries have actually attempted to do this and have tried to have separate systems for some of their pastors, particularly in a partnership form, and it turns out to be extraordinarily complicated. So that's kind of one of the issues. If you did it just for the net income of the flow-throughs, then you may be providing that more favorable rate treatment to, you know, since the return to labor that's accruing to the owners of those flow-throughs, which would create kind of the friction that Len was describing.
That said, going back to a point that Len made, a lot of the flow-through income is subject to the top two rates. The numbers I run myself and have seen others run tend to be in the 40 to 50 percent range of the flow-through income and is subject to the top two rates. So from an economic perspective, that's kind of what you would focus on. It is true that most of the people, most of the business owners if you counted them up -- when you count up the business owners, because it's -- well, maybe not because it's including people like Len. He may be further up the income distribution based on what he said earlier -- but a lot of business owners may well be in the lower tax brackets. That sort of dichotomy between counting people and counting income is very similar to the capital gains debate from the early 1990s where one side was counting people and the other side was counting income. And I think Len usually tries to count the income is my impression -- focused on the income because that's where the economic effects would accrue from.
MR. BURMAN: I think they're both important, but they're different questions.
MR. CARROLL: Right.
MR. HENCHMAN: Joe Henchman with the Tax Foundation. I'm going to echo the gentleman who asked the question in the audience a little bit because I think the panelists have been very generous in one regard, and that's what is in the way of tax reform? Now we can come up with all the wonderful tax plans that we can design that achieve progressivity. Len mentioned the Bowles-Simpson plan, which I view very favorably and positively. But there's a group out there that hated it a lot, and it was not really Grover Norquist and his acolytes. It was some progressive activists because all they care about is the rate, the top rate. So the Bowles-Simpson plan which raised revenue, which made the system more progressive, I know what they called it. They called it the cat food commission.
My job takes me all around the country and during the Occupy period I took time out of my day to go and talk to Occupy protesters, and they don't care about any of this. The CTJ chart showing progressivity and how structures -- no, none of it matters. All that matters is the top rate. And what they said about the Bowles-Simpson Commission is that it cut taxes on the rich. Now we all know that it didn't do that, but that's all they care about is the rate. This is why we have every Congressional bill from that side of the aisle, proposing a new spending program, they pay for it by new taxes on the rich. CBPP and CTJ, they propose tax proposals. It's not as Rebecca conceded here that everybody needs to pay higher taxes. No, no, no. There's one group of people they think should be paying higher taxes.
Now luckily the American people, including the good citizens of Washington, which is not the reddest state in the country, they generally don't go in for that. They are very critical of some rich people -- the crony capitalists, the beneficiaries of bailouts, the beneficiaries of government largesse -- but for those people that have rolled up their sleeves and worked hard, they want nothing but success for them.
I don't know how many people here have ever watched The West Wing. It was one of my favorite shows. It's no longer on the air. They had a character on there, Sam Seaborn. He was a very liberal ideologue, but very sensible in many ways. In one of the scenes he's arguing with one of the people on his side of the aisle who keeps talking about how the rich need to pay their fair share. And he says, "Look, I used to be a lawyer. I made $400,000 a year, which meant that I paid 27 times the national average in income tax. I paid my fair share and the fair share of 26 other people. Now I'm happy to because that's the only way it's going to work, and it's important that people go to schools and have roads to drive on, but I don't get 27 votes on Election Day. The fire department doesn't come to my house 27 times faster. The water doesn't come out 27 times hotter out of my faucet. The top 1 percent of wage earners in this country pay for 22 percent of this country. Let's not call them names while we do it, is what I'm saying."
MR. BERGIN: The gentleman back here.
MR. BRAZELL: David Brazell. Listening to this it seems like this argument --
MR. BERGIN: Could you give us your name, please?
MR. BRAZELL: David Brazell. I work for a large government agency. This discussion really heavily depends on the framing of the questions. In the discussion I'm hearing, everybody seems to be assuming here that income measures are the appropriate measure by which one should measure regressivity [and] progressivity. We could also use consumption as that basis I think on very good arguments. And in another way, I think Len mentioned, we need to trade off efficiency and equity or fairness. That sounds good, but with efficiency we have very good economic theories about what we mean by efficiency. On the fairness side we have no idea what that means, and no one can agree. Everyone has different motives for arguing one way or the other. In fact, it doesn't even rise to the level of pornography where at least with pornography, you know it when you see it. And here I don't think we can identify a state of affairs where everyone could agree that that is fair or most people would say it's fair. You ask those in favor of raising rates on the higher-income folks -- ask them: "Well, how high do we have to go to be fair?" And usually you don't get an answer for that because there is no answer for that. One could go back to 1934 when FDR said that no one should be making more money than $3,000 or he should be able to keep that -- a statement to that effect. I think he moved away from that very quickly, but I think he didn't want Babe Ruth earning more than he did, probably.
But the point is we cannot define this, and there's different motives behind arguments for one rate. We can't even define fairness here, whether we're talking about the people at the low end or at the upper end. The conference was on whether we're supposed to raise taxes on rich people, but to there it's just envy or whatever other motives might come into play, it seems to me.
So my question is, is fairness art or pornography I guess?
MR. BERGIN: I'm sorry, is fairness --
MR. BRAZELL: Art or pornography? Can you identify it?
MR. BURMAN: So David raises a good point, which is that there are huge measurement issues. And there are disagreements as to what -- how it even defined the base conceptually. If we decide that it's income, how do you measure income? And the thing that's income on tax returns isn't very closely related to what economists would call income. The fact is that there are measuring problems both in terms of defining fairness and progressivity, there are measurement problems in efficiency as well. Our measures of efficiency come at very highly stylized economic models, and the fact that we can't measure it perfectly doesn't mean that it's not an issue. Fundamentally, it is an issue that the political process is as Joe pointed out, should be working out and not something that economists or even people in this room ought to be deciding. The tax system ideally should reflect the best we can. What is consistent with our values? I think almost everybody would agree that some notion of fairness is related to taxation. It might be that everybody ought to pay the same thing. It might be this notion of horizontal equity. But even for that, you'd have to have a measure of income that we agreed was consistent. But the fact that we can't measure perfectly doesn't mean that we shouldn't consider it.
MR. BRAZELL: I guess my argument is we can't address this analytically in a sense because the only way we can agree how to, as you say, measure fairness --
MR. BURMAN: But there are a whole bunch of economic articles that do try to measure it, that do try to -- there's a whole lot of tax literature that do deal with them, that the measures of fairness are just as stylized as the measures of the economy that generate the efficiency conclusions.
MR. BERGIN: This goes to Joe's point.
MR. THORNDIKE: I mean I think that's what I really think people should do is just sort of embrace the arbitrary nature of it. I mean, we shouldn't -- I don't think we should tie ourselves in knots trying to come up with theories of fairness when it is really an intuitive political decision. And we may not like that, but government makes all sorts of intuitive political decisions all the time that address fairness issues in realms far removed from tax. And earlier it was pointed out that people will always want to tax the rich, and that's true, and maybe that's sordid and terrible. And if so, that's just a problem with democracy. I mean, it is just not avoidable. There's no way to duck this argument and to replace it with something that's nice and scientific and clean. There's no owner's manual for government. No one will tell you how much is enough. You can learn how much gas to put in your car to fill up your tank, but you can't figure out how to tax the rich.
To me, that's the beginning of an argument, not the end of one. That's what the issue is really about. So I'm interested in all the questions of efficiency and administrability and other such things, and they affect my views of this. But ultimately they're second-level issues and honestly, even in the large development of tax policy, I think they are often second-tier issues, too. For all the complaints that economists have been offering about, say, taxing income rather than consumption for decades now, you still see a lot -- the voters still seem to embrace the idea of taxing income, right or wrong.
MR. CARROLL: But I think there are some very important questions we can ask to better frame the debate. We can provide some measures of progressivity of the tax code. That's something that we can offer up. Len has some very good charts in his handout that show, let's say, average tax rates by income class, and it gives us some sense for at least where we are by some standard. And you could produce other standards that would give you a somewhat different result, but that's very important.
I think Joe's point that this really narrow focus on the rates, I think, is really problematic because it's the rates that really contribute significantly to the economic costs of the tax code. And the notion that progressivity is defined by how high the rates are, I think 1) it's not accurate and 2) it's very counterproductive. I think it leads us down the wrong path, the wrong discussion. So I think that's a problem, and I'll leave it there.
MR. THORNDIKE: I mean, I tend to agree with that. And again, just to retreat to the history for a minute, what's striking is how powerful those rates have always been -- that those high-end rates, even when they were in many ways meaningless, and one of the great studies of FDR's tax policy is called The Limits of Symbolic Reform.
MR. CARROLL: I think the rates are very easy to understand. I think people can easily under-equate progressivity with the rates, and I think it's really something that -- an important public service we could all provide that I hope is being provided with this forum and others is that that's really just a piece of the puzzle.
MR. THORNDIKE: I mean the thing in many ways -- and we really haven't talked about this in here today -- but a more meaningful issue is a question of brackets and where they start and where they end and how many we have because 90 percent of rates on very small numbers of people are really, truly meaningless. I mean, there was a rate in 1935 that applied to one person because the bracket was so small.
I think it is a relevant question. I'm not endorsing the idea. But the idea that we don't have enough brackets and that the difference between somebody making $350,000 a year and somebody making $350 million a year is meaningful. I think that is a reasonable argument to have. And the fact that we have relatively few brackets in historical terms right now is unusual and not necessarily permanent, I don't think.
MR. CARROLL: But then again the focus on the brackets is a focus on the rates and not the progressivity of the tax system or the progressivity of the federal government's footprint.
Another point, and Len mentioned optimal tax theory, the road that optimal tax theory would lead you down is those income sources that have the highest elasticity, so the most responsive, that are most mobile -- things like capital income in the international setting or across time. Optimal tax theory would generally lead you down the road of -- if you want to follow an optimal tax system, you would tax capital income a lot less is one of the rationales for consumption tax. This is capital income across international boundaries or across time tends to be much more responsive to changes in its tax treatment, the rate at which it's taxed relative to labor income. So if one wanted to use that standard, that's kind of a way of trying to introduce this notion of: what is the progressivity and at what cost and how progressive should the tax code be? My own sense is that most people view -- their view is that we ought to have a progressive tax code. Then the question is, if you made it a little more progressive, is that where you would stop or would there always be pressure to make it more progressive? And that is one of the reasons, I think, there is some reluctance to add additional progressivity because it's not the endpoint.
MR. BERGIN: OK, on my blind side here -- I apologize. I didn't see this hand here and then we'll go over here.
MR. DILWORTH: Bob Dilworth. I'm a tax lawyer with some private and public experience. I was wondering, do tax-exempt owners of capital count as rich?
MR. BURMAN: Typically, we think of businesses and nonprofits as -- it's actually kind of an interesting question. We allocate the income of corporations to the shareholders. Nonprofits are kind of in this other world that is mostly ignored. I mean, the fact is that you could very well argue that universities and arts institutions and other things are to some extent basically providing services for high-income people who also tend to be the major donors. Syracuse, for the record, isn't rich. If you'd like to make a contribution, I think that would be just awesome.
MR. BERGIN: Marty?
MR. LOBEL: Marty Lobel. We've been focusing on the trees, not the forest. And picking up on Len's initial comments, the income maldistribution in the United States right now is reaching crisis proportion, which is why we're focusing on tax reform. We only really reform the tax code when there's a crisis because by and large -- and I worked on the Hill for years -- the only ones who get a voice are those who can afford to pay for it either by hiring lobbyists or by making campaign contributions. The public is focused in on the rates paid by the very rich and by the large corporations. You know, a lot of people are getting really unhappy about the tax subsidies we're providing to the multinationals, which puts them at a great advantage over domestic companies. We haven't heard a word about that in terms of tax rates.
Now who are the beneficiaries of these tax subsidies? Usually very, very wealthy people who are now, I think, in the public's mind using their money to influence public policies for their benefit. You have on the right the Koch brothers and Sheldon Adelson, and on the left you have George Soros. You have a situation where the public right now, I think, is acutely aware of the massive shift of income from the middle class to the very, very wealthy. We focus on the top 1 or 2 percent? No, no, no. We ought to be focusing on the top one-tenth of 1 percent because there's a big difference between a lawyer who may be earning $1 million or $2 million as a partner in a major firm and someone like John Paulson who earned $3 billion in one year. And didn't pay taxes on it, by the way, because it's all earned in the Cayman Islands and he only pays taxes on it when it comes back to the United States.
The public takes a look at these examples and says wait a minute, this is a democracy. We're entitled to have some relief. And that's the benefit of a democracy. It provides a method of relieving tensions in the public before it reaches explosive stages. They're asking questions like -- I was at a recent meeting and someone said well, why are American CEOs making 10 times what British CEOs make? Didn't have an answer. I don't know. But the people are becoming more and more aware of it because they're hurting economically. This last meltdown has acutely raised awareness in the public, and unless Congress -- as Diane points out -- takes some action to alleviate the tax inequities -- and I think we all agree that the tax code is far too complicated and is riddled with tax subsidies and needs to be cleaned up -- but until the public reaches that explosive stage -- and it may be this year, it may be because of tax Armageddon, or it may be in 2014 -- we're really not going to have the kind of relief we want because I got to tell you, we've got the best Congress money can buy.
MR. BERGIN: Under the theory of "don't tax you, don't tax me, tax the person behind the tree," I'm all for cutting tax rates for lawyers.
I'm going to go over here and then over here and then I'm going to let the panelists have a last word. If I've cut anybody out, I apologize. But we're going to try to end a little bit before 11:00. So one, two, and then I'll ask each of you to quickly make a final statement. Is that okay? OK.
MR. SHVEDOV: Maxim Shvedov from AARP. I just had a couple questions. First of all, we would like more fairness, but there is also an issue of self-interest. When we look at the situation in Europe today or in Central America, for example, it may be perfectly reasonable for a rational individual to want to pay more taxes today, given the fact that if you don't pay today, society will face one of those, you know, undesirable options. So it may be perfectly reasonable if I have the capacity and flexibility to buy insurance, so to speak, today by making higher tax payments and prevent any of the crisis. You know, 20 years from now, I don't see there is some sort of a rational thing. And some people have short-term goals, some people have long-term goals. What's wrong with that?
Another point I wanted to make about this connection between nonpayment of taxes and involvement in the government, which I really could never understand, let's take 1941. Income tax applied to 2 percent of people; government was financed by tariffs of all things, at least (inaudible) today. Yet somehow, people went to war next month, right? Or another example, a person receives $3,000 in earned income tax credit. How is he less connected to his or her government than the person who pays $10 in income tax?
I just don't see this point as -- you know, what's the evidence behind this assertion basically?
MR. BERGIN: We'll have one more here and I'll go in reverse order with you guys.
MR. SUNLEY: Emil Sunley, retired from the International Monetary Fund. Joe started out with an important point this morning, that we really have difficulty defining quite what we mean by fairness. And this question of taxing the rich more comes in a question, in part, of fairness, but a lot of this discussion today morphed into the other issue of should we tax income or should we tax consumption? And economists often make a strong efficiency argument for taxing consumption and sometimes also make a fairness argument that you're taxing what people take out of the pot, not what they contribute to the pot through producing goods and services.
We also get the fairness argument that if I have high income, I pay taxes for 27 other people and I only get 1 vote. But I also have a lot more influence in the election by being able to give unlimited amounts to the campaigns, as we see this year. So if we're going to tax consumption, we got to remember that a lot of what economists think of consumption may not represent my total power that I have if I have high income because I get on the symphony board, I get to have buildings named after me at Syracuse University, I can give $20 million if I find a man I'd like to run for president. So there's a lot that comes with having high income that may not be taxed under the consumption tax.
I think the charts we have today are very helpful because I think when you think about fairness, maybe we can't define it, but we can look over time what has happened. We can look across countries to see what happens. There are clearly countries where our sense of fairness and wanting a progressive tax isn't given quite the same weight as it seems to be given in the United States. They will adopt a flat-rate income tax even with a no-exempt or zero-bracket amount. A few countries have done that and they said it wasn't important. They just want -- the first dollar should be taxed or the first zloty or something.
And then we look at what's happening in this country, I mean, at least the last chart prepared by Tax Justice shows that it almost goes back to what we used to call at the Brookings Institution the Joe Pechman whale diagram. Because when you showed the distribution of income and average effective tax rates, the diagram begins to look like a whale. It has kind of a blunt front end because at the very highest level it was no longer progressive; it was actually regressive. And the highest percentile pays a lower average effective tax rate than the group right below that. So you can say, well, now, does that seem reasonable?
So I think though we don't know how progressive the tax should be, I think we should be informed by what is happening over time and across other countries. And I think here the economists have a lot that they can contribute to the debate, recognizing that ultimately the decision of how progressive the tax should be and how we should get there through broadening the base or changing rates is primarily a political decision, hopefully informed by good analysis and some economic judgment. Thank you.
MR. BERGIN: Thank you, Emil. I want to give everybody a quick last word, go in reverse order than we started.
MR. CARROLL: Yeah. Well, again, thank you very much to Tax Analysts and Chris for putting this together. I think obviously it's a very important subject, very important to tax reform and tax policy generally.
The only point, I'm not going to take much time in my closing remarks, the only point I'm going to make is, you know, a couple points I've already made. I have no idea what the right distribution of the tax burden is, I don't claim to have -- you know, the Hand of God has not come down and told me exactly what that is. What I do think is an important part of the debate is to, you know, really understand the tradeoff between progressivity and the cost of progressivity in terms of economic terms, in terms of efficiency loss.
Then the other point I would make, I think it's very important to distinguish between the graduated tax rates schedule and base broadening.
MR. BURMAN: Again, I thank Chris and Tax Analysts. I think this was a great forum. I would have paid to -- well, actually I shouldn't say that.
MR. BERGIN: You've got to be careful. Careful.
MR. BURMAN: The one point I want to make, which I think some people have made this point in comments, it's not just the rich. We're not going to solve our budget problems just by raising taxes on the rich people, and particularly not by raising tax rates. And the idea that you can just hit people with incomes over a quarter million dollars, it's completely antithetical to tax reform. There's no sensible tax reform that only applies to people at the very, very top. I would leave you with that thought.
MR. BERGIN: Thank you. Joe?
MR. THORNDIKE: And I would echo that, and the comments of both my co-panelists up here. You know, we've talked so much about rates on the rich and on these very narrow issues about what these guys are paying. The real issue going forward is really a question of just enough.
And I think, again, to offer advice to the progressives in the room, I think that liberals lose sight of that and there are historical reasons why they have, why they've been sort of fixated on the upper end, on the high rates, on the upper brackets. And there's a reason why we're here and why we still talk that way, and it is historical because we started down this road 75 years ago. But ultimately, that kind of over-fixation on progressive taxation, I think, has actually gotten in the way of progressive government in that it forces us to, again, try to look at the whole picture. It's a much more meaningful picture.
And Europe and most of the rest of the world has done this, so really to end this discussion on the taxing the rich, it should really be about the VAT, which is the elephant that's not in the room you know that that is really the question. Every other country uses it in its larger debate over what constitutes progressive government, and I think that's where we're going.
MR. BERGIN: Thanks. First, let me thank this excellent panel. You were fantastic.
Let me also note that these conferences require a lot of work by the staff of Tax Analysts, not me, so let me thank the staff of Tax Analysts who did, once again, a great job.
And finally, let me thank you all for being here. I hope this was as educational and as fun for you as it was for me. Please give yourself a round of applause. (Applause)
(Whereupon, at 11:00 a.m., the PROCEEDINGS were adjourned.)