TAX REFORM AND FAIRNESS — WHAT'S FAIR WHEN IT COMES TO PAYING TAXES?
Friday, September 9, 2005
CHRISTOPHER BERGIN, Moderator
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MR. BERGIN: We're going to start, because it looks like we're all ready to go. There's an event on the street outside so I'm assuming that some people will be drifting in here as we go on but they should arrive shortly. Also there are handouts on each of your chairs from the participants and there are also additional handouts available outside. Feel free to grab whatever you need. And I think we can get started.
Good morning, everybody. I'm Christopher Bergin, President of Tax Analysts, which is the nonprofit publisher of Tax Notes Magazine, Tax Notes Today, State Tax Notes, Tax Notes International, and many other print and online tax publications. Welcome, all of you, to the fourth in Tax Analysts series of roundtable discussions on tax reform and thank you for coming.
When President Bush said he would make tax reform a high priority in his second term and then when he appointed a panel to study the issue we at Tax Analysts decided that we could provide an important public service by highlighting the key issues that any serious reform effort would have to address. We decided to bring these issues to life through a series of roundtable discussions with people like you, leaders in the tax policy community, and since the tax reform panel has now decided to postpone its reports we may be talking a little bit longer about this issue.
At our first roundtable in April we had a stimulating discussion on the question of what lessons we can learn from the effort that produced our last major reform, the Tax Reform Act of 1986. In our second discussion in June we asked what role can tax reform play in promoting economic growth. That question too prompted a stimulating exchange of ideas. In our third discussion in July we asked what role should simplicity play in tax reform. Once again we had a lively debate.
Today we ask what's fair when it comes to paying taxes. For those of you who are new to our process here's how it works. I will open things up with some brief remarks to introduce our subject. I will then introduce our distinguished panel of three speakers seated around the table here. Each of them will address aspects of our topic for about 10 minutes.
After that we will open up the discussion and you all are encouraged to participate whether you're sitting around the table or anywhere else in the room. Just wave, and I will find you. We are recording this event and will post the transcript on our website as we did with our previous roundtable discussions.
Also for media purposes we're on the record so when you are recognized please tell us who you are. Also speak into a microphone. For those of you who are in the audience we have handheld mics that we will quickly get to you. I will moderate the discussion, and we will end at 11:00 o'clock so let's get started.
Nothing ignites a more explosive political debate than the issue of who pays taxes and how much they should pay. That should not surprise us. The great political scientist Harold Lasswell defined politics as "who gets what when and how." Also at the heart of politics is the flipside of that, not just who gets what but who pays what when and how, who gets the tax bill?
This tax code is not just full of carrots and sticks. It's the honeypot for some and the shaft for others but, as we know, the debate of fairness is more complicated than that. It's not just how much people and businesses pay in taxes. As I suspect we will see today, the debate is over how we should measure their contribution.
For instance, should we focus on the total amount of raw dollars paid by average taxpayers at different income levels or should we focus on the percentage of their income that they pay in taxes or the portion of their contributions to the total taxes paid in the United States or the share of GDP that individuals pay compared with corporations? Of course, those questions just scratch the surface because when you get beneath the surface of how to measure taxation you then need to ask questions about what kind of taxes to measure. For instance, should we focus just on income taxes? Should we include payroll taxes that are supposed to finance specific retirement and health programs but, as we all know, now underwrite all sorts of federal spending? And should we include other kinds of taxes like gift, estate, and excise taxes, which people pay only if they do or buy specific things?
As we have found out in our previous conferences, the issue of fairness, like reform in general or economic growth or simplicity, can be made to sound simple but the more you think about it and discuss it the more complicated it gets. That's why I'm delighted that we have such wonderful speakers to give us their take on fairness and tax reform today. I look forward to their comments and to the discussion that we will have for the next two hours. Let me introduce our panel. These are all very good friends of Tax Analysts.
First to speak will be Scott Hodge, who is the president of the Tax Foundation. Next will be David Cay Johnston, Pulitzer Prize- winning reporter from the New York Times who wrote the book Perfectly Legal, which is all about tax fairness, and I hope you'll sign my copy before you leave. Next will be good friend Gene Steuerle, a senior fellow at the Urban Institute. I thank our panelists very much for being here. So, Scott, without anything else from me I turn to you.
MR. HODGE: Well, thanks, Chris. I feel like the kid who's been invited to the grown-up table at Thanksgiving for the first time, intimidated by some of the folks around the table, Bill Niskanen, Don Alexander, and others. I guess going first my job is to be somewhat provocative and set the tone for the debate.
A few years ago I was on Hardball with Chris Matthews with the substitute host of Mike Barnacle, and I was there to defend corporate inversions. And at the end of this program Barnacle looked to me and he said, Scott, you seem like a very nice guy. You've just got a indefensible position to defend.
So in the spirit of defending the indefensible I'd like to share with you a few thoughts on tax fairness and a lot of the work that the Tax Foundation has been doing over the last few years in pulling the onion layers away from tax data and, as we call it, putting a face on America's tax returns. And I have a premonition of the tax reform debate.
I think the serious discussion over the economic benefits of fundamental tax reform will last all of about seven minutes. It will then be replaced by a blizzard of reports looking at the distributional effects of whatever tax reform is put forward. And I think most likely what we will see is each and every one of these reports will show that somehow the tax reform will hurt the poor and benefit the rich.
But I think we ought to be extremely cautious about using distributional analysis and distributional tables to drive tax policy. I think that these class-based reports actually impair rather than help our ability to understand good tax policy. First, by lumping all of us very unique individuals into these sterile quintiles we vastly overstate and oversimplify the effects of tax changes. As everyone in this room knows, no two tax returns are the same. We've got single returns, we've got married returns, joint filing singly, we've got head of household returns, we have returns with only salaried income, returns with business income whether it's business from eBay sales or major S-corporation profits.
So comparing Philip Anschutz's S-corp return to the 23-year old kid in his first job out of college seems like comparing apples and oranges to me and quite unfair. Second, distributional analysis does not account for the vast demographic changes that have been happening in the United States over the past 30 or 40 years that I believe require us to change and reassess our notions of class distinctions and much of this class-based analysis of tax policy is about as outmoded as some of the Steinbeckian images of Dust Bowl farmers that drive our agricultural policy. The basic fact is that Ozzie and Harriet have retired and are living comfortably in a golf course community somewhere in Arizona.
Lastly, distribution analysis does not account for the fact that America has become polarized between a growing class of Americans who pay no income taxes and a shrinking class of Americans who are bearing the entire burden in large measure because of the tax cuts during the Bush administration and previous to 1997. We have the old 80-20 rule at work. The top 20 percent of Americans are paying more than 80 percent of the income taxes. Conversely, the bottom 80 percent are paying less than 20 percent of the tax burden. If our goal of fundamental tax reform is to broaden the base and lower the rates we're in a political conundrum. How do you broaden the base without bringing those people back on the rolls or increasing their taxes? How do you lower rates without cutting taxes for the rich? There's no easy answer for that.
Let's look first at the myth of the middle class because that will dominate a lot of the debate and most of the political discussion of tax policy is about how to protect the middle class or, even better, how to benefit the middle class. And generally when we mean the middle class we mean the statistical middle 20 percent, those earning roughly between $25,000 and $45,000 a year.
The problem is that the taxpayers in the statistical middle today look more like the cast of the TV show Friends than they do Ozzie and Harriet. The majority of tax returns in the statistical middle are singles or heads of household. The vast minority, about 43 percent, are married returns. And it's strange to think that our tax policy should be driven to protect self-centered idiots like Phoebe and Joey; not quite the image I think most of us are trying to accomplish.
Over the past 30 years we've seen a massive increase in the number of single filers, single workers. Overall single filers account for almost 60 percent of all returns while married couples comprise the remaining 40 percent. And these single returns are flooding the lower income groups, quintiles, and effectively pushing the married couples, who are increasingly dual income, into higher and higher tax groups.
The basic fact is that the bottom of those taxpayers in the bottom quintile 85 percent are single. Conversely of those taxpayers in the top quintile 85 percent are married. It doesn't take a rocket scientist or a PhD to understand that if you have two incomes in a household they're going to be wealthier, oftentimes twice as wealthy, than a tax return with one income.
And don't forget too that if Joey, who is earning a middle class salary of $40,000, marries Phoebe with a middle class salary of $35,000 their new joint income of $75,000 puts them into the wealthiest quintile; interesting transformation, after one "I do." As I'll talk about in a minute, I believe the new middle class is at least on paper the statistically wealthy dual income couples who are really, I think, everyday folks like ourselves but are unfortunately lumped into these categories.
But I think that the biggest threat to fundamental tax reform and I think our democratic institutions is the growing gulf between those Americans who are paying no income taxes and the shrinking number of folks who are paying all the bills.
Tax Foundation estimates that in 2004 roughly 43 million tax filers or one third of all of us who file a tax return will actually have a zero tax liability after taking advantage of their credits and deductions. This is a 50-percent increase in the number of zero filers as we call them over the last four years alone and a 160 percent increase in zero filers since 1985.
Who are these nonpayers? Well, largely they are low-income. The majority have incomes below $40,000 a year. They're young. The majority are under the age of 35. They're women and unmarried or single moms with children. They're part-time workers. Very, very few of these nonpayers are actually full-time workers, and they are tremendous beneficiaries of refundable credits like the earned income tax credit and the child credit. About 54 percent receive these refundable credits.
But in addition to these nonpayers as we call them you have the nonfilers. These are families who earn some income but not enough to file a tax return and there are about 15 million of these families. And when you add them up to the nonpayers we have a population of about 57-1/2 million income-earning households who paid no income taxes last year.
That does not account for all the Americans who are off the tax rolls because once you include all the dependents on those tax returns or in those households we're looking at roughly 120 million Americans who are outside of the federal income tax system. The libertarian in me would like to be one of them but the "small-d" democrat in me shudders at the thought of what can happen when you have a vast majority of Americans or a near majority of Americans off the tax rolls and what kind of political influence that could have. People who are net consumers of government could stand up and demand more because they pay none of the cost, and the shrinking minority who are paying all the cost will be stuck with the tab.
Well, who are these payers? Look around you. They're largely you and I. Most of what we see as the new wealthy are in fact middle America and suburban middle America. They're largely dual-income married couples. Two thirds of all working married couples today are dual-income. That's a huge increase from what it was 35 years ago.
They live in high-cost metropolitan areas and they have correspondently high incomes to match that living cost. They have average living standards but they have high tax bills and high effective tax rates because their nominal incomes put them into higher tax brackets. They're older workers at or nearing their peak earning years. Taxpayers in the top income group we estimate are 50 percent older than taxpayers in the bottom income group.
And I think this is a really unexplored area of tax policies, the effective life cycle, and what that has in giving the appearance of a growing disparity between rich and poor especially when you have the cohort of baby boomers now moving like a pig through the python of our system.
They are college-educated and they have professional jobs. Two thirds of all upper income taxpayers have a college education or some college education. The flip side, two thirds of the poorest Americans have a high school education or less. If that's not an incentive for people to go out and get a college education I don't know what is.
They have business income. There are 25 million returns have business income. That's twice what it was in 1980. We've seen an explosion of entrepreneurship in America over the last 20 to 25 years especially in S-corps and partnerships and sole proprietorships, not just the eBay people but others, larger corporations. As you know, those pass-through entities, the income of that is passed through the individual tax form. That can often give the appearance of a disparity between the rich and poor.
The bottom line is that middle class is a value system. It's not a point on the income scale. And I think that the new middle class is this rising number of dual-income working couples, older couples, educated couples, and couples with business income. And unfortunately on paper especially compared to this rising army of single taxpayers they look statistically wealthy.
And the political debate in Washington will often be demagogued into being denied tax relief. And in most areas of America these are middle class citizens by any standard but they're taxed at higher income rates because our progressive tax rate system is not adjusted for things like cost of living, age, education, and the number of incomes in a household.
But unless we reform the tax code so that it's neutral to these demographic trends America's suburban middle class will be the only taxpayers actually paying income taxes in the next few years.
Let me just wrap up by saying that I think most economists agree that tax policy should be used solely as a means of raising income for government programs with the least harm to the economy as possible. It should not be a tool for social policy either to punish one group of taxpayers or enrich another. It's clear, however, that our nation's attempt to use the progressive tax rates to make the wealthy pay more while using targeted tax measures to reduce the burden on the middle class has actually created two Americas, the payers and the nonpayers, and within this bifurcated America are the seeds for social conflict and the undermining of our democratic institutions.
The only way to mitigate the punishing effects of our progressive tax rate system on the new middle class is through some sort of a flat rate system either on consumption or income. And once we've done that we should throw out the distribution tables. Thanks, Chris.
MR. BERGIN: Thank you, Scott.
MR. JOHNSTON: Well, good morning. I'm sorry you all don't have something more important to do than listen to the three of us. I think that in this discussion of fairness in taxes one of the biggest mistakes we can make is to focus on rates because I think that this is a much, much broader issue and when we talk about fairness in taxes we need to think about a whole variety of things.
For example, we need to think about law enforcement. If we have large numbers of wealthy people who pay no taxes, who are undetected by the government, who engage in what is criminal behavior, and we are not prosecuting them are we being fair? If we have a system which Charles Rissotti, the former IRS commissioner, has observed, is extremely efficient and effective in capturing the income and requiring the payment of taxes of wage earners but we do not do the same with people whose income comes from business activity, being landlords and investors, because we don't have third-party independent reporting are we being fair to all people? Or do we have a system that instead says if you're a wage earner you will obey the law, if you are not a wage earner it's up to you; it's a voluntary system and to the degree that you're willing to be aggressive in approaching the tax system if not downright dishonest you can profit from your crimes?
We need, I think, to think about whether we want to live in a society that forces most families with children to have two incomes. Is that really good social policy? Now, I have eight children so I may have a little more stake in this game than most people, and I want to say that so that I'm clear to people. But when I was a young man and had six children in my 20s I was able to afford a home in a middle-class neighborhood on one income to raise my children. I had no debt, did just fine. Couldn't do that today because we have changed the nature of the economics of our society.
My $29,000 middle-class home in Sunnyvale, California, in the heart of Silicon Valley resold recently for three quarters of a million dollars. We've changed fundamentally the nature of our society and the tax system to the degree that it forces and encourages people to have two incomes imposes a horrendous cost on us in terms of making our society endure. The average family in America with children does 820 hours more paid labor today than it did in 1970. That's back when I had my house in California or shortly before I got my house.
Eight hundred twenty hours is five and a half months. You add in the time to commute to work. How many of you ever commute in 15 minutes? An hour? Yeah, you add in that time and all the other things related to that and then ask yourself is this good social policy to make our society endure. Is that how we want our children to be raised? Is that what we really want to do? Maybe we do, I'm not arguing we should or shouldn't, but I think that's a fundamental question of tax policy.
One of the things we've done in this society is raise the price of failure. And you can make an argument that that's a good thing, that by saying to people if you don't go to school and you don't pay attention and you don't get an education you're going to be condemned to be poor we certainly are encouraging people with a stick to get ahead and saying to them that the price of that is enormous. That may be very good social policy.
But if that's the case then why is our tax policy discouraging investments in the most valuable asset we have, the human mind? Why is it that when I was a young man, and I grew up in poverty my father was 100 percent disabled veteran, I could go to college with no marginal cost and in my case I got a little bit of money from the GI Bill that bought my books.
If I were 17 years old again today I would not be able to go to college and I have interviewed and spoken with many young people in America, 17, 18, 16 years old, who cannot produce the money to simply go to their neighborhood community college. They don't have it, the family doesn't have it, and the corrosive social effect is that the family's attitude is oh, well, that's the government taking care of people who are better off. That's not for you.
To think there's not a connection between government policy and social attitudes on these issues I think would be quite naove. We've raised the cost of going to education to the point where if you want to be a school teacher, a librarian, a police officer, you want to do any one of these helping professions can you afford to do that if you have to borrow all the money to go to college and be in debt for years and years and years? Well, tax policy plays a major role in that area of fairness.
What about prosecutions? Is it fair for the United States Government to do something which I've encouraged it to do? And that is to prosecute people who deny the legitimacy of the tax system without answering their questions. Now, they're stupid questions and there are stupid questions, let me assure you. You'll hear a lot of journalists say there's no such thing as a stupid question. There are lots of stupid questions.
But the fact is that we had the trial of a woman named Vernice Cooglin, a pilot for FedEx. Evidence, I think, that she is reasonably intelligent: they gave her a $50 million airplane and put it under her command. She wrote to the government and said "I've read all this literature that says I don't have to pay taxes. Show me where I have to pay my taxes." They ignored her letters and they indicted her.
Now, that's the answer to her question, but is that a fair way to do it? Is a fair way to do it to simply mail people a simple publication? Here's where the law says you have to pay your taxes. Now if you don't want to pay your taxes let us know and we'll prosecute you. But is it fair?
Is it fair that Al Thompson, one of the people who were prosecuted as a result of my stories, was sentenced to six years in prison for not turning over a half million dollars of payroll taxes because he believes you don't have to pay them and, trust me, on a sincere belief defense I'm surprised that Mr. Thompson was not acquitted. He's nutty enough that he probably could have actually gotten away with an insanity defense had he not been representing himself.
But on the other hand it was reported the other day by the Justice Department that they had won a conviction against someone who is a third-time tax offender, shorted the government out of a $100 million, and he got, as I recall, something like 13 months in prison. I'm sorry. Where is the fairness and the equity in that?
One other point and then I want to turn to history. We are in a country that doesn't live by providence. We don't save. We spend money we don't have. Look at the alarming increase in bankruptcies going on in this country. One of every seven families in America has filed bankruptcy in the last decade. Many of that's because people lose a job or they have medical bills.
But that so many people are there tells you a lot about the level of unsecured debt people have taken over in this country. When we spend money in Washington that we don't have we are taxing the future. Is it fair? Does any reasonable moral policy say that it's good for me to have a party today so that my children and grandchildren can bear the burden of it in the future through debt that the government owes? By what possible standard does someone come to that being fair?
And that leads me to my underlying point. Fairness is in the eye of the beholder. Are there any historical precedents that we can turn to? Are there examples or lessons that we have learned that can give us any guidance to what is moral? Well, yes, I think there are. And I want to start with ancient Athens.
Ancient Athens was a tyranny at one time. That's what we call it. They didn't call it that. And in order to live in Athenian society, and that was to have a wonderful life compared to living outside of Athenian society, you had to pay a tax. It was about an absolute flat tax. For all but the rich it was a burden. In fact for the majority of citizens it was the single biggest obligation that they had and yet they paid it because they understood how valuable it was to be a citizen.
Well, as the leaders of Athenian society chewed on this issue they came to an interesting insight. They came to the view that those people who received the greatest economic benefit from living in Athens had a moral duty to bear the greatest burden of the taxes to maintain the society that had made them so well off. And with that they invented taxation based on ability to pay or what we would call today progressive taxation. And when they did that they invented democracy.
Now, there is a reasonable moral basis, I would argue, for the idea that those who are the greatest economic beneficiaries of a society should bear the greatest burden. That is not an argument for the system that we have, for the level of taxes that we have. It is for the principle that the burden should be distributed. It is an ancient idea. It is written about and supported by Aristotle, Plato, Adam Smith. Those of you who quit reading Adam Smith when you got through the "pin" story in college I encourage you to go down to the public library, find a Wealth of Nations. There are lots of publications of it now thoroughly indexed like a Bible with a concordance. Read about what he wrote about the carriages of the wealthy and how imposing heavy tolls on them would lead to better roads in England and would improve economic conditions overall.
Now, Smith certainly was not in favor of high taxes. He saw taxes as fundamentally unless you could show some benefits growing out of the meaning of dead weight loss. But he believed in the principle.
Adam Smith was not alone in this. Every single one of the classic worldly philosophers wrote in favor of the idea of taxation based on the ability to pay, an idea that is quickly losing currency in the United States.
Now, we do have in our current system of nonenforcement against people who are not wage earners an interesting connection to the ancient text of Islam. I have been reading a lot of Islamic scholarly works from the 6th, 7th, 8th, 9th, 10th, 11th centuries, particularly on taxes. I have a three-volume treatise on this that I'm reading.
It turns out that it was argued at least then two fundamental points which I think you will see have immediate parallels to our society. If a man is a member in good standing of the faith and is a Muslim and declares that he has paid his taxes, it is written in these texts by the Imams, it is no right of anyone to question whether he actually paid his taxes and he must be allowed to go. Secondly, if you are any one of the vanquished peoples you may be forced to pay any tribute whatsoever to the government. And I find in that astonishing parallels to our system today.
And, by the way, Scott's point about large numbers of people not being in the tax rolls is true only for the income tax system. There is abundant evidence that the poorest fifth of the Americans pay one percentage point less of their income in taxes and fees of all kinds than the top 20 percent. And I think, by the way, quintiles are terrible measures. The top quintile begins at $72,000 a year and in 2004 topped out at over $3 billion, the amount of dividends paid to Bill Gates. I don't have anything in common with Bill Gates and I don't think anybody making $72,000 does in terms of their economics.
The value in looking at our tax system on fairness is that it causes us to debate or should cause us to debate the fundamental issues of democracy, this still new idea in the world that we can govern ourselves and make our own decisions, that we live in a society in which my numbers are a little lower than Scott's, but I won't quarrel with him. About 50 million tax units don't pay any taxes or get money back from the government, probably not a good thing. Among other things it removes an active interest by those people in the tax system and how their government is run.
It means that well, what do you care if a bunch of rich guys who are billionaires don't pay taxes. If some guy in Washington, his name is all throughout government filings and reports, makes $2 billion and never files a tax return and the government never notices what do you care? You're not paying taxes.
On the other hand you do care about things like the sales tax and the property taxes. They affect you. And we see as we get richer and richer and richer that we are increasingly impoverishing the education of our children and of the future.
So I hope that as we go through this debate today what we think about is that taxes are the system by which we decide who is going to bear the burden of government and that we need to think about that not just in terms of the rates people pay but in the broad context of all of our society, equitable law enforcement, not making crime pay, not shifting burdens off of ourselves regardless of our income on the future generations. We need to think about how to encourage good behavior, getting people to invest in themselves, getting people to have an education, getting people to behave well so that we have a society of free people who endure.
And at the core of this in the long run, not today and not tomorrow, hopefully not in my lifetime, in the long run if we do not get fundamental tax policy in its broad context right there will be an inevitable result that I don't want to contemplate. Someday some descendant of mine will sit down, and so will yours, in a high school English class to get their lecture on this era and they will read a chapter in a book that begins with the words, "The United States of America was —"
MR. BERGIN: I don't know about you, Gene, I'm thinking of getting my pitchfork and head down to the Capitol.
MR. STEUERLE: Let me say I think it's entirely appropriate for Tax Analysts to be hosting this session. If we go all the way back to its founding as Taxation with Representation it was a bit of a group of gadflies, Don Quixote types, who sat in Tom Field's basement and decided that they wanted to lobby for tax reform and it was all essentially on the basis of equity or fairness that drove their basic motivation. So I think it's entirely appropriate that Tax Analysts is hosting this meeting.
I'm going to argue that concepts of equity and fairness permeate tax policy, they permeate the policy of government in general, and they are totally unavoidable. It doesn't mean that we can easily reach agreement on what they mean. Scott has brought up a number of examples as has David and I'm not sure everybody will agree with the examples even that they gave but the fact that we're discussing it, the fact that they're discussing it, I think just shows it's a permutation.
In fact I'd argue that nothing is more fundamental to the character of a successful democracy than that citizens trust essentially that their basic human rights are there and that this democracy provides equal justice under the law. That's reflected from documents going from the Magna Carta to the Constitution, to the Universal Declaration of Human Rights.
But efforts to assert these equal justice and rights go far beyond, as I say, tax policy. It's hard to think of any major legislative, regulatory, or other action that doesn't involve this debate, the debate over equal voting rights. That's a notion of equal justice under the law.
Some people might think we don't need to provide equal voting rights but that's certainly what the debate is about. Or a debate over statues in the park area, if we provide a statue for the men from Rhode Island who served in the Civil War we'd better sure have a statue for the women from Nebraska who served in the Civil War, too, and that's a notion of fairness or equal justice. It's not necessarily an argument over efficiency or something else and, of course, we can look at the current debates over what to do in response to Hurricane Katrina. These are driven by fairness arguments.
Now, along with them we do get into other issues. How can we efficiently provide relief in a fair way? But fairness is driving, if you think about it, the debate. Again, I don't want to say that other objectives cannot dominate the process. Sometimes you cannot do something even if think it's fair because you can't officially get there. You can't administer the type of law you might want to have.
Growth, simplicity, all of these other principles need to be given attention and when equity gets too much attention sometimes we have to back off and say well, gee, we're going too far, we're trying too hard for equity and therefore we're losing too much on simplicity, and we need to move towards rough justice under law.
And I'd argue even that if we follow lobbyists when they go to the Hill and we listen to them closely and they argue on behalf of their clients they argue a fairness argument. They basically say my industry X is not treated fairly relative to industry Y. It's really not fair. Or even if you think about it, even the growth argument, it's not fair to future generations that you don't give us this subsidy because if we don't get the subsidy we don't grow as much, if we don't grow as much it's the future citizens who are going to lose. They don't go up and say I'm going to lose if you don't give me this subsidy, I, Capitalist X or Wage Earner Y, are going to lose. They say no, it's not good for these other people out there. That is fundamentally a fairness argument.
And if we go back to the philosophers I think we understand a little bit about it. C.S. Lewis, who is a theologian best known for his children's tales, once argued that as a matter of natural law — he was a natural law advocate — we humans always appeal to some standard of behavior to justify every one of our actions. He said, talking about two parties discussing things, it looks very much like both parties had in mind some kind of law or rule of fair play. He was actually referring to the fact that when you have a dispute with your spouse it's often "I deserve to be mad at you because you did this." That's a fundamental argument of fairness.
By the way, Scott, you used the term "fair" too. You said the use of the distributional tables was unfair. So you yourself referred to fairness or equity in arguing against the particular ways that they're using. So in some ways you're really arguing maybe we don't use the distributional tables efficiently or that they're not well designed but you went to a fundamental argument of fairness in actually making your case.
So, as I say, while the Constitution and the courts require equal justice under the law they don't require greater efficiency or simplicity. I don't think any standard reaches the lofty status, especially equal justice in the affairs of government, of the souls of humans. Now, you noticed I said equal justice because now we'll get into a more complex issue, which is that at least economists and I think lawyers now too and accountants divide up fairness issues into different compartments and I'll divide them into the three that I'm most familiar with, which is the notion of horizontal equity, vertical equity, and individual equity.
Horizontal equity is basically an argument that equals should be treated equally and, as I said, it goes back as far as you can into any written document that has any philosophical undertones and most people agree with them and most people do not think it conflicts with other principles. It's tough to apply, and we could get into all the ways of trying to measure who are equals or equal because they have equal consumption and equal income and all these other types of issues but the notion of treating equals equally is fundamental and I think it's embedded in the notion of equal justice under law.
Even the Constitution, even though for some reason, and you lawyers will have to explain to me, we seem to be willing to apply it to some aspects of law but when we come to tax and spending we tend to often throw it out. David, you gave some good examples there as well.
The greater conflicts are over vertical equity. Vertical equity or progressivity argues that in some sense those who have more should pay more. And this principle at times conflicts with what is sometimes called individual equity. Individual equity says if I work I'm entitled to the fruits of my own labor or if I save I'm entitled to the fruits of that saving and that conflicts with the notion of progressivity or vertical equity.
We say we're going to tax from those with greater means in some cases or in many cases whether they earned it through their own endeavors or not. And so those two principles come into conflict, and I think part of what democracy is about and to me the heart of a good political debate on the Hill is, when the heart of those principles is addressed directly, not all the other stuff that's going around. But basically we look at those two principles and debate between them.
You might think individual equity is something that's only on the side. It actually comes interestingly enough in benefit taxation, the attempts to assess taxes according to the benefits that you receive. In many ways this is an attempt on the efficiency side to apply what on the equity side we'd call individual equity; that is, if you're entitled to the fruits of your own labor then you're entitled to the returns on your own tax payments.
And a place actually coming up in spades right now is the debate over how to design the combined tax and expenditure system we now know as Social Security but also is now thrown into the debate over personal accounts where there'd be a mandate that you participate in a system like Social Security but in fact you get back essentially the fruits of your own labor. You get back the return on your contributions. Notice the mandate itself means you don't have entirely individual equity but you have more individual equity than if you're just simply transferring to other people.
And in fact this debate, the social insurance debate, just anecdotally I think this is going to become a major debate as we move into the future because as we debate issues like trying to provide not just social insurance for old age but health insurance and everything else the question is if we have people who in our society are going to get redistribution if they don't have enough income, say, to retirement but they're capable during their working years of saving or if we have people who are capable of paying for the health insurance but don't and then they have a big major accident and they go to the hospital the question is who should pay for them.
On an ex ante basis we'd argue on a horizontal equity basis they should have paid. They were as capable of paying as anybody else but they didn't and now the rest of the society is caught paying for them. And that's a large part of the social insurance debate is how do we actually provide this balance to any system that progressively wants to provide for people in need at the same time wants to make sure that people who can pay do pay ahead of time if they're able to do it.
Now I'm going to turn to what I think is one of the really major areas of confusion in the progressivity debate and that is the fact that we separate taxes from expenditures. I think it's wrong, I think in some ways it's always been wrong, but I think there's a reason why it happened. Historically taxes mainly paid for systems of justice, the basic systems of general government, often defense, public goods in the broadest sense of the word where it was very, very hard usually to think of who were the beneficiaries of these taxes. As we've moved into the 20th century, and it is a very modern phenomenon historically, government now mainly provides transfers to people.
And so when we're providing transfers to people the issue of who gets what and who's paying is the same in many cases on the spending side as it is on the tax side. Now, tax people here know that it comes up in the tax expenditure debate, right? We say well, we got spending in the tax system. Well, we also got all sorts of taxes. This is often ignored but we got a lot of taxes in these spending systems. So we phase out earned income credits, we phase out food stamps, we phase out all these items. By the way, we do it on the basis of income, which is an interesting aspect of the consumption-income debate which I don't think we want to get into too much.
We want to have income taxes for the poor and the middle class when we phase them out of programs because we still want to do that on the basis of income and for some reason we want to have consumption taxes on the rich. But my general point is that the taxes and spending issues really cannot be separated. They cannot only be separated but if you look at the public debate, and I would even argue the professional debate, it is actually inconsistent on that tax side and this is a little bit technical.
On the tax side we usually argue progressivity according to whether taxes are proportional. So Scott made a case for proportional taxation. So we said if the rate is flat we say that's proportional. That's neither progressive nor regressive. If the rate goes up as your income goes up we say it's progressive. If the rate doesn't go up or goes down as your income goes up we say that's regressive.
But when we turn to the spending side we don't use a proportional analysis. We don't say spending should be proportional to income. And so if I give a millionaire $10,000 and I give somebody who has nothing $10,000 we don't say that's a fair system. But in fact that's more than proportional, right? We'd be giving the poor person or the person with the $1 we give him 10,000 times his income, the millionaire we'd be only giving 1/100th of his income. So that's far more proportional.
And so what that means is because there are inconsistent definitions things that are determined as regressive in the tax system and regressive in the spending system together can be very progressive. So a simple example, if I tax Joe, Joe makes $100,000 and pays $10,000 in tax. See if I can do this in my head. And I make $10,000 and let's say I pay $2,000. So it's a regressive system. I paid 20 percent and you paid 10 percent but together we paid $12,000 in tax and we redistributed $6,000 to him and $6,000 to me.
Would we say that that was a regressive system? Well, hardly. I made out. I paid two and got six, and he paid 10 and got 6 so he lost 4 and I gained 4. So that ends up to be a redistributive system. But some people would say "Gee, that's regressive, both systems. There's a regressive tax and regressive spending."
And I think that causes confusion and it also causes confusion, I think, Scott, when you talk about do we want proportional taxation. We may very well want proportional taxation, but I don't think that's an equity issue because to determine the overall equity issue we have to examine the taxes and the spending together.
The arguments you mainly made, I think, was a democracy issue. You were arguing we want individuals to participate. You made a strong case that individuals at all levels should participate in democracy even if they're getting benefits far in excess of the taxes they pay. But as far as redistribution if I'm a moderate income person and I pay $2,000 in tax and get $10,000 in benefits versus I pay nothing in tax and get $8,000 in benefits I'm getting the same amount of redistribution from that society.
I think you would argue, I may be wrong, you would rather have the former system even though it has more spending because you want to me to participate in the tax system as a participant but again I would argue that's not a fairness argument. That's an argument about how you want people to participate in democracy. And I think this is a great, great source of confusion and in fact I really don't think that one can any longer separate the tax from spending.
I could go on. There are all sorts of issues that come up once we decide we want to deal with equity as an issue in the tax system. What do we do about income in kind? What do we do about potential income, people who can work who don't work? What do we do about adjustments for needs such as the fact that there are medical expenses? What do we do about the fact that people may have income that varies across accounting periods so their income is high in one period and low in the next period?
All these issues have to be dealt with and there are people who say, "You guys, this is so complex, let's just throw it out the window." But I'd argue that's like arguing if I find $100 on the ground and there are a lot of good choices on how I can spend that money I still don't need to decide. It's like there are a million good choices that I can make with the $100 and there are probably a billion bad choices and we still have to figure out how to discriminate between those good ones and bad ones and equity, fairness, is one of the ways we're going to make that decision. And so you can't throw it off the table even though it's exceedingly complex.
My final point is an argument mainly to the economists in the room who argue that equity is an issue totally different from efficiency. I'd argue that if voters or individuals indicate that they care about the poor, and this get back to * * * that is indeed an item if you want to in their utility or consumption or well-being function and there's no reason why we cannot efficiently try to figure out how much they want of that any more than we can ask how much they want in the way of automobiles or how much they want in the way of other public goods, that fairness itself is something that people want.
I'm willing to pay to have, for instance, a system of equal justice even if I don't think it affects me at all. I'm willing to pay for that and if I'm willing to pay for it then we have to examine the question of how we can efficiently deal with these issues. And you'll see in this essay that I provided on the side I don't think the issues of equity and efficiency are actually when we think in the grand scheme of things separable at all.
Conclusion, I think equity will always reassert its rightful place as the first and the most basic set of principles when applied to constitutions and laws.
MR. BERGIN: Thanks, Gene. We're going to open it up now, just a couple of ground rules. If you're out in the audience we have hand mics. We'll get them to you quickly. Just wait for the mic to arrive. I know many people here, but I'm going to pretend I don't know you so if you would state your name that would help us a lot.
MR. KURLAND: I'm Norm Kurland from the Center for Economic and Social Justice and so I look at the problems of justice and efficiency. I think if you maximize justice in the society you'll also maximize efficiency. Now, the question that I would like to throw to the panel first, in listening to issues of fairness and justice or equity whether people on the panel are aware of Louis Kelso's writings on the subject, particularly The Capitalist Manifesto that he wrote with Mortimer Adler.
How many people on the panel are aware of that because they went into principles? One person, two, good. Because I was also a student of Wally Blum and Harry Kalven, who wrote the classic, so I'm looking at that and furthermore we were involved in trying to change the tax system, Kelso, and we got a little pimple on the system called employee stock ownership plans which changed to some extent in the ERISA laws the treatment of dividend taxation, the treatment in terms of how you accumulate in a tax-free way.
So it was looking at the system from the standpoint of how we reduce the disparity between those at the top and those at the bottom because I think you can measure equity and justice in terms of disparity of rights, privileges, powers, and responsibilities particularly if we're talking about a democratic society where everyone is supposed to be treated equally before the law.
So we want to look at the burdens. I think it's worthwhile to look at the three principles that Adler and Kelso stated were basic in terms of understanding economic justice. One was a principle of participation, the other was a principle of distribution and that was according to contribution, and the third was a principle of limitation.
I think if you look at that triangle you begin to see that the principle of participation is something that Kelso and Adler added, particularly Kelso, in terms of the fact that there are barriers to participation to ownership.
MR. JOHNSTON: Now what's the question?
MR. KURLAND: Well, first I wanted to see because if in fact there are people who agree that participation is the problem we have to look beyond the tax system to the overall economic system to look at the various barriers and there are barriers in the tax system.
MR. JOHNSTON: So what's the question?
MR. KURLAND: Well, it's not so much a question but to say that I believe that Marx was wrong in terms of progressive income tax and we have been following that and that you can have a flat rate tax and it will work if you open up the barriers to ownership. And you begin to open it up so that all citizens would have access, the same privileges of access, to ownership and then everyone would be able to pay. In the beginning you could have a flat rate tax over all forms of consumable income whether it comes from capital gains or it comes from dividends or interests above the poverty line and you could balance the budget. You see? And you could begin to look at Social Security and payroll taxes and fold that right in because that's what the poor pay mostly.
MR. JOHNSTON: So where's the question. What's the question?
MR. KURLAND: The question is: does this offer a framework for being able to reconcile the differences between the three speakers?
MR. JOHNSTON: Well, I don't know that you're going to reconcile differences between people. In my case in particular I'm here mostly to pose questions about how we think about these things. To be clear if I haven't been, under our Constitution we can tax anything we want. I mean, frankly, as I read the Constitution while I'm sure the privacy advocates would go nuts at this suggestion I would suggest we could balance the budget by taxing sex. There's no prohibition — in the constitution that I read but my wife and I had a very fun discussion about this. The young would pay more.
MR. WHITE: That was already proposed in Gulliver's Travels.
MR. STEUERLE: You're only going to do the research on the project?
MR. WHITE: It was self-reporting in Gulliver's Travels.
MR. JOHNSTON: The notion that we all ought to be owners and have assets is I think a very good idea. I mean, one of the most interesting things about Sweden, for example, which we think of as our perfect example of a socialist society, is that it's incredibly capitalistic. People are very provident. There's a word we've lost sight of in America. We've replaced providence, a virtue, with greed, a sin.
The problem is that if you take all the assets in the United States and all of us were asset owners there's not enough assets to support people. Most of us are going to have to work. Labor and taxing labor are going to be fundamental issues throughout our society. But having systems that encourage people to own certainly promote stability.
They certainly and absolutely promoted enduring society and they lessen alienation from society or they ought to overall. But I think that's an awful broad reach from the fundamental issue. We're talking about a fairness of taxes because what you're talking about is fairness of the economic system. And while I think you need to see taxes in terms of that that's the focus of our conversation today. Taxes is a subset of that.
MR. MINARIK: Joe Minarik from the Committee for Economic Development. I'd like to react to some of the things that Scott said and his presentation was a series of assertions and some of them appeared to be directed towards distributional analyses. Some of them appeared to be directed towards issues of tax policy. I think it's important to pull the two apart.
So, for example, a question. If you're looking at a distributional analysis of a change in tax law hypothetically the results are garbled to some extent by the mixing in of single people and married couples. There's an easy answer to that from the point of view of distributional analyses. If you're using micro data tax returns you look separately at single returns and joint returns. And back when I was young enough to have the physical strength to crank a main-frame computer and do these things I did that all the time.
I would bet that if somebody did that today, and I think some people are doing that, and you looked at the distributional assessment of recent pieces of tax legislation separately for single people and married couples you'd come to the same conclusion that you'd come to when you look at them together which is to say they have increased the share of after-tax income of upper income people relative to lower income people. It's just the way it works.
The criticism of the system with respect to a growing population of people with zero tax liability, I think there are really two answers to that as an issue of tax policy. Number one, for many years people have been saying that one of the greatest simplifications that one could achieve for people with modest incomes is to get them out of the system entirely. And if you go back to the debates of the 1970s and 1980s one of the arguments for increasing the personal exemption or increasing the standard deduction was to lift from many people with modest incomes the obligation to fill out a tax return at all. And in many ways that seems like a quite reasonable objective.
But another reason why we have had a growing population of people with zero or negative tax liability, and that's a distinction I think we also want to keep in mind, is decades of wage stagnation. And that has been going on for some time. It's the major contributor to the problem that David cited with respect to people, married couples in particular, having to work a lot harder. Part of that I think is coming from increases in healthcare costs because the total compensation of people with modest wage income is probably growing faster than their wage compensation because, as some healthcare experts have been pointing out, if you consider employers as seeing an obligation to provide healthcare for their employees the cost of healthcare is like a head tax on their workers and it's holding down the wages of lower income people more than upper income people.
Another point that Scott raised which possibly was oriented towards distributional studies or possibly towards policy issues is this notion that a middle class defined by behavior or location in suburbs or social status or whatever is being overburdened and being, I think the quote was "demagogued into being denied tax relief" on that point. Evidently not. We have an enormous deficit and we've had enormous tax cuts across the board in recent years.
But I hear that and I don't want to be moralistic but there are lots of couples out there who work. You have two couples who work a combined 60-70-80 hours a week, make $100,000. You've got couples who work a combined 60-70-80 hours a week and make $25,000.
Minimum wage, 2,000 hours a year, $5 an hour, it's $10,000. The $20,000 or $30,000 a year couple could have the same number of children. They're not paying taxes. They're heck of a lot worse off than the higher earning couple. We have a progressive tax system in order to provide some relief for those people with more modest incomes.
One other point with respect to the desirability of a single rate tax, I haven't heard anybody advocate a single rate tax without exemption or deduction of some sort. Everybody wants some exclusion of income from a single rate tax. If that's true you can collect the same amount of revenue from a single rate tax with a lower exemption and lower rate or a higher exemption and a higher rate.
They have different degrees of progressivity. For any single rate tax you can approximate the results in terms of distribution with a multi-rate tax with different kinds of exemptions and credits and it makes me wonder what's so sacred about a single rate tax if the degree of progressivity from a single rate tax is elastic in terms of its design or can be replicated in terms of a multi-rate tax. The notion of a single rate I think in some segments of society has been deified and I just don't see the point.
One final point, very practically speaking, one element of fairness in a society that is already up and running and already has a tax system has got to be defined by the tax system you've got today. You could come up with a flat rate system or some other kind of alternative system that would make a quantum change in the current system and make an airtight philosophical argument for its ethical supremacy. Theoretically speaking I don't believe you could but suppose you did. If the result of that was that 30 percent of all homeowners were defaulting on their mortgages because their taxes went up enough that they couldn't make the mortgage payments I don't know that very many people would consider such a tax system as fair.
So one way or another when you're talking about a new tax system today you have to have in the back of your mind the tax system you've already got and are you going to be indefensibly disadvantaging some of the people who have signed mortgages, signed car loans, signed education loans, made long-term commitments all on the basis of the tax system they've got and that has to be a constraint on what you do.
MR. BERGIN: So change could be unfair?
MR. MINARIK: Change to a system that is "fair" could be unfair.
MR. SHAPIRO: Hi, I'm Rob Shapiro, a couple of comments. First, Gene, I've been working and talking with Gene for 20 years. I just want to say I've never had a conversation including today from which I don't learn a great deal and I really appreciate that, Gene. Second, I don't want to pile on Scott here and I'm not going to make specific comments, but I am struck through this conversation by the sense of the degree to which the United States is an outlier in the advanced world on so many of these issues.
There is no other advanced country where there is a debate in which a significant party or a significant side argues for a proportional tax system. It's just absent. And there is no other place in which part of the tax and expenditure system doesn't include universal healthcare and universal access to a higher education.
So it's interesting because Americans think of equality as something which is distinctively true about the United States and yet we do have a system in which we use income to determine access to many generally considered public goods that no other society does. So I think we ought to, in trying to think through issues of equality, begin with some self-awareness of the American context, which is that equality and fairness here seem to mean something different with respect to a lot of fundamental issues than it does in the rest of the advanced world.
And the third comment, and this is really a question, if we look ahead over the next 10 or 15 years I don't know any public finance economist or public finance analyst who wouldn't say that the size of the public sector is going to increase and perhaps with some significance. Again we ought to remember that our public sector is substantially smaller than every other advanced country except for Japan but we'll set that aside. So the issue is going to be raising taxes for Medicare, for Medicaid, for Social Security, perhaps for defense and so I'd like to ask the panelists whether the issue of fairness, again in the American context, is different when the issue is how we raise taxes than it is in the context of reforming the system in a tax-neutral way or the more common instance, which is in the context of lowering taxes.
MR. BERGIN: Who wants to go first. Gene?
MR. STEUERLE: I'm not going to answer the question in its entirety but do want to make two comments on it. One is I've looked historically at a very interesting aspect of tax increasing in the industrial countries of the world in the post-World war II period is that they have all been through the adoption of additional or increased flat rate taxes.
I * * * in my talk but we often associate progressive taxes with big government and I think that's largely because in the first half of the 20th century governments got larger, we adopted things like income taxes, they were exceedingly imposed. I mean, do we think about how progressive * * * percentage distribution of the burden we think they're progressive now, they were really progressive at the start. They were mainly on corporations, mainly on rich people, and so we associate that growth in government with the growth in income taxes but income taxes are inherently a very conservative instrument of policy and that's because unfortunately I think the advocates for lower taxes mainly argue for lowering taxes for the most part on the rich.
The simple fact that if Joe pays a 30 percent tax rate and I pay a 15 percent tax rate you could think about his 30 percent tax rate as being bigger government but you could think about my 15 percent tax rate as being smaller government because by not imposing a 30 percent tax rate on me you raise less revenues and it turns out the income taxes in Europe and the United States the individual income tax, for instance, never collected much more than about 10 percentage of GDP and so countries that rely upon this system because the top rate gets to about the max people are willing to accept and they have lower rates in the bottom.
So what have these countries done? They've turned to value- added taxes and Social Security taxes which are flat-rate taxes because they actually collect from a lot more people. So a fascinating aspect of this debate is that as government gets larger it does turn to flatter rate taxes to supplement its progressive systems because that's how it collects lot more government so if your purpose is small government it's not clear abandonment of the income tax is in your best interest. It may even be worse.
Now, the other thing I said I want to cover and I'll do it more quickly which is that I do think that members of Congress, and this just an empirical statement, not a theoretical one, when it comes to raising versus lowering taxes, operate in a very different manner.
When it comes to lowering taxes or doing spending increases, when they're on the give away side of the budget, it's like first person to the trough wins. Now, sometimes there are interest group we might like, sometimes there are interest groups that we might not like, but look at recent energy bill or anything else and it's like whoever got there first and made their case in the right way got fed at the trough first. There was very little principle guiding the policy.
But when we take something away from the public, when all of a sudden policy makers have to go out and tell the public "I'm going to take something away from you, I'm going to cut your spending or I'm going to increase your taxes," boy, they quickly start reverting to principles. And so we have this fascinating aspect that when I came to government in the '70s people said we can't do tax reform unless we have all these surpluses. In the '70s we had horrible tax policy in many cases. We just gave away stuff left to right to anybody who came in. Then when we got in the '80s and things got tight and we actually had some good tax reform. I'm talking about tax reform in terms of horizontal equity and efficiency. I'm dodging the budget issues.
And that's because things were tight and the policy makers had to go out ask the public for something so that's actually a fascinating empirical observation I make about do we appeal more to principles whether it's raising taxes or cutting spending when we deal with the deficit and future deficit issues.
MR. BERGIN: Scott, I heard more consensus between you and David than I feel in some of the questions. I think both of you are arguing that the middle class gets nailed under the current system if we go to a system where we have to raise taxes. Now Sheldon and I are going to have a side debate on whether there is an upper middle class but —
MR. STEUERLE: There is an upper middle class.
MR. BERGIN: We can get to that in a minute.
MR. COHEN: Everybody is in the middle class. I've never met anybody who wasn't.
MR. BERGIN: So I think you both agree that the current system is unfair whether we lower or raise to whatever the middle class is.
MR. HODGE: I think you're right. I think that no matter how we try to solve some of these fiscal problems the working stiffs are likely to get it. I was in Great Britain earlier this summer meeting with some Inland Revenue people and one of the senior people in their tax department shocked the congressional staff that I had on this trip by saying if you want to fund big government there is no more beautiful system than the value-added tax because it is completely hidden and jaws dropped not because of what he said but that he felt comfortable enough to say it. And I think that for all of those people who are looking to try to solve some of our social spending imbalances and looking at the VAT ought to take that in mind.
I just have great, great concern, in getting back to some of Joe's points in defending the indefensible again, about a vast array of admittedly the political challenges in getting into some of the points that proportional taxation for the poor is somehow wrong. I have vast concerns about large swaths of America looking at the IRS as an ATM machine, and I think that Don Alexander will tell you that the IRS doesn't relish that role either.
Tax policy should not be social policy because it ends up looking like that book that Chris was waving around earlier, the IRS code, and there are difficult political choices in this but I think that we have to face the fact that the tax code just doesn't treat us all fairly.
MR. JOHNSTON: I want to just if I can follow up on what began back here. I don't accept necessarily the notion that if we raise taxes in the future, and our physical balance sheet certainly suggests that there has to be some major adjustment in the future, unprecedented economic growth, enormous cuts in spending including promised spending or higher taxes, one of those things is going to happen down the road or perhaps we'll discover that in fact there is an endless ability to borrow money that we don't have. But I don't necessarily accept the notion that higher taxes mean that the working guys are going to get the shaft from this, Scott. I think one of the fundamental issues of tax policy important to think about is the level of participation of citizens in their government. And I have had many, many speeches I've given, and I've given hundreds of these, said to people in the audience call up your congressman's office and tell him you want 15 minutes of the congressman, sometimes I say five, any time at his convenience. I have yet to hear back from someone who actually got a meeting. I have heard back from people who were asked, I kid you not, what I'm about to describe as a criminal offense. Are you a donor?
That's a crime. And I've had people who send me copies of letters from staffers when they disagreed with the congressman's vote on some tax issue lecturing them on what they should think. That suggests to me a government alienated from the people and the people alienated from the government and that if in fact burdens were higher perhaps as a matter of choice individuals would decide just as someone pointed out here that, I think it was Joe, to provide economic relief for the poor maybe a consumption choice that we make and willing to pay for it that if we face tougher tax burdens perhaps we would see people more engaged in their government and spending less time following Paris Hilton. I think that will probably be a social good.
MR. BERGIN: I'm having difficulty here being fair. I'm seeing hands up.
MR. NISKANEN: Bill Niskanen, two points, one is at the request of a member of the tax commission I did a calculation of the relationship between the VAT tax rate among OECD countries and the relative size of government. And what I found is really quite dramatic is that with very little standard deviation the government share of GDP among OECD countries that have a VAT, which is almost all of them, is 22 percent plus the VAT rate, a very, very low variance on either the 22 percent or on the marginal effect of the VAT rate.
The implication of that for me is that for any broad based tax system we have to have a super majority rule on rates because if you don't have that if you broaden the base tweaking the rates generates an awful lot of money and what happened after the 1986 reform I think was illustrative. We got rates fairly early in the first Bush administration and we got a rate increase again fairly early in the Clinton administration.
So I think that in terms of economic effects VAT has very preferable effects in terms of dead weight loss but it clearly leads to a bigger size of government and I think that we should test the support of that by a super majority rule.
The second question that I've been mulling for the last hour or so is that I've heard some confusion among at least five different concepts, fairness, justice, equity, good social policy, and efficiency. I think those terms have been used too much interchangeably.
Fairness is an attributive process, not of outcome. Last night I went to the ball game. It was a fair game in the sense that it was played by rules to which both teams had agreed. It was a lousy outcome for the local team. The only real concept of fairness is did I agree to the rules and were the rules followed and that has to be regarded as a fair game in that case.
Equity has two many different dimensions, as Gene has suggested. Equal treatment of equals doesn't even help that much because does it mean equal amount of taxes per person or does it mean equal proportion of taxes per person or whatever?
Justice is less defined. Good social policy is in everybody's mind. Efficiency is the economist's concept of a tax system to minimize the dead weight loss for any given amount of revenue that is raised but even that begs the question of the consequence of the tax system on how much revenue is raised and that is importantly a function of the nature of how broad the tax system is given the evidence about the effects of the VAT.
So I think the concept of fairness is not a useful concept for the VAT for a tax system because by being willing participants in the particular democratic society in which we live we have agreed to the rules of that society and to the extent that the rules are followed basically any kind of tax system has to be regarded as fair.
I have voluntarily chosen to live in about the highest tax jurisdiction in the United States called the District of Columbia and I complain regularly when I pay my taxes but I don't have any basis for that complaint because I chose the combination of convenience to the job and other values of the District of Columbia to be more valuable than the fact that I pay a 10 percent marginal income tax rate to the District.
I think we should be very careful about the use of these terms and not regard them as in some sense interchangeable. Fairness is different from equity, different from justice, different from good social policy, and different from efficiency.
Now, on the efficiency front we can go a good bit toward the vertical dimension of tax policy by Jim Buchanan's rules. Buchanan has come up with the rule for which people will get just the amount of public goods that they demand and that rule is that the rate of progressivity should be equal to the ratio of the income elasticity of demand for the public good over the absolute value of the price elasticity for the public good. For public goods alone that can lead to either proportional or less than proportional or more than proportional depending upon the ratios of the income elasticity and the price elasticity demand for public goods.
For private goods provided by the government itself which maybe they shouldn't do at all then the rules are more straightforward that people shouldn't pay any more than the value of the private good to themselves. But we have a good bit of literature in economics and in public choice that bears upon these concepts and I despair that there does not seem to have been very much consideration of sorting out and making more careful definitions of these different concepts.
MR. BERGIN: Eric.
MR. TODER: Eric Toder, Urban Institute. I guess the discussion has veered in a different direction. I'd like to make a few points about distributional tables and distributional analysis and one other point that was raised by something Scott just said about the taxes and social policy and then I've one question for the panel. First a small factual point about distributional tables. When I was at CBO we argued about this a lot but the distributional analysis that was done there did have an adjustment for family size so the income bracket people were put into was lower if they had the same income but was a family of four rather than a family of one. And that didn't give markedly different results than other distributional studies.
I do think as David made the point that you have to include payroll taxes in any measures of tax burdens. Roughly 80 percent of people if you count the employer part as paid by the worker pay more payroll taxes than income taxes and you just can't ignore that and say all these people are not paying any tax. Now, there is the other question of whether you should do what Gene suggested and expand that to include some measure of the transfer benefits people receive in these tables too and I think that would certainly be desirable but when you're looking at changes in tax or proportional changes in tax you really have to look at something broader than just income taxes.
And the one example I like to use is the earned income tax credit, which offsets a big part of the payroll tax for a lot of low- income workers. So the question is, are they paying positive payroll taxes and negative income taxes or are they paying smaller or zero payroll taxes and no income taxes? And you could say it either way. It really is not a relevant question.
The other thing about the distribution, if you look at many of the plans that are being considered, I don't think this point was highlighted. Many of the cuts we're not talking about the middle class versus the upper middle class. We're talking about the very top of the income distribution versus everything else.
As Joe said, if you have a flat rate with an exemption you can have a variety of distributional effects depending on how large you set the exemption but that's redistribution between the poor and the middle class. There's no way you could have a revenue-neutral flat rate without having a very large tax cut at the top.
And the other thing, in many of the plans that are being considered now are talking about taking capital income out of the tax base. It's a factual matter that also comes out of the distribution tables but it would even come out of straight IRS statistics that the overwhelming majority of taxable capital income, interest dividends, capital gains, go to people in the very highest bracket, a very, very large percent going to the people in the top 1 percent or even in the top 10th of 1 percent and that distribution of those taxes is much more tilted toward the top than distribution of the income tax burden as a whole and so you'd really have to face it.
And also, although capital income is concentrated among the higher groups, the taxable portion of capital income is much more concentrated among the higher groups, because the income from pension plans and 401(k)s, which is exempt, is also for a lot in the top quintile of the distribution. But it's really mostly in the bottom part of the top quintile where a lot of that exempt income is. So you're making a very big change and I think one of the issues that people have to look at is how much should the very top groups in the system pay relative to everyone else.
I'm sure there are disagreements on that. It's a core question of values and philosophy, but I don't think you can deduct that as a central equity fairness question in the debate.
Just an aside on the tax policy should not be the social policy point that Scott made: I've spent a very substantial part of my career in the government arguing incrementally against various attempts to use the tax code for social policy to subsidize this activity or that activity but I have to say it's really a second order question. The question isn't whether a tax policy should be used for these things. The question is whether these subsidies should be in the law at all whether on the tax or the spending side.
And if you shifted all these things to the spending side there might be some administrative benefits in some case, there might be actually some administrative disadvantages in other cases, but whatever it is the big issue is the programs themselves, not the part of the government which is funding them.
Finally my question to the panel is, since I raised the issue of capital income and how it's distributed, there's been a long-standing debate as to whether a consumption tax is a fairer tax than an income tax and whether we should or should not tax capital income. That's clearly going to be a part of the debate when the tax reform proposals are introduced and this is from Gene's categorization horizontal equity, forgetting the distribution for a moment, but whether somebody who gets income from interest and dividends and capital gains should be paying the same tax rate as somebody who gets it from wages or maybe should be paying a different or a lower tax rate and I'd really like to see the panel address that.
MR. BERGIN: David.
MR. JOHNSTON: Well, first of all it's a very interesting discussion we're having about social policy. Taxes are social policy. Distributing the burden of taxes is government policy and we can argue whether providing a specific benefit to this group of people, poor people, owners of certain forms of capital, et cetera, is an extension of that but on the threshold issue taxes are social policy by their very definition. We decide who prospers and who benefits by the way we decide to create our tax system.
MR. TODER: Excuse me. I won't argue with your definition but my comments were addressed toward using the tax system for expenditures.
MR. JOHNSTON: Fair enough, Eric. There is a lot of popular support. I mean, look at the number one best selling book in America right now both at Amazon and the New York Times is this book on getting rid of the IRS, because it's this wonderful fantasy. We won't have to have an enforcement mechanism for the tax system. But the idea, why is it that consumption taxes are popular and should we tax capital incomes, well, if we don't tax capital incomes we'll get more capital. I think that's a given. That's what they taught me at the University of Chicago.
MR. TODER: You may be wrong but that's another issue.
MR. JOHNSTON: Well, we should get more capital, and we should have more people who are saving capital. But the underlying question is why is this so popular? Well, I think it's the same reason that people say that they trust first and foremost their local TV news, which is the least accurate, least reliable news. Why? Well, (a) they're familiar with it and (b) perhaps more importantly, it just floats by without having to think about it and then it's gone with the wind.
And so the idea of a consumption tax I think appeals to a lot of people, and we can have a consumption tax, I'm not arguing for or against one, but I think it appeals to a lot of people because it fits what their life is. It's something what they see that make sense to them and they aren't thinking about the top 10th of 1 percent. They aren't thinking about the effect it will have on other policies. So it's inherently attractive to do that.
The rise of the S-corps and the pass-through entities that Scott talked about which is enormous and the C-corps which Nina Olson has pointed out are the last great area for tax cheating for working people because the nature of how the C-corp works, and both ways you can report income you don't have to get a bigger EITC if you're very poor, you can put your lifestyle in some ways on to the Schedule C if you're a middle class or upper middle class. But the rise of the pass-through entities reflects in fact in part the different ways we decide to tax capital in this country and I have a hard time seeing an argument for not taxing capital and I would argue that anybody who's a Christian or a Jew would have a very hard time arguing not taxing capital based on what's in their religious texts.
The overwhelming number one obligation that is conferred by God to those who are believers is that you are not to oppress the poor. And if you exempt the very rich who cannot pass through the eye of a needle from taxes on their capital and you tax people who even if they're not poor do not have those kinds of resources I'm not sure you are meeting your commandment from God over your stewardship of His resources, since it's not yours, it's God's, whatever you have.
MR. BERGIN: We're still on the panelists so I'm going to go here, there, and David. Gene? We're still answering Eric's question.
MR. STEUERLE: Just a quick question thinking about what type of taxes you might impose on the grounds of fairness or equity, I define fairness pretty much as equity but I understand there's reason for * * * but what would you to finance the cost of the hurricane Katrina? Who should bear this burden. If you say it's a proportional tax you're saying well, all of us in society should bear some we could say proportion to what, we could say proportion to income. If you say it's a consumption tax we say well, we would tax those people who consume but we don't want to tax the people who have capital and wealth who aren't consuming.
There's some notion of a consumption tax but we might eventually tax these people to pay their share but it will be 50 years from now when they finally consume but right now we'll give them a loan for their share. But if we think this is an obligation on ourselves today who should bear the tax I'm not even answering the question but it's an interesting way to break the tax question up. Who would you today assess the tax on (and we are going to pay a tax, to pay for some relief, which all of us agree we're going to provide for the victims of this hurricane)? It just seems to be an interesting way to think the question out.
MR. BERGIN: It is.
MR. COHEN: Scott, I'm Sheldon Cohen and I'm a professor at GW right now. Scott indicated that he wanted tax policy and not social policy. I just want to give an illustration. I testified in I think '68 or '69 that the thing that made me most ashamed was to collect the taxes from poor, people who we define as below the poverty level. The very first piece of legislation I drafted in the '54 Code was for Dan Smith and I remember going to Dan Smith. I had gone to the college on the GI Bill and I'd gone to law school on a full scholarship and I'd lived at my father's home. He gave me a roof over my head, and he claimed me as a dependent.
So when I was trying to define dependency I was trying to eliminate social policy and I defined the support that I got as including the government's payments to me as a veteran and payment for my education and that scholarship to law school plus I got a stipend. And I remember going in to talk with him about this. He was a 50-ish professor from the Harvard Business School and he looked at me and he said "No, Sheldon, 180 degrees the other way." Now, that's the rule. Now, how do you not draft social policy into that rule? One way or the other whichever way you make the decision you've got social policy.
MR. HODGE: Well, I think we have to though remember the law of unintended consequences. We've used tobacco taxes to try to prevent from smoking and what do we get? And we know this from 300 years of tobacco tax history. We get smuggling, we get contraband, we get illegal activities.
MR. COHEN: But there's a cut in smoking, right?
MR. JOHNSTON: It's interesting. We didn't put any money into law enforcement, did we?
MR. HODGE: But that's an inevitable consequence of using tax policy to try to prevent some sort of behavior.
MR. JOHNSTON: But criminal behavior response to law enforcement, I mean, the fact is we have these huge payouts from the companies and we raise taxes for them to make these as part of this and I'll give you a simple example. In the Middle East when you buy a pack of cigarettes the tax stamp is inside the cellophane envelope but because of the laws in the states in this country it's on the outside. You can't have smuggling if you just move the stamp to the inside and you prosecute the people who violate the law. Let's go after the criminals.
MR. HODGE: Smuggling is huge.
MR. JOHNSTON: I think you can eliminate it. You can eliminate the smuggling by changing the way you do the tax.
MR. HODGE: It's still going on in the world. Most of it's coming out at —
MR. JOHNSTON: There's no enforcement going on. That's what's going on.
MR. HODGE: But I'd be interested in Steve Entin's point in the whole capital question because the question is how many times do you tax capital and shouldn't we only tax it once?
MR. BERGIN: Let Don in here.
MR. ALEXANDER: Maybe the rate on dividends, counting the rate on the corporation paying the dividends is 10 percent or 15 percent perhaps at the most tax on the weight of the stockholder, the weight of Bill Gates, because surely Microsoft doesn't pay an effective rate of 35 percent. Nor does anybody else as far as I know. Anyway what I was going to trying to say and have been wanting to for some time, Mr. Chairman, was, going back to Charlie Kelso and ESOPs, we would really solve our problem of taxing capital if all corporations were to become pass-through entities owned by ESOPs. That would solve the problem because immediately you'd have no current tax, a deferred tax, but a deferred tax at a capital gains rate, things like that. So —
MR. JOHNSTON: And how would you deal with the stock market where people trade constantly? They're not long-term owners like ESOPs.
MR. ALEXANDER: Those people? Well, they use fancy things anyway and they come out even. I'll call up Quellos and ask how they're doing. We all know who they are. Eric Toder covered most of the little points I was trying to make. One of them simply went to the use of that tax system as a transfer mechanism at the bottom quintile and whether that is a desirable way to use a tax system to pay out rather than to collect from people.
Some of us think that it would be better to have the departments that have goals in that particular direction like HHS to have the responsibility for administering that goal and then perhaps we could test each year to find out whether the goal was a suitable one. I would like to ask one question about the recent highway bill, the Safe transportation bill. Why was it necessary to put in Safe transportation three special provisions for distillers? Does more booze lead to a safer highway?
MR. BERGIN: Steve?
MR. ENTIN: Thank you. Chris, I want to thank you first for publishing the recent series that you've done on revenue estimation, the whole series you're putting together. It appears that they are going to be appearing in the Heritage book on that subject coming out shortly. Mine was tax instance, tax burden, and tax shifting, who really pays the tax. You stuck that in Tax Analysts' Tax Notes December 13, 2004, and what I'm about to say is fully covered in that that you can also find at our Web site iret.org. I also —
MR. BERGIN: Identify yourself.
MR. ENTIN: I'm Steve Entin with the Institute for Research on the Economics of Taxation, thank you. Again, you can find that discussion in the December 13th Tax Notes or at www.iret.org, our Policy Bulletin 88. I also tried to apply that to the recent hearing on extending the 15 percent tax rates on dividends and capital gains before the Finance Committee which is in our Congressional Advisory No. 190.
Scott was asking me about the burden of taxes on capital and Bill Niskanen had said some very interesting things about burden. I'd like to get back some basic economic concepts. None of the burden tables that you see, those that Eric is quoting from as he tries to analyze how much of the tax burden is on capital and who has the capital income, none of these burden tables reports the tax burden. The tax burden is what does the tax do to people's after-tax incomes after all effects have been realized through out the economy.
What you're seeing in the burden table is really the initial incidence of the tax. None of the economic consequences are counted. They even get the incidence wrong. And Scott mentioned, they don't show lifetime earnings, they show only the snapshot in time, and even if you adjust for age and family size you're only doing a snapshot, and people's incomes and consumption patterns change over their lives. Treasury is trying to do panel studies which reveal that in more detail but the current incidence tables don't.
The way the incidence tables really mess up in calling themselves burden tables is that they * * * the economic consequences of the taxes that are levied. There's a large economic literature which suggests, and it's not just the University of Chicago, it's microeconomics in general and I know people who'd take micro and macro often prefer macro and make fun of micro but it's the micro that's right and it's the macro that's nonsense. If you lower the service price of capital you get more capital. If you get more capital the productivity of labor rises. If you get a higher productivity of labor since the factors have paid their marginal product you get higher wages. And if you have taxes that depress wages all across the board that's a penalty on everyone and that penalty has to be considered as part of the tax burden which gets us to fairness. Bill's right. "Fairness" is a term thrown around in a very wrong way.
When we exempt the poor from tax we do it out of the kindness of our hearts and we should be charitable and it is charity. It's not fairness, at least not as I would define fairness. And, by the way, David, yes, Christians and Jews are supposed to be charitable but we're supposed to be charitable as individuals. We're not supposed to have to be forced into it through government and if government forces me to be charitable I'm not being charitable. I'm being coerced. There is no merit in heaven in paying your tax because you don't want to go to jail.
Now, fairness. As an economist I'm going to say equal treatment under the law and fairness are from the standpoint of how we treat people when they do good things. I'm going to equate it in a sense with the economic efficiency because that's my definition of it. Everybody can have his own.
If you have two farmers noting that some new families have moved into town and they are going to increase their grain output to help feed those new people and each farmer produces an extra hundred bushels of wheat and is producing this product and the tax collector comes along and says "You, Mr. Farmer A, are going to pay 10 percent on your earnings from the 100 bushels of wheat and you, Mr. Farmer B, are going to pay $30 on your 100 bushels of wheat even though they each do equal good for the new families coming into town," you're discriminating between producers.
If you did it because and one was white and one was black we would say that's horrible. If you do it because one farmer happened to have produced a half million bushels of wheat and is now adding 100 while the other one has only produced 100,000 bushels of wheat and is adding another 100 so that the first farmer has started with more income than the second then we say "Oh, that's good, that's kind, that's fair, that's just." It's economically inefficient.
If the efficient farmer decides not to produce the extra 100 and the other farmer has to produce 200 but the soil is more rocky and the price of food gets pushed up a little more heavily because of it and the poor now have to pay more for their food because we taxed the wrong farmer out of the production system that's not fair, that's not efficient, that's not even sensible, and yet we admit all of that from the definitions of fairness.
In the economy it's the marginal rate and the marginal incentive that matters, not the average, so, Joe, if you want to say I can have an equally progressive tax systems with a large exempt amount and a high rate or a small exempt amount on a low rate the small exempt amount and the low rate have better marginal incentives for added output and lower costs of goods and services.
Remember, goods and services are called goods and services. They're not called bads and disservices. So if you look at fairness to the producer you're going to want at least at the margin even if there is an exempt amount at the bottom a flat rate. The burden tables don't show any of this and unless you go through the analysis of the effects of the taxes you're not going to get the right answers.
There is the growing literature which suggests that consumption-based taxes will yield a high enough increase in the capital stock so that even if the consumer has to pay a little bit more in tax in the beginning as a worker the after-tax wage will have gone up anyway because the gross wage will have gone up by more than the tax. And if that's the case, as Glenn Hubbard has written, we really need to start talking about moving to the consumption basis with appropriate grandfathering so that in the transition we don't clobber some people who have contracts on the way out which would be unfair and retroactive and all of that. So I hope we bring back the economic consequences of the taxes into the discussion on fairness and not confuse fairness with charity. Thank you.
MR. BERGIN: David, go ahead.
MR. BRUNORI: The exemptions for the poor are charity and not fairness, well, then the biggest benefactor of our charitable goodwill has to be Microsoft. I mean, they pay no taxes. I mean, there's where the real charity is going up more so than it's going down. I haven't heard that assertion before that the —
MR. ENTIN: That's not true. You're not defining income properly or charity.
MR. BRUNORI: Well, perhaps but if the poor are exempt from tax and Microsoft is exempt from tax and Microsoft made $80 billion last year and Joe the poor guy made $9,000 last year it would seem fair to characterize them along the same lines but that's not my question. I have a question actually for Mark and that is, Mark, before the tax reform commission your testimony was that you would find a flat rate starting at $40,000 acceptable given all of the political limitations on —
MR. HODGE: I was just reiterating Joe's point that a flat rate system with a generous family allowance like what Forbes is advocating in his new book, a $46,000 family allowance, would roughly produce the same distributional arrangement what they have.
MR. BRUNORI: Right, now, my understanding is Mr. Forbes doesn't want to tax capital income. His flat rate would be purely on —
MR. HODGES: Wages.
MR. BRUNORI: On wages which —
MR. HODGES: No — no.
MR. BRUNORI: Is that not right?
MR. ENTIN: There's been a longstanding debate in economics whether the principal you put into the bond and the interest you get onto the bond are both income. You earn your wage, you put the 100 bucks into the bond, you earn $4 in interest. In fact if you tax both the principal and the interest and count them both as income you've taxed the original income that was saved more heavily than the original income that was used on consumption.
Now, that's in all the consumption income debate literature so I'm not going to go into it too deeply here. But in fact the income tax is not saving-consumption neutral. It's biased against saving, which is biased against capital formation which hurts wages and all the rest, which is where all the argument comes from. In addition to that we have the corporate and shareholder additional layer of tax and then there is the estate and gift tax.
So capital is taxed multiple times, consumption generally only once unless it's alcohol, tobacco, tires, bows and arrows, and tackle boxes, which is why fishermen use tool boxes instead of tackle boxes. But in any event, when you say Microsoft has earned all this money and isn't paying tax, they had expenses that were in the form of investment and that is a real cost and unless you simply ignore the costs and look only at the revenues and call it income, you don't get the results you're getting. If you properly define saving and investment as outlays for earning future income and net them out then you get basically to the argument for the consumed-income base and that is another way in which the burden tables mess up because they assume the broad-based income tax is the norm instead of a tax system which allows saving and investment to be regarded as costs of earning income. And that's where you get your examples, which are really quite a bad distortion of what economists would regard as income, which is basically consumption.
MR. BRUNORI: But if I am Steve Forbes or I'm Bill Gates or I'm some guy who's making a million dollars interest is better. I have billion dollars in the bank and I'm making $10 million a year in interest.
MR. MINARIK: Which you inherited.
MR. BRUNORI: Which I inherit, yes, better yet, which I find on the street or I inherit or whatever. I get a check for a million dollars every year.
MR. ENTIN: Capital income under Forbes is taxed at the business level before it's distributed to the initial saver instead of being —
MR. BRUNORI: I have my million dollars in my pocket and poor Scott who has to work for a nonprofit is getting his wage and he has to pay tax on his wages —
MR. JOHNSTON: Steve's point, David, to be fair, is that it's not fair to say that Steve Forbes, an inheritor, would live tax-free because at the business level the business will be taxed and whatever he takes out of the business that isn't wages has already been taxed, right? That's your argument?
MR. ENTIN: Yes, the tax is collected at a different point. You have to remember that it's the owners or the lenders to the businesses who are the people who actually got the income from the business. The business is only a thing.
MR. JOHNSTON: And that argument has an important assumption in it, Steve, and the assumption in that argument is that the only bearer of the corporate level tax is the owner of the capital.
MR. ENTIN: Which is another error in the burden tables because it's really the labor that bears the corporate tax.
MR. JOHNSTON: So therefore one might make a plausible argument that Steve Forbes would live tax-free if he can in fact get workers who work under him and his company to bear the burden of the tax through lower wages.
MR. BRUNORI: While Steve Forbes is sitting at the country club, the guys who are serving him are paying the tax on their wages, their salaries, and the guys who are enjoying the martinis and playing golf are not. And you can talk all the economic mumbo jumbo you economists want to talk about. I will tell you there is nothing fair in that system.
MR. JOHNSTON: But, I mean, Steve's point, I don't disagree with this point. I'm just astonished that Steve is arguing about the incidence of the corporate tax falling entirely in one place and he acknowledges in fact it might not. And I think that's why there is an issue about fairness which, by the way, the fourth definition of my dictionary that I looked up last night was equity.
We can all apply different definitions and meanings to words but nonetheless if were to adopt a consumption tax like the flat tax, and, by the way, the author of it, Bob Hall, when he originally conceived this idea as an exercise responding to a speech by George McGovern for a value-added tax, intended it to have multiple rates. He doesn't think that complicates the system.
MR. STEUERLE: He actually testified with me. He said (a) that he didn't like the term "flat tax," that his companion came up with and (b) now he's changed his mind and he doesn't even want a single positive rate. He wants multiple positive rates.
MR. JOHNSTON: So he's going back to his original idea but nonetheless since the incidence of corporate tax is uncertain it seems to me that would argue if anything that if we're going to —
MR. STEUERLE: He does want a consumption tax.
MR. JOHNSTON: Yes, he wants consumption tax, I agree. That if we're going to move to a different kind of system that the way to do it is to make all corporations pass-through entities so there's no question about the incidence and then whatever flows to you from the business you're taxed on. But it's not unreasonable, Steven, for people to argue that under the Steve Forbes flat tax Steve Forbes would never pay taxes. Personally he would never pay taxes on the income that he gets from it. The entity would be taxed.
MR. BRUNORI: And if the entity that's paying him is the bank on interest it's not even his entity. I mean, my point is if you take the pure example of inheritance, sure, that money is taxed somewhere along the line down the road 100 years ago, 50 years ago, 20 years ago, 10 years ago, but the bottom line is Bill Gates' children when they're getting their dividend checks was that money taxed? I guess somewhere but the incidence at a corporate income tax, and I'll tell you I've read many books from the Urban Institute and various other places, fuzzy.
Does it fall on labor, does it fall on consumers, does it fall on shareholders, does it fall on all three? That's not entirely clear where the real burdens are falling. But we know one thing. It's not falling on Steve Forbes personally, at least in this example he may pay some taxes.
MR. BERGIN: Let me get back in here and see if I can gain some control. It is 11:00 o'clock. I don't think I ever had it. To follow up on what Rob said before, I learn from everybody who speaks at these things and I think that's a wonderful thing about what we're doing here. I'm perfectly willing because there are hands here I haven't recognized to go another 15 minutes if people want to sit around this table and continue this discussion.
MR. STEUERLE: Let's at least let the people have their hands raised speak.
MR. BERGIN: That's what I think. I know Jack is one.
MR. STEUERLE: He hasn't spoken at all.
MR. BERGIN: Steve, do you want to get back in here?
MR. ENTIN: Maybe at the end.
MR. BERGIN: I will come back to you. Howard?
MR. GLECKMAN: I'm Howard Gleckman at Business Week and I actually want to follow up on something that Gene mentioned. He asked about Katrina and paying for that and I think it's interesting we're actually going to have a test over the next several weeks. We're going to spend $150 billion or maybe $200 billion on Katrina and at the same time we're going to be debating what to do with the estate tax, what to do with making permanent or extending the tax cuts from 2001-2004.
This is all going to be very much on the table and it's going to be interesting to see if people do what Gene just did and put these two issues in some context. I think it's also amusing that as we speak they're discussing what to do with the estate tax. And the question of equity there seems to be as they debate whether they want to mess with the rate or whether they want to mess with the exemption whether we ought to be more fair to the merely rich or the extremely rich.
So I think that the very immediate political context here is going to say a lot about where the Congress and the government wants to go in some of these questions. Frankly, my own view is the question is which taxes that we're going to use to pay for this. Probably none, we'll probably just borrow the money. It's clear we're not going to cut spending.
MR. NISKANEN: The case for a flat tax to me implies that we have to have a two-rate income tax system very much like the 1986 act such that the second rate cuts in when the payroll tax cuts out so that the sum of the payroll tax rate and the income tax rate then would be the same over the whole of the earnings distribution anyway. And so it would be very much like what we had in 1986 with the exception that the second rate would cut in right now at $90,000. And you can raise this much money as we have now or raise this much money as we spend now with a combined marginal rate in the 30 percent range.
MR. BERGIN: Joe?
MR. THORNDIKE: I'm Joe Thorndike with Tax Analysts, and I just wanted to offer little historical perspective on this, particularly on the question of taxing capital income. One of the more interesting debates, I think, on this happened in the 1920s when Andrew Mellon actually suggested that capital income should be taxed more heavily than labor income and this was in the context of trying to lower tax burdens generally, including the burden on capital income, but he proposed and actually got Congress to pass an earned income credit that gave a 25 percent credit for labor income.
The interesting thing about it was that the Democrats were more or less not interested in the idea and it passed with their acquiescence but they didn't actually make a point of it because they were more interested in actually repealing or exempting a larger swath of the population from the income tax and they managed to more or less triple the number of people who weren't paying taxes.
That's a mistake, I think, that liberals have made over time and I'll join you in the defense of at least one indefensible point here which is that I think that those large exemptions are a problem for the tax system. And that's a bipartisan argument. I mean, Andrew Mellon made the argument most often but certainly Franklin Roosevelt also was willing to endorse the idea that everybody should pay some taxes. That used to be a much more broadly accepted idea and I think because it's mostly a moral point not an economic point even.
But ultimately the arguments about tax fairness are political in nature and, I mean, Mellon's advocacy of a lower tax rate on capital is a political argument, not an economic one I think those will carry the day.
Mellon was arguing for a higher rate on capital. I think that those sorts of arguments are going to carry the day again because it's a political argument. I mean, we have a lot of good debate here about the economics of what's fair, what might seem fair, or an intellectual debate over what seems fair but ultimately that question is answered by voters and voters have pretty consistently supported progressive taxation generally, progressive rates more specifically, and somewhat preferential treatment for labor income when they've been put to the test on this and I think that we're likely to see that again.
MR. WHITE: Jim White from GAO, I had a question for the panel. I don't know if we'll have time to discuss it but the question is: the panelists have all and I think everybody around the table agrees that equity will be at the center of a debate over tax reform and the question I wanted to hear some discussion on was whether the public is prepared for such a debate, whether the public understands, for example, where they fall in the distribution. And if they're not well prepared for that debate, what kind of information they would benefit from having, what additional information either government agencies or other analysts should be providing?
MR. HODGE: Earlier this year the Tax Foundation commissioned a nationwide poll conducted by Harris Interactive and one of the issues that we were trying to get at is, number one, how do people sense themselves, what do they believe about wealth, the relative distribution of incomes, and so forth, and, not surprisingly, as we probably heard earlier, more than 80 percent of Americans, close to 90 percent of Americans, think of themselves as middle class. Only 2 percent identify themselves as upper class and about 10 percent identify as lower class.
So Americans generally see themselves in the broad middle of the income scale. They do, however, according to the poll results see the tax system is inherently unfair. We did ask them the question about the 40-some million who are paying no income taxes and whether they thought that was fair and whether people should pay at least some income tax, and the large majority said yes, people should pay at least something in income taxes. They thought that that was unfair.
But people are somewhat confused, I think, on how to fix the system. There was generally more support for a flat tax than a nationwide sales tax but generally what we found is that people thought that rates were too high, the system was too complicated, and remarkably 59 percent of our respondents thought they were paying a higher percentage of their income in income taxes than was Donald Trump. So they believe that the rich are getting away with it and that they're paying all bills.
MR. JOHNSTON: Just so you know, the tax returns of Donald's that are in the public record show he has negative income.
MR. HODGE: I'm not surprised.
MR. JOHNSTON: Therefore he doesn't pay taxes.
MR. LOBEL: I'm Marty Lobel and I've listened to the debate with a tad sense of unreality because everybody has forgotten how our tax laws are made. The bumper sticker I saw just before I did the article in this week's issue of Tax Notes said Invest In America, Buy A Congressman. That's how our tax system is really made and until we reach a crisis which Katrina may give us or the gas prices may give us or the public is aware of what's going on one thing I noticed in Howard's magazine this past week was a little squib, it was buried, that in the last five years the college graduates on average have lost 5 percent of their income. I mean, that's outrageous. The public is not prepared because you with the exception of David and Howard and a few other people, Paul Krugman and Steve Pearlstein, have not covered the issues. It's a disgrace. Democracy cannot function without an effective press.
Tax Notes has published, God knows, how many articles, Marty Sullivan's articles and a whole bunch of broad data that should have alerted the general press and it hasn't. We've reached out to the general press, we've done it time and time again, and you get this, "Oh, nobody cares about taxes," and democracy can't function without an effective press and I got to tell you it's going to take a real crisis before any of these discussions that we've had here, and it's been a very high and very sophisticated discussion, is ever going to reach the American public.
Now, I will grant you taxes are like pornography. I don't know whether it's fair or not but I know it when I see it and the public is outraged. If you take a look at its statistics, and we've all quoted statistics here, if Bill Gates were sitting in this room we'd have a room full of billionaires on average. If you take a look at the Quarterly Journal of Economics, which is one of the most prestigious journals around * * * point out that in the last 30 years the overwhelming majority of the income of the United States is gone to the top one-tenth of 1 percent.
MR. JOHNSTON: The growth of income.
MR. LOBEL: Growth of income. And there's another interesting question the press hasn't even taken a look at which is why that growth in income isn't matched by a growth in wealth. Is it because we're a banana republic and all the very rich are hiding their money offshore in hedge funds? The IRS wouldn't know because they don't have the resources to go after it. As Sheldon and Don will agree, they're very good at collecting wages, your W-2s and your 1099s, but when it comes to the very rich we have cut enforcement over the last 20 years by two-thirds, the budget, and the amount of tax returns that were supposed to be audited has increased two-fold at least.
We've got an honor for the very rich and the public knows that. You see time and time again. Carl Levin up in the Senate has had these hearings about tax shelters for the very rich and Citibank keeps getting into trouble because its private banking somehow forgets to report the income that U.S. citizens earned in Bermuda or in the Cayman Islands and they get hit with a $100,000 fine. Big deal, it's not even a rounding error for Citibank.
It's going to take more than a discussion of fairness or equity to get the public involved enough so that we get a system that we can be proud of. Right now I've talked to people around the world actually talking about our tax system and it's a joke, it's a disgrace, and the reason it's been allowed to become a disgrace is because the press by and large has not covered the issue. The public knows they're getting screwed but they don't know why or how. And you take a look at investigative journalists in the tax field, Lee Shepherd, Marty Sullivan. Who else?
David Cay Johnston, he writes these commie-pinko radic-lib books, Perfectly Legal. But really as a practical matter there isn't anybody in the general press on TV willing to call accurately what's happened.
I had one journalist tell me he tried to do it and the owner of his newspaper chain put it down because they were afraid of losing a couple of FCC Licenses and they didn't want to offend the administration. Now, is that prevalent? I don't know. It's certainly not prevalent at the Times or The Washington Post but is that a real problem? I mean, what are we going to do?
We can sit here and talk about various equity and fairness and the fact of the matter is that unless the people understand what the issues are and the press bears its responsibility nothing is going to happen before there is a major economic crisis. And that's when we get a real tax reform when the public is so outraged.
Now, it may be the bursting of the housing bubble. It might be the tax burden of Katrina. It could be high gasoline prices. It could be a lot of things but I got to tell you as a matter of process the only time you're ever going to get some real reform is the press covers it and we have a crisis. I hate to be such a pessimist.
MR. OCHSENSCHLAGER: Tagging on to what you're saying there, we've talked a lot about fairness and a lot of economic theories have been tossed out here and that's all very important but, frankly, fairness is in the eyes of the beholder and I think when you think that it is whatever does happen to our tax system is going to be a political decision and a political decision is not really going to depend on whether it's fair but whether it's the perception that it's fair.
With all due respect to the studies that you're talking about, people are not going to perceive it to be fair if capital is not taxed. And so I think it's a non-starter even if that were a more fair system and we can support that through our economic studies. And I don't think, frankly, any level of education through the press or whatever would turn people around to convince them that that's a fair system. So I think ultimately you have to address not so much to economic studies although ideally that's the way we should make our decisions but whether this can be in effect marketed. I hate to use the word but marketed so the people would perceive it to be fair.
MR. BERGIN: Steve, I promised you the last word.
MR. ENTIN: Thank you. You've raised some very good points so let me address them very quickly. In these consumption-based taxes or consumed-income taxes the capital is taxed; it's just that the cost of providing the capital is deducted first so that only the net capital income is taxed and that has to be explained and the public has to understand it. They do seem to, however, like their 401(k)s and IRAs, which get you to that point, and they do seem to dislike the death tax, which is an extra tax, and they do seem to buy the fact that corporate income is double-taxed which allows you to do the 15 percent interest rates on dividends and capital gains.
So I don't think the public is uneducable on this. I think in fact they're somewhat inclined toward it. It is an educational problem we have to solve. The wage problem, that is an important one but again we have to have the facts before us. I think the burden tables don't give us the facts. I think the wage data does not give us the facts.
Total compensation is growing more rapidly than cash wages. In that differential are fringe benefits and options. We don't really want to look at the options. Those get to a fraction of the people. We want to know what most people are getting but we needed fringes plus compensation and we don't have good data on that because they lump everything else in. You don't know whether there is a wage stagnation until we get better data. It's a mess.
We need to understand the economics of these things. I've pointed out some of the economics of the way we treat capital but let's look a little bit of the economics of the college graduate if they had a wage dip. We had a recession. They may very well have had a wage dip. We also have had a lot more people going to college.
When hand calculators first came out they were 150 bucks. When they became a dime a dozen they were literally given away as dinner prizes on everybody's plate by the people whose ads were on the back of them. You don't know what the market's telling you there and I think we have to be wary of using data that we don't understand to make important policy decisions.
We probably will need a lot more education and a major crisis before we get wholesale reform unless we do it slowly and incrementally which is what we've been doing for the last five or seven years. But we're not going to get it from Katrina.
Given all the faults of our tax system, there is a difference between the Unites States and Europe. We have half their unemployment rate and twice their growth rate among the other things he was talking about. So whatever the ills we have here we're doing something right.
Katrina, even if it costs us $200 billion, that's not the cost. The cost is the human cost of the lives lost. But the $200 billion is one tenth of one year's federal budget. It's a very small fraction of one year's GDP. Even if we borrow the whole $200 billion at 4 percent we'd be paying $8 billion a year in perpetuity. That is not a large number in a $12 trillion going on $15 trillion going on $20 trillion economy. That's not going to be the crisis. I think we have time to do this right. I think we can to do it gradually and not hurt people during the transition. It will require some education but I think the public is already ahead of the politicians and perhaps ahead of the economists and perhaps ahead of the journalists on this.
MR. BERGIN: Let me thank everybody for being here. I was thinking that we have been truly blessed at these conferences with our participants and the panelists and these three panelists we had today are an indication of the people we've had at these conferences. I want to thank Scott and David and Gene and all of you for a stimulating debate. Thanks.
(Whereupon, at 11:20 a.m., the PROCEEDINGS were adjourned.)
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