The Benefit and The Burden: Tax Reform: Why we Need it and What it Will Take,
By Bruce Bartlett
Our tax system is ludicrously complex. (I have practiced tax law for more than thirty-five years, so know this first hand.) Too many questions lack answers, and aggressive taxpayers with certain kinds or amounts of income easily game the rules with the assistance of lawyers and accountants.
That is hideously unfair to those who play by the rules as written or do not have the opportunity to manipulate their income and deductions. For a good example of the ludicrousness of our current tax system, one need look no further than Governor Mitt Romney when he ran for President in 2012. Romney had $102 million dollars in his individual retirement account (though annual contributions for the kind of IRA Governor Romney contributed to generally were limited to $30,000 per year). In addition, Romney declined to take all the charitable contribution deductions to which he was entitled, in order to avoid reducing his tax rate below 14 percent (which is a lower tax rate than the then lowest nominal rate of 15 percent, applicable to taxable income of an individual taxpayer whose annual income did not exceed $22,100).
I am not sharing these facts as a swipe at Governor Romney–his father George Romney is my Liberal Republican hero (I have a framed picture of George Romney on the wall in my office), and Governor Romney is just the sort of Republican Party elder who should be leading the movement to resurrect Liberal Republicanism. Rather, I point them out to illustrate, especially to advocates of high marginal tax rates, that the truly wealthy and well advised do not often pay high tax rates on most of their income, even when such high tax rates have been enacted into law. Rather, high rates are much more likely to be paid by merely affluent people, usually working as employees of others, including for the largest corporations and financial institutions in America. (This same group of tax payers is likely to be among those seeing tax increases from the 2017 tax legislation.)
As a further, absolutely obscene illustration of the unfairness of our current tax system, consider this: According to the United States Government Bureau of Labor Statistics, in 2013 there were 157,800 kindergarten teachers in America, who together earned about $8.34 billion. That year the top four American earners in the hedge fund industry made $10.4 billion. That is, those four individuals combined earned $2 billion more than 157,800 productively employed school teachers.But that isn’t the obscene part of this story, at least in terms of illustrating the ludicrousness of our current tax system. Because of the way so-called carried interest is subject to taxation, most of the income of those four taxpayers is taxed at a lower rate under current law than some of the earnings of some of these kindergarten teachers might be if, for example, they were long-employed kindergarten teachers married to suburban police chiefs or long-employed high school chemistry teachers.Nor is that the obscene part of the story either. The really obscene part of the story is that the major historic defender of carried interest taxation isn’t a conservative Republican Senator from Alabama or Mississippi, but progressive Democratic Senator Charles Schumer of New York. This is a Senator who is not adverse to castigating the “plutocrats” of the Republican Party. Perhaps this should be expected given the nature of our political system–after all, the financial services industry is based in New York. But, it does illustrate how broken our tax system is, and that it isn’t legislators from one political party, or from one political ideology, who are responsible for this mess.It’s really not too difficult to understand why so many people are so angry these days, and willing to blow up the current political system (including our tax system), hoping that whatever comes next is better than what we have now. But what if angry Americans could channel their anger into changing our schlerotic, insider-friendly laws, and tearing out the rot of our current political system in a constructive, rather than in a destructive way? Reforming our tax system is as good a place to start that process as anywhere.Bruce Bartlett’s The Benefit and the Burden is an outstanding, easy-to-read book that describes the rules and the policy issues relevant to reforming and simplifying the monster that our tax system has become. Reading this book may be the best means for most of us to begin to understand, in practical, human terms, our current tax system and how to reform it. As quotes at the beginning of the book from Speaker of the House Paul Ryan and former Speaker Nancy Pelosi evidence, politicians across the political spectrum advocate for simple and fair taxation. Simplicity should be relatively easy to achieve–especially simplicity that is degrees of magnitude greater than what we currently have. Fairness, however, is obviously something on which Mr. Ryan and Ms. Pelosi disagree, so will be less easy to accomplish. But it’s time to try, and a Liberal Republican agenda could provide a middle ground, and a Liberal Republican political faction could provide the votes to bridge the differences between Mr. Ryan’s and Ms. Pelosi’s visions. A Liberal Republican political platform should advocate for eliminating many of the tax loopholes that have been procured by the privileged–individuals, corporations and not-for-profits–from progressive Democrats and conservative Republicans and everyone in between, as a result of lobbying and influence peddling that almost all angry Americans find repugnant. Liberal Republican tax reform should not only be geared towards eliminating these preferences for the privileged but, where possible, toward reversing advantages already procured through complex legal maneuvering. (In my professional field this might consist of taxing gifts and inheritances as income, rather than having separate estate and gift taxes. Not only would this simplify the tax system by cutting in half the number of Federal tax regimes to which individuals are subject, but it could bring back into the transfer tax system substantial amounts of the private wealth that is currently ringfenced from estate and gift taxation through methods many regard as alchemy.)
The Benefit and the Burden helps frame the debate about tax reform based on history and substance, rather than on the media’s and politicians’ talking points, which have little connection to history or substance. For example, The Benefit and the Burden describes how a consumption tax would work, and its advantages and disadvantages compared to our current tax system. (Interestingly, Alexander Hamilton–back in the news due to the success of the Miranda Lin Manuel’s Broadway hit Hamilton–was an advocate for a consumption tax. I am too.) Bartlett believes that we will ultimately enact a VAT because he does not believe we can cut spending enough to avert a fiscal crisis, meaning that taxes must eventually rise a lot; but that raising income taxes as high as necessary to put our financial house in order would be economically debilitating.
The Benefit and the Burden also illustrates the corrupting effect lobbyists have on tax legislation and, interestingly, how much greater a problem this is today than it was twenty years ago, before Congress changed the procedures for enacting tax legislation.
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Set forth below are eleven “fun fact” summaries of some of the “hot” political topics related to taxation that Mr. Bartlett writes about in a simple and clear way. As you will see if you read the “fun facts” below, he debunks a lot of the myths of the Right and the Left regarding tax policy. Thus, the book can help readers–legislators and their staffs, academics and ordinary engaged citizens who are tired of being fed partisan nonsense– to think constructively about tax reform and to cut through the crap that forms the basis of much of the debate around tax reform today. While reasonable people of different political views often disagree on appropriate policy, The Benefit and the Burden can help them argue about things that actually merit discussion and argument. After all, two doctors arguing about the appropriate dose of a drug to give a sick patient aren’t going to help the patient if the drug they are arguing about is the wrong drug, regardless of the dosage given.
Fun Fact # 1. The aggregate revenue loss from the George W. Bush Administration tax cuts were the largest in US history as a percentage of gross domestic product. Both Presidents Ronald Reagan and Harry Truman passed larger individual tax cuts, but took back a material amount of those cuts with subsequent tax increases. President Bush never increased taxes, in contrast to President Reagan who signed eleven or so (depending how one counts) tax increases. President Reagan, while conservative, was pragmatic and flexible. President Bush held office when most Republican legislators had signed a tax pledge promising never to increase taxes, regardless of economic conditions or deficits.
Fun Fact #2. As Mitt Romney famously said when running for President in 2012, in 2011 47 percent of Americans did not pay Federal income taxes. For 22.9 percent of filers, all of their payroll taxes were offset by refundable tax credits as well. (Even for people who do pay only Federal payroll taxes, it should be noted that payroll taxes do not support the government’s general operations. Rather, payroll taxes fund our Social Security and Medicare. And the vast majority of taxpayers get far more back in benefits than they pay into that system. Bartlett cites an Urban Institute study that found that the average person retiring in 2011 at age sixty-five will receive lifetime Medicare benefits that are three times greater than his or her contributions. “Men will get back $170,000 of benefits for a lifetime contribution of $60,000. Because of their greater longevity, women will get back $188,000 of benefits.”)
Some of the advantages of a VAT (“value-added tax”, a form of consumption tax common in most of the world), are that, not only is it relatively simple to administer, and more difficult to game than our current tax system, but also that with a VAT a lot more people would have “skin in the game” regarding how much government should tax and how much government should spend. This is important in a vibrant democracy. It is natural for people to spend other people’s money much more freely than they spend their own, and to consume more of things that are free. (This same phenomenon applies to Wall Street traders trading with shareholders’ money, or Federally-insured deposits, rather than their own capital.) I have watched young people (including my own contemporaries once-upon-a-time) take a much more active interest in how government taxes and spends money once they see significant tax withheld from their own paychecks. If you are a fan of the television series Friends, you will recognize this when Rachel Green gets her first paycheck and asks, “Who is FICA? Why is he getting all of my money?”
Fun Fact #3. Former Treasury Secretary Larry Summers stated that the reason the United States does not have a VAT is because liberals think it’s regressive–disproportionately impacting the poor–and conservatives think it is a money-generating machine for the government. Summers says we will get a VAT when liberals and conservatives reverse their positions. Bartlett points out that one way to deal with this regressivity would be to abolish income as well as estate and gift taxes except for the wealthy (and I would argue that estate and gift taxes should be abolished too, and should be replaced by taxing inheritances and gifts as income), and replace the lost revenue with a VAT.
Fun Fact #4. VAT is much more efficient than an income tax–it cost less administratively to generate equivalent amounts of revenue and it is much harder to manipulate a VAT so as to avoid paying what you legally owe than it is to manipulate an income tax. It could also relieve the vast majority of Americans from ever having to file a tax return. Finally, many argue that, with our ballooning long-term deficits (see Fun Fact #11), a VAT will ultimately be necessary to keep America from impoverishment.
Fun Fact #5. In 2008 the average tax burden in OECD countries was 34.8 percent of GDP, while it was 26.1 percent in the United States. (The OECD is a major international group of more-developed countries.) In 2012 those percentages were 34 and 24 percent.However, in most developed European countries, health insurance is government-financed; in other words, through taxes. So the differences in tax burdens between Europe and the United States are much less meaningful if we adjust for the health care payment differences. As Bartlett says, “In effect, the Federal government directs that $184 billion of the nation’s resources be directed into health care (through tax deductions for employer-provided health insurance). But because it’s done through the tax code rather than by providing health care to people through national health insurance, as in other nations, we pretend that we have a smaller public sector than nations with government-financed health systems. In other countries people basically pay taxes for health insurance, whereas Americans have that cost deducted from their compensation or pay it out of their pockets.” A bit of smoke and mirrors…
Fun Fact #6. Those European countries with high marginal tax rates tend to have much less progressive tax systems than the US does. Bartlett shows that, in 2010, the top US marginal income tax rate did not kick in until a taxpayer was earning 9.6 times the income earned by the average worker. In most Northern European countries (models for what America should be like in the opinion of many Progressives), the top rates kicked in at about three times the income earned by the average worker. In other words, there is much less progressive taxation in Northern European countries.
This lack of progressivity is compounded by the fact that these countries not only have a VAT consumption tax, but they also tend to rely much more on VAT than income taxes for government revenues.
Fun Fact #7. Most countries with large social welfare systems not only tax consumption heavily, but also tax capital lightly. Bartlett suggests that this public finance mix allows large amounts of revenue to be raised without reducing economic growth. But as you can see, this mix provides something for everyone on the US political continuum to complain about.
Fun Fact #8. Bartlett also points out that all OECD countries except the United States and Mexico generate substantial public revenue from environmental taxes. In 2008, the average OECD country raised almost three times as much revenue from environmental taxes as the United States did.
Fun Fact #9. Bartlett states that the idea that everyone is entitled to do anything they can to reduce their taxes has become ingrained in American life. Americans view “taxation as theft”, Barnett says, “rather than a shared burden that all should contribute toward as the cost of maintaining a civil society.” Thus compromise on tax reform has become almost impossible. Bartlett devotes a whole chapter to Grover Norquist, the head of the political advocacy group Americans for Tax Reform, who seeks to make Republicans take the tax pledge mentioned at the end of Fun Fact #1 above or risk a primary challenge from someone who will take the pledge. In fact, Bartlett titles the chapter “If Tax Reform Happens, It Will Be Because Grover Norquist Permits It”.
Fun Fact #10. With the advances in medical technology and the increasing numbers of “miracle drugs”, health insurance premiums paid by employers have consumed a rising share of employee compensation for a long time. Bartlett states that this is one generally unrecognized reason that cash wages have stagnated since the 1970’s. He also explains that Medicare taxes and premiums only cover a fraction of benefits, “and almost all beneficiaries receive a large net transfer that improves their well-being.” (See the end of Fun Fact #2 above.)
Fun Fact #11. Barnett discusses the long-term deficits of which young Americans will bear the brunt unless something is done to address them fairly soon. (This is NOT the current deficit which, as a percentage of our economy, is not historically high and which arguably would be reduced in the long-term if government spending on infrastructure and other public goods were increased now, especially because the government can borrow money at such low interest currently. It is the fact that, on our current trajectory, these deficits would explode in the coming decades.) For an excellent recent discussion of what awaits you if you are in your Thirties or younger and this problem isn’t addressed through sensible tax reform, see the op-ed piece by Paul Volcker and Peter Peterson, “Ignoring the Debt Problem”. (New York Times, October 21, 2016 http://nyti.ms/2euUrXw) Mr. Volcker was the most successful Chairman of the Federal Reserve in my lifetime, and has served Presidents from Reagan to Obama.
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As you can see from the Fun Facts, our political rhetoric and polarized politics have become disconnected from the kinds of conversations we need to have if we are to simplify and reform our tax system thoughtfully. And for anyone interested in seeing meaningful tax reform happen, there is no better place that can help you to think critically about the subject than this wonderful book.
1. The Internal Revenue Code contains around four million words, seven times the length of War and Peace, and about four times the length of all of the Harry Potter books combined. Provisions of the Internal Revenue Code say things like:
“For purposes of paragraph (3), an organization described in paragraph (2) shall be deemed to include an organization described in section 501(c)(4), (5), or (6) which would be described in paragraph (2) if it were an organization described in section 501(c)(3).” (This was President Reagan’s favorite example of the most difficult sentence to understand in the Internal Revenue Code. I am pretty sure I have seen worse.)
According to Jim Darby, the “Mark Twain of tax writers”, one sentence of the Internal Revenue Code (repealed in 2003) contained more words than the entire Gettysburg Address.
2. It is interesting to note that it was a Republican President, William Howard Taft, who advocated for a Constitutional amendment to permit an income tax after the Supreme Court held it to be unconstitutional.