I began the day speaking at a great Tax Notes forum and throughout the day, I’ve stumbled on numerous interesting articles on tax policy, both from high and low analytic altitudes.
The forum was to mark (I’d say “celebrate” but not everyone would agree) the 100 year anniversary of the federal income tax (they even had a cake!). I’ll find a link to it at some point—the other panelists were really interesting.
Here’s a summary of my points, with some of those articles sprinkled in:
What’s Right and What’s Wrong with Our Tax System—and Our Debate About It
Let me begin by just ticking off the things I think are healthy and less healthy about our system of taxation. I’ll largely focus on federal taxation but will mention state/local in passing, since they’re important too.
As you just heard [from Joe Thorndike], we have a very enduring system of revenue collection. I’m not saying everyone loves it, but its infrastructure is firmly in place, widely accepted, and highly functional. Though of course you can find people who will disagree, the system is broadly viewed as legitimate.
I will, in a few minutes, introduce ways in which I fear that legitimacy is becoming more fragile and what we should consider doing about that.
What else is healthy about our tax system? It’s elastic to growth. Revenues are cyclical which helps avoid structural deficits, and provides people with more after-tax income in recession. In fact, as I’ve often stressed on my blog, while Clinton-era tax increases certainly helped achieve the surpluses of the latter 1990s, economists widely attribute economic growth as the key determinant (and, of course, one must note here that tax increases did not preclude such growth).
Also, there has been, throughout history, though much less so today and this is a big problem, a linkage between paying taxes and building and protecting a better nation. Pay your taxes to beat the axis; to build the infrastructure we need to fix today; to stand up our national system of public education (and here, state and local taxes also come into play).
With that, let’s turn to ways in which our system of taxation isn’t as healthy as it needs to be.
Most fundamentally, we are at serious risk of losing the connection between what the majority wants from government in terms of investments, public goods, safety nets, social insurance, national defense—and what they’re willing to pay for it.
In part, this harks back to the Laffer curve and what I think of as extreme supply side economics—we can raise more tax revenue by cutting taxes, especially on the wealthy—versus a view that says “you won’t lose of much as you think.”
It also relates to irresponsible politicians/policymakers and all sides of the aisle who are comfortable promising lots of goodies but very uncomfortable paying for them. Let me give bipartisan examples.
During his presidential bid, Mitt Romney attacked Obama for a) not being willing to tackle unsustainable entitlement costs, and b) cutting Medicare. And of course he constantly fell back on “dynamic scoring” to make the case that his supply-side tax cuts would add up.
The President, both in his inaugural address and especially in his SOTU presented a robust, and I thought enlightened agenda, but said not a peep about paying for them.
President Obama has also consistently contributed to the illusion that we can achieve meet the challenges and demands we’ll face going forward on tax increases only on HHs above $250,000, or now, post-fiscal cliff deal (which made 80% of the Bush-era tax cuts permanent, $450,000. I cannot overemphasize the extent to which this position has cramped the tax debate.
On the other hand, the President also deserves high praise for having the courage to place a tax increase, even on a narrow slice of the electorate, at the heart of his campaign. Even though the vast majority of the electorate wouldn’t be affected by it, in today’s climate, that’s still a step in the right (left?) direction.
–the tax system doesn’t raise enough revenue. And that’s not just the recession; it’s also tax policy and anti-tax pledges.
What is enough revenue? I don’t know, but historical averages (e.g., 18% of GDP) don’t really provide guidance…aging boomers, health care cost pressures, obligations to veterans (many of whom will need more help than earlier cohorts), aging infrastructure, future debt service, education, inequality, regulatory demands (climate change!)—all of these pressures mean the past is poor precedence in terms of adequate revenue levels.
–the system has become less progressive, with the largest declines in effective tax rates at the top of the income scale. Look, I’ve been worrying about the growth of income inequality for decades now, but let me be clear: the growth is largely a pretax problem and I don’t expect the tax code to fix it. But I sure don’t expect it to make it worse!!
Here’s also where the legitimacy of the tax code—a critical issue in a democracy—comes into play. If average folks feel like the economically privileged can get a much better deal out of the tax system than they can, that system will lose legitimacy and that is, of course, a real risk today, one that was highlighted in the recent election.
To tie this to a concrete policy, when we privilege a particular unearned income and debt financing over paychecks, we’re chipping away at legitimacy. Now, there could be good reasons for accepting such a tradeoff, e.g., if such favorable treatment led to faster growth and more investment. But it doesn’t. And this is a real problem we could and should fix.
–Corporate taxation in the US is a mess: high statutory rates, low effective rates, and historically low collections…massive tax avoidance, often through transfer pricing. This also hurts legitimacy.
What to do? At this point in the forum, economists invariably call for switching to a consumption tax, but I won’t do so. I just don’t see it in the cards and there are, of course, regressivity complications.
I’d instead be guided by these principles:
–there should be no distinguishing between spending through revenue collection or deficits (borrowing), and tax expenditures. The latter is simply spending through the tax code. If politicians truly believe we have a spending problem, then they also believe we have a tax expenditure problem.
–we’ve got the worst of all worlds in corporate taxation; White House proposal has lots of fine ideas—takes the rate down to 28% and closes loopholes—but a) heavy lift (my loophole is your treasured investment incentive), and b) as per all the above, I don’t think revenue neutrality is the right goal.
–to the extent possible, I’d suggest we try something new in this space—or, if not new, something that hasn’t been around for a while; tying tax increases to what they’re intended to pay for. To health coverage, infrastructure, education (as Gov Brown recently did in CA), preserving retirement security. Dedicated taxation might be one way to help reconnect this very damaging gap between what we say we want and what we’re willing to pay for.