Time to get smarter about taxes

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When taxes come up in discussions about the government’s fiscal affairs, SAFE’s suggestions tend to be negative. Don’t raise taxes because that’s not an effective way to balance the budget. Don’t cut taxes because that would increase the deficit, which is already much higher than one would wish. The default conclusion is to preserve the status quo by leaving taxes as they are. Ho, hum!

We shouldn’t overlook the potential, however, for making gains (or avoiding further losses) by observing the principles of tax reform. The concept is to streamline the tax system so it will raise the same amount of revenue with less economic drag. Over time, economic results would be enhanced – much as when regulatory red tape is cut – with the result that more tax revenue will be collected without raising rates or imposing new taxes.

In 2010, this concept of tax reform was embodied in a SAFE plan developed as an alternative to the flat tax and “FairTax” proposals that were on the radar screen at that time. See the
Taxes page of this website.

SimpleTax – A thorough overhaul of the current tax system to make it a vehicle to raise revenue vs. fostering social policy goals. Thus, for the individual income tax: broaden the tax base; repeal tax credits, Alternative Minimum Tax and most exemptions; eliminate double taxation of corporate income and marriage penalty for 2-earner households, reduce tax rates by 5+ percentage points at all income levels.

Details of the SimpleTax proposal would have to be adjusted due to subsequent tax law changes, but the concept of broadening the tax base while reducing tax rates remains attractive. Regrettably, Republicans blew an opportunity to include substantial tax reforms in the Tax Cuts and Jobs Act (TCJA) that was enacted in Dec. 2017. Mid-term issues: Taxes,

The Republican tax plan [didn’t] go far enough in eliminating tax preferences for either individuals (increasing the Child Tax Credit would represent a step in the wrong direction) or businesses. And although the tax cuts should fuel faster economic growth, thereby reducing revenue losses, projected deficits would still be boosted by some $1 trillion over the next decade.

SAFE envisioned that the tax cuts might be accompanied by spending discipline, which in combination could set the stage for overall deficit reduction. Our hopes were dashed, however, by the Bipartisan Budget Act enacted in February [2018]. Not only did the BPBA clear the way for a 2-year, across the board spending increase of up to $432 billion, but it also reversed numerous tax reforms [by restoring several dozen expired special interest tax credits] that had seemingly been accepted earlier.

There is no realistic opportunity for additional tax cuts at this point, but it would make sense to make some of the TCJA cuts permanent. Notably, we would favor abolishing (a) the phase-out of current expensing of capital expenditures (after 2022), and (b) the expiration of lower individual tax rates (after 2025). A look ahead at expiring tax provisions, Amir El-Sabie, taxfoundation.org,

Given some of the ill-advised tax increases that are being proposed in the run-up to the 2020 elections, moreover, a refresher on tax design principles may be in order. Examples and discussion follow.

1. Use of proceeds – One Democratic candidate after another has attempted to burnish their fiscal responsibility credentials by proposing tax increases to “pay for” their new or additional spending proposals. As an example, consider this proposal by the current front runner. Biden tax plan, Bloomberg News, investmentnews.com, 12/4/19.

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Leaving aside the merits of the specific proposals, notice that this package would do nothing to reduce projected budget deficits. Like drops of water in a pond or grains of wheat in a silo, budget dollars are fungible. Accordingly, there is no logical reason to view the contemplated tax increases as covering the cost of proposed new spending versus contributing to the ongoing cost of existing spending.

2. Distribution of benefits – The main complaint about the GOP tax cuts has been that they primarily benefit affluent taxpayers, thereby exacerbating the supposedly inequitable division of pretax income and wealth. Tax cuts for the wealthy make inequality worse, Alan Blinder, Wall Street Journal, 11/1/19.

Two economists at the University of California, Berkeley, Emmanuel Saez and Gabriel Zucman, just published an important new book, “The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay.” Perhaps the most stunning finding: “For the first time in the past hundred years, the working class today pays higher tax rates than billionaires.”

There are major flaws in the logic, however, which suggest that this finding is substantially exaggerated if not flatly wrong.

•Data re the distribution of pretax income should be adjusted to reflect government benefits being paid to Americans in various categories via entitlement programs, welfare benefits and refundable tax credits. Democrats want to solve an inequality problem that doesn’t exist, Tim Worstall, Washington Examiner,

The entire system of measurement being used is wrong. We're simply not counting all the things we already do to make America more equal, a particularly stupid place from which to start when we're trying to design policy to deal with however much of the problem still remains.

•In the Saez/Zucman study, corporate tax cuts were wholly attributed to shareholders. “This [adjustment] is crucial,” states Professor Blinder, “because most of the ultrarich earn their money from investments, not paychecks.” Tax cuts for the wealthy,
op. cit.

This ignores the possibility – nay likelihood – that corporate tax payments are viewed as a cost of doing business and a substantial portion thereof is passed on to consumers via selling prices. Who bears the burden of the corporate income tax? Gerald Prante, taxfoundation.org,

A new report released Thursday by the Congressional Budget Office (CBO) estimated that for the corporate income tax in an open economy like the United States, workers could bear as high as 70 percent of the tax burden, while owners of capital would bear around 30 percent.

•Payroll tax payments were also taken into account by the study, even though these taxes represent a partial payment by the individuals concerned for government programs that benefit them personally. When it comes to bearing the general costs of the federal government, lower income workers have very little skin in the game. No rich Americans don’t pay lower tax rates than poor Americans, Andrew Wilford, federalist.com,

The most recent [Congressional Budget Office data [show] that the wealthiest 1 percent pay an average effective rate of 33.3 percent in federal taxes, while the bottom 20 percent pay just 1.7 percent. *** Saez and Zucman do include state- and local-level taxes in their analysis, which are, generally, more regressive than federal taxes—however, not nearly enough to make up the kind of gap that exists between their data and the CBO’s.

3. Economic effects – All tax levies transfer money from the private sector to the public sector, thereby reducing the funds available for consumption or business investment while increasing the funds available for government programs (some of which, of course, transfer funds back to designated beneficiaries for various purposes).

On a net basis, the private sector creates economic wealth while the government consumes wealth. Therefore, tax increases tend to slow the economy while tax cuts have the opposite effect. Supporters of the TCJA argued that the proposed tax cuts would give a big boost to the economy and thereby effectively pay for themselves (in terms of tax revenue collected) within a few years.

SAFE wasn’t entirely persuaded by such claims, particularly when it came to the individual tax cuts in the package, and it bothered us that the TCJA was so light on tax reform. After joining in an initial coalition letter (signed by 88 groups) in favor of tax cuts, we declined to support a second letter (signed by 40 groups).

Re business taxes, the proposed corporate tax rate of 20% looked fine – SAFE had used the same rate in the SimpleTax proposal – but where was the wholesale elimination of business tax preferences we had envisioned in 2010? (Further, as previously noted, many of the tax breaks that seemed to be on the chopping block would be stealthily restored in Feb. 2018.) Assessing Republican tax plan,

Here’s a query for congressional Republicans: Is the Tax Cuts and Jobs Act the best you can do?

Still, we continue to have a positive feeling about the business tax cuts that were included in the TCJA because they have the potential to directly make funds available for productive US investments and/or distribution to US investors for reinvestment. The individual tax cuts (particularly in the case of lower income taxpayers), on the other hand, will initially serve to boost consumption of goods and services that may or may not be produced in the US.

In contrast, TCJA critics appear to view the reversal of corporate tax cuts and tax hikes for higher-income taxpayers as the top priority. See, e.g., Buttigieg calls for repealing corporate tax rate cut to pay for healthcare expansion, Cassidy Morrison, Washington Examiner,

To pay for [his proposed] healthcare expansion, the South Bend, Indiana, mayor would reverse the corporate tax rate cut implemented by President Trump and congressional Republicans, raising the rate from 21% back up to 35% — the highest among developed nations.

If it were deemed necessary to raise taxes, moreover, the best approach would not be to raise tax rates or impose new taxes – it would be to abolish some of the many tax preferences that have been embedded in the Internal Revenue Code to serve various supposedly beneficial purposes. See. e.g., Tax Reform Has Never Been So Easy. Let the Tax-Extenders Remain Dead, Adam Michel, townhall.com,

Why all the stress on eliminating tax preferences while keeping tax rates low, thereby minimizing tax complexity? Reduce tax preparation effort for taxpayers and enforcement effort for the IRS – encourage voluntary compliance and reduce fraud – avoid distortion of economic decision-making that should be left to the private sector.

As an example of problems with the current tax system, consider the estimated amount of federal taxes (income, payroll and excise) that are legally owed but aren’t being collected. Tax gap tops $500 billion a year, Scott Eastman, taxfoundation.org,

The IRS estimates that, between tax years 2008 and 2010, the U.S. had an annual gross tax gap of $504 billion, and an annual net tax gap of $447 billion, in 2016 dollars. The annual net tax gap is lower because that number is adjusted for late payments and payments due to enforcement. Overall, the voluntary compliance rate was 81.7 percent, while the net compliance rate was 83.7 percent. These compliance rates are a few percentage points lower than tax gap estimates in 2001 and 2006, but according to the IRS, most of this decline is due to recent methodology changes and the addition of new tax gap components, not to changes in taxpayer behavior.

Simplifying the tax law wouldn’t solve all the problems, of course, but it would likely contribute to minimizing them.

4. No free lunches – There is an old saying about tax legislation, which goes as follows: “Don’t tax you, don’t tax me, tax that fellow behind the tree.” Translation: people readily accept the idea that other parties should pay more taxes but they are less accepting when it comes to tax hikes that would impact them personally.

Candidate X is proposing this or that new program, which sounds pretty good, to be paid for by raising taxes on millionaires/billionaires and big corporations. OK, I’m not in either one of those categories!

Or there’s a complicated new program, something about saving the world by fighting global warming, but there isn’t any stated price tag so I’m not going to worry about it.

Beware, however, because experience has shown that there aren’t any free lunches.

Millionaires and billionaires aren’t all that fond of paying taxes either, and if their tax rates soar they may move out of the jurisdiction, lobby legislators for loopholes, hold on to investments rather than paying tax on capital gains, or simply not work as hard. Taxes on the rich [federal, state and local] weren’t that much higher in the 1950s [when the highest marginal rate for the income tax was 91%], Scott Greenberg, taxfoundation.org,

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And that complicated regulatory scheme will wind up raising your energy costs, just like a straightforward tax on carbon would, whether you know how the calculations work or not. Midterm issues: renewable energy,

Hard though politicians may try to suggest otherwise, middle class Americans would wind up paying most of the cost for the government programs that are being proposed to create a European style welfare state in this country. That’s how things have worked out in Europe, and there is no basis to expect a different result here. The middle class always pays, Wall Street Journal,

Researchers at the DIW think tank in Berlin looked at Germany’s tax system in 2017 and found that median earners pay roughly the same proportion of income in taxes as the highest earners do—43%. Germans in the 60th and 70th percentiles of income pay a higher proportion of earnings in taxes than anyone else, approaching 52%. The wealthiest paid more tax on income and investment, but consumption and payroll taxes walloped the middle class. This is how Berlin balances its budget.


#I agree. Power in Washington is achieved by directing tax revenues to constituents. The Left loses power when their programs are deleted or prevented from becoming law. – SAFE director

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