Last week brought news of the largest tax reform proposal in 20 years. It stirred some serious rhetoric and was immediately damned by Republicans across the board as a "tax hike."
David Leonhardt, in
The New York Times
, tried to clarify matters for the public by outlining five truths to follow in the tax debate. However, he missed a rather large elephant hiding in plain sight -- supply-side economics. The
Laffer curve has been used over the past 30 years to obscure a trend in U.S. taxation: It has become much less progressive. Fairness will surface as a big issue in the tax-reform discussion.
Several major changes have made federal taxation less progressive. Not only have tax rates on the highest bracket dropped -- from 70% in 1980 to 35% now -- along with capital gains taxes, but also corporate taxes have fallen over the years through the many loopholes in the corporate tax code. Thomas Piketty and Emmanuel Sanz
Corporate income taxes as a fraction of grossdomestic product have fallen by half, from around 3.5-4.0 percent of GDP in the early 1960s to less than 2 percent of GDP in the early 2000s. ... Meanwhile, corporate profits as a share of GDP have not declined over the period.
Honest arguments could be made for lowering the tax rate on the wealthiest Americans. You could, for example, argue that low taxes are a positive factor for economic growth, both real and psychological. You also could argue that if the wealthy retained more of their money, that would spur investment. The wealthy would be in a better position to diversify their investments, including risky investments required for venture capital.
But supporters of supply-side economics choose to obfuscate the truth about taxes. They insist that tax cuts, particularly those on the wealthy, result in economic growth and then pay for themselves. Any other action results in job loss and possibly recession.
If you have read my columns (
here), you would know I'm no fan of the Laffer curve and supply-side economics. It's true tax cuts put more money into the economy. But history hasn't shown that tax cuts pay for themselves with higher revenues (see the
study from the Treasury Department). There is, however, evidence indicating it results in massive deficits and debt. I hope people don't get taken in by the argument that higher taxes for the rich augur poorly for the economy.
While understanding the numbers remains important, deciding how to set tax policy comes down to creating a system of taxation. Would the system be fair? The fairness argument interests me more going forward. One of the results of the Bush tax cuts were that they highly
favored the wealthy. In other words, they were regressive.
I doubt anyone would seriously argue in favor a regressive tax system. So the obvious choice would either be a flat tax or progressive tax, both of which represent a philosophical choice.
We have to look no farther than Wall Street to find proponents of either. Steve Forbes has been a major advocate of the
flat tax over the years. He proposes abolishing all federal taxes and imposing a flat 17% tax -- both personal and corporate -- that would exclude a family of four earning up to $46,000. His plan appears to ignore the Social Security tax. It offers a tax cut for everyone and favors the wealthy -- no more capital gains or estate taxes.
His plan competes with other versions of a flat tax. John Goodman and Laurence Kotlikoff
proposed one that improves on Forbes' by addressing the Social Security tax and offering greater breaks to low-income families. That therefore would result in a mildly progressive tax.
Another popular flat tax is the
Fair Tax, or a consumption tax. It would abolish the IRS and all other taxes (I assume by getting rid of the 16th Amendment to the Constitution) in favor of a national consumption tax set at 23%. Like Forbes' plan, it excludes some lower- and middle-income earners who would receive a monthly tax "prebate."
One of the disadvantages of the Fair Tax vs. the other flat tax would be bureaucracy. A government agency would be needed to ensure low- and middle-income workers receive benefits. Furthermore, a black market economy could spring up in the service sector, where there would be a big incentive to cheat the system.
Advocates for a progressive tax system would complain that these plans heavily favor the wealthy. Take, for example, Warren Buffett. A strong proponent of progressive tax reform, the Oracle of Omaha has been on record many times decrying the injustice of his secretary paying higher taxes than him.
Buffett, in a recent interview with
news, called out other wealthy people to support tax reform. His preference would be for a progressive consumption tax.
Another progressive tax advocate is former Labor Secretary Robert Reich, who quotes free-market economist Adam Smith to add weight to his argument. Smith said: "The rich should contribute to the public expense, not only in proportion to their revenue, but something more in proportion." Smith sounds right to me. The wealthy benefit greatly from the system and should pay an additional amount for that privilege.
Reich defines this sentiment around a sense of who can afford to sacrifice: "Equal sacrifice means that in paying taxes, people ought to feel about the same degree of pain -- regardless of whether they're wealthy or poor." Mathematically speaking, if you make a small amount of money, a 17% or 23% tax rate makes it more difficult to use the remainder to buy goods or invest. Let's use someone making $50,000 versus $5,000,000 -- leaving $41,500 vs. $4,150,000.
Knowing the facts about taxation only gets you so far. At some point, a philosophical decision has to be made about what type of tax is "fair."