TOWNHALL

April 2009

Tax Truths

THIS ISFAIR?

Tax Truths

A look at who’sactually payingtaxes and how thetax code impactsour economicgrowth revealsthat dire change isneeded—but notthe kind of changethat’s being pushedby the White House.

by Daniel J. Mitchell

Beginning as a simpletwo-page form in 1913,the internal revenue codehas morphed into a complexnightmare that simultaneously hinders compliance by honest peopleand rewards cheating by Washingtoninsiders and other dishonest people.But that is just the tip of theiceberg. The tax code alsopenalizes economic growth,distorts taxpayer behavior,undermines Americancompetitiveness, invites corruptionand promotes inefﬁciency.There are three broad reasonsthe tax code has become a nationaldisgrace:

Class warfare.

Some politiciansseek to gain votes by pitting one groupagainst another, and soak-the-richtaxes are a common manifestation of this impulse. Lawmakers ﬁgure thattaxes imposed on a small slice of thepopulation—such as the top 10 percentof earners—will be welcomed by theenvious and ignored by everyone else.

April 2009

TOWNHALL

kicker

Tax Truths

TOWNHALL

April 2009

Tax Truths

Social engineering.

The ability tomanipulate behavior through the taxsystem gives politicians considerableleverage, and they are not shy aboutusing that power to impose their values. By tilting the playing ﬁeld(economists would say “by changingrelative prices”), lawmakers seek toinﬂuence both the source of incomeand the use of income.

Legal corruption.

Many loopholes,exclusions, deductions, credits,exemptions and other preferencesare in the tax code solely because of campaign contributions and otherforms of political support.Ironically, these three factors often work at cross purposes, and the resultscan be quite perverse. Politiciansimpose high tax rates and supportpunitive double taxation of saving andinvestment because they want to goafter the so-called rich. Yet the vastmajority of tax preferences benefitupper-income taxpayers. Politiciansclaim that social-engineering tax breaks such as the itemized deductionsfor home mortgage interest andcharitable contributions are for themiddle class, for instance, but theoverwhelming benefit flows to thosemaking more than $100,000 per year.The special tax loopholes in the code,needless to say, are almost entirely forthe benefit of wealthy (and politically sophisticated) people and businesses.

(see Figure 1)

The best way to solve all the currentproblems is to repeal the entire internalrevenue code and replace it with asimple and fair system such as the flattax. If the 16th Amendment could berepealed, another great option would be a national sales tax plan such as theFair Tax. Unfortunately, rather thanmove in the right direction, politiciansin Washington want to make the taxcode even worse. Obama has statedthat he wants the rich—however they are defined—to pay higher incometax rates. He also wants them to pay higher payroll tax rates, and he wantsto increase the double taxation of theirdividends and capital gains. Last butnot least, he wants to also hit them with a 45 percent death tax if they create a nest egg for their children.This radical agenda shows that theadministration is clearly taking a class- warfare approach to the tax code. Butthis does not preclude other changesthat will make the internal revenuecode more convoluted. Obama hasa bunch of gimmicky tax proposals,including the temporary payroll taxcredit that already was enacted as partof the so-called stimulus. These nanny-state proposals obviously increase thelevel of social engineering in the taxcode. The president also has quickly learned to play the corrupt game of providing special loopholes to the big-money crowd. The tax break in the“stimulus” legislation for a Microsoft billionaire would be a good example.These are the add-insult-to-injury aspects of Obama’s tax agenda. Socialengineering and special loopholesundermine efficiency by luring peopleinto making decisions for tax purposes, but the economic consequences of theclass-warfare provisions are far moretroubling. Persecuting so-called richpeople with oppressive tax rates may be a good way to win elections, but it’snot a good idea for the economy unless you think America should be morelike France, with high unemploymentand lower living standards. Highertax rates—especially steeper tax rateson investors and entrepreneurs—aremisguided.

HIGH TAX RATES ON THE RICHREDUCE INCENTIVES FOR PRODUCTIVE BEHAVIOR.

Ronald Reagan used to say that when you tax something, you get less of it,and when you subsidize something, you get more of it. Politicians actually understand this principle when it suitstheir purposes. They routinely seek toimpose higher taxes on things such asalcohol and tobacco, and they explicitly argue that higher “sin” taxes arenecessary to discourage drinking andsmoking. Setting aside the questionof whether government should try to control people’s private lives, thepoliticians are right about the impactof higher tax rates. Higher “sin” taxesdo reduce smoking and drinking.(They also encourage smuggling andother forms of criminal activity, butthat is a separate issue.)Unfortunately, politiciansconveniently forget about economicanalysis when they decide they wantto tax productive behavior. And just as high “sin” taxes discouragedrinking and smoking, high incometax rates discourage work, saving,investment and entrepreneurship.Some proponents of class warfareactually favor this result since they think the economy is a ﬁxed pie andthat ordinary people get less money

In 1981, President Ronald Reagan signed the largest tax cut bill in U.S. history at his ranch near SantaBarbara, Calif. Under Reagan, the top tax rate was cut from 70 percent to 28 percent. This cut led toincreased federal revenues.

(AP/Charles Tasnadi)