TAKING A STAND

ON

TAXES
By Helen P. Rogers

Taking a Stand on Taxes

Other Books by Helen P. Rogers
Everyone's Guide to Financial Planning Social Security: An Idea Whose Time Has Passed The Election Process: A Grassroots Call for Reform The American Deficit: Fulfillment of a Prophecy? The Deficit: 12 Steps to Ease The Crisis

Taking A Stand On

Taxes

Helen P. Rogers

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WELLINGTON PUBLICATIONS CARMEL, CALIFORNIA

The author has chosen to use a question-answer format in order to make the often complex subject matter, easier and more enjoyable to read. Q and A is not a dialogue between real people--the author has provided the dialogue for both Q, standing for Quaero, which in Latin means "I search for" andA, Auctor, which in Latin means "person responsible".
Laws. regulations. economic. and social conditions constantly change: therefore. the reader is urged to use this writing as only a beginning to his own investigation. The information presented is believed to be correct at the time of this writing. The ideas presented do not pretend to be original with the author but are gratefully acknowledged as stemming from many publications, audio and visual news sources as well as discussions with colleagues. Although I may be unaware of the origination of many ideas still I would follow the admonitions of the Talmud which says when a scholar acknowledges all his sources he brings the day of redemption a little closer.

First Edition Copyright © 1991 by Wellington Publications
All rights reserved. No part of this book may be reproduced or utilized incmy form or by any means. electronic or mechanical, including photocopying. recording. or bycmy information storage and retrieval system. without permission in writing from the publisher. Inquiries should be addressed to: Wellington Publications. P.D.Box 223159. Carmel, California 93923.

Library Of Congress Catalog Number: 91-065692

ISBN: 0-915915-16-2

Printed in USA

This book is dedicated to James Davidson of the National Taxpayers Union, Lewis Uhler of the National Tax Limitation Committee, Joel Fox and Estelle Jarvis of the Howard Jarvis Taxpayers Assoc. and the numerous determined men and women who work tirelessly to achieve a more reasonable tax system.

Taking A Stand On Taxes
Q - Are higher taxes the wave of the future?

A - A conference on tax policy was held in Washington D.C. in October 1987 which concluded that the entire world had better be prepared for " ...more expenditures than we would like, financed by higher taxes than we would like." Demographics was given as the main reason.
Q - The average age of the populations in the industrialized world is rising

and that means fewer workers paying for the Social Security and health care benefits for more and more retirees. A - But governments will not have an easy time collecting the needed revenue. As labor decreases in proportion to capital income, as it has been doing over the past couple hundred years, revenue will come increasingly from investment income.

Q - In the future, because of the ease with which business, capital and labor
will move across borders, governments will be forced to try to find less mobile tax bases. A - Exactly. They may start taxing consumption rather than income. This would generate a demand for international agreements on tax policy to keep national revenues from being eroded by competition. Unless international agreements and coordination oftax codes can be achieved, technology will make it easy to shelter investments in nations with the lowest tax rates.

Q - The so-called brain drain, which I understand is a phenomenon of the
20th century, together with new technology, will only quicken the pace. But what we reall y need in this country is to stop consuming and get savings up in order to provide our own investment capital. A - Let's examine the idea that Americans "need to consume less." Enjoying a higher standard of living, which some people choose to equate with consumption, is the goal of all societies. Savings and
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investments are merely means to that goal. To say America should give up the goal (consumption) in order to embrace the means (savings and investment) is pure nonsense. In a situation where men are permitted to trade freely, supply and demand is the only regulator that is needed.

Q - Amazingly, we find evidence that almost 160 years ago men were
grappling with the same questions. Let me quote you something from the January 1830 edition of the Edinburgh Review:
Our rulers will best promote the improvement of the nation by strictly confuting themselves to their own legitimate duties-by leaving capital tofind its most lucrative course, commodities their fair price, industry and intelligence their natural reward, idleness and folly their natural punishment - by maintaining peace, by defending property, by diminishing the price of law, and by observing strict economy in every department of the stale. LeI the government dothis=-thepeoplewlll assuredly dathe rest.

A - That was the prevailing philosophy in this country in 1830 also. Remember it wasn't until 1913 and the enactment of the sixteenth amendment legitimating the income tax that government gained the means to expand its power.

Q - I guess it was with forethought and the best of intentions that the
founding fathers specifically stated in our Constitution that "... no direct tax shall be laid, unless in proportion to the census". A - One of my son's high school text books reads •...Since wealth is not evenly distributed among the States, a direct tax levied in proportion to population would be unjust to the people in certain States."

Q - That's interesting. Just as an aside it gets me wondering about the power
the text book writer has in defining "just" for highschool students. A - The text goes on to say in reference to the 16th Amendment, that "Congress varies the rates according to the needs of the government." (Italics mine) This is exactly the type of tax the founding fathers meant to forbid, and for good reason.

Q - I get you-needs

are unlimited. How in the world did sentiment for such a major change as

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instituting an income tax ever get started? I recall that Abraham Lincoln tried to raise money for the civil war with such a tax and the Court ruled that it was unconstitutional. A - That's right. But much later, in 1894, to be more precise, Congress passed a bill imposing the first-ever peacetime income tax. It required all citizens with incomes of more than $4,000, only about one percent of the population, to pay a one percent tax. What an outcry ensued! The New York Times called the income-tax law "a vicious, inequitable, unpopular, impolitic and Socialistic scheme" and on top of it all it heaped the epitaph "Uri-American"! The Washington Post said the graduated aspect of the tax "represents a repudiation of the spirit as well as the letter of Democracy ... it punishes everyone who rises above the level of mediocrity ... The fewer additional yokes put about the necks of the people, the better for the commonwealth."
Q - But the Courts went along with the income tax?

A - Not at all. In 1895 the Supreme Court ruled that the Constitution explicitl y stated that a tax should be levied in proportion to population, and not differentiate by income level.
Q - No one could deny the specificity of the Constitution in this area.

A - Therefore, the Court ruled, the income tax was unconstitutional. The New York Times editorialized that the nation had seen the end of attempts to tax incomes.

Q - They hadn't counted on the affinity of elected officials to public money.
A - So back to the drawing boards. An amendment, which would allow taxation based on incomes, was sent to the states for ratification in July 1909. The New York Times responded with "When men get the habit of helping themselves to the property of others they are not easily cured of it." The Washington Post, on the other hand, had mellowed a bit since 1894 and argued that an income tax was needed to "wipe out the deficit without impairment of the public service or calling a halt upon needed public improvements."
Q - That somehow sounds familiar.

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A - The New York Times predicted that the new income tax had established a "rock of credit from which abundant streams of revenue will flow whenever Congress chooses to smite it ... We may be sure that it will be smitten hard and always harder, until the national conscience, if there is such a thing, revolts against the inequality and injustice of such a plan of taxation." Q - If I remember correctly it was to their credit that both New York and Massachusetts rejected the 16th amendment which in February 1913 became the law of the land. A - But one wonders if even the New York Times could have foreseen the acquiescence of the population to the changes that would occur in just fifty years. In 1887 there was no federal income tax and over 60 percent of the federal receipts, which amounted to only about 3 percent of GNP, came from customs. Almost all of the remaining 40 percent of total revenue came from excises on alcohol and tobacco. By contrast, in 1937 the federal government took about 5.5 percent of GNP with 45 percent of the total supplied by taxes on the incomes of both individuals and corporations. The new tax on employment (Social Security) accounted for about 5 percent of all federal revenue in 1937.

Q - Going another fi fty years into the future we find that in the 1980s the
federal government has had no qualms about helping itself to revenue accounting for about 20 percent of the GNP with 55 percent of that revenue coming from income taxes and 35 percent from payroll taxes. A - But what the New York Times would really find incomprehensible is the government's practice of spending more than it has the courage to collect in taxes. Q - Or what about the way we think of assets and private property? It would seem strange to our ancestors to listen to how we speak today of what it costs the government to allow an individual to keep some of what he has earned via a tax deduction or credit. The idea has been twisted so that it appears the government has a fundamental overriding right to all dollars; the heavy handed Internal Revenue code sees to that. A - For some reason, governments are unable to understand the underpinings of economic opportunity. Progressive tax rates destroy incentives

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and prevent successful productive players from benefiting from the knowledge they gained through their original investment. Instead of being taxed out ofthe market, successful players should be encouraged to play again. No matter the claims of the reformers. tax codes distort markets, and are responsible for the misallocation of resources, the decline of capitalist energy, the mix-match of producers and consumers, the suppression of creativity and generally frustrate the creation of wealth.
Q - George Guttman, a tax attorney with the Research Institute of America,

supposes that the role of government is not the confiscation of wealth, but seeing that wealth is spread more evenly throughout society. A - In a capitalist society, already?!
Q - To accomplish this goal, he suggests a tax on recipients of wealth-an

inheritance tax set at income tax rates. A - Since when is any tax not a confiscation?
Q - There would be less need for expensive estate-tax lawyers to devise

elaborate schemes to avoid death taxes. The nation as a whole would benefit, according to Mr. Guttman, because wealth would be less concentrated and probably put to more productive use. A - There are pros and cons enough for a good debate on both contentions but such a debate would be missing the real issue -what right does the state have to "spread" anyone's wealth? A capitalist society functioning under the old-fashioned commonly understood meaning of the words used in the U.S. Constitution, cannot justify such action by saying it might be "good for the country" (debatable), might be "put to more productive use" (Once government gets its hands on it? Oh yeah, and how many bridges have you bought today?) or that "spreading wealth" might put some "expensive estate-tax lawyers" out of work.
Q - What are you saying--that

a great industrialized nation like ours should run its government on fees and excise taxes as was done in the 19th. century?

A - If I had my way all taxes would be called fees. That way a connection

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would be made in the payors mind between the cost and the benefits. That connection is absent now and that's why there is so much waste in government programs.
Q - I wasn't being serious--but

I've got to admit that some government agencies are already financed via fees.

A - Only a very small portion. The FY1991 Securities Exchange Commission budget of $187.5 million, relies on recapturing $30 million from offsetting fees like the filing charges on public offerings. On the other hand, agencies such as the FDA. have resisted fees. Proposed charges here might focus on the cost of plant inspections or the processing of generic drugs.
Q - Actually a good many agency heads would prefer to be self funding and

not have to depend on the Treasury. A - The Reagan administration proposed user fees for national park services, ports and waterways. meat inspection services and similar government provided services. Is this really so terrible? Why shouldn 'r students be asked to pay for insurance to guarantee the repayment of their loans? Why shouldn't tourists pay for the upkeep of national parks? Why can't the meat and poultry industry pay for inspection services? What's wrong with asking yacht owners to pay for towing by the Coast Guard?
Q - With the economic mess the country is in, which many believe is directly related to Reaganomics, I wouldn't invoke anything having to

do with the Reagan administration's tax policy as an endorsement for new ideas. A - That's nonsense! The reasoning behind the 1981 Reagan tax-cut was sound and not the voodoo economics that detractors, before and since, have made it outto be. As GNP rises, it is only natural to expect deficits to decrease. This is not only due to the increased tax revenues from more people working. but as employment rises the need for assistance in the form of welfare, food stamps and other subsidies diminishes. But Reaganomics never got a fair chance to work. Everyone overlooks the fact that Social Security payroll taxes rose more than income taxes fell, in effect eating up the "cut". On top of that, Reaganomics collided with the slowest growth in the money supply

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in twenty years. The restricted money supply meant business couldn't expand as "planned". Q - What is it they say about "The best laid plans of mice and men"? A - The Reagan tax cuts were not used by businesses creating more jobs and producing more revenue; instead payroll taxes increased, as did Social Security expenditures and expenditures for defense ($146 billion in 1980 and $265 billion in 1984). Sure taxes fell from over 20 percent of GNP in 1980 to 18.6 percent in 1984. But if the economy had expanded and broadened the tax-base. 18.6 percent of a larger GNP could have meant an increase in revenue. Q - Imagine the headlines: Reaganomics Succeeds. A - Instead there was a loss in revenue of$50 billion. As for excise taxesthey are the easiest to pass and the easiest to keep. Q - I don 'tthink so. In response to the perceived threat. a group ofindustries that would be hardest hit by excise taxes has formed the Coalition Against Regressive Taxation which argues that the burden of higher excise taxes will fall most heavily on Joe Sixpack. A - Federal excise taxes on beer and wine haven't been increased since 1951. and with society taking an increasingly dim view of smoking and drunk driving, sin taxes don't look half bad to most lawmakers. Q - If I recall correctly, on June 16. 1987 President Reagan specifically ruled out excise taxes as a way to cut the deficit. A - Didn't he once say something about corporation taxes being unconscionable too? Ronald Reagan's actions rarely matched his rhetoric. Already on the state level. according to Jeff Spinner, a policy analyst for an organization called Citizens for Tax Justice. there's a lot of gasoline, alcohol and cigarette tax increases and some sales tax increases also.

Q - Also there are those who advocate using gasoline taxes to encourage
domestic fuel production and energy conservation. current price on American gasoline is too low. They say the

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A - A higher tax would not encourage production because any increase in price would go to the government not the producer. Besides who and how is one to decide when a price on anything is too low? Anyone can claim the price on clothing is too low because people have a closet full of clothes and no one really needs more than two suits (inventory) or food is priced too low as evidenced by overweight citizens, and if we made people go to bed at dusk and rise at dawn think how much energy we could save ... Q - Hold on. I'm not advocating an increase in the gasoline tax. A - That's good. because the Wharton School in Pennsylvania figured if a ten cents a gallon gasoline tax was imposed, our GNP would be reduced by $10 billion in the first year and personal savings would decline by 3 percent-for starters! Q - Actually the gasoline tax hike is as much a user fee as it is an excise tax, since under one proposal the proceeds are supposed to go into the Highway Trust fund. A - There is supposed to be $17 billion in the combined Highway and Transit Funds. The country needs that money to maintain roads, but Congress has been using it for other purposes. The $1 billion from each penny per gallon tax would be eaten up in the hike in consumer prices and business operating expenses. Q - I recall a debate where Senator Wirth wanted the gasoline tax. to ease our dependency on foreign oil. He said 11 million barrels are used in this country for transportation every day. He advocated the section in the original Bush Clean Air Act which included $1 million for alternative fuel vehicles. A - But that was dropped despite the claims it would have saved 2 million barrels of oil a day by the year 2000. Senator Sasser was one who supported the tax on gasoline and justified his support by pointing to the poor shape of our nation' s highways and bridges. He quoted a Times poll which said 84 percent of those polled would be willing to sacrifice for Desert Shield whereas 73 percent said no to a gasoline tax.

Q- What about a value added tax (VAT) which adds a little to the price of 8

goods at each step of production? A - Most countries that use a VAT, tax corporate income only once, and have no tax on interest and dividends. Many of these same countries do not allow sweeping personal exemptions for home-mortgage interest, for employer-paid health care, for unearned public retirement benefits and so forth. Japan taxes business and capital at a lower rate than we do and consumption at a higher rate.

Q - No wonder the Japanese save!
A - Japan's recent tax reform involved a tax on savings in an effort to discourage this seeming virtue which it was thought the Japanese carry too far. The government now wants to stimulate spending.
Q - This sounds like aJack Sprat situation where Japan, as Jack, could eat

no fat, (couldn't consume) and the USA, as his wife, could eat no lean (couldn't save). It is not clear how long the Spratt's marriage lasted under the circumstances described, nevertheless it is popular wisdom that the United States should now encourage savings and discourage consumption. A - Well the way the VAT would do that is to tax people on what they purchase not what they produce; that is the good part. In my opinion, the only good part. Norman Ture, president of the Institute for Research on the Economics of Taxation in Washington DC, estimates after allowing for certain exemptions to protect low-income individuals, a VAT of 3 percent would raise about $45 billion.

Q - Didn't Alice Rivlin, the first head of the Congressional Budget Office,
support the value added tax? A - She would get rid of state sales taxes and substitute a nationwide VAT with the proceeds being parceled out on a per capita basis to the states. Just as an aside, in her address to the National Academy of Public Administration in November 1991, Ms. Rivlin urged political leaders to incorporate health insurance with social security thus relieving the states of that burden and freeing them to take on the job of effective education, child care and job training. 9

Q - It seems to me that the increased private and corporate savings rate. which seems to accompany VATs, might be another good part. A - Sir Alan Walters, formerly an economic adviser to the Thatcher Government. assumed he was describing virtues when he said the VAT" ... is less perceptible and therefore less painful than the income tax." This is a feature, which for obvious reasons, is highly prized by politicians. But many people, like myself, oppose the value added tax (V A 1') in part because of this lack of pain. A gradual unremarkable but steady rise in such a tax is almost inevitable. Subtle taxation is to be avoided like the plague by any people wishing to remain free and in control of their own destinies.
Q - Already

a good many Americans are becoming so accustomed to payroll withholdings for Social Security and income tax that they hardly notice a rise in the government's "take". If they do wonder why the harder they work. the "behinder" they get, the answer is less apparent than it would be if they actually wrote a check to pay those taxes every year.

A - Absolutely. A passive fleecing creates a feeling of helplessness and dependency which our government should discourage. Many taxpayers have too much money withheld, which is in effect giving the government an interest free loan.

Q - Who can afford to give interest-free loans, if given the choice?
A - With the new W -4s, over-withholding is more likely than ever to occur. In FYl986 the IRS received 102.4 million tax returns and issued 74.2 million refunds averaging $982 each. Those refunds represent loans to the federal government by citizens of close to $73 billion. Q - I understand that median income earners in 1950 paid 2 percent in taxes and the same group was paying 23 percent in 1988. A - What do you think would happen if taxpayers, rather than politicians. decide on the amount of dollars they are willing to pay for collective purposes? Into the kitty: so much to A so much to B so much to C and bureaucrats would simply have to make do just as wage earners make do. Anyone who wants to serve will have to add additional from his own resources the way many school teachers and parents who send their

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children to private schools have been doing for years.
Q - One thing I can say is that you are consistent. I think you were saying

the same thing in your book on U.S. Competitiveness, and 1 quote:
In a collectivist economy public needs enjoy the same sort of built-in priority that private consumption enjoys in a capitalist economy. In the collectivist economy all resources are available to the public sector and private consumption is restricted. In a capitalist economy, public services are restricted to claims against the private sectorthat is, they are dependent upon raising taxes.

A- 1also continually tell the story of Davy Crockett. who in the 1830s, was Tennessee's representative to Congress. One day a bill was presented, calling for an appropriation of money for the widow of a distinguished naval officer. The speaker was about to put the bill to a vote when Davy Crockett stood up and said, "I have respect for the deceased and sympathy for the widow, but we must not collect money from the taxpayers, one group of people, to give to others to whom it does not belong. This would be an abuse of our power." He then offered to give a week of his own pay to the widow if the other congressman would do the same.
Q - In order to get legislation passed, or to get elected or to be able to do

whatever it is someone wants to do, fine sounding promises are made. Citizens like you and I have got to discipline ourselves to discount these promises from the outset. A - It's not exaggeration. stupidity or incompetence, at least not always. It's just that the future is unknowable and estimates are unpredictable, especially when they deal with the many variables in today's complex economy.
Q - Moslems are bound to give 2.5 percent ( a fortieth) of all accumulated

wealth (not income) to the church at the end of each year. It's not a levy on money in active use, only on money that has been idle for a year. The idea is to avoid hardship on the donor while ensuring that the poor in the community have at least the necessities for life. This system encourages economic activity as well as risk-taking. A - The problem would be in defining idle money. but at the very least, the levy would provide the incentive to seek out the best use of one's funds. 11

Q -You've expressed concern about our national debt and continual huge
budget deficits as evidence by three books on the subject. What, in your opinion would be the best tax to get that deficit in line-the tax that would have the least adverse effect on the economy? A - Milton Friedman was recently asked that and he refused to speculate, saying all taxes would have bad effects and it is not a profitable use of our time to ask "what's the best way for our opponents to destroy us?" I certainly agree with the good professor that the government should avoid efforts to fine tune the economy. It should provide a stable framework and then back off.
Q - Walter Wriston, former chairman of Citicorp, agrees. He feels the best

government action is "no action" and let the markets adjust naturally. A - Perhaps we can get him to run for public office to prove to policymakers that less meddling is the best policy!

Q- On November 7, 1991 Congressmen GephardtandRostenkowskiheld
a press conference to present a new tax plan with relief for the middle class taxpayer, A - They were just gearing up for an election year. You'll see a lot of politicians catering to the large middle class in 1992.
Q - Their plan included a 10 percent sur-tax on millionaires and a new 35

percent rate in exchange for a reduction for 90 million middle-income tax payers. A - I saw that press conference. They had a simplistic basic color chart appropriate for any Headstart classroom in the country. It had a large wide swatch of brilliant blue, a smaller slanted band of yellow and a very narrow L shaped strip of red-the L lying on its back with the bottom going part way up the side of the chart to represent the very narrow group of people who would benefit from the tax legislation that this color represented-the rich. The yellow stood for those that would be affected by Senator Bentsen's plan -mainly tax rebates for those with children and the blue was the $200 or $300 the congressmen wanted to put in the hands of 90 million Americans.
Q - I remember Congressman Gcphardt said, "People need their confidence

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rebuilt." and he and Mr. Rostenkowski were proud that they were fashioning a little something for those cherished and deserving middle income Americans. A - One of those lower to middle income people from Ohio called the CSpan Journalist Roundtable discussion the next morning and said "Forget the $200 or $300 rebate-what I want is a cut in the taxes enacted last year-the excise taxes on my beer, cigarettes and gasoline." Q - I don't think its productive to criticize without presenting solutions of your own. A - You mean me? I've been saying all along that government should provide stability-law and order-then back off. I believe government could function on very low revenue if its responsibilities were cut back. Q - How would you do that with so many needs in the society? A - Transfer the responsibilities to the private sector, which I am convinced can do a better job at most things. If you want more specific and short term suggestions concerning taxes, and keeping within the realm of possibility, I have those too. For instance, I suggest we keep marginal rates low on income tax, lower regressive taxes on labor, gasoline, alcohol, and tobacco, lower the capital gains tax and add incentives for investment and savings. In fact if you don't mind a walk through fairyland I would end double taxation by eliminating the corporate tax, eliminate all taxes on capital gains and substitute a tax refund (guarantee minimum income) for our current welfare payments to low-income earners. And if you were up to really thinking big, I'd tell you about my dream of abolishing the IRS and the wrong-headed income tax entirely. Instead, how about if we get real and I compromise and try to convince you that a flat tax is a feasible and better alternative to our present system? Q - Sure. Go to it! A - Several years ago Idaho's former congressman, George Hansen, introduced a fifteen percent across-the-board tax on all income. Ten

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percent proposals were made by Congressmen Philip Crane of Illinois and Ron Paul of Texas, as well as Senator Jesse Helms of North Carolina. Congressmen Panetta of California and Duncan of Tennessee proposed virtually identical nineteen percent plans. In most "flatrate tax" proposals. allowances are made for business expenses in varying degrees and under different guises.
Q - That sounds like the De Concini Bill (S.B. 2147) which I was familiar

with about ten years ago! A - Great! That will help if I just refer to that piece oflegislation as "the flat tax" for the purpose of our discussion. You may remember it was proposed March I, 1982 and developed to meet four criteria: First, that all income should be taxed once and only once and as close to its source as possible. Second, that all types of income should be taxed at one low rate. Third, that the poorest members of society should be exempt from taxes and lower income families should pay a smaller fraction of their income in taxes than should higher income families. Fourth, and finally. that tax returns should be simple enough to fit on postcards.
Q - I'll sure buy that last one!

A - Keeping in mind that the 1986 reform has minimized some of the distortions the earlier system exaggerated. let's see how the old system measures up to each of these four requirements. First, all income taxed but only once. As long as corporations are legally separate tax paying entities, some income will be taxed twice; once at the corporate level and again when received by the shareholder as a dividend. I have several newspaper headlines dated January 28, 1983 which I keep as a reminder that occasionally all politicians think they have enough power to turn the tide and the guts to try. As it happened. an extremely popular and beloved president found the undertow, backlash or whatever you want to call it, too strong.
Q - I remember that. After asking in a prepared speech in Boston" ...when

are we all going to have the courage to point out that in our tax structure the corporation tax is very hard to justify?" Ronald Reagan was forced 14

to run for cover. A - Because the concept is not politically feasible does not mean it is wrong. QI never said the concept was wrong, but I do think the president did more than simply run for cover.

A - What do you mean by that? Q - In their 1987 book Showdown at Gucci Gulch: Lawmakers, Lobbyists and the Unlikely Triumph of Tax Reform, Jeffrey Birnbaum and Alan Murray claimed, that despite Ronald Reagan's earlier expressed abhorrence of the corporation tax, his administration managed to transform the 1986 reform into the largest increase in corporate taxes ever enacted by Congress. They wrote that
(then Secretary o/the Treasury) was able to cut not only individuals' tax rates but also individuals' tax bills by an average 0/ 8.5%. Tax revision was turned int 0 old-fashioned tax cutting, with corporations picking up the bill.

By raising corporate taxes, Mr. (Donald)Regan

"Running for cover" is one thing, but this is the action of a turncoat. A - The deficit-reduction accord that was hastily thrown together at the socalled "summit" (November 1987) again hit corporations the hardest. One proposal alone, increasing the coverage of the corporate minimum tax, was estimated to cost corporations over $2 billion.

Q- Is it any wonder that the economy is stagnating with all the regulatory
and confiscatory country? edicts that are being heaped on business in this

A - In the past, when corporations contested their tax levies the IRS charged 8 percent interest on the amount contested. In 1991 that interest rate increased to 13 percent. Q - I think that applies to underpayments that exceed $100,000. A - That's right. Firms must decide eitherto pay the amount up front before litigating or risk larger interest costs while in Tax Court. This makes it harder to contest in Tax Court. For some firms, with disputes going

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back six or seven years, the interest is going to be more than the tax. Congress expects the IRS to raise $2 billion over 5 years because finns will probably speed up their payments.
Q - It can't be over emphasized that business cannot function well in a climate of uncertainty. A good fiscal and regulatory policy means

clear stable rules that can be counted on.
A - Not only that, excessive taxation from income generated via capital is

self-defeating. Now the amount of tax on capital income depends on the manner in which a particular investment was financed. If via debt, then some of the capital appears as interest payments, which means dual taxation. If any investment is financed by retained earnings or new stock, then the taxable capital is profit, which gets hit with the corporate income tax. If via equity, i.e. offering shares or retaining taxable earnings, the capital is subject to triple taxation
Q - I've heard of double taxation, but triple taxation?

A - If dividends are paid to shareholders, capital is taxed a third time, only in this case the individual shareholders pay. If profits are retained, they are subject to the capital gains tax also.

Q - I can see that corporations would be e motivated to use debt, because
the double taxation of debt-financed investment would be more attractive than the triple taxation of equity-financed investment.
A - Exactly.

And this incentive was made even more attractive by the effective rise in the capital-gains tax rate in the 1986 tax reform, the the tax code should tax consumption instead of income? Instead of taxing consumption, which is what we take from society, we tax income, what we contribute to society. To tax anything is to ensure less of it.

Q - To minimize the distortions against equity investment, don '1 you think

A - How about if we treat capital expenditures as fully deductible current expenses? Even better, simply get rid of the corporate income tax and substitute the flat tax.
Q - Let's measure the current tax code against the flat tax's second

requirement, low uniform rates.

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A - When different forms of income are taxed at different tax rates, clever attorneys and CP As arrange for clients to take income in ways that are taxed at low rates and receive deductions against income taxed at the highest rates.
Q - That's their job, after all!

A - I'm not finding fault with them, just with the system. The system encourages the use of stock options instead of cash wages when there is a lower capital gains rate, for instance; or deferring income from a profitable year to the next year when a client expects to be in a lower tax bracket; or the shameful liquidation of a profitable corporation for the sole purpose of escaping the corporate income tax imposed on its earnings; or passing assets to family members in lower tax brackets when judgement, unaffected by tax laws, tells a person the timing is off.
Q - I understand that the basic idea behind the flat tax is that everyone

should be taxed at the same low rate and that by disallowing deductions, exemptions and credits, the revenue base would actually be increased. It seems to me the elimination of a lower capital gains rate would be seen by you as a step in the right direction. A - Not by itself without removing other disincentives and burdens on capital. Nevertheless, I would be the first to admit many changes in the 1986 reform went a long ways towards reducing inequities, but still the law favored those who could afford to pay creative men and women to study the new road map and come up with detours and ingenious approaches. The rules may be new, but the game's the same. Our present tax system makes us dependent on the whim of policymakers. Q - I can think of a situation to back up your point. A group of Virginia investors intended to build a $220 million rail line to Dulles International Airport and certain provisions of the 1986 tax reform put a damper on things. Without the investment tax credit, stretched out depreciation periods and limited tax-exempt financing, the investment changed dramatically. I am not arguing in favor of the subsidies, rather I'm agreeing with you that consistency from Washington D.C. is extremely important for the health of the nation. A - Absolutely! Under our present system, planning cannot be done 17

rationally because too much depends on who knows who--on the dispensation of favors and unforeseeable changes in the law. A favorable push given to a competitor is a risk which must always be considered and to guard against risks is costly. But the game goes on.
Q - For instance taking away the incentives to build low income housing

only transferred the burden to the Treasury. It made it less desirable to invest in rental housing and so the four or five dollars per week saved in taxes is overshadowed by increases in rent. These changes could make the consumer suffer in the long run. A - One change that was not made in the 1986 reform, and that I would have love to have seen, is a provision that would allow the self-employed to deduct 100 percent of their health insurance premiums.
Q - My big gripe with the reform concerns energy-to be more preciseoil. In my opinion it was not too smart to take an industry in as much trouble as oil was in 1986 and give it a three billion eight hundred and fifty thousand dollar kick in the teeth. The industry was only functioning at ten percent of capacity so someone came up with the brilliant idea to tax it more!

A - What about the removal of the lTC-investment tax credit? There was already concern that the nation was turning away from capital intensive industries toward the service sector when the reformers removed the investment tax credit. Many people felt the removal of the ITC would mean less investment in plants and equipment. In 1992 you will see more and more people in favor of restoring it to get the economy moving again.
Q - Also, the Inventory Capitalization Rule proposed in the 1986 tax reform, was extremely harmful to small business. No one knew how

the capitalization rules for inventory were going to work; even the staff was unclear when the bill was presented to the Joint Committee on Tax Reform in August of 1986 shortly before its passage. A - I remember, Senator Danforth tried unsuccessfully to gain time for clari fication.
Q - Many critics felt that by asking businessmen to declare the percentage

of their purchases left at the end of the year (inventory) as taxable

18

income, could mean a gradual liquidation of a business over a period of years. They predicted that a small businessman might see his taxes jump as much as 50 percent with the application of the rule. A - Changes in the 1986 Tax Reform Act limited the potential savings for people with Section 403(b) plans whose annual salary exceeded $47,500. Formerly all salary could be deferred under Sec. 403(b) and it wasn't taxed until received by the employee, usually in retirement.
Q - But Sec. 403(B) only affects the employees of private nonprofit

institutions like symphonies, universities, museums, hospitals etc. A - Maybe so, but under the old law, employees of nonprofit institutions were able to defer up to 20 percent of their annual salary into sheltered annuities, depending largely on how long an employee had worked at the institution. The reform limited the annual deferral to $9,500, (20 percent of $47,500 is $9,5(0) less any payments to other tax deferred savings vehicles such as 401(k) trusts and 457 deferred-compensation plans. The new law added a 10 percent penalty for early withdrawal which makes people think twice about squirreling money away for retirement in case an emergency arises and they are unable to get to it. Besides, tax-sheltered annuities had been a recruiting tool to attract employees to tax-exempt organizations; organizations that are often unable to pay competitive salaries.
Q - I guess they had to find other ways to be competitive until the next

reform. A - What really bothers me is the undisputable fact that most reformers are busy people who tend to streamline their actions. They have found if they have too little time to reall y study the ramifications of a proposal their goal cannot be hurt much if they simply go with a kind of all purpose "soak the rich" philosophy. In the above example not many employees actually cam enough to be hurt by the new limitations.
Q - Getting back to the flat tax, how does the third requirement fare under

the present tax system? A - The third requirement, exempting the poorest members of society, was met. The 1986 reform removed more than six million low income potential taxpayers from the tax rolls. Income tax progressivity has increased, not decreased. 19

Q - Are you serious? Everyone knows the middle class is now paying more than their "fair share" of taxes, thanks to that phony reform!

A - I'm taking about income taxes and you're thinking of payroll taxes. which have undoubtedly fallen more heavily on middle income tax payers. Besides, the best way to "soak the rich" is to lower their income taxes, leading them to voluntarily re-enter the taxable economy. Take the 1981 tax cutthat is constantly blamed for everything under the sun. Taxpayers with an adjusted gross income (AGI) of more than $1 million in 1985 paid 260 percent more in taxes than in 1981, while tax payments from those middle-income Americans earning between $25,000 and $50.000 feU slightly. Tax payments from the rich rose in every year during Ronald Reagan's first term. Correcting for inflation with the consumer price index, they rose 19.2 percent over the four years. In 1981 the rich paid $2.42 in income taxes for every doUarpaid by the poor; by 1985, that ratio had risen to $3.12, an increase of 29 percent. According to IRS records, in 1981 the top one percent of taxpayers, measured by AGI, paid (after allowable credits) $51 billion, whereas the lowest fifty percent of taxpayers, again, measured by AGI, paid onl y $21 billion. That means the top one percent of income earners shouldered 18.05 percent of the nation's tax burden and the bottom fifty percent were responsible for 7.45 percent of total taxes paid in 1981. By 1985 those numbers had changed to show an increase in the first group's share of the burden from $51 billion and 18.05 percent to $72.1 billion and 23.1 percent whereas the less affluent group, although their tax payments rose from $21 billion to $23.1 billion their percentage of the entire tax bill dropped from 7.45 percent to 7.1 percent. Q - In contrast to the IRS data, the Congressional Budget Office (CBO) produced a study during the final quarter of 1987 which showed the "poor" paid slightly higher average tax rates in 1987 than they did ten years earlier before all the reform, What do you say to that? A - As I tried to point out, the higher average rates were the result of the continual large increases in Social Security taxes. No one can deny that the wealthy are paying more tax dollars now, mind you, but amounts don't count in the minds of those who weigh "fairness" in tcnns of percentages. It is also interesting to see how

20

carefully results from tests must be read and how futile it is to compare, oreven accurately cite, findings. In the appendix of the CBO study we find that
T~ richest 10% of Americanfamilies (notice families as opposed to taxpayers and ten as opposed toone percent) paid37.5% of allfederal taxes in 1984. comparedwlth. 35.9% in 1977,andthey'Upay38.6% in 1988. T~bottom50%of allfamilies, on the other hand. saw their share of all taxes fall--- to 12.9% in 1984 from 13.3% in 1977.

It's also interesting to note that the CBO study only documents figures for 1977 and 1984! Here less percentage-wise, equates with more actual dollars. because the income of the top 10 percent has increased about 15 percent. The study claimed the income of the top one percent will have increased 40 to 50 percent before taxes and as high as 63 percent after taxes.
Q - I guess that is supposed to show the extent that the changes in federal

tax law have benefited the rich. A - Taking the nation as a whole, the study found that in 1977 people were paying 22.8 percent of their income to the federal government in taxes, and in 1988 they were paying 22.7 percent. No mention of state, local, excise and property taxes.
Q - The data suggest that Ronald Reagan may have been playing the part

of Robin Hood during his presidency. A - But you wouldn't have learned that from most media accounts during those years.
Q-

I know that taxes over all increased during the Reagan years, but I wonder how much and in what areas.

A - I can give you a brief rundown: TEFRA, the Tax Equity ad Fiscal Reform Act of 1982 increased taxes by $311 billion, the Social Security amendments enacted in 1983 were responsible for another $377 billion, there was a gasoline tax hike in 1983 for $28 billion and theDeficit Reduction Act of 1984 brought in another $101 billion. The 1986 reform, advertised widely as "tax neutral" increased the government's take another $30 billion and the 1987 budget accord accounted for $23 billion with miscellaneous increases amounting to $9 billion.
21

Q - That was a pretty thorough analysis but you did forget to mention the bracket-creep due to inflation which occurred between 1981-85. A - That's right. Before indexing took effect, bracket-creep added another $650 billion to the federal coffers. Q - Scream bloody murder at any hint of repealing indexing! A - When all is said and done eliminating bracket creep may tum out to be President Reagan's most valuable contribution to this country.

Q - The American people are paying a whale of amount in taxes - our
forefathers would never have thought it possible. A - The Social Security payroll tax, in the early 1980s, shifted about $80 billion in annual revenue collection from progressive to regressive taxes. Q - What about the 1986 tax reform? I've heard so many negative comments about the 1986 tax reform. Do you share the disillusionment? A - The 1986 tax reform was supposed to be tax neutral over a five year period. The catch is no tax bill in recent memory has remained in tact for a period as long as five years. Q - That's right. There were four reforms in Ronald Reagan's first five years in office. A - So, once again pushing OUf way through the smoke and mirrors, we see that because deductions and so-called loop-holes were removed first, and rates were not lowered until much later, the 1986 reform generated close to $25 billion in new revenue the first year, Q - In other words, it was a revenue raiser, not tax neutral as advertised. A - During the Joint Committee hearings on tax refonn in August, 1986, Senator John Danforth warned that the tax reform bill was being rushed through the committee hearings without proper caution. He called the reform a bad bill for the future of the country, warned that it hit capital intensive business, was anti-growth, anti-jobs, anti-

22

future. He said: "It hurts people. You can't take $120 billion from corporations without hurting people's jobs."
Q - That's something the Democrats still haven't accepted.

A - Senator Danforth gave the picturesque analogy of the Senate's version of the tax bill as a "fair maiden" and said when you cross a "fair maiden" with a "gorilla" (House version of the tax bill) the gorilla's dominant genes are bound to win. He warned the other committee members that they were sacrificing the future for immediate consumer gratification. He pointed to the fact that the bill put a cap on the money colleges can raise without bonds being taxable. The bill discouraged the contribution of depreciated property and stock and therefore contributions, period. Taxing scholarships and even fellowships would be harmful for education in his opinion, and tough in the long run on the economic strength of the nation. You figure this one out: The tax reform of 1986 only extended the tax free status of employer-paid group legal services and educational assistance for one year. At the end of 1987 these two fringe benefits expired automatically.
Q - Yet Congress continues to talk about ways government

can help

education! A - Exactly! Loss of the Investment Tax Credit (ITC) would hit heavy industry hard, yet politicians rant and rave about our loss of manufacturing jobs and the need to invest in industry in this country. Q - It sounds like more gobbledygook! A - Senator Danforth could only see Silicon Valley (high-tech less capital intensive) and high tax paying corporations benefiting from the 1986 reform. But the worse thing, according to the Senator, the committee was asked to vote on a mere summary. Senator Danforth felt committee members were being railroaded and declared there was no reason to sign the report then and there because the legislation was too important and affected too many citizens to be subjected to such speedy action. He claimed the Republican members on the Ways and Means committee were not even able to participate because so much was being done behind closed doors. He requested more time and public exposure for

23

the biU. He claimed Secretary James Baker and Senator Bob Packwood were afraid to open the bill to public scrutiny because "people will find out what we're doing and bring pressure on us during the recess ... I can't understand what's wrong with a little sunshine in government" he concluded.
Q - Was Senator Danforth the main critic of pushing the legislation through

so quickly? A - Bill Archer of Texas didn't want to sign so quickly either. "We are going to affect the lives of all Americans." He predicted an early revision if the refonn was rushed through in 1986.
Q - The verdict may still be out on the 1986 reform but it is beginning to

look like some of the concerns may have been justified. A - At any rate Senator Danforth in particular, put up a good fight. Senator Bill Bradley was much more optimistic about the bill and offered some convincing and some so-so reasons. He was pleased because young workers would have less reason to concentrate on avoiding taxes (young, old and in between) and could go ahead and make money because thanks to the 1986 reform they'll get to keep more of it. He was optimistic because corporations may often pay less than before the reform; from 40 percent down to a top of 34 percent, depending on the type of activity as discussed above. Additionally Senator Bradley saw the reform as a victory for general interests over special interests. ("Special interests" are almost as nasty as "the rich" and there's always open season on them both!) Richard Gephardt of Missouri took a philosophical approach to the bill. He said "We all understood we would have disappointments in order to restore a base of $300 billion." Senator John Chafee of Rhode Island mused, "Tax bills aren't forever. It won't last five years - we'll fix it."
Q - How about members of the Reagan administration?

A- Secretary of the Treasury, James Baker sat there and recommended the bill be signed immediately.
Q - Meanwhile, I guess Senator Bob Packwood and Congressman Dan

Rostenkowski, the joint chairmen. wanted everyone to trust and obey.

24

A - "Trust and obey" is something Americans in every walk of life are being asked to do too much lately. The more complex those in charge make a situation, the easier it is to manipulate those they have thereby made dependent.
Q - The opponents of the more recent budget agreement were right when they said that it would reduce tax receipts and increase spending.

A - I assume you mean the budget proposal presented in mid-October 1990, which was 70 percent revenue increases.
Q - Right. The 1990 legislation demands any cuts be accompanied by new

revenue sources. TEFRA demanded revenue be accompanied by cuts. A - During those 1990 debates it was suggested that indexing be removed but it would have no effect on the top brackets ...
Q - They would remain at the top. But indexing would greatly harm the

middle class taxpayers. Congressman Jim Slattery of Kansas disagreed with the opponents and claimed that 2/3 of the deficit reduction was to come from spending cuts and 1/3 from tax revenues. The Republicans were not allowed to present their plan which froze spending for 3 out of the next 5 years and had no tax hikes but only reduced the deficit by $410 billion. A - The 1986 reform called for eventually two tax rates; 15 percent and 28 percent, but it started out with five rates ranging from 11 percent to 38.5 percent. The top corporate rate was scheduled for 34 percent.
Q - In 1987 the top corporate rate was 40 percent.

A - Because of the base and rate change, it means the effective rates are indeed progressive - more progressive than under former law. Those making between $20-30 thousand got a 9.8 percent cut; $30-40 thousand got a 7.7 percent cut; those making over $200,000 got a 2.3 percent cut. The wealthiest got the smallest break percentage-wise and three hundred and seventy-five taxpayers will have to pay the higher alternative minimum tax.
Q - But you can't deny that sixteen percent of the tax reductions go to the

half of one percent who earn more than $200,000. 25

A - And six and a half million people, who before the reform paid the lowest taxes, got 100 percent relief.

Q - You mean they were dropped from the roles.
A - Of course in order to obtain the $300 billion worth of rate cuts the 1986 reform had to broaden the tax base by the same amount - $300 billion was laid on the shoulders of business.
Q - It seems to me that when it comes right down to it, it is tantamount to fraud to call the reform a "tax cut" for anybody. After all, business will

pay the increased tax levies by raising prices and/or decreasing employment. A - Let's look at the fourth requirement of a flat tax, that it be as simple as possible. Since I graduated from college, and that's more than 30 years and we'l1 leave it at that, the tax code has tripled in size, per-capita tax collections and cases pending in the Tax Court have increased sevenfold and the number of IRS employees has grown by almost 90 percent. Rewriting the tax code via the 1986 reform, entailed training 17,000 revenue agents to understand and enforce the changes.
Q - I heard that government

attorneys were reassigned from other branches to the Legislation and Regulations Division.

A - The 1986 reform definitely led to a more complicated system. For instance, interest deductions under the new regulations were not equal; it all depended on what the borrowing was for. Credit cards, trips, car purchases were all personal interest which meant you could deduct 40 percent in 1988, 20 percent in 1989 and only 10 percent in 1990. However if you borrowed to buy stocks or bonds, all interest was deductible as "investment interest" up to $4,000 in 1988, $2,000 in 1989 and only $1,000 in 1990. Interest related to passive investments, like rental real estate, was deductible only as an offsetto income generated, whereas interest on loans for business or on home mortgages was 100 percent deductible.

Q - Give me a break! Supposedly the regulation pipeline was already
clogged as evidenced by the fact that some corporations had been wait-

26

ing for regulations to guide them in their tax planning since the 1969 tax bill! A - Is it any wonder when you consider that the Internal Revenue Code consists of fourteen volumes - eight for income taxes alone. A high reading and comprehension score is needed to determine eligibility for deductions, exemptions and credits. It's often hard, even for professionals, to tell the difference between constructive deductions and loopholes. In addition to the old seventeen page 1040 Form and its forty-four page instruction booklet, there are pretty near three hundred tax forms and schedules covering every conceivable transaction. Q - No wonder six million tax payers pay commercial firms to complete their Simplified Short Forms. A - Unfortunately the 1986 Reform did little to simplify the system and in fact many tax professionals have been able to expand their practices with little fear of having to constrict in the near future. Q - I understand the earned-income tax credit for the approximately 14 million lower income families with children, is so complicated, with its nine pages of instructions and tables. that the IRS has agreed to make the computations itself if the taxpayer only lists the children. nontaxable income and health insurance payments. A - The help from the IRS was the result of urging by Senator Kohl of Wisconsin. But under the flat tax that we are discussing. we are talking SIMPLE! "All Income Taxed But Only Once" is ensured by using a combination of two separate postcard size fonns. The Individual Compensation Tax Fonn is used strictly to report wages. salary and pensions. From the figure derived from wages, salary and pensions the computed personal exemption is subtracted ($6.300 joint, $3,800 - single. $5,600 - head of household. with each additional exemption $750. Family of four $7,700 exempted) and 19 percent of that number is the tax due. (Actual numbers are unimportant for this illustration.) Those simple steps are all that would be involved for about 80 percent of the population who receive no business income. For the other 20 percent of Americans. the Business Tax Form must also be filed. Although under this particular flat tax proposal. the 19 percent rate is lower than the old corporate income tax in this country and in most

=

27

other parts of the world, it would actually raise more revenue because of its much broader base.
Q - Why is business taxed on a separate form?

A - The Business Tax Form does not constitute a tax on "business per se" but rather on individuals at the business source. Gross revenue from sales goes on the top line. From that may be deducted the cost of foods. material and services the business purchases to make the product it sells.

Q - I would think. the tax on these things would be already paid by the
original seller? A - Right - on his business-tax top line. The firm can also deduct the wages. salaries and pensions it pays because the recipients pay tax on their compensation form. Lastly, the business can deduct its outlays for equipment, plant and land. Nineteen percent of the resultant figure is the tax due.
Q - I notice there is no deduction for interest payments, state and local

taxes, charitable contributions and fringe benefits. some of which were destroyed by the 1986 reform at any rate. A - This is not so much to increase the tax base as it is to ensure "All Income Is Taxed But Only Once". Interest is not taxed when received because it has already been taxed at its business source by not being deducted from gross revenue.
Q - This sounds like the flat tax scheme explained in the book Low Tax, Flat Tax, Simple Tax published in 1983 by McGraw-Hill and written by

Robert Hall and Alvin Rabushka. two economists then at the Hoover Institution in Stanford. California. A- You've got it, But you're the only person I've ever known that has even heard of it! On page 41 the authors show a tax return just this simple made out for Exxon, the largest corporation in the world at that time. Forreasons explained above, the corporation ended up paying $700 million more under this theoretical flat tax proposal than under the tax laws in effect in 1982.

28

Q - By no stretch of the imagination is the flat tax a tax on profit. A - Exactly. Because business can deduct the cost of land, plant and equipment. in a record sales year when the company is also expanding. it may have a negative taxable income. If so it would be handled, not by government refunds, but by carry forwards which are not limited to any number of years. The balances carried forward earn the market rate of interest. A negative taxable income is no particular problem, because when expansion slows and sales increase, the total contribution to Uncle Sam will be even greater! Q - A startling concept of the flat tax is its treatment of the total amount of investment as an expense to be deducted in the year it is made. No more complicated depreciation calculations, no more figuring out the amount subject to recapture, or what investment credits may be available, or whether the project can be stretched out long enough to qualify for full credit and all the other contortions which are part and parcel of our present cumbersome tax law. A - The concept of investment as expense is included, not for the sake of simplicity, but rather from a commitment to the philosophical concept that savings should be encouraged rather than penalized. Q - I like the idea because a flat tax would prevent persons from diverting savings from their most efficient destinations, one of the main stated goals of the 1986 reform. A - Here, because of equal tax rates, there would simply be no need to divert into unproductive and uneconomic channels in an attempt to avoid, reduce or defer taxation. The loss to the economy from all the effort to reduce or escape taxation has been estimated to be a minimum of $50 billion. Add to that the $6 billion that could be saved by eliminating 600 million hours filling out returns (figured conservatively at $1O/hr). Because they will get to keep more of what they earn, ambitious citizens will be encouraged to work longer and harder.
Q - Under our current progressive tax system the harder citizens work the

more they end up paying. A - Exempting investment from taxation is almost the same as exempting savings.

29

Q - Since one makes the other possible.
A - We're on the same wave length. Since consumption is the difference between income and savings, then consumption is what should logically be taxed. Consumption being what people take out of the economy and income being what they put in. Q - The flat tax is more accurately a consumption tax rather than an income tax. A - By expensing investment the double taxation of saving will be eliminated. Under an income tax people pay tax once when they earn and save and again when the savings earn a return. The flat tax abolishes the first tax. Backers of this proposed reform, with its top marginal rate of nineteen percent, claim it would balance the federal budget even if spending were not decreased. Q - I bet the claim was made before the budget had attained its present size. A - The 1986 reform reduced tax shelters, but it is impossible to eliminate them as long as Americans remain creative. Unfortunately the need for shelters was not reduced along with the shelters themselves. The flat tax would reduce the attractiveness of the underground economy even further and help make an honest nation of us again. It would end the penalties for success, improve incentives for work, entrepreneurial activity and capital formation, all of which will, in the end, raise the gross national product (GNP) and everyone's standard of living.
Q - I agree. The flat tax could amount to an economic renaissance -

not

all at once, but gradually over the decade after enactment A - I admit that "good" and "ridiculous" are subjective terms but having made that concession I can say that it seems to me the "good" ideas are acted on timidly and often die off without proper discussion whereas the more "ridiculous" ones keep getting pushed through without time for clear analysis.
Q - I recently heard an address given by Alvin Rabushka, at Harvard

University. In his presentation he mentioned that Hong Kong's top income tax bracket was 15 percent-16.5 percent the corporate tax rate fluctuated between 15 percent -18 percent and was then 16.5 percent

30

and that the citizens of Hong Kong are not subjected to a tax on capital gains. He said a 20 percent tax on income would be absolutely unacceptable in Hong Kong. A - Hong Kong used to have a 15 percent tax on interest withholding but now it is zero in order to compete with Singapore. Singapore sets prices internally. The state-run corporation sets prices above Hong Kong's and makes a handsome profit from its monopolistic activities. This frees the population of any direct tax burdens. Q - Hong Kong has only 250,000 taxpayers out of a population of 6 million. Most citizens are exempt and don't pay taxes. Although their's is a flat rate, since only 5 percent of the population pays SO percent of all income taxes, it is one of the most progressive systems on earth. A - The Asian Tigers have been practicing free trade, free markets and low taxation and their prosperity proves it works! Q - I understand that Mexico is becoming an example of how to dismantle state-run enterprises which Eastern Europe and the former Soviet Empire might emulate. A - Absolutely. Mexico has already sold off 80 percent of its state owned assets and is in the process (end of 1991) of dismantling its state run banks. Mexico has cut income tax rates and instituted a V AT as a substitute for the sales tax we have in this country. They allow property to be transferred and they are getting rid of their notoriously crooked customs inspectors. They have made huge strides in deregulating their economy over the past two years. Q - Professor Rabushka spoke of having some shares of Mexican telephone, which were not too long ago selling for 9 cents. At the end of 1991 they were selling for between $4.50 and $S a share. A - I know. They appreciated 40-fold in two years. Q - The phone system in Mexico still doesn't work well but it has "great expectations"; the key in its rise to possibly valuable from absolutely worthless. Overnight Mexico experienced a huge inflow of capital.

31

A - Confidence, a perception, an attitude makes all the difference in the world. Stock markets are extremely sensitive to perception. Q - I know one thing, and that is the tax revolt is still in full swing in this country. Voters in nine states, with more than a fifth of the nation's population, voted in November 1990 on initiatives to limit or repeal taxes. Sixty-six percent of voters polled near the end of 1990 thought their income taxes were too high-the highest percentage in 20 years! A - State taxes alone are due to rise by $20 billion in 1991-the steepest increase, adjusted for inflation, since the depression of the thirties. California had a $14 billion budget gap in the summer of 1991 which took $7 billion in new taxes to help close. Many aerospace and high-tech industries left California. Already approximately half a million jobs have vanished. Many business leaders believe California is no longer competitive with other locations when it comes to the cost of doing business. Just as good expectations help, poor expectations hun. When investors loose confidence, it's contagious. Q - Not to mention the regulatory hassles there. What can be done? A - States are getting creative. For instance. in 1987 Nebraska enacted a tax credit program which has generated 6,397 new jobs. 45 companies were given a total of $10.6 million in income tax credits and $3.4 million in sales tax credits in addition to $18.8 million in sales tax refunds. Companies were given incentives to hire categories of disadvantaged employees. All the costs ofthe program were not readily available, but critics suggest that lost revenue in 1990 cost the state $23.9 million and will cost $30 million in FY1991.

Q - What about the increased revenue all those jobs have brought in?
A - Naturally the expectation is for a net revenue gain in the future. California has the most assertive tax collectors in the nation. The state has what it calls a "source tax" which is a license to uncover income sheltered years ago. California's tax collectors hound senior citizens all over the country. They go after proceeds of Keogh 410s trying to trace the source of the current income to California. Q - California's not alone. Twelve other states do something similar. Do

32

you know which states have no income tax? A - Seven states have no individual income tax: Alaska. Florida. Nevada. South Dakota. Texas, Washington and Wyoming. New Hampshire and Tennessee only tax income from interest and dividends. Q - Connecticut has a 7 percent capital gains with 32 percent on interest and 14 percent on dividends. Massachusetts has a 12 percent tax on interest. dividends and other capital gains and just under 6 percent on regular income tax. A - As of October 1.1991, Califomiahad the highest sales tax rate at 7.25 percent. Colorado and Wyoming had the lowest. at 3 percent and Alaska, Delaware. Montana. New Hampshire and Oregon have no sales tax. Q - Well. Rhode Island charges the highest state gasoline tax at 26 cents per gallon, Connecticut charges 25 cents, Nebraska. 23.7 cents. Washington 23 cents and North Carolina 22.6 cents. Florida has the lowest gasoline tax at 4 cents per gallon. A - This may faU into the trivia category, but Virginia has the lowest cigarette tax in the country. only 2.5 cents a pack while Connecticut has the highest at 45 cents per pack. According to the National Conference of State Legislatures. states imposed more than $16 million worth of new taxes on their citizens to balance their 1992 budgets. Q - I guess no one can quarrel with the fact that states and local governments need new sources of revenue in order to balance their budgets. A - Montana is the first state to permit payment of 1990 personal income taxes with credit cards. Q - What I want to know is where does all the money go? A - Let me give you an example from New Jersey, which is not unrepresentative of many states. New Jersey established a Commission on Sex Discrimination in the Statutes in 1987 to ostensibly look over any proposed or existent

33

statutes to determine if they had, or might have, a "disparate impact" on the sexes. It was supposed to be a temporary two year commission, but like hundreds of other questionable state councils, commissions and agencies of all kinds, it was re-budgeted over and over. It's funding was renewed for four 2-year periods, with the fifth renewal giving it enough funds to continue for five additional years. Q - What kind of "funds" are you talking about? A - The Commission went through $534,000 between 1987 and 1990 and has a current annual budget of $150,000. Q - Trimmed no doubt, due to the state's on-going fiscal problems. How many commission members? A - Three who function as a feminist advocacy trio. Q - How can they use the tax-dollars feminist point of view? A - The Commission's of those who don't share their

Executive Director will tell you,

/ think that taxpayers need to be paying this, because they pay for all kinds a/things that are not in everybody's interest. And we think this is something that makl!s society healthier.

Q - I guess this is one tiny example of a nationwide expanding bureaucracy, that once set in motion cannot easily be turned back. But unless an effort is made to sunset these "temporary" agencies, taxpayers will pay ad infinitum. A - There's a chain reaction that we haven't even touched on. Let me switch to St. Paul, Minnesota where some schools were charged with sex discrimination because they offered boys ice hockey and didn't make any provision for the girls. Now we have tax payers footing the bill for attorneys and consultants in defense of the public schools.

Q - Some people claim the public service employee unions are responsible
for swollen public payrolls and deteriorating public services. What do you think?

34

A - I know the number of workers on state payrolls has expanded at twice the pace of the general population during the 1980s.
Q - That's on a nationwide basis. In Illinois public employees grew four

times as fast, 6 times in Massachusetts, 7 times in Connecticut and 14 times as fast as the population at large in New York. A - Speaking on a nationwide basis again, the number of state and local government workers now amounts to well over 15 million workers. That's a 55 percent increase since 1971.
Q - I don't get it. I thought union membership was down.

A - Sure, overall union membership is down from a high of 35 percent of the entire workforce in 1954 to only 16 percent in 1991. But while industrial unions languished. public employee unions took off. Today they have about 5 million members, all being paid by tax dollars. Just in the last ten years these unions enjoyed a 30 percent increase. Three times as many government workers belong to unions as do those working in the private sector.
Q - Great!

While private sector workers struggled to become more competitive during the eighties, by doing more with less, public sector workers. urged on by their union leaders, contented themselves with doing less with more.

A - Right on! There's no doubt employment costs (wages and benefits) rose for all workers during the eighties, but public sector workers' costs rose more. According to an interesting article by James Cook (Forbes 5-1391) a 1990 study of the union employees at the State University of New York, found their salaries rose 50 percent between 1983-1990 whereas the CPI (consumer price index) in New York rose only 29 percent during the same time period.
Q - Why were public employee gains so much higher than the gains made

by private sector workers? A - No competition. Audrey Freedman, economist for the Conference Board was quoted in Forbes,

35

In the public sector, bargaining is much more political ... There's no competition. no counservailingforce, as there is inprivate industry. Industry hasto compete with other producers, and government does not.

Q - Not only that, unions want more than good wages and benefits-they

want control of the workplace. I remember you said that happened in, of all places, Japan. I quote from your own 1988 book, The Deficit: 12 Steps To Ease The Crisis, page 235:
In 1953 Nissan' s management made a deal with union leaders giving the union a large voice in decision making. In the late 1970s the union had its say abou: establishing plants in Europe andthe UnitedStates.ln-fightingbrokeoUlwhichstifkdthecreative process ... People with original ideas couldn't develop them .•.

A - You've heard of AFSCME? The union with one and a quarter million members-the American Federation of State, County and Municipal Employees? Well, its president, Gerald McEntee, again according to the Forbes article, made
clear his concern:.. are not with the effu:iency and effectiveness of the public institutions. That's for the taxpayer to worry aboui.

Q - Tax revolt groups across the nation are trying their best to show the

taxpayers that if they don't worry Mr. McEntee is right, nobody else
will.

A - The Forbes article went on to say,
a city must stumble along. even at the price of progressive decay of infrastructure and services ... What money there is will go to (unions) .... government after government is beginning to discover how greatly the public sector unions threaten the fiscal integrity of state and local government

The November 1991 issue of Governing magazine printed figures "recently published" from the 1987 Census of Governments. It gave a break down of the fringe benefits provided by states, counties, cities, school Districts, Townships and Special Districts. Fringe benefits amounted to 22.8 percent of total wages and salaries in 1987, compared to 23.9 percent in private industry at the same time.
Q - You mean all levels of government paid 22.8 percent of their wages

in fringe benefits?

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A - No, of course not. Municipalities paid the most-26.8 percent the states, 23.7 percent, Townships 22.9 percent, counties 22.7 percent special district, 20 percent and school districts came in last paying their teachers and non-academic staff 19.9 percent of their wages in fringe benefits. Q - How did the fringe benefits break down? I mean did the study detail how much went to health benefits, or retirement and so forth? A - Municipalities paid 12.7 percent in retirement benefits, 6.8 percent went for health insurance, 4.2 percent for social security and miscellaneous fringe benefits amounted to 3.1 percent. States paid 10.7 percent retirement benefits, 6 percent went for health insurance, 5.4 percent for social security and miscellaneous fringe benefits amounted to 1.6 percent. Townships paid 10.4 percent in retirement benefits, 7 percent went for health insurance, 3 percent for social security and miscellaneous fringe benefits amounted to 2.5 percent. Counties paid 9.3 percent in retirement benefits, 6.2 percent went for health insurance, 5.4 percent for social security and miscellaneous fringe benefits amounted to 1.8 percent. Special Districts paid 5.9 percent in retirement benefits, 6.1 percent went for health insurance, 5.1 percent for social security and miscellaneous fringe benefits amounted to 2.9 percent. And finally the school districts paid 9.8 percent in retirement benefits, 5.4 percent went for health insurance, 3.8 percent for social security and miscellaneous fringe benefits amounted to only 1percent

Q - An average Cali fornia business paid 50 percent above the U.S. average
to insure against employee injury in the work place, according to

Workers Compensation Monitor.
A - Average workers' comp costs may have doubled between 1985 and 1991. No one really knows the total obligation incurred because some times claims are filed long after a worker has been terminated, California is one of the few states that allow claims for stress disability. The claim is made most frequently against government agencies. The average cost per litigation has been $7,000 per case in California, which meant in the state suffering from a $14 billion budget problem, allowing stress disability cost one and a half billion dollars in 1990.
Q - Why are litigation expenses so outrageously high?

37

A - Everyone's making money off the procedure. Whereas a complete physical for a corporate executive might cost in the neighborhood of $600, a straightforward back exam by a non-treating forensic specialist runs about $1 ,500 in a workers' comp case. Costs are high and benefits are among the lowest in the nation--everybody's being ripped off by high-priced attorneys and doctors.

Q - Can't something be done about this waste? It sounds like taxpayers are
subsidizing blood suckers. A - Governor Wilson tried to get a ban on stress claims, but the legislature was only willing to extend the prohibition to the first six months of employment Q - This may be a little off the subject, but I heard the absentee rate of women in the work force is about twice that of men? Any truth to it? A - That's what the statistics show.

Q - Did you know that in 1900, for each 1,000 working people between
the ages of 25 and 54, there were 111 people 65 and older. Now the corresponding number is 295 people 65 and older. If there were only 111 as in 1900 the $340 billion spent in 1985 on aid to the elderly would have been only $128 billion, $212 billion less which would have been ample to wipe out the deficit. If the birth rate of 1957 had prevailed from 1930 -1960, there would be about 15 percent more workers age 25-54 in the workforce in the late 1980s, and they would have paid enough additional taxes to cut the deficit by at least 50 percent. A - What good are ifs? It's time to face reality! That stack of dollar bills sixty-seven miles high lamented by Ronald Reagan as an intolerable deficit in 1981 was joined, under his stewardship, by a second stack higher than the first. The problem can't be cured by taxes. Q - That's why one 1988 presidential candidate promised to collect the debt owed the federal government before, (not instead of) raising taxes. And I've heard the same idea promulgated by the 1992 candidates. A - I don't know what the delinquent debt amounts to in 1992, but as 1988

38

began, the United States government had approximately $83 billion worth of delinquent debt with the $51 billion due in IRS penalties representing the largest portion of that debt. Q - You sound like such a wealth of knowledge in this area, do you happen to know the breakdown of the other $32 billion worth of delinquent debt? A - Oh sure, right off the top of my head! Seriously, if you want, I can read them to you from statistics provided by the Office of Management and Budget: Farm Loans totaled $11.8 billion, Student loans $5.7 billion, VA mortgages $2.9 billion, SBA loans $2.4 billion, Pentagon overpayments & education loans amounted to $2.0 billion, HUD housing loans $1.5 billion, Export-Import Bank loans $1.3 billion and miscellaneous $4.4 billion. Q - Is it true that government criminals off the street? spends more than $22 billion keeping

A - Probably much more than that. Iread that $21.2 billion was spent just by state and local governments back in 1989. Spending for prisons and jails is growing at about 20 percent a year. Q - Why the sudden explosion in the need for more prisons? AIt's not a crime wave as much as itis a demand by the public for more incarceration. In 1970 the incarceration rate was about 1 of every 1,000 and by 1990 that had tripled to 3 out of every 1,000. I know California has had a terrific increase. John Petersen, in an article for the Novcm ber 1991 issue of Governing Magazine, said that the percentage of felonies leading to jail sentences in that state rose from 15 percent to 35 percent between 1975 and 1990.

Q-

A - California voters, in November 1990, defeated a $450 million bond issue which would have gone towards funding the $5 billion needed for capital outlays and $1 billion annual additional operating expense to increase the stale's prison capacity by 51,000. Q - We've been talking about the state. Half of the capital spending by counties in California (mote than a billion dollars) has gone for new

39

jails for the past five years. They were unable to get matching funds from the state because, as you said, voters rejected their bond issues time and again. A - Maybe it's time to follow Florida, and the lead taken by some other states in this area, and put a greater emphasize on alternative punishments. Q - You mean treat convicted felons to something other than time behind bars? Like what?
A - Technology has made possible all sorts of alternatives,like house arrest and intensive supervision. I wrote about a good many of the options in my 1988 book The American Deficit: Fulfillment of a Prophecy?

(pp 118-125) The National Council on Crime and Delinquency reports that alternative programs saved Florida over $5.500 for each offender diverted from prison. and reduced recidivism in the bargain.

Q - California has done a lot of that I know Sacramento County reduced
the number of beds needed by 15 percent. with its pretrial release and own-recognizance program. But the big problem is the fear the typical law abiding citizen has of a convicted felon loose in their neighborhood. This naturally chills the enthusiasm of any politician who might otherwise be willing to experiment with alternative sentencing. A - But alternatives have to be found in order to curtail the runaways costs of incarceration which is eating up too large a portion of government revenue.

Q - Harry Brown, an economist and popular author. sees no evidence the
public is screaming for more government. The real questions should be: (1) How well is government doing this? (2) Should government be doing this? (3) Is there a better alternative to government's doing this? A - Too often taxpayers end up paying for the absence of common sense on the part of bureaucrats.
Q - I'll second that sentiment! For instance the state of Nevada entertained

a suit by a prisoner who claimed his civil rights and rights to property worth $2.50, were violated when he received creamy instead of the crunchy peanut butter he had ordered from the prison store.

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A - You've got to be kidding!

Q - It took a federal judge to decide the plaintiff should seek relief
through the prison grievance system of Nevada 's smaIl claims courtthis after hundreds of dollars in judges, lawyers, secretaries and clerks time had been used in this foolishness. A - Actually I don't know why I'm surprised. Those same no-commonsense public officials are all over the map. In Colorado a state politician introduced a bill giving agricultural producers the right to sue anyone who makes "reckless and unfounded claims" about food. Luckily the governor had the good sense to veto the legislation. Meanwhile California is entertaining suits filed by death row inmates who seek to procreate, either through artificial insemination or conjugal visits. Q - But taxpayers foot the bill for these suits, frivolous or not. Philadelphians may have to pay the $1 million damages awarded a family in a wrongful death suit when their son commited suicide while in a Philadelphia jail. AI know the case you mean. The jailers checked on the young man every 15 minutes, if I recall, and removed his belt and shoelaces, but he managed to hang himself by using his trousers. Courts ruled that the city should have done more.

Q - Like what? A - Hired jailers with more training which might have made them more aware that an intoxicated youmg man is a high risk for jail-suicides and should never be left alone. Q - That in itself would add a huge expense to a city, that in all likelihood, is hard put to afford adequate incarceration facilities and even regular personnel. A - Regardless of the cost, the City could not escape liability even after showing that only 15 thousandths of one percent (.00015%) of the City's prison population actually committed suicide. The City failed to make "sufficient expenditures".

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Q - This is a situation where a judge makes instead of enforces law. It reminds me of the case in Massachusetts where a judge ruled Boston should provide a higher standard of living for welfare recipients and in Kansas where the judge in essence raised the taxes, single-handedly, on residents in order to force them to provide better schools. A - It does appear to be a co-mingling of the powers of the various branches of government and makes for an unfortunate precedent. By such rulings, judges are usurping the role of legislators and inposing additional taxes on citizens. Q - In a similar vein, Vice President Quayle has been chastising the court system, claiming frivolous lawsuits and extravagant punitive damages are making it hard for U.S. business concerns to compete in global markets. The ABA, in its Journal, claims caps on punitive damages, which the Vice President champions, would
limit a person's ability to recover real damages for flagrant acts of misconduct. This proposal (Quayle's) would amount 10 a thumb on the scaleofjustice,favoring corporations and others who already have tremendous advantages over individuals • . .Punitive damages botn punish wrongdoers and deter othersfrom similar misdeeds.

A - You're right. There is a parallel between the damage done to taxpayers and damage suffered by businesses due to excessive and often frivolous litigation which, aside from the damages, take time and money to defend. I was surprised at how quickly the Vice President acquiesced to the sensitivities of the American Bar Association. Q - You mean their reaction to his speech at their annual meeting in August, 1991? A - Exactly. It is nonsense for the ABA to claim, since tort cases comprise only one-half of one percent of our state court dockets and 20 percent of the federal docket, that the large damage awards meted out to American businesses are inconsequential. Nevertheless the Vice President moderated his stance, and to hear the ABA tell it, all but apologized. Q - I don't know about that, but I do know that businesses pass those court costs on to consumers and government is finding it harder and harder to pass its costs on to taxpayers. Local governments are just as strapped for funds as state governments and are coming up with some

42

creative fund raising. For instance the city council of Port Hueneme, California, decided to tax residents according to who has the best view of the ocean. A - Are you serious? You mean residents paid for their views in the price of their homes, in the property tax assessments and now are asked to pay a third time separately because some philosopher-kings said so? Q - The levy wasn't that arbitrary-thank goodness. Somebody still thinks there must be some kind of justification for a tax, no matter how flimsy, and in this case the "lighting and landscaping" assessment district is the fall guy. The 1972 lighting and landscaping Act permits assessments for certain property related services. Its gotten so assessment districts are a dime a dozen. A - That's becoming more and more the case. California's Proposition 13 allowed for "special taxes", but only with a two-thirds vote of the citizens. To get around this requirement the Orange Unified School District levied a $50 per taxpayer charge to maintain school facilities through a newly created maintenance assessment district for that purpose. Not long after, the Whittier Union High School district pulled the same thing and other schools may well follow suit. The school district relies on the same 1972 Act. Q - Talk about stretching it! A - Proposition 13 is under attack and may suffer a devastating blow in 1992.

Q - What do you mean?
A - Under Proposition 13, it's common for otherwise similar pieces of property to carry widely varying property-tax loads. Property taxes are limited to 1% of value, established at 1975 levels and escalated by a maximum of2% a year unless the parcel changes hands. This means recent purchasers of homes and other property pay higher taxes than long-term owners. This obvious unfairness has angered enough people so that a revision of some kind may be put to California voters in November, 1992.

Q- The U.S. Supreme Court ruled in 1989, that West Virginia's version 43

of California's Proposition 13 violated the equal protection clause of the Constitution. A - The same thing could happen in California. If taxes are to be equalized the question is which way-everybody's lower, or everybody's higher.

Q - Higher would relive the revenue crunch.
A - But home owners vote, so the second alternative is likely if it comes to a vote.
Q - Another alternative is to keep the taxes on homes low. but raise those

on commercial and industrial property. A - That would be bad for everybody in the state. An 18 member California Senate commission (Senate Commission on Property TaEquity and Revenue) came into being in 1990 for the purpose of overhauling Proposition 13. On June 13,1991 it recommended a return to market valuation of property in the event that Proposition 13 is overturned. The annual reassessment cap for longtime homeowners would be increased by two percent per year so that taxes would increase by four percent the first year, six percent the second and so on until market value was reached. The countywide tax rate would be lowered to equal the prior years revenue.
Q - This would give temporary relief to more recent home buyers.

A - But local taxes could be increased by a simple majority vote essentially giving non-owner residents the power to enact a tax and make somebody else pay. Citizens would be at the mercy of inflation and population growth and be forced to give up the predictability they had attained via Proposition 13.
Q - What would happen to income-generating property?

A - All business property, including apartments, would be reassessed at market value immediately. This would take an additional $5.9 billion from the pockets of hardworking producers and give it to government bureaucrats to spend. Overturning Proposition 13 would mean an increase of $11 billion in property taxes throughout the state. Seven of

44

the 18 Commission members wanted to put the recommendations into effect without waiting for an overturn of Proposition 13 by the U. S. Supreme Court. Q - Are you familiar with the findings of the four academics commissioned by the Howard Jarvis Taxpayers Foundation to come up with revenue-neutral alternatives to replace Proposition 13 in case it is overturned by the courts? A - I'll give you a rundown. Arthur Laffer suggested that most state and local taxes be replaced by 6.1 percent levies on personal and business income. Deductions would be allowed for charitable donations and rent. There would be no taxes on welfare payments. Revenue would be divided on a 65-35 basis between state and local governments. Alvin Rabushka suggested rolling back all assessed valuations to 1975-76 levels plus two percent annual increases. He said the $7 to $8 billion in lost revenue could be made up by surcharges on the state income tax, bank and corporation tax and insurance premium tax. Gary Galles, associate professor at Pepperdine, suggested all property assessments be raised to current market values and that tax rates be cut from 1 percent of assessed value to .28 percent for owner occupied homes and other property would be taxed a t .52 percent. The possible $2 million in lost revenue could be made up by eliminating most income tax deductions. The team of Stubblebine and Smith at Claremont McKenna College suggested all property be assessed at full market value, but that county-by-county caps be placed on property tax income. According to their plan, assessed values could increase in any county, only as fast as personal income. Q - Didn't Macys bring a suit of some sort recently which involved Proposition 13? A - Macys sued, charging unfair treatment after its reorganization triggered a reevaluation of the property it owned at Sun Valley Mall in California. I f the company had not withdrawn its suit, and had indeed won, it was generally believed that the Court's decision would have efectively overturned Proposition 13 for California homeowners-hardly the type of public relations Macy's would want to engender if it could help it.

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Q - It seems like the citizens of California have imposed strict mandates
on the politicians in the area of spending and taxes and the politicians are determined to get around them. When voters turned down the pay raise of the 7-member Pasadena City Council, they created a subcommittee to propose pay increases for the 7 members of the Community Development Commission, whose pay can be raised without a vote by the public.
A - I've got a sinking feeling that you're going to tell me the 7 members of both groups are one and the same. Q - You're no fun! A - Governor Wilson's proposal to balance the state's budget included a temporary increase of taxes and fees to the tune of $7.5 billion.

Q - Didn't Ronald Reagan's temporary hike in California's income tax in the sixties become pcnnanent?
A - You're right. And that fueled the tax revolt of the seventies and

eighties. In Wilson's case the increase in the income tax, a half-cent of the sales lax and one-third of the other taxes and fees have sunset provisions.
Q - You mean they will automatically expire.

The freeze on the colas (automatic cost -of-living-increases) going to welfare recipients are set to expire at the same time.

A - Nice play! Expenses will rise just as revenue is reduced. Q - Give the Governor a break. He negotiated spending cuts for tax hikes.

California's welfare payments have long been the highest in the 48 contiguous states. He is hoping to have an initiative on the ballot in November 1992, limiting payments to new residents to the level that existed in their former state at the time they left. He would also pay teen-age mothers $50 a month to stay in school.
A - He played the same game Ronald Reagan played at the federal level when he agreed to $1 of tax hikes if it was matched by $4 of spending

cuts.

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Q - You mean the increases took effect and the cuts never materialized.
A - Exactly. Do you realize Los Angeles recently increased its real estate transfer tax by more than 800 percent?

Q - I thought Proposition 13 was still in effect. Doesn't it prohibit that
type of thing? A - You should know by now that clever attorneys can always discover loopholes. A law was never written by man that another man could not circumvent. Transfer taxes were ruled legal in Oakland recently in another clever move. Section 4 of Prop 13 excepts "ad valorem taxes on real property or a transaction tax or sales tax on the sale of real property within such City, County or special district." An appeals court in Oakland decided in what is known as the Cohn case, that a transfer tax would be legal if the revenue was placed into the general fund of the collecting entity.

Q - Give me a break.
A - The Pacific Legal Foundation and the Howard Jarvis Taxpayers Association have challenged the assessments, claiming they violate the provisions of Prop 13 and constitute a double property tax.
Q - I heard that Prop 13 hasn't done much to curtail taxes anyway.

A- It's hard to know what taxes would have been without Prop 13, but it's true that the year before it's passage, property taxes for cities, counties and special districts amounted to $4.7 billion and in the 1988-89 tax year they had increased 271 percent despite Prop 13 to a whopping $8.5 billion. Other taxes and fees, not including sales taxes, came to $6.5 billion a year.
Q - I can attest to the creativity oflocal tax raisers. Business license taxes,

taxes imposed on hotels and motels ... A - The utility user tax recently topped $777 million a 250 percent increase over the $200 million revenue it generated immediately prior to Prop 13.
Q - According

to the Howard Jarvis Taxpayers Association,

service

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charges and fees increased 260 percent to $3.3 billion between the passage of Prop 13 and 1988. Assessments grew from $36 million in 1978-79 to $279 million in 1989-an increase of 672 percent! A - If you think that is bad, remember special districts, which set aside funds to use for specific purposes, grew by 2,506 percent over the same period!

Q - What about California's sales tax? Has it skyrocketed in the same
fashion? A - It has enjoyed a more modest increase over the same time period of only 118 percent. But it has been expanded to include what some people derisively refer to as the snack tax. Q - Snack tax? What's that? A - California, in a wrong-headed effort to raise $240 million a year to pour into a $14 billion budget, imposed a tax on a confusing variety of snack foods. This had the effect of decreasing sales, which had the grocers up in arms. Q - I would think such a tax would hit low income earners, the largest consumers of snack food products, the hardest. A - Exactly. Also hard hit are the smaller establishments without scanners who have to use their memory to keep track of over 4,000 snacks or keep referring to a 87 page list supplied by the state. Some things are obviously snacks, but why are Ritz crackers included and saltines not? Everyone is confused. Q - Is California the only state to tax snack foods? A - Maine has a new "snack tax" and is encountering the same difficulty in coming up with an inclusive definition of a snack food. Q - I think Wisconsin came up with an even more outlandish tax. The Wisconsin Department of Revenue tried to impose a sales tax on drinks purchased by passengers as they flew over Wisconsin airspace. The levy was upheld by a lower court and struck down by a state court of appeals in January 1991. The judge pointed out that "in" did not mean "over"!

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A - I love it. The ingenuity of man knows no boundaries. According to the National League of Cities, between September 1990-1991, 85 percent of all municipalities raised fees and taxes, or imposed new ones, which meant another $10 billion a year going to government Q - Nevertheless 61 percent of city governments claim they will not have enough money to pay their bills.
A-

Maybe they'll get some common sense and start curbing some of the waste we're always hearing about.

Q - Iknow what you mean. Let me give you a rundown of some ridiculous 911 calls, paid for by taxpayers, as they were reported in the Los
Angeles Times in the summer of 1991: Someone called because he slept wrong, another person was out of breath from running from the police, a woman called about blisters from worldng at Taco Bell for three days in a row, a 13 year old called because she stubbed her toe on a stereo speaker, a 17 year old cut her foot while trimming calluses and an 18 year old boy complained that he couldn't get any rest at home and called for a ride to the hospital. A - No wonder hard working tax payers are fed up with such nonsense being funded with their dollars. Did you know that New York City had a $3 billion budget deficit in 19911

Q - And a lot of angry residents. A real estate developer placed a frontpage ad in the New York Times: "Karl Marx government didn't work in Moscow. Marx Brothers government doesn't work in New York." To take the pressure off, more and more states are turning to lotteries. A - John Herbers. writing in the November 11, 1991 issue of Governing magazine. said "lotteries become less productive of revenue unless they are bolstered by constant innovations and ceaseless advertising aimed at enticing participants to gamble." Two years earlier he warned that lotteries were a sham offering false hope, especially to the poor. Displaced farm workers, after receiving their welfare checks, line up for lottery tickets.

49

Q - Lotteries were commonly used in the 19th century to finance public

services and facilities until they were infiltrated with massive corruption and the public became disillusioned. A- There have been no reports of major scandals recently, but then it would be understandable for newspapers and other media that receive hefty revenue from lottery advertising, to look the other way . What do they say about the fox guarding the hen house? Self interest?
Q - The person in charge of Kentucky's lottery "admitted that he pulled

commercials from Massachusetts stations during the time when he ran that state's lottery because of news broadcasts he considered unfair." A - Mr. Herbers claims the public's sense of what constitutes the proper role for government seems to have dimmed in recent years. He thinks the easy slide into state-sponsored gambling-which would have been impossible a generation ago-may be a metaphor for the larger faults in our public life. Too often issues take a back seat to personalities in our political dialogue.
Q - When we were talking about waste awhile ago, I couldn't help but think

of the taxpayer whose 1985 IRA (lnvesunent Retirement Account) was disallowed as a deduction by the IRS (Internal Revenue Service) although he sent proof to the IRS office in Fresno, California six times showing why the IRS was wrong to disallow the deduction. Each time he was ignored and received a greater penalty for his trouble. As each notice was received the taxpayer conscientiously tried to comply with the instructions and furnished what he thought the IRS requiredproof that the IRA was deductible. A tax expert explained the facts of life to the poor taxpayer. From the time of the first IRS notice the taxpayer had 90 days to file an appeal in tax court and now of course the time had expired and all the penalties were owed. The fear the notices encouraged and the waste of time and energy were all unconscionable and we all know this scenario is repeated hundreds of times every day throughout the country. A - Absolutely. A good friend of mine had almost the exact same experience. It's not surprising if you stop to consider that the IRS made 16,100 incorrect levies last year, primarily caused by delays and errors in recording the payments sent in by taxpayers. Sometime payments were

50

applied to wrong taxpayers or wrong tax periods. This was supposedly caused by incomplete computer modernization.
Q - The suffering by ordinary citizens caught in the web of red tape and

fines is very real. A - And, I believe, not worth the revenue that the income tax generates. The other forms of taxation are less damaging to the spirit of the nation. American citizens have come to fearthe IRS as Soviets were once said to fear the KGB. This is an intolerable situation.

Q - That's because, where the IRS is concerned, we're presumed guilty
unless we incur the expense, take the time and endure the frustration of proving our innocence. When the IRS says we owe money or have failed to comply with one of their regulations or have not completely satisfied them in any way, we are at their mercy. A - I am getting angrier by the moment just thinking of all the injustices that have been endured and the suffering that this system has caused people I have known or heard about. For instance, the IRS tried to sell the gill net permit of an Alaskan fisherman to collect back taxes. Alaska said the permit is a use privilege protected by state law, whereas the IRS saw the permit as property and a seizable asset. The IRS refused to allow an unemployed plumber to claim tax deductions for 7 or his 10 children. When he appealed he was told "Get off my back and pay the money." The President of the IRS Whis tleblowers said the IRS is an agency out of control. "When it tells a father that 7 of his 10 kids don't exist and then steals his Christmas savings, then it is time for IRS reform legislation."
Q - Arkansas' Senator David Pryor has held hearings regarding the IRS.

At one of them a 72 year old EI Paso painter said 5 years after his case was heard, he was still waiting for the IRS to refund his money. He said, "At my age I fear we will die before we get it." He was paid $13, 925 for ajob the employer said earned the house painter $35,305. The IRS billed him an additional $13,700. IRS acknowledged there was little or no evidence that the painter had received the larger amount but it was up to him to prove it. Fortunately, in the painter's case, the Court ruled the IRS action was arbitrary and erroneous. A tax deficiency must be based on something more than a suspicion of cheating.

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A - For all the good it did him! Just as you said, the burden is on the taxpayer, there is no presumption of innocence with the IRS. You should read the book written in 1990 by former New York Times reporter, David Burnham. In A Law Unto Itself: Power Politics and the IRS, Mr. Burnham chronicles a host of abuses by this agency. He claims that the power of the IRS comes from the fact that it operates under administrative rather than constitutional law.

Q - What's the difference?
A - Administrative law is the body of law created by administrative agencies in the form of rules, regulations, orders and decisions. Procedural rules and regulations for most federal agencies are set forth in the Code of Federal Regulations. It is a body of law distinct and parallel to judicia1law. As we said earlier, the burden of proof is on the taxpayer, there is no presumption of innocence as far as the IRS is concerned. In a sense, the constitution is suspended as the IRS doesn't need warrants to gel any information it deems necessary from employers, banks and numerous institutions.

Q - I guess that's why the IRS can lien, and even seize, property like cars,
houses, bank accounts and garnish paychecks with apparently little restriction or accountability. A - According to journalist, Mark Issacs,
J n J 900 alone, the JRS closed 2.8 million delinquent accounts by filing 904.000 liens. serving 23 million levies, and making 12.870 property seizures.

Q - Just how big is the IRS?
A - What do you mean? Q - You know-how many employees, how wide spread, how large a budget and so forth. A - In 1990 the agency worked from ten regional offices and 63 district offices and had 123,000 employees and an annual budget in the neighborhood of $6 billion. Also in 1990 they were lobbying for another 33,600 employees, claiming with the additional manpower they could audit another 100,000 tax returns a year.

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Q - How many do they audit each year without the additional employees?
A - Close to a million. They expected to extract another $537,000,000 from taxpayers via the additional audits. Again, according to Mark Issacs who wrote in April, 1991
InMarchaninternalWhiJeHousedocumenlwasleaJu:dtothepress. Thisdocument encouraged the IRS to begin a wave of "aggressive audits" on lower and middleincome individual taxpayers. These taxpayers-not the super rich-are vital to federal revenue enhancers since they pay the vast majority offederaltaxes each year.

Q - That's hard to believe! A - You can see why Senator David Pryor of Arkansas has generated a lot of support for his Taxpayers' Bill of Rights. The bill's purpose is to more clearly define the boundaries within which the Internal Revenue Service operates. to provide greater congressional and independent oversight of the tax collection process and to furnish additional protections to taxpayers involved in disputes with the IRS. Q - I heard the Senator's bill would shift the burden of proof in tax disputes to the IRS. Is that true? A - That's right. That is only one of the many provisions in the Senator's bill that deserves our support. Another is the provision that would allow taxpayers to recover the costs of defending themselves, should an IRS claim be held unreasonable, and to recover actual damages if it is found that the IRS acted with "careless, reckless or intentional disregard "of rules and regulations. QAI thought we already had these rights! A lot of people naturally presume that. One would hardly think that it would have to be spelled out that the IRS be required to schedule interviews at times and places convenient to both the agents and taxpayers involved.

Q - Common sense and courtesy should have taken care of that one. A - Another reasonable provision in Senator Pryor"s Bill of Rights is for the establishment of an independent inspector general's office to

53

police the IRS and provide taxpayers and IRS employees with a neutral place to air their grievances. And one of the most popular provisions would prohibit the practice of basing promotions or pay raises of revenue agents on the number of levies and property seizures they make.

Q - I thought there were already rules against that,
A - It may be against IRS policy, but no one can deny that it is common practice. There are numerous other provisions such as requiring the IRS to give the taxpayer a "simple, comprehensive and non-technical statement" of his rights and obligations at the beginning of an audit, the right to make a tape recording of the interviews, requiring the IRS to make installment payment plans available to small taxpayers who are found to owe the government money, and requiring that banks hold accounts garnished by the IRS in escrow for 21 days so that taxpayers can have an opportunity to recover their money. Q - I heard George Will say (11-3-91) "The percentage of GNP taken today is greater than at any time in history." A - One taxpayers group claimed Americans were working for Uncle Sam until May 7th, in 1991. Milton Friedman set the date even later in June.

Q - Serfs in the middle ages didn't have to give that much of their produce
to their lords! A - It's a combination of fees, excise, sales, property, payroll and not just income taxes. We're paying more now than in 1980 when the highest income rate was 50 percent. Q - Earlier it was 70 percent, but with loop holes, those in the top brackets actually ended up paying less income taxes under the higher rates. A - In November, 1991, Donald Trump, the wealthy (once-upon-a-time) real estate developer, made an attempt at getting those good '01 days back. He urged congress to raise income tax rates on the wealthy and give back their tax-breaks so they would see the benefits of investing once again. He claimed the lower rates removed the necessity (his word was incentive) to invest. "The higher (the income tax rate) the more incentive there is."

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Q - What do you think about the popular contention that taxes in this

country are not too low; spending is too high? A - It may sound trite but I believe it is true. Despite a massive rollback in personal tax rates and major tax reforms, federal revenue at the end of his tenure amounted to nearly as large a share of the economy as it did when Ronald Reagan took office. Nevertheless when the 1DOth Congress convened it didn't take the new Speaker of the House, Jim Wright of Texas, long to call for new taxes for FY1988.
Q - I've heard George Perry of the Brookings Institute, declare, along with

distinguished Nobel Laureate economists like Paul Samuelson and James Tobin, that Americans are under-taxed. So why shouldn't high income earners pay more? A - Peter Grace, co-founder of Citizens Against Government Waste, has criss-crossed the nation pointing out in his humorous, and somewhat caustic manner, that if we took 100 percent - every last penny from persons earning $75,000 and up, the government could run for only ten days on the proceeds. As for the poor middle income earner, he's seen his taxes increase 32 times as fast as his income with each increase resulting in more spending by government, not deficit reduction. For instance, in April 1987, individual income tax payments were a record $120 billion compared with $91 billion in April 1986.
Q - Partly because investors cashed in a large amount of capital gains at

year's end before the special tax rate on them was raised. A - OK, I'll grant you that. Unfortunately outlays for FY1987 increased also.
Q - Only half as much as they did the previous year.

A - But that still meant a rise of about 2.5 percent! Every year government takes in billions more in taxes than it did the year before, but it's never enough.

Q - Senator Steve Symms first came to the Senate in 1980 from Idaho. He
has been trying to hold the line on taxes ever since he arrived in Washington' D.C. He's tried to freeze budgets---or allow only a 4 percent inflation increase which could be handled without new taxes.

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A - We would have saved $9.9 billion if the freeze bad been instituted in FYI991 and ifonly COLAs (cost of living increases) were allowed for the next 4 years there would be an additional $82 billion in savings, according to Professor Paul Craig Roberts. The tax hikes in the eighties added $366 billion more to the Treasury's coffers than tax cuts took out.

Q - I remember you sending me a rundown on the February 8,1989
hearing on the "Deficit & the Economy" which was held before the House Ways & Means Committee. Do you think you could dig that up again? I think the variety of opinions offered there shed a lot oflight on our taxing-spending spiral. It would be interesting to view the arguments made then, pro and con various means to curb the deficit, in light of what has occurred since. A - Or more aptly put, what has not occurred since! Congressman Sander Levin of Michigan set the tone for me by asking "How do we set targets for revenue without determining needs?" And then he proceeded to enumerate a long list of society's needs. Norman Ture, President of the Institute for Research on the Economics of Taxation, and a special friend of mine, answered with a analogy of a private household. How do they determine their needs? Government must ask what discretionary changes in revenue are tolerable in terms of their economic effects. Define an appropriate revenue target and decide how much government is to spend. Otherwise you're saying government has unlimited access to the resources in the economy. Fred Bergstrom, Director of the Institute for International Economics had what I remember thinking was an absolutely ridiculous retort. "If an individual wants to spend more, he can work harder and earn more he doesn't have a revenue ceiling! The concept ofa revenue ceiling is very Un-American!" Mr. Ture said the key was being able to work more to produce more of something that other people value enough to pay for. He pointed out that constraint does not, regrettably, operate in the public sector. Fred Bergstrom chuckled and replied "If the Congress votes for an increase in spending programs, in some sense that's the American

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public voting for increased outlays. Analogous to the individual deciding he wants to spend more and therefore he goes out to increase his revenue." Nonnan Ture volleyed, "Providing the American public thought it was going to pay ... Now we have a tax system which largely divorces spending decisions from body politic in the sense of what cost it must bear." Congressman Sander Levin of Michigan thought Mr. Ture 's view was untenable. He claimed Ture was a fiscal radical and asked why Ture tries to downplay the budget deficit. Mr. Ture claimed his ideas stem from the British economist, Alfred Marshall. He said "It's the amount the government spends and how it spends; it's the amount the government taxes and how it taxes, that are the relevant fiscal variables." Don Sundquist, a congressman from Tennessee, asked Fred Bergstrom "Should people pay what we want to spend?" He said James Miller of OMB (Office of Management and Budget) stated historically tax increase lead to greater spending. Cutting taxes will cut spending. Arkansas congressman Beryl Anthony, Jr asked Norman Ture how bestto increase revenue, ifmore is needed. Mr. Ture answered, Asset sales. He suggested reducing the tax rates on capital gains also.
II It

Nancy Johnson, congresswoman from Connecticut, agreed with Norman Ture. "(We've) managed to severe the connection between taxing and spending." She pointed out that the catastrophic health bill clearly brought back that relationship. People could readily see who pays and who benefits. Mrs. Johnson also expressed some concern about foreign investment in this country, saying it made a big difference to her whether the foreign investment was in production or real estate. Q - Do you share Mrs. Johnson's fears? A - I don't believe foreign investors and their research and development and ownership of patents is as large a threat to our future as she fears. Mr. Ture doesn't share her concern either. He claimed our markets are highly competitive and the danger of a hurtful monopoly is very remote. We (USA) would be the beneficiaries of any research here.

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Foreigners bring financing. The concern that they may not keep their technology here is unfounded. Lots of American patents now come from foreigners.

Q - But Mrs. Johnson was not afraid of protectionism; she was afraid of
strong foreign markets that fail to offer us equal access to their markets. A - She thinks we need "protectionist bargaining chips"-for purposes. Q - Just what is protectionism? retaliating-restructure-action retaliation

Certainly Mr. Bergstrom would not call protectionism.

A - Mr. Ture suggested a "duck test" for "protectionism"! (If it looks like ...sounds like ... walks like ... then it is ... !) Before leaving Mrs. Johnson, I would like to report her feelings regarding the deficit and spending. She said some issues needed to be funded despite the deficit (child care, health insurance etc.) She did not think people would favor cutting Medicare even though that $100 billion program is set to increase 50 percent over only a 4 year period if something is not done to contain it Q - And certainly nothing has been done, which may well mean we are looking at the $95 billion in 1990 mushrooming to $143 billion by 1994! A - Health costs have risen about 12 percent a year during the 1980s. Mrs. Johnson suggested some of the costs of health care may be due to the mounds of paper work required by government regulation. She criticized what she saw as an increased inefficiency due to other regulations. "(Her state) reduced the number of patients a home nurse can visit in a day from 6, to 8, to only 4" and she saw this as an example of why costs increase. She asked "Is this society afraid to face death?"and added "The system has become micro-managed by congress". She said that in one Connecticut hospital, 85 percent of the patients are on Medicaid. This particular hospital was going bankrupt, so the state was making the other two urban hospitals share the loss, which, she said, may mean three hospitals end up in bankruptcy! Q - Criticism is cheap. Did Mrs. Johnson have any suggestions?

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A - She said that liability insurance has to be reformed, Now only the most costly intervention can protect a health care provider from malpractice suits. Texas congressman J.J. Pickle, asked Richard Bolling, John Rhodes and Carol Cox, all members of the Committee For A Responsible Federal Budget (RFB), about the role social security should play in deficit reduction. They answered that a COLA freeze would be a short term solution; long-term they advised changing the taxing method.
Q - Did anyone suggest tampering with the payroll tax?

A - It makes it easier to talk about social security if it is referred to as "the payroll tax". Everyone wants to restrain the growth of social security. Most people are willing to sacrifice to allow congress to reduce the deficit, but it must be across the board sacrifices-no exceptions! Rod Chandler, congressman from Washington, wanted to publicize the liabilities of the social security system.

Q - What liability?
A - He meant we should be aware of the amount of money we are promising to payout of that system in the future. We are "liable" for a pretty big chunk of promises made to baby boomers-the time bomb goes off in this country when they begin to retire! Mr. Chandler's point was, that as long as an investment is in Treasury bills, it is only offsetting the deficit and there is no real savings. He warned, "There is a shock coming in 2OISH" Mr. Ture joined in, saying that's "incontestably true!". I remember he offered an interesting definition of savings as the purchase of a source of future income.

Q - "The purchase of a source of future income." That's pretty good.
A - Stephen Entin, also with the Institute for Research on the Economics of Taxation, asked his audience to suppose a portion of the payroll tax were not there and that the income tax was somewhat higher. This, he maintained. would be nothing more than a shift in accounting, and wouldn't really change anything. We'd still be dealing with the basic

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impact on the credit market. He cautioned against having the government invest trust funds in the market place. saying such an alternative would only socialize the private sector. If the social security trust fund was not counted in the unified budget. the deficit would appear that much larger and scare everyone into another tax hike.He reminded everyone that tax increases come primarily out of private savings. Norman Ture also thought social security should be included in the unified budget. Professor Robert Lawrence thought it should be removed to ensure that the increasing surpluses are isolated. Mr. Ture said isolating social security would be an impoundment of the annual social security surplus and would reduce the money stock. Robert Lawrence, of the Brookings Institute. countered social security surplus is used to finance the budget deficit stock would be smaller than if the trust fund were kept Separating the trust fund would increase capital ostensibly, to Lawrence. that if the the capital separately. according

Mr. Ture said that it is almost trite to say that the USA overspends. He says it is incontestable that our aggregate outlays exceeds our aggregate production, but overspending is not necessarily the result of our budget deficit. As a matter of appropriate public policy we may want to get private consumption down, but not private investment The question is. do we want to reduce federal purchases of goods and services?

Fred Bergstrom. said the federal budget deficit may be in either surplus
or deficit according to the accounting method. No one denied the enormous increase in government spending (gross and net) and private spending. The question is where to cut back to bring domestic spending in line with domestic resources.

Michael Andrews. representing the great state of Texas, asked a
question regarding LBOs (leveraged buyouts). He said a paper the committee received from Robert Reich of Harvard, which had been read at the Greensboro Democratic weekend (1st weekend in Feb), suggested capping interest deductions and imposing some fonn of tariff on foreign investors who attempt to participate in LBOs. Q - Was Congressman Andrews in favor of Professor Reich's proposal?

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A - He brought up the document precisely because he did not agree with Reich. Robert Lawrence also appeared to be against Professor Reich's idea. Of course you've got to remember the time sequence and Mr. Lawrence reminded everyone that sensitive negotiations were going on in the world in February, 1989. Q - Aren't they always! A - Treasury Secretary Nicholas Brady wanted to deal on the interest deduction side. If we were to limit interest deductibility it would give foreigners an advantage. Mr. Ture cautioned that our capital would cost more. We need free movement of capital across international boundaries. Robert Lawrence was quick to agree, and even Fred Bergstrom put in a good word for direct foreign investment. Mr. Bergstrom went on to say the budget deficit caused the trade deficit. At that time we were borrowing at a rate of $10 billion per month from the rest of the world to keep our economy growing.

Q - In other words, people in other parts of the world had enough confidence in our economy, heavily indebted and full of warts as some lament, to place their investment dollars here. A - Bravo! Nevertheless, Mr. Bergstrom was fearful about relying on foreigners to such an extent He reminded those present that in 1987 foreign funds dried up twice and that foreigners could cause the dollar to fall, resulling in a rise in inflation and interest. Q - That was in 1989. There wasn't even that much foreign investment here at that time. Right? A - Foreign investment was already up to $1.5 trillion, with $700 billion having been borrowed from foreigners over the previous 5 years. Inflation was his main concern. He thought the job facing us at that time was to restore world confidence. During the 1980s we tried to spend more than we produced at home. We purchased imports and that's how the budget deficit caused the trade deficit. We have to bring domestic spending in line with domestic production. It would be good to eliminate all tari ffs by 2000 and to keep the European Community's

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feet to the multinational fire throughout the Uraguay Round (GA ITGeneral Agreement On Tariffs and Trade) which ends in 1992. Robert Lawrence said that our saving rate approximated 7 percent of our GNP in the 19608. In the 1980s it dropped to 3 percent. He was worried because as the 19805 were ending, spending had continue to grow faster (2.2%) than production (1.2% land we were borrowing to finance the difference.

Q - Sounds like what Mr. Bergstrom said.
A - They're looking at the same set of facts. Wouldn't you expect to find some agreement?

Q - That makes sense.
A - I'd like to interject a point of view rarely heard on the subject which I ran across in an article in the July 19,1991 WallStreetJournal by John Paulus, chief economist for Morgan Stanley & Co. in New York. He point out that
Americans' assets substanliallyoUlWeightheirdebts. U.S. non{'lIIIlIICial orporations c own $3.27 of assets for every dollor of credit markel debt OUlstanding. Households own $535 of assets for each dollar of debt indebtedness .•. when the balance sheets are examined, the inescapable conclusion is that neither the corporate nor the household sector is burdened by excessive leverage and that both are poised 10 contribute to afairly vigorous economic recovery.

Q - You sure like to keep company with optimists!
A - Only when they have the truth on their side. The notion that debt is all bad is just plain out and out hogwash-and dangerous hogwash at that. I participated as one of three experts on an hour long ABC news special on the national debt a few years ago and came offlooking like an absolute dummy. I totally clammed up because I realized the program was aimed at saying how terrible and ruinous the debt was to the nation and I didn't want to add to a mindless hysteria. There is another side to debt which the program was not geared to show.

Q - Granted. In fact the birth of our nation and its first hundred years was
financed by debt-mostly by foreign investment. 62

A- You are already more enlightened than most people. I believe the facts Mr. Paulus was able to back with statistics, deserves a wider audience. I mean who knows that for every dollar of debt, nonfinancial corporations added "a total of $2.32 in income-earning tangible and financial assets"? Mr. Paulus compares the debt of U.S. corporations with their counterparts in Germany and Japan and comes up with some more surprising statistics. The ratio of the debt of nonfinancial corporations to GNP is almost double in Germany what it is in the U.S. and three times as high in, of all places...
Q-

Japan?

A - You've got it. Japan's corporate debt ratio increased four times as fast as the U.S. corporate debt ratio in the 19805. Once more German and Japanese companies have maintained their high debt ratios for decades.
Q-

You mean U.S. corporate debt is no big deal?

A - Mr. Paulus tell us,
In the 1980s, the credl: market debt of American households increased by $2.47 trillion. Meanwhile household ownership of tangible assets ... rose by $3.21 trillion, while holdings offinancial assets-primtJrilydeposils. credit market instruments and equities-increased another $7.54 trillion. Thus, tangible and fuumcial assets of American households grew $10.75 trillion in the 1980s, or by $435 for every $1 increase in debt. In 1991 American households had assets totaling $21 trillion-$7 trillion in tangiblesand$14 trillion infinanclal assets and had borrowed against these assets (mostly mortgages) a mere $4 trillion.

Q - I get it. So where's the beef-right? A - Something like that. Mr. Paulus went on to say that high household debt to disposable income ratios have been extremely high in 23 of the past 39 years and have not constrained consumption as many experts expected. Q - You mean consumer spending was identical during the 39 years of high debt and the 16 years when the debt ratio was lower?

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A - According to Mr. Paulus, spending depends on the growth of income, regardless of debt. You've got to remember that whether debt is ok or detrimental, depends on the destination of the borrowing proceeds-and that is true for government debt, business debt or household debt. An investment is good if it makes the borrower more productive, as by being used for infrastructure, education, equipment, expansion or the purchase of hard assets rather than merely consumed with no assetshard or soft- to show for the borrowing.

Q - Gee-I

guess I could have figured that one out.

A - Surprisingly, many people consider all debt "bad". Getting back to the hearing: Mr. Lawrence rejected arguments that claim the deficit isn't really so important. There may be an error in the measurement but the direction is certain-we have lowered our savings rate. Others say we're borrowing to finance invesnnent but we don't have an investment boom and we do have a savings bust Just because other countries want to invest here we shouldn't take their money. He expected a financial crisis but admits we could go on the way we are for a long time. In his opinion, we were looking at a long-term, rather than a short-term problem ("Not the wolf at the door but termites in the woodwork."). He reminded everyone that since 1973 there had been a decline in productivity growth. Q - Hold on and let me get your own book, The Deficit: 12 Steps To End The Crisis where you claim an increase in productivity. I quote from page 209:
manufacturing productivity grew faster in this country under the Reagan administration than during the average postwar expansion. According to the 1987 report of the Council of Economic Advisors, output per hour rose an average of3.8 percent per year in the manufacturing sector between the third quarter of 1981 and 1986; more than double the average 1.5 percent rate reported for the 1973 10 1981 lime period. Although between 1980-1985 manufacturing lost an enormous number of jobs, productivity (hourly output) continued to rise faster than in the non-manufacturing sector.

A - You are falling into the trap of misreading statistics. First of all let's establish that both Mr. Lawrence and I are indeed talking about growth, rather than productivity per se. We would have both agreed that America is, or at least agreed in 1989,that America was the most 64

productive nation in the world, but that other countries were experiencing faster growth and catching up. But note that he talks about an absolute growth in manufacturing productivity between 1973 and 1989; I described a period between 1946 and 1980 and the average growth of that period is compared with the growth in productivity which occurred during most of the Reagan tenure in the White House 1981-1987 ( when my book was written). Just forthe record I'd like to quote a little more of what I had to say about American productivity. For instance on page 210, I acknowledge the probable source of Mr. Lawrence's information:
M economist Lester Thurow likes to talk about America's decreasing productivity; from 2.4 percent 1965-/972. to 1.6 percent 1972-/977 and only 0.2 percent 1977-1982. Between /983 and /985 the value of the dollar skyrocketed. certainly skewing figures and apparently making them too optimistic for Dr. Thurow's use.

rr

And on page 211,

I caution

Notice the variety of years for which statistics are recited here and note tha: sometimes manufacturing and non-manufacturing productivity are combined and other times they are counted separately. It makes one wonder where Peter Peterson got hisfigures when he claims in his book "TheMomingAfter" thatourproductivitygrowth has amounted to less than hal! of one percent a year from 1979-1986.

Q - OK. I've been warned. Let's get back to Mr. Lawrence. A - Just a minute. I'd like to take a moment to bring the discussion of productivity more up to date by referring to the article by Mr. Paulus again. He attempted to show, through a series of statistics, that debt financing during the 1980s was not the evil destructive force fueled by greed. that is so often portrayed. but rather it served a very constructive purpose in providing relatively inexpensive sources of capital to American companies struggling to compete globally and handicapped by our overvalued dollar. In referring to the many corporate restructures due to LBOs, he said,
According to several studies. these activities generally raised worker productivity. andprobably contributed to the hefty output permanhour gains of3% to 4% peryear that U'S .factories achieved after 1982.

And Professor

Mankiw, in another article which appeared in the

65

October 31, 1991 issue of the Wall Street Journal, claimed that slow productivity growth is a larger problem for the economy than is recession. Q - Why is that? A - It seems that GNP is lowered by about 5 percent as the result of a typical recession, whereas the slow down in productivity since the 1970s may be responsible for as much as a 20 percent reduction in GNP. Q - How can anyone know that--and especially economists with their notoriously poor record for forecasting? A - You' rc right. and that is the problem Professor Mankiw has with fine tuning the economy via the tax code.

Q - I'll buy that! Now for Robert Lawrence?
A - Mr. Lawrence suggested that demographic changes-a greaternumber of elderly in the population- demand more savings. He claimed it is the job of the federaJ government to save for the nation and recommended an 8 percent savings rate like we had in the 1960s. He was anxious to see a surplus in the trust funds.

Q - Did he talk about taxes?
A - Mr. Lawrence was partiaJ to the VAT (vaJue added tax) and an oil consumption fee and suggested eliminating the home mortgage deduction from the tax code. He went on to talk about bringing the trade deficit into line through protectionist measures or foreign exchange rate changes. He felt these measures would inject more purchasing power into the economy, but at the cost ofhigherinfiation. Therefore he stressed the importance of bringing the budget and trade deficits down in tandem. Savings would be increased and so would our ability to compete in world markets. Norman Ture disagreed about the reasons to bring our budget deficit down. He saw a major reason as a need to restrain government spending. Deficits misinform us about the cost of government and weaken our desire to economize. Mr. Ture saw no connection between the trade and budget deficits.

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Q-

If I remember correctly, in early 1989 CBO (the Congressional Budget Office) was claiming further reductions could be made without draconian cuts or higher taxes, simply by slowing the growth of spending.

A - It was thought that even a 1981-1982-type recession would only temporarily set back deficit reduction. Tax increases would hurt the economy and likely (historically) encourage more spending. On the other hand, to exclude social security flows would do nothing to help beneficiaries and would only serve to justify tax hikes, which would precipitate a further drop in private savings. Q - What is a current account deficit? A - A current account deficit refers to the difference between national savings and investment. Mr. Ture' s point was that a tax increase would not help investment but would rather reduce it and slow productivity. Cutting government purchases of goods and services is the only workable solution. Tax restructuring is called for.-we should link spending to revenue. He had several recommendations: I) Revision of the procedure to require setting of revenue targets for each fiscal year before taking up authorization with limits of outlays to revenue. 2) Spending programs should all be on-budget because off-budget spending leads to misinformation and erroneous and improper decisions about the kinds of things government ought to be engaged in. 3) We should reform the accounting system to bring it in line with generally accepted accounting procedures. Now it's a hodge-podge. Cash basis accounting can be very confusing. Accrual accounting would help. 4) We need to measure changes in budget outlays and revenue through time. by reference to the preceding year's actual outlays, authorizations and receipts. 5) If tax increases are enacted, revenues should be impounded by requiring an equal increase in the Treasury's cash balances. Debt limit should be raised only by the amount of the previously projected deficit target, less the tax increase. Added borrowing should no be used to cover increases in spending.

Q - Those are concrete proposals that sounds like he means business.

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A - You bet. But he was realistic. Mr. Ture called not for actual cuts, but only slowing of the spending growth. Q - Not another decrease in the increase! Washington, D.C.? Is that all they preach in

A - Don't knock it unless you know a way to get consensus on something better. Between 1973-1981 the average annual rate of increase in federal spending growth was 13.5 percent but between 1981-1988 it was down to 6.7 percent.

Q - Well, by golly. You mean to say the Reagan Administration-the
biggest spenders of all time-until cut the growth rate in half? the Bush Administration-actually

A - Didn't cut spending, mind you, but the rate in the growth of that spending. I remember one rather humorous moment when Chainnan Dan Rostenkowski told Mr. Ture, "We've surgically cut spending as Ronald Reagan suggested-there's nothing left to cut." Jim Moody, a Wisconsin congressman, asked Norman Ture if the interest payments on debt were considered "spending" and Mr. Ture answered by declaring that the interest on the public debt was larger than the entire deficit. And of course the interest keeps growing as the debt keeps building up from the overflow of the deficits generated every year. Finally I remember Mr. Lawrence commenting that some part of the interest rate is to compensate bond holders. Financing interest by raising taxes would amount to a withdrawal of purchasing power from some citizens and giving it to others. I remember that especially, because it has become more relevant as the Federal Reserve reduced interest rates significantly in 1991. Actually the discussions and recommendations almost three years later are almost the same as in February ,1989. Anti-consumption talk with proposals for consumption taxes, which almost always include a push for higher gasoline levies. People are talking about shifting U.S. tax policy in order to reward investment-looking for ways to encourage investment by measures like tax credits for research and development and a revival of tax-deductible individual retirement accounts.

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Q - That's what's needed more than ever during a recession. The full state

and local revenue coffers during the Reagan years were due to the start up of new businesses, record employment and the general boomtime atmosphere. A - If you want to talk about faulty predictions-in the summer of 1982 TEFRA was estimated to produce $229 billion which was supposed to reduce the deficit to $407 billion. By December of 1982 that estimate was in a shambles and the projected estimate for the four year period grew by 240 percent to $976 billion-almost a trillion dollars!
Q - Anyone who has followed these attempts at budget reduction, knows

that tax hikes and budget accords always lead to larger deficits. AYou'l1 get no argument here. The 1990 budget accord, which saw Bush go back on his "no new taxes" pledge. was supposed to lead to a, $500 billion reduction over five years. Instead we had the largest annual budget deficit in history, with a projected increase in the deficit for FY1995 of $803 billion.

Q - Why does this continually happen?
A - One reason is that tax hikes slow economic activity and thereby reduce the revenue base. Secondly, when public officials know a tax hike is coming, they make plans to spend it. New and better programs are enacted, which generally prove to be more expensive than estimated, resulting in higher debt than ever before. It happens to everyone-it happened to Reagan. In 1981 revenue grew to $82.2 billion, but the '82- '83 recession brought zero growth and added to the deficit, as did the Fed's tight money policies in 1989 and 1990.
Q - The 1981 tax bill included a generous investment tax credit and cost-

recovery system which was meant to encourage manufacturing. However, most of the increase in business investment occurred in commercial real estate and expenditures for office innovations such as computer systems. A - That simply shows that policymakers, no matter how determined, cannot push the American people where they do not want to go. The 1981 tax cut was supposed to raise revenue over a four year period by about $250 billion, and that's taking a $500 billion loss from the tax cut into consideration.

69

Q - How was this miracle to occur? A - The economy was supposed to grow an average of 4.5 percent a year which would bring in $7 billion more by FY1985. which would more than make up for the $190 billion rise in expenditures over the same years. Without the 1981 tax cut, a surplus of at least $122 billion was expected by FY1985. Q - What actually happened? A - FY1985 saw a deficit of $212 billion and a doubling of the outstanding federal debt along the way! Q - It seems like the worst thing one can do in a recession is raise taxes! A - Today most Democrats claim a tax increase is needed to reduce the budget deficit. while many Republicans hold that tax increases will only lead to more spending, stunt economic growth, reduce revenues and actually increase the budget deficit. Q - But it's been the Democrats' baUgame. They are, after all, in control of both Houses. The 1DOth Congress came up with many creative ways for "enhancing revenue". Senator Chiles of Florida, early in 1987, suggested a temporary tax surcharge to lower the deficit. Congressman William Gray of Pennsylvania came up with an even worse idea; to convert our trade quotas into tariffs in order to raise revenue. A - Some experts favor a new national sales tax in exchange for the elimination oftaxes on capital gains and on interest received from investments. We already talked about a higher tax on gasoline. Many politicians believe a gas tax might be the best of unpleasant choices.

Q - Considering inflation, the 1940's price of 29 cents per gallon was
more than what we're paying today for gasoline. A - When Speaker Tom Foley was an ordinary rank and file congressman, he argued in favor of such a tax, claiming every penny increase in a gallon of gasoline in this country would raise $1 billion in revenue. He suggested if the tax were referred to as a user fee Ronald Reagan might come around in his thinking.

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Q - Of course the obvious danger is that a penny increase could easily
mushroom, to a dime, a quarter and even higher at the gas pump. A - Already Peter Peterson was talking in terms of 25 cent levies! It might be well to recall that when President Johnson signed the Medicare Act he quipped that an extra $500 million in federal spending would be absolutely "no problem": twenty years later Medicare cost 150 times more than estimated! Q - Taxing Social Security benefits is gaining support as a possible revenue raiser. A - That proposal has been floating forever. On the David Brinkley Show on January 17, 1988, Washington correspondent Sam Donaldson said that if we have paid into the system and don't "need" the benefits when we retire we should consider that we have simply performed a social duty. Q - He and others feel it is wrong for the wealthy to receive benefits. So what if they paid into the system? The government doesn't really mean what it says anyway! A - As far as I'm concerned, means-testing Social Security benefits undermines the integrity of the government because it reneges on promises made. This is the real danger!

Q - I remember in his FY1988 budget, President Reagan held firm to his
pledge to oppose any tax increase. He even opposed a major spending-reduction bill purported to save $72 billion over three years because it contained the Superfund excise tax, a one percent acrossthe-board tax on manufacturers to pay for toxic waste disposal. A - But even more relevant to the discussion at hand is the way the 1983 Commission on Social Security master-minded the tax increase on the self-employed. Those that work for themselves know that for a long while contributions were three fourths the combined employee-employer rates for OASDI (Old Age Survivors Disability Insurance) and half for HI (Hospital Insurance). Starting in 1984, both were supposed to equal the combined employee-employer contributions, but with a tax credit. Actually the self-employed pay an effective rate of 86 percent of employee-employer rates.

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Q - Disguising the true state of Social Security has reached an incredibly high state of the art A - To soothe the self-employed, a tax credit amounting to approximately 1.5 percent of the overage was conjured up. That tax credit allowed Treasury to bring in general revenue. Q - The cavalry! A - It was really an underhanded way to beef up Social Security, but they didn't want to let anyone know it needed beefing up.

Q - Again!
A - The rationale for the self-employed of an earlier day to pay only three fourths of the employee-employer combined rate was that the selfemployed paid income tax on 100 percent of their contributions, i.e. they couldn't deduct the tax as a cost of doing business the way a large corporation does. Since employees don't pay income tax on the employer's deductions, employers are allowed to deduct the contribution they make to their employees' accounts as a cost of doing business. Q - The way I understood it, the general revenue tax credit gimmick was only supposed to be good through 1989. After that, half of the selfemployed's contributions were to be considered net earnings, but they would be able to take deductions on the other half up to 50 percent. A - Such are the wondrously detailed plans of a centrally controlled government! A tax reform thatis revenue neutral only when taken over a five year period; a 75 year summary statistic that masks the long tenn deficit in the Social Security system with short term surpluses; a subtleintroduction of general revenue funds into the Social Security system to beef up reserves.
Q - Sometimes I think. our representatives underestimate the ability of the average citizen to see through the smoke screens that billow out of their

Congressional committee rooms. A Wall Street Journal-NBC Poll found in December, 1990 that 84 percent of the voters supported a millionaire surtax. Even GOP

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staffers favored embracing it and dropping the crusade for a capitalgains tax cut A - The poll found 51 percent of the voters favored raising the rate on capital-gains to 43 percent! The Wall Street Journal (7-16-91) reported that, based on 1990 tax returns, the average taxpayer paid 13.4 percent of his AGI (adjusted gross income) which, before deductions, was the same as in 1988.

Q - According to IRS publication Statistics of Income, middle class
incomes, between $30,000-$50,000, rose slightly from 11.1 percent of AGllo 11.2 percent. All other categories fell slightly. The largest drop was 1/2 of one percent for those with incomes of $100,000 to $500,000. The year before the decline in average tax rates for the most wealthy was between 2.5 and 4.2 percent, depending on the income category above $200,000. But the richest still paid a larger percentage of their incomes than anyone else, solidifying the desire for progressivity. Those with incomes between $200,000 - $500,000 paid an average of 23.4 percent of their incomes, according to their 1990 tax returns. A - Senator Bentsen said in a speech in March 1989 at a Democratic Leadership meeting, that the federal government collects revenues amounting to 18.5 percent of GNP (gross national product) but spends 22 percent of GNP. He said that foreign nations are helping us close the gap by investing their dollars here. Then he dramatically asked, "Who holds our debt? The wealthy! Who pays? Working taxpayers! What can better demonstrate that the Republican Party caters to the rich at the expense of average Americans than the creation of more debt in the last 8 years than from George Washington to Jimmy Carter?"

Q - In October 1990 I heard the following dialogue on a bay area radio talk
show: Caller A-"I'm not a rich person, I don't even like the term ... but the business people and the earners give, give, give and the dead beats only take, take, take." Caller B-Offered the following information: He worked 80 hrs a week at 3 jobs and his wife worked one additional job. Together they made $80,Ooo/year and paid 40 percent in taxes which made the caller very angry. His house payments alone were $2,200 a month.

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Caller C-A retired lady living on $11.000/year and paying monthly rent of $600 plus. Her taxes amounted to one month of her pension. She worked for 45 years and was very indignant that Caller B should complain. A - The media has put out the notion that the rich have been benefiting at the expense of the poor. The truth is the average real income of the bottom 20 percent of the population increased 11 percent between 1967-1983.

Q - That may be, but the gap increased between the bottom and the top
during that period. A - However, Reaganomics was not the culprit. The problem was mainly caused by demographics. There was a big change when fewer young people began entering the work force. Earlier there were so many college graduates in the job market that supply outstripped demand and wages were lower for white collar workers. This meant the ratio between the higher paid college graduates relative to their lower paid high-school only graduates, was narrower. The blue collar workers didn't get higher salaries, it was just that the white collar workers got less during the 1970s. In the 1980s the education level of new workers continued to rise but there weren't as many new workers, and as supply barely met the demand, wages rose. In 1989 college graduates made 61 percent more than high-school only graduates on average.

Q - As world competition becomes more keen, and less demand is placed on physical labor and brain power becomes a premium, the return to
individuals and the nation on a higher education will rise. This realization ledCongressman David Price (NC) to introduce a bill to restore the tax deduction for interest paid on an education loan. A - There is also a disparity within the professions themselves. New lawyers command anywhere from $42,000 to $110,000. Electrical engineers start on average at $40,000 and go to $65,000. Companies pay for top talent because competition forces them to do so. Unions have lost power simply because the demand for manual labor has lessened. Q - You said the media has given the impression that the rich have been getting rich on the backs of the poor but I heard David Brinkley

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(11-4-90) point out that 20 percent of the top income earners pay 72 percent of the taxes in this country A - That's interesting. How about these figures: The top 1 percent of taxpayers supplied 7 percent of the total income taxes collected in 1981. Their share grew to 14 percent in 1986--doubled!! If one makes the same calculation for the top 2 percent of taxpayers, their share increased to 34 percent in 1986 from 26 percent in 1981. However, the share paid by those citizens whose income fell below the median, declined 1 percent. These figures are fully documented by Lawrence Lindsey, the Harvard economist mentioned earlier, in his book The Growth Experiment. Q - Aren't you the one that puts little or no faith in statistics? There are as many sets offigures concerning who pays how much of what and what group benefits at what other group's expense as there are members of congress. A - I can't argue with that. In fact I was about to compare Professor Lindsey's figures with those recited by Congressman Gephardt during the final days of the FY1991 budget summit He claimed that the poorest 20 percent of American families are paying 16.1 percent more of their family income in federal taxes today than they did in 1980, while the richest 20 percent are paying 5.5 percent less and the top 1 percent are paying 14.4 percent less. As you will notice, the Professor is talking about share of taxes collected whereas the congressman is talking about share of their various incomes. Q - Apples and oranges! But most people don't pay that much attention to what is really being said. All I know is that the idea of more progressivity is pervasive. For instance, people are taking seriously the proposal to lower the rates on the payroll tax and lift the ceilings on the amount of wages taxed. A - The hann done by the progressive income tax can be illustrated by the example of my uncle who was a cracker-jack salesman back in the 1950s when the top income tax rate reached the dizzying height of more than 90 percent. Q - Are you trying to tell me that for some high earners they would be lucky to keep a dime of any additional dollars they made?

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A- I know, it's hard to believe. Anyway, when his eamings gotto the point where he was paying more than half of any additional dollars generated to the government, my uncle used to take off. That gave him three or four months of vacation every year.

Q - So what's so harmful about that?
A - For my uncle, probably nothing, although he never realized his full potential in the field. The harm occurred to the dozen or so production employees who were left idle by his decision. I heard that he sold enough products to keep about 35 employees on the production line and when he worked only part time, his orders were cut, so that only about 24 people were needed.

Q - Obviously that hurt the income of the eleven people let go due to the
tax code.

A - And if you think about it, the high rates actually decreased the amount of revenue collected by the government. Those eleven unemployed people, instead of contributing taxes could have ended up as a drain on the taxes provided by other workers.
Q - I guess this is one more example of unintended consequences.

A - Policies that attempt to "soak the rich" often end up hurting the middle or lower income worker.
Q - On a static-revenue basis (forget the incentives and disincentives of the laws) ERTA prevented revenue of close to $1.5 trillion 1981-1990 but the 1981 cut was followed by a tax increase every single year-TEFRA in 1982, Highway Revenue Act of 1982, Social Security fix of 1983 plus the increases to bases and rates previously scheduled for social security which took effect in 1983. the Deficit Reduction Act of 1984, small hikes in a variety of taxes from 1985-88 not to mention

bracket creep which pushed incomes into higher brackets and totaled revenue gain to the Treasury of approximately $1.9 trillion. A - California Congressman Dana Rohrabacher gave a special order in October 1991 in which he said the charge that Republican tax policies favor the rich is not true. He claimed that in 1981 the wealthiest people in the country paid 18 percent of all taxes and seven years later, in 1988 they paid 27 percent of all taxes.

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Q - The congressman
Lindsey.

was making the comparison

made by Professor

A - Maybe, but he didn't define "the wealthiest". He went on to say that in 1991 the wealthiest half paid 95 percent of all income taxes and 83 percent of all the social security taxes collected. He also claimed a $IO,ooo/year income earner would be paying 134 percent more in taxes if the Carter policies had been continued, and although those making $1,000,000 a year would be paying 62 percent more in taxes than they are now, they would also have their loopholes in tact. Of course interest rates would have continued at over 21 percent and inflation would have remained in double digits with much, much larger deficits as a result of Carter's unchanged policies.

Q - That's not what the average citizen hears.
A - I expect fairness to be an issue in 1992 as it was in 1991 with many Americans echoing the partisan cry that the rich are getting a free ride. Bush even ok'd a rise in the top income tax rate from 28 percent to 31 percent. Q - He approved as long as it was accompanied by a cut in the capital gains rate from 33 percent to 15 percent. A - Knowing at the time of the proposal that the Democrats would never go along with it.

Q - But the Democrats wanted a top rate of 33 percent and a 10 percent
surtax on incomes over $1 million. A - I remember Representative Tom Andrews of Maine campaigned saying "Tax cuts for the super-rich that have been passed since 1978 now cost the rest of us more than $160 billion every year. It's time for a fair-share tax policy" Q - Washington Post writers, Thomas Edsall and E.l. Dionne have a new set of figures which show the income of the top one percent of the population rose by 87 percent in the 1980s whereas the increasing payroll taxes offset any income tax cuts the middle class may have received.

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A - A report from the Congressional Budget Office (CBO) found that on average, the wealthiest one percent of Americans pay 27 percent of their income as federal taxes and another 13 percent or 14 percent as state and local taxes. The richest 2 percent to 4 percent offamllies have average pre-tax incomes of $126,000 and after federal taxes that drops to $93,000. The wealthiest 5 percent to 10 percent of families have pre-tax incomes of $82,000 and after-tax income of $61,00. The richest 11 percent to 20 percent of families average $64,000 pre-tax income and $48,000 after-tax. Slate and local taxes take another 10 percent to 15 percent The super-rich, top 1 percent have pre-tax incomes of $550,000 according to CBO and end up paying about 13 percent of that to the federal government, or collectively, a whopping $150 billion. Their contribution makes up 15 percent of all federal taxes collected. If their marginal rate rises from 27 percent to 30 percent it would bring in an estimated additional $45 billion.
Q-

It looks like the super-rich are getting poorer, not richer. In 1990 Forbes lowered the requirements necessary to be included intheir 500 from $275 million to $260 million. Billionaires dropped from 71 in 1989 to 66 in 1990. Nonnally half of the income of this group of citizens is derived from capital gains and investments.

A - The middle and lower classes want to see sacrifices imposed, not equally on all, but in proportion to the ability to bear sacrifices.
Q - That doesn't seem to be keeping with the American ideal.

A - Maybe not, but the blue collar working population was happy enough under the Democrat's New Deal, which meant redistribute some of the riches from Republicans. Now it is the worker that is having his wages redistributed to the non-worker.
Q - I heard that only one Argentine family in 25 pays any income tax. Do you know if that's true?

A - Yes, but because of the lost revenue the government has had to print money which is defeating the anti-inflation policies it had committed to. The Menem government had promised the IMF that Argentina would have a $328 million surplus but the reality has been $60 million.
Q - There are all sorts of new economic policies being tried all around the

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globe. For instance the Soviet republics have a new five percent national sales tax with 70 percent of the revenue to go to the fifteen republics and 30 percent to the federal government. A - Ronald Reagan's tax policies were the inspiration for Sweden cutting its tax rates from 72 percent to 51 percent An average Swedish worker's income will rise 35 percent, although a lot of that will be siphoned off via a broadening of the VAT tax. Sweden is trying to encourage productive work, reduce tax evasion and spur the economy.

Q - Conservative Premier Carl Bildt is responsible for bringing Swedish
taxes down while curbing government spending. Mr. Bildt declared in November 1991 " the new, market-oriented cure had to begin at once." Why can't our leaders be as bold? A - On September 15, 1991 Sweden voted out the Social Democrats. The socialists had been in power for 53 of the past 59 years. Public expenditures consumed 57 percent of the GDP (gross domestic product) compared with 34 percent in our country and 25 percent in Japan. Capital flight, slow growth and inflation took over as the 1980s came to an end. Taxes and social-insurance took 70 percent of each worker's pay. Socialism was the tired answer to child labor, long working hours and economic inequality.

Q - By the way, didn't Social Security have its start in Sweden?
A - Social security arose in the mid-19th century under Bismarck in an attempt to fend off Germany's socialist movement. Even today Germany is one of the world's most thoroughly developed welfare states. What has survived is socialist morality-especially the idea that inequality is bad.

Q - By the end of 1991 every politician in this country was climbing on
the tax-cut wagon. Martin Feldstein, former chief economist under Reagan said that all the talk about cutting taxes "doesn't make any sense at all. I don't think it will do any good, and it could do a lot of harm." The talk raised the interest yield on government bonds, which Feldstein says, "could frighten the bond markets, push up long-term interest rates, clobber housing, raise the dollar and hurt exports." Any comment?

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A - Tax cuts usually mean a revival of inflation and that hurts the bond market. I agree with former CBO Heads, Alice Rivlin and Rudy Penner, that reducing the deficit would be preferable to lowering taxes. Before 1981 the Phillips curve, with its trade-offs between growth and inflation, dominated economic thought. Opponents of supply side theory felt tax cuts would lead to over consumption, debt, high inflation. deindustrialization and make us noncompetitive in world markets. According to Professor Robert Barro of Harvard, "The right policy would be to lower permanently the rate of taxation of capital income. This would be good for the recession. good for long-term growth and good for the stock market."

Q - Don't low interest rates reflect a low demand for capital?
A - True. Again I quote Professor Barro,
In the long run all a country getsfromhighermonetary growth is higher inflation. higher nominal interest rates and a less productive economy ..• Nominal imerest rates on U. S. government bonds with 10-year f1UJturi.ty ere low and relatively stable throughw out the mid 1960s but then rose, along with inflation, to a peak of about 7 percent in 1970-71. an outcome that led to price controls and the closing of the gold window ... The real disaster for monetary policy was the increase to around 13 percent by the end of 1980.

The professor claimed the high and volatile interest rates that occurred between 1981-1985, were the price paid by the Fed and Ronald Reagan to restore long-term credibility. Thanks. in part to the pain suffered then. we have enjoyed more stable rates since.
Q - In 1991, the administration gave serious consideration to reinstituting

the investment tax credit-giving a dollar-for dollar match to business for a portion of investment in new plants and equipment. President Bush would also have liked to make permanent a tax credit of up to 25 percent for business R&D (research and development). A - Many people thought the investment credit might jump start the economy more quickly and forcefully than a cut in the capital-gains rate.
Q - Going back a ways, in a speech in 1963, President Kennedy said,
The present tax treatment of capital gains and losses is both inequitable and a

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barrier to economic growth. The tax on capital gains directly affects investment decisions. the mobility andflow of riskcapitalfromstalic to more dynamic situations. the ease of diffICulty experienced by new ventures in obtaining capital. and thereby the strength and potentia/for growth of the economy.

The onerous rate JFK deplored was 25 percent and he proposed to reduce it to 19.5 percent A - Democrats will generally claim that 80 percent of the benefits from a reduction in the capital-gains rate. goes to Americans earning $100.000 or more.
Q - But there are politicians on both sides of the aisle that know better and may be willing to admit that taxing capital gains at a low rate raises

asset values. unlocks capital. stimulates investment and even raises revenue. A - It seems like opponents of capital gains base their opposition on three objections:. cost. effectiveness and equity or fairness. Q - I know. They claim the wealthy get a disproportionate share of the savings. And I 've also heard the wealthiest 2 percent of the population receive more than 25 percent of their income in the form of capital gains, and that nearly 75 percent of all capital gains are realized by taxpayers with incomes over $100,000. 45 percent of these gains go to those with incomes in excess of $500,000. Bush's proposal would save the wealthiest $25,000 a year but save taxpayers earning $60,000 or less, very little. A - But capital gains realizations are spread throughout the income spectrum. In fact those making under $20,000 accounted for more than 25 percent of all capital gains reported by taxpayers in 1985. Q - That's hard to believe. The statistics I have seen between 1980-84 show the share of capital gains taxes paid by taxpayers earning $20,000 or less declined from 5.3 percent to 2.9 percent. How could there suddenly have been such an increase in 19851 Also my statistics show the capital gains tax paid by those making $500,000 or above rose from 29.6 percent to 48.6 percent in 1985. A - To show you the variety of statistics available, 67 percent of the direct benefits from a capital-gains tax cut would go to people making more 81

than $200,000 a year, according to the Joint Taxation Committee. You know what I have always said about statistics; they can be made to say anything the user wishes just by starting and ending at particular dates and including this instead of that. Let's generalize and see if you will agree that there is historical proof that a lower tax on capital gains leads to the wealthy paying more taxes. If so, you must realize that a proposal like Bush's would unlock gains that would not otherwise be realized because of high taxes. Under a lower capital-gains tax, payments by the wealthiest segment increased more than 8 times that of the lowest income group. Q - You're preaching to the choir. I agree that a cut in the capital-gains rate would boost the economy and help all income groups. I also agree that a lower capital-gains tax generally leads to a higher volume and that the lower taxed assets become more valuable and more desirable when there is no tax disincentive to trading them. A - And my point was that a higher volume and value generates more revenue, not less, for government coffers.

Q - I know an increase in the capital-gains rate in 1969 resulted in less
revenue for the Treasury. Of course some critics claim an increase in tax revenue merely reflects the inflated gains in the stock market. Realize that I 'm playing devil's advocate here. A - During 1980-84, the New York Stock Exchange composite rose by 36 percent compared to the 306 percent rise in tax payments by the most wealthy segment of the population. 'This rise was due to a greater investment in taxable assets and greater mobility of capital. Q - Non-reoccurring capital gains distort the picture. A - But most are not reoccurring events. Most capital gains tax payments are triggered by the sale of a small business or a widows liquidation, the sale of stock to purchase a house or provide for a child's college education or liquidation of an investment portfolio in anticipation of an economic downturn.
Q - More than a dozen proposals to reduce the capital gains rates have been

introduced. Professor Lindsey's research placed the beneficial capital gains rate at between 9 percent and 21 percent.

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A - Ideally there should be no holding period before an asset becomes eligible as a capital gains rather than ordinary income. To have one is to add one more distortion to investment decisions and leads to inefficient allocation of economic resources. Unfortunately our tax code makes a distinction between short-term and long-term gains with qualifying periods ranging from 3 months to as long as 4 years.

Q- Why?
A - Holding periods are an attempt by our philosopher-kings to correct what they believe to be the short sightedness of American managers. But even the Japanese, who are credited with long-range strategies, fail to make such a distinction. Besides, a lengthy holding period could discourage start up businesses.

Q - In an effort to target the tax incentive to preferred forms of economic
activity, every proposed bill that I have seen would limit the coverage to certain kinds of investments. A - That's absolutely right. One bill covers only common stock in firms with less than $100,000,000 paid-in capital. Some bills favor only new ventures.

Q - This would assist start ups at the expense of established competitors.
A - I'm glad you noticed. To take advantage of the tax structure, many companies would restructure, which is costly and unproductive. The distortion caused by philosopher-kings is boundless. It's as if they were manuevering their constituents as they would toy soldiers.

Q - Taxes should not be used for social engineering and to effect public policy decisions that could not be agreed to otherwise. I think it is
wrong to use taxes to shape (distort) economic preferences. A - Most people are used to it and many, especially the academics, even embrace this use of the tax code. The Bush proposal covered all common stock, bonds, land and nondepreciable real property. Office buildings and apartments are excluded from some proposals. Precluding bonds from capital gains treatment could raise their interest rates relative to the return on equities and penalize those firms dependent on debt for capital. Such

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a burden could fall more heavily on the mature industries and leave them with limited access to equity markets. Q - I would think it might also be harmful to institutions, like pension funds, with bonds in their portfolios. A - Generally when a business starts up, it issues a conservative number of shares. It increases the issue over time to raise capital as needed and as it becomes better established in the market. If Senate Bill 348 were to take effect, newly issued shares would be sold at the one time capital-gains tax preference. Existing shares would decline in value in secondary trading whenever a new issue is announced Q - Wouldn't this cause the distortions you were talking about? A - Unfortunately you're correct. This would add uncertainty, not to mention the distortion caused by the four year holding period, also a part of SB 348. It would also encourage start up financing. The tax code would benefit original bonds and decrease the value of later issues. This would be a topsy turvy market. Q - It seems that it should be obvious to everyone that gains shouldn't be taxed because the income has already been taxed once. A - And besides, sometimes only inflation is taxed. An investment returning a real return of 5 percent in an economy with 8 percent inflation (13% return) would be subject to a real tax rate of 57.5 percent on real earnings if sold after 5 years. A 1970 investment in stock that was sold in 1988 would pay an effective rate of 339 percent on the net real gain.

Q - I don't follow all that, but I do understand our earlier discussion about
taxing the same income more than once. Triple taxation occurs on the same capital when first the corporation is taxed on earnings, then a shareholder is taxed on dividends and finally is taxed again when he sells his shares. The tax code has tried to compensate for this. Since a house is the largest asset of most Americans, the code has a targeted built-in protection against the capital gains penalty. If a home is sold and the proceeds are re-invested within a certain time period in another home of equal or greater value, no tax on any gain in capital is assessed. The same is true if real property is traded for another piece of real

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property of equal or greater value within a specified time period. Finally a person over the age of 55 is allowed a one time gain free of taxes when a home is sold even though another of equal or greater value is not purchased. A - Even so, our present tax code discriminates against capital income and discourages investment. It makes America less competitive because many foreign competitors are free of capital-gains taxes. Q - You mean some countries have absolutely no tax on capital gains? A - Holland, Italy, Belgium and Hong Kong tax neither short nor long-term gains and Germany taxes short-term gains only at a pretty hefty 53 percent rate. Q - What about Japan? A - Japan taxes both long and short-term gains at a very low rate; one percent of sales price or 20 percent of net gain in both cases. According to the infonnation published by the American Council for Capital Formation in the summer of 1990, the United States places the heaviest penalty on long-term gains. Although Britain and Australia tax at a higher rate (40% and 47% respectively) they take inflation into account and index the asset cost. As for the other industrialized economies-Canada and France make no distinction between the taxation oflong and short-term gains. Canada taxes at a 21.8 percent rate and France at 16 percent. Sweden taxes long-tern gains at 25 percent, slightly higher than the USA 33 percent rate, and short-term gains at a lower 17.5 percent rate. Q - No one denies that a lower capital-gains rate would reduce the effective cost of capital and encourage the acquisition of productive assets. A - Especially if capital losses could be deducted beyond the current $3,000 annual limit. It's somehow unfair that the government taxes the entire gain, no limit, but refuses to treat losses in the same manner. A - A lower rate would also encourage investors to take risks. Various studies have shown that lower rates on capital gains have stimulated growth in the venture-capital market.

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Q - But a substantial amount of venture capital comes from non-taxed
sources such as pension funds. A - True, but studies show individual investors are a larger source of capital for small start up firms,

Q - What studies?
A - In 1988 an economics professor from the University of New Hampshire, and another from Babson College in Massachusetts, sent questionnaires to 1,073 technology-based ventures founded in New England between 1975 and 1986. Of the 284 firms responding. it was found that individuals were their most frequently used source of capital. Usually an equity share with the right to participate in the profits was the offered incentive. Most of the capital raised from individual investors was under one million dollars. Individuals tend to invest earlier in a venture than would other sources of outside equity capital. When capital gains rates increased between 1969 and 1978, the study found that lPOs (initial public offerings) declined from an average annual $2 billion in 1972 to an average $225 million between 1975 and 1978. With the rate reductions in 1979, and again in 1982, IPO capital soared. After the 1986 refonn they stalled, and declined as capital gains was taxed at the same rate as regular income.

Q - That's only one study.
A - MIT's James Perturba, in a study for the National Bureau of Economic Research, found that between 1976-86 the stock of commiunents to the U. S. venture capital industry rose at a compounded annual rate of slightly over 17 percent and grew almost 5 times as large. Harvard's Lawrence B. Lindsey garnered evidence from various studies that showed the plausibility of lost revenue from the 1986 reform of capital gains ranging from $27 to $105 billion dollars when compared to what might have plausibly occurred under prior law.

Q - Well my bottom line on the issue is how the capital-gains tax affects
real live people. I can't seem to forget John Kling, an elderly gentleman who I read about on the front page of the November 13, 1990 issue of the Wall Street Journal. Mr. Kling was hit so hard by the higher capital-gains tax that he was forced to surrender his Gulf stock, the backbone of his life savings. And because of this, his

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retirement nest egg was greatly diminished. I remember thinking at the time how unfair it was that the hike in the capital-gains tax penalized those far-thinking, frugal people of modest means. I wondered how many other John Kling's were finding a sizable portion of their retirement funds vanish due, to what I would consider to be a rather nonchalant tinkering by the 535 members of congress, none of whom, if you remember, even read everything that was in the 1986 tax reform that we, the ordinary people, are forced to live with. A- What really gets meis that ordinary citizens arebeing asked to tighten their belts because of the ramifications of the national debt, although it is apparent to everyone that Congress is not willing to suffer any pain. It raises its own pay and increases pensions, remodels dinning rooms, gyms and hair salons, all as if the debt were non-existent. Q - The surest and fastest way to get out of a recession may be to adjourn congress. The next best solution is to impose a flexible freeze on our budget and stick to the "no new taxes" pledge. A - Some members of congress would themselves agree with you. For instance, Senator Gordon Humphrey told his colleagues that ordinary people are paying more and more and therefore congress should forget asking the people to sacrifice and should instead exert a modicum of self-discipline and cut programs-no new taxes! Senator Dole pushed for the Symms Amendment which he claimed would trim $43 billion right off the top of the bloated FY 1991 budget. Q - The problem, as we mentioned earlier, is that the whole government is set up to take advantage of the taxpayer. Only those who can afford the services of good accountants and good attorneys seem able to withstand the onslaught. A - I fear the decisions that were made by the Bush administration in preparing the FY1991 budget will reverberate to cause George Bush a great deal of grief as he campaigns for re-election in 1992. Q - What do you mean? A - Bush will reap the destructive effects of a tax increase, rise in the minimum-wage rate, not enough deregulation, little progress in

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reforming the regulation of the financial industry, increasing the length of unemployment-insurance benefits, civil rights legislation which will increase litigation. None of these promote growth!

Q - I've heard it said that George Bush holds the record for the slowest
pace of economic growth since Franklin Delano Roosevelt A - A growth of only one tenth of one percent annually according to Paul Craig Roberts, Chairman of the Institute for Political Economy. George Bush took office in the middle of the seventh straight year of a peacetime expansion when the economy was growing at a real rate of 3.6 percent. Only a few months into the Bush administration the growth was down to 2 percent. The expansion didn't die a natural death; it was killed by bad economic policies.

Q - Planning doesn't necessarily work. As George Gilder likes to say "One
free mind plus a workstation can outperform any array of regimented minds." A - Paul Craig Roberts blames the recession on the administration's increase in regulation and government spending. "Regulation has exploded-in the environmental, physical disability and financial areas." The 5-year deficit projection doubled to more than $1 trillion in additional debt.

Q - During the mid-1980s the Fed tightened money and the stock market
flourished. A - According to Professor Roberts, easy money from the Federal Reserve cannot begin to offset excessive regulation and taxation.

Q - Fed Chairman Alan Greenspan refers to the "marked downsizing of
economic output". Do you know what that means? AIt means we are producing ever more value with ever less physical input.

Q - How did we get out of the 1980-1983 recessions?
A - Many people believe the recovery was due to tax cuts of 1981 and 1986 tax cuts. Now we have tax hikes, anti-business legislation (re: hiring.

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discrimination and how to run your business etc.) and a run-away national debt, bank failures and declining real estate markets and spending as usual by congress. The only cuts were from defense and they were replaced in the budget by the Gulf War fallout and pork barreling.

Q - And besides, spending by the government continues to increase with
the FY1992 providing $22 billion in new spending for the Departments of Labor, Education & Health & Human Services plus another $24 billion for parks, land, energy and water projects and all the congressional goodies we mentioned which, although the amounts might be tiny in the scheme of things, shows an uncaring attitude on the pan of our elected officials. A recession reduces revenue so the new tax hikes won't fulfill their mission. A - The FY 1991 budget agreement states that a future cut in one tax, must be accompanied by a rise in another tax, so there is no tax relief in our future.

Q - Of course the budget agreement, made so contentiously in the fall of
1990 could, and probably will be repealed. A - Contrary to popular belief, it may be easier in the future to cut spending than to raise taxes. People with ability will gravitate to the most opportunity and the lowest tax rates; not surprisingly the two go hand in hand. Historically lowering tax rates increases revenue. A true flat tax will reduce the need to cut consumption and is fairer than a value added tax.

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