Yeah, I’m the Taxman

As the deadline for filing tax returns approaches, amidst a great political pseudo-debate about whether to finally get serious about the deficit (hint: the answer will be, “not really”), it seems timely to reflect on just how our tax payments fit into the overall picture of America’s public finances.  The Washington Post and New York Times have put out some great interactive graphics that are well worth browsing for a few minutes to pick up some facts.

I think people generally become pretty irrational when asked to think about taxes.  My guess is that more than 95% of people feel that they are individually paying their “fair share” of taxes, but that they also believe that at least 25% of the country does not – this 25% for the Left tends to consist of high-earners, whereas for the Right it tends to consist of net recipients of government largesse.  People have religious debates over how to define one’s “fair share” of the burden of paying for public services, which are difficult to disaggregate from questions about: the proper role of government, the relative merits of publicly-managed vs. privately-managed provision of government services (even those that are ultimately funded with public dollars), whether (or, better: which kind) of taxes are good or bad for growth and by extension aggregate social welfare (not to mention whether this is a fair link to make), and the general fitness of government agents to spend public funds as wisely as they would their own.  These are all difficult and worthwhile questions, but I call these religious debates because I think they are usually not informed by facts – actually, people look at the same facts (e.g., that the top 1% of earners pay N% of all taxes) and draw different conclusions about whether N is too high or too low based on their prior views on all of the questions above.

My favorite ridiculous claim about taxes from the Left is that high-earners actually want to pay higher taxes, but they just haven’t been asked to do so.  When the President says it, it’s almost too incredible to imagine.  I also find it amusing when billionaires make the same claim, without any apparent sense of irony that they have deliberately (1) taken advantage of the arbitrage between income tax rates and capital gains tax rates to build enormous tax-deferred wealth over time & (2) dispensed the overwhelming majority of that wealth into tax-exempt non-profits who do the bulk of their work outside of America.  These claims clearly fail the revealed-preferences test: of course Obama or Buffett or I can pay higher taxes if we want to.  The Treasury department is very clear that gifts to the United States are always welcome as a patriotic expression.  I think it’s fair to ask why anyone who claims to be in favor of higher taxes for his income bracket doesn’t voluntarily pay those taxes himself.

My favorite ridiculous claim about taxes from the Right is that high-earners are chomping at the bit to use any incremental after-tax income from lower marginal income tax rates solely for the purpose of creating jobs (rather than, say, hoarding wealth).  It is true that tax rates are relevant for businesses’ and individuals’ investment decisions.  I think there are worthwhile arguments to be made about lowering business tax rates (at the level of payrolls and of the corporate entity) while raising them for dividends and long-term capital gains (and possibly also individual consumption) if we want to change the relative incentives for businesses to reinvest earnings rather than distribute them to their generally affluent stakeholders.  But, even though I think Buffett is disingenuous in discussing his willingness to pay higher taxes, I think he is correct in asserting that “trickle down” has worked much better in theory than practice.

Even though I’m skeptical that our political process will be able to make meaningful progress on tax reform, I’m glad that the subject is at least being discussed.  Since our plan seems to be to borrow trillions of dollars during the next decade anyway, it seems hard to imagine that we can construct a tax code that is worse-equipped to generate the growth and revenue we will need to have any shot at fiscal balance.  Now would seem like a perfect time to conduct a radical experiment in simplification.  I think the concept of multiple income tax brackets with progressive marginal rates is sensible.  There probably should be something like a millionaire’s bracket with an even higher marginal rate.  Crucially, though, we would need to stop using the tax code as a set of levers for social engineering if we want to stop people from paying lower effective tax rates than we intend for them to from a public finance perspective.  If we want to incentivize specific behavior, it seems drastically more efficient to do so through a mechanism like a “mail-in rebate” – at the very least it would make clear the cost of the policy, and make it easier to monitor for fraud.

I’m convinced that there are ways to increase total tax revenue without compromising economic growth, competitiveness, and job creation: when the pie is bigger, everyone gets more pie.  But I think it will be hard to figure out what exactly those ways are, if we’re forced to consider them in the context of a system that is already complex, opaque, and under-resourced to stop cheating and fraud.

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