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Cato Policy Report, May/June 1999
Vol. 21, No. 3

Policy Forum:

How Taxes Drive Americans Crazy

On February 22 the Cato Institute and the Independent Womenís Forum held a Book Forum for Amity Shlaes, an editorial writer at the Wall Street Journal and the author of The Greedy Hand: How Taxes Drive Americans Crazy and What to Do about It. Rep. Jennifer Dunn (R-Wash.), a member of the House Ways and Means Committee, commented.

Amity Shlaes
Amity Shlaes: ďGovernment is taking a greater share of the economy than it has at any point in our history except during wartime.Ē
Amity Shlaes: As a Wall Street Journal editorialist on tax policy, I covered the rise and fall of taxes as an issue in the 1996 presidential campaign. It was clear that, on one hand, the tax issue was important. Steve Forbesís success was clearly due to the bold way he led on taxes. On the other hand, it was clear that taxes werenít entirely penetrating. There was a terrible disconnect. Polls showed that people were eager for tax relief, and the politicians knew that they should give tax relief and even had their concrete solutions. Yet there wasnít complete communication. The failure to communicate was, I think, for the Republicans, part of the greater failure of their presidential campaign.

After that campaign, it seemed to me that it was time to look at the problems the average American experiences. In other words, I chose to delve into what I call the culture of tax. I started my research by going to H&R Block tax school. I looked at taxes the way the average man does when he wrestles with Form 1040, when he pays sales taxes, when he fights the local school board, when he plans his retirement.

Unfortunately, many of our tax-cutting politicians are making a mistake. Theyíre acting as though tax problems today are the same as they were in the 1970s. But in a sense the politicians are fighting the wrong war. The 1990sí tax experience is very different from the experience of the 1970s. The 1970sí and the early 1980sí tax troubles were generally income tax troublesótroubles made acute by the ravages of inflation. The tax problems of the 1990s have a range of sources that are general and hard to understand. In other words, todayís problems are not acute, theyíre chronic. That explains why voters are both angry and disaffected.

The best image for depicting this modern tax discontent comes from Thomas Paine, the publicist and agitator who played such an important role in our countryís founding. Paine wrote the following in The Rights of Man: ďIf, from the more wretched parts of the old world, we look at those which are in an advanced state of improvement, we still find the greedy hand of government thrusting itself into every corner and crevice of industry, and grasping the spoil of the multitude. Invention is continually exercised to furnish new pretense for revenue and taxation. It watches prosperity as its prey and permits none to escape without tribute.Ē

Weíre prosperous today, and yet the government takes a lot. Here we are in the age of the freest markets, and we should be celebrating the invisible hand of Adam Smith, but itís Paineís hand, the greedy hand, thatís growing. In fact itís growing even faster than the invisible hand at this point. Government is taking a greater share of the economy than it has at any point in our history except during wartime.

For several reasons I like this hand image. The first is that itís kind of disembodied and creepy, which is just the way people feel about taxes today. We know thereís a problem; we donít know why it bothers us. Thereís another thing about the hand that voters recognize and donít like: itís not only greedy, itís meddling. Although lawmakers are giving up on social engineering through entitlement, they are not giving up on social engineering itself, unfortunately. All the energy that used to be applied to writing welfare law is now poured into editing individual lives through the tax code. And finally, perhaps the worst thing about the greedy hand is that itís hidden. In other words, weíve constructed a tax structure that works too well. In France, long ago, it was said that the art of taxation consisted in plucking the maximum feathers from the goose with the least hissing. And thatís what we have today. It doesnít mean that the goose is happy.

Everyone is well aware that thereís a problem with Social Security, but lawmakers, for whatever reason, tend to focus on the pension end of it. They work to ensure that the pensions of future senior citizens will match the generous ones todayís seniors get, and they donít always show much understanding of the onerous nature of the payroll tax burden borne by those paying into the system. The payroll tax is the tax on low earners. Itís the biggest tax on 7 of 10 filing households; itís the tax on labor and industry; itís the tax that makes the lives of younger earners, our children, unfairly grim. And if you want to think about how high the payroll tax is, consider this: Todayís payroll tax rate, at over 7 percent, just on the employee side, is higher than the rate millionaires paid when the income tax was instituted in 1913. Then, the top rate was 7 percent.

Why has this happened? The answer probably isnít malice or hostility. I would say itís amnesia. The current high payroll tax rate isnít part of the personal experience of lawmakers or other people in the political leadership. When Alan Greenspan or Bill Clinton was younger, payroll tax rates were much lower; in time, payroll tax rates moved to their current terrible high. But most politicians and most leaders donít feel that. Thatís because many of us have moved above the cap; weíve moved past the point where we continue to pay payroll tax on our income. So our actual average personal payroll tax rate is lower. We donít feel what itís like for someone starting out. We just canít relate to that experience.

Then there are sales taxes. Politicians treat them as ancillary matters, and you see static analyses of state revenue departments that assume that states can capture new revenue simply by raising rates. But Americans have already developed an extensive culture of sales tax avoidance. People shop for tax breaks the way they shop for sales. A good example is the Mall of America, the nationís largest tourist destination. But itís also a prime example of tax avoidance. People go to Minnesota and to the mall because Minnesota has no sales tax on clothing. I think itís important to recognize, therefore, that when Americans choose to cross the state line to go from New York to New Jersey, or from the District of Columbia to another jurisdiction, just to save pennies on sales tax, theyíre actually telling government something. Theyíre saying, this amount is too much. Or, this I wonít pay. They send the same message when they choose to order from L.L. Bean or any other mail order house that enables them to escape state sales tax. Internet shopping is another example of this message. The fury that erupted when state revenue departments tried to tax Internet shopping was American tax rage. Todayís tax shoppers, as I call them, are milder than the citizens who boarded ships and dumped tea into Boston Harbor, but they are the direct descendents of those revolutionaries and they are communicating with their lawmakers.

And that brings us to income tax itself. In recent decades weíve tended to think that any new tax fix will please voters. The Taxpayer Relief Act had many good things in it, but it was a classic example of what Iím talking about. The act was called relief and it changed hundreds of items in the tax code, but change and complexity are themselves trouble. Citizens donít like change, and today we are not only changing the tax code but accelerating the rate of change. Americans have an ambivalent relationship with their professional tax preparers. You can interpret the rise of H&R Block as an expression of the unease Americans feel about the federal code. The more uncomfortable we are about talking to government directly and interacting with the Internal Revenue Service, the more likely we are to hire professional tax preparers. Professional protectors, you might call them. And when the Taxpayer Relief Act was passed, Block was very happy. Their commercials followed the news. But they werenít happy commercials in the sense that they said, ďOh wonderful new tax breaks for you.Ē The theme song of those commercials after that act was ďSomeone to Watch over You.Ē Block knew that the best marketing strategy was to play to taxpayersí fear of complexity. That, by the way, explains why Congress raced to pass its IRS reform in 1998, a very important reform. The complexity problem is a bad one though, and itís a reason for some of the IRS rage. And in that sense the reform was a detour around the real problem. For the real problem isnít the messenger, however demonlike the IRS bureaucracy seems; itís not the IRS for all its evils; itís the tax code and its complexity.

Finally, there is progressivity, the fact that rates move up as we begin to succeed. I call this the ultimate success tax. Today we donít have inflationary bracket creep, the way we did in the 1970s, but we do have another kind of bracket creep, real bracket creep. This is due to our prosperity, something that has nothing to do with government. We find ourselves in higher brackets than we ever imagined being in. Unfortunately, the recent fondness for credits has, to some degree, ex-acerbated the progressivity problem. The new credits are fine, as long as you fit into the income category that is entitled to those credits. But when people begin to earn more and move out of that category, they lose the credits and they face very high effective marginal tax rates. They pay a lot more in tax on the last dollar they earn than the statute actually says they pay. This is hidden progressivity, as opposed to visible progressivity, and most voters canít articulate what the trouble is. They only know that the experience is bitter.

Lawmakers should be tackling this issue straight on. Instead, theyíre avoiding it, just as theyíre avoiding it in the marriage penalty debate. Perhaps motivated by polls on this issue, people have tried to fix the marriage penalty. But the marriage penalty is very hard to fix, and thatís one reason the legislation stalled. Everyone who works on the marriage penalty discovers that you canít fix it, at least not in a deep way, without addressing progressivity. The marriage penalty debate is, again, really a proxy, a side debate, when actually maybe itís time to take on progressivity itself. And for whatever reason, weíre not ready to do that or havenít been.

There are several lessons you can draw from all of this. One is that the greatest economic philosopher on tax theory isnít Milton Friedman, the champion of free markets, but James Buchanan, an economist who won a Nobel Prize for founding a school of thought called public choice theory. Public choice theory says that government is like a crustacean: itís reflexive, itís mindless, it will do anything to survive. It will even cannibalize other parts of government. How else can you explain the growth of the tax code and of our tax troubles overall?

The next lesson, I would argue, is that itís time for big income tax cuts, broad cuts. Little cuts and little fiddles wonít do anymore. The IRS isnít the enemy, and even the targeted little troubles arenít the enemy. The enemy is the overall burden.

And last, I would say there is a cost to delaying. A number of lawmakers are distressed that taxes donít always rank number one when voters are polled about what they want changed. But itís natural that voters donít want to ask for tax cuts. Theyíve learned, unfortunately, through the tax hikes in 1990 and 1993 that when it comes to taxes, a pro- mise made is a promise broken. And when they feel this way, they express it by sales tax avoidance, by IRS rage, and, principally and most important, by not showing up at the polls or thinking politics isnít for them. I argue that our low voter participation is in large part the expression of a massive and stubborn tax discontent.

In conclusion, I think we can go back to Thomas Paine for guidance. In the same book where he first gave us the image of the greedy hand, The Rights of Man, Paine wrote of how that hand might be vanquished. ďPeople merely needed the political will to change,Ē he wrote. ďIf systems of government can be introduced less expensive and more productive of general happiness than those which have existed, all attempts to oppose their progress will in the end be fruitless.Ē

Jennifer Dunn
Jennifer Dunn: ďWomen care a lot about taxes these days. Women are starting businesses at twice the rate of men.Ē
Jennifer Dunn: The entire U.S. Congress finally agrees that there should be tax relief. Now, when has that ever happened before? Certainly not in my six years of serving in Congress. When I first got elected in 1992, I wanted to do something about regulation and our huge, overpowering, overzealous, overinvasive federal government. And I wanted to get taxes down because when you cut taxes youíre really doing two things: youíre leaving the money in peopleís pockets and youíre taking the money away from government, which will surely spend it.

So for the first time in ages, I have seen the list of agenda items for the Senate and for the House overlap on four categories: on education, on Social Security reform, on national defense, and on tax relief. Unfortunately, tax relief may be sixth, seventh, eighth on the list of the publicís desires about what to do with the surplus or government spending in general. But tax relief is being constantly talked about. It is part of the vocabulary these days. There is not a member of the House or the Senate who has stood up, within my hearing, and said, ďWe refuse to give tax cuts to people.Ē

The debate is between targeted tax provisions and across-the-board proposals, which I talked about in the State of the Union response: 10 percent across the board, no means testing, and moving the 15 percent bracket up.

There are several important issues that Congress must address in this session, and Iíd like to comment on some of them briefly. IRS reform is one. That has a huge impact on the number of dollars that are spent by government. Last year, we put in charge of the IRS a private-sector oversight board that will preclude the IRS from spending another $4.5 billion on putting in a computer system that never did produce the information the agency needs on the income it brings in.

Another issue Congress needs to address is the marriage penalty. Right now, when a couple marries and the second earner, usually the wife, starts paying taxes at the highest marginal rate of their combined income, thatís about a $1,400 per year increase over the total of what they paid separately. We need to change that.

Social Security is another key issue. A woman who is in the workforce her whole life, whoís putting money through her payroll taxes into the Social Security system, may, at the end of her career, opt to take a portion of her husbandís Social Security. She has that opportunity and therefore the dollars that she put in during her working years would have been for nothing. Now, just think of the difference if she could have put those dollars into a personal savings account that would belong to her, that at her death could be willed to a child or to a spouse. Thatís vitally important.

Women care a lot about taxes these days. Women are starting businesses at twice the rate of men. That is phenomenal. By the year 2000, half the businesses in this nation will be owned by women. This is important because it means that women are interested in benefits for their employees; theyíre interested in where payroll taxes go, Social Security, Medicare. But taxation affects them even beyond the way it would affect a man starting a business. For example, 84 percent of women use a certain portion, in most cases a large portion, of personal savings to start their businesses. So, capital gains taxes are very important. If a woman got to keep the dollars she would pay the federal government in capital gains taxes, for example, when she sells her house, that money would go into savings. So capital gains taxes are closely linked with business start-ups, which translate into freedom and independence for women.

This article originally appeared in the May/June 1999 edition of Cato Policy Report.