Cato Studies

July/​August 1995 • Policy Report

Studies, Forums, Testimony back Radical Tax Reform

As Washington and the nation begin discussing what to do about the increasingly unpopular income tax, Cato is poised as a major voice for changes that would make the tax system less burdensome economically and less destructive of civil liberties. In June Stephen Moore, Cato’s director of fiscal policy studies, testified before the House Ways and Means Committee, whose chairman, Rep. Bill Archer (R‐​Tex.), has vowed to radically change the tax system. Cato has become so identified with the cause of repealing the income tax that Sen. Richard Lugar (R‐​Ind.) used Cato’s F. A. Hayek Auditorium to announce that a centerpiece of his campaign for the Republican presidential nomination would be replacement of the income tax with a national retail sales tax. Cato launched discussion of that option in 1993 with a Policy Analysis (no. 193) by economist Laurence J. Kotlikoff.

In recent months the Institute has documented problems with the Internal Revenue Service and presented the benefits that would accrue from a sales tax in a Policy Analysis and at Policy Forums. Dan Pilla’s Policy Analysis, “Why You Can’t Trust the IRS” (no. 222), pointed out that the IRS often wrongly assesses taxpayers, provides incorrect information, and commits financial malfeasance. A Policy Forum on the flat tax featured Alvin Rabushka, long‐​time advocate of a flat tax at the Hoover Institution.

A Capitol Hill Policy Briefing, cosponsored with Citizens for an Alternative Tax System (CATS), featured a debate between proponents of the sales tax and of the flat tax, including syndicated columnist Jack Anderson; Norman Ture of the Institute for Research on the Economics of Taxation; Cato president Edward H. Crane; Washington Post columnist James Glassman; Victor Krohn, CATS executive director; Andy Laperriere, senior tax adviser to House Majority Leader Dick Armey; and Pilla.

An edition of Cato Forum, the Institute’s weekly television show on NET, the Political News Talk Network, also carried a debate over whether the sales tax or the flat tax was the best alternative to the present income tax. Crane contributed to a Reason magazine symposium on the two approaches to tax reform, and Moore argued for trading the IRS and most federal taxes for a sales tax in National Review.

In his testimony before the House Ways and Means Committee, Moore noted that the sales‐​tax and flat‐​tax proposals would have much in common: simplicity, a flat rate of 17 to 20 percent, an absence of special‐​interest exemptions, and consumption as the tax base. But, Moore said, “I favor a national sales tax because I believe that the income tax is incompatible with a free society. The IRS routinely intrudes on our basic civil liberties and privacy rights–and its intrusions are getting worse all the time. I want an America where it is no longer the government’s business how much money you make and what you do with it.” He concluded, however, that enactment of the flat tax might be a good intermediate step, with the transition to the sales tax coming later.

Moore set out a sales‐​tax proposal that included an 18 percent rate (gradually declining to 15 percent) on all final‐​use goods and services except housing and securities, a rebate for every American on the tax paid on the first $5,000 of purchases, collection at the state level, and a requirement for a two‐​thirds supermajority in both houses of Congress to raise the tax. Under the proposal, the IRS would be largely disbanded.

The news media and commentators have noticed the widening interest in lifting the weight of taxation on savings and investment so that the economy can grow and raise living standards. Cato will be in the forefront on the issue that will soon come to dominate public discussion.

Critiques of Crime Bills, Medicare SSI Costs Soaring out of control, study warns

Unless costs are controlled, the Social Security Supplemental Security Income (SSI) program will increase 60 percent by 2000, making it larger than Aid to Families with Dependent Children, food stamps, subsidized housing, the earned income tax credit, and all other forms of public assistance except Medicaid. So argues Christopher Wright in “SSI: The Black Hole of the Welfare State” (Policy Analysis no. 224). SSI paid $20.7 billion to over 6 million people in 1993. Wright calls for major reform and, ultimately, privatization to rein in what he calls a costly and corrupt entitlement program. He documents some of the more outrageous stories about SSI. For example, a Wisconsin father coached his daughter to put gum in her hair, act up in class, and earn bad grades. She won an $18,000 lump‐​sum payment from SSI, which allowed her family to buy new clothes and furniture and vacation in Florida. In a drug raid, police found a paper sack containing $5,000. The drug user later produced documentation showing the money came from SSI payments she received because of her heroin addiction, which qualifies as a disability under SSI.

Wright says changes made to the program in 1994 were a mere nod in the direction of needed reform. Current proposals by House Republicans, he adds, still fall short of the restructuring needed to correct for fraud, abuse, and misuse. Pending eventual privatization of disability insurance, Wright proposed that Congress end automatic cost‐​of‐​living adjustments and retroactive lump‐​sum payments, abolish assistance to substance abusers, and establish an enrollment cap.

Corporate Welfare Should Be Eliminated

A new Cato Institute study recommends eliminating 129 federal programs that funnel $87 billion of taxpayer money annually to private businesses. Stephen Moore, director of fiscal policy studies, and fiscal policy analyst Dean Stansel wrote “Ending Corporate Welfare As We Know It” (Policy Analysis no. 225) in response to a challenge by Secretary of Labor Robert Reich to identify “corporate welfare” that could be cut from the budget. The study criticizes the very concept of corporate welfare, calling it anti‐​consumer, anti‐​capitalist, and unconstitutional. Moore and Stansel say corporate subsidies create an uneven playing field, foster an incestuous relationship between business and government, and often support industries that would not be viable in a truly competitive business environment.

The subsidies identified by Moore and Stansel for elimination include nearly $100 million a year to Sematech, a consortium of microchip producers that includes Intel and National Semiconductor, two of the most lucrative companies in the microchip business; over $430 million for the Advanced Technology Program, the Clinton administration’s high‐​tech version of the Small Business Administration, which last year granted funds to such industry giants as General Electric, United Airlines, Xerox, Dupont, and Caterpillar; and roughly $2 billion to large, profitable electric utility cooperatives, such as ALLTEL, which had sales of $2.3 billion last year. According to Moore and Stansel, the most efficient way to promote economic growth is to reduce the overall cost and regulatory burden of government.

Time for a New Aid Policy

Congressional proposals for restructuring U.S. foreign aid programs do not go far enough, according to Cato senior fellow Doug Bandow in “A New Aid Policy for a New World” (Policy Analysis no. 226). Bandow says current proposals, which include merging U.S. AID into the State Department, would keep foreign aid schemes largely intact. Bandow questions noneconomic rationales for foreign assistance and refutes the notion that aid is now or was ever essential to economic progress. He criticizes the Clinton administrat ion’s attempts to preserve U.S. AID as well as conservative arguments that foreign aid fosters the development of free markets abroad.

Bandow cites, among other examples, the fact that dozens of countries are in worse economic shape today than they were decades ago when they began receiving U.S. “development” aid. Despite claims that South Korea and Taiwan are foreign aid success stories, economic growth occurred in those countries only after aid was cut off, writes Bandow. He notes that a recent study by the London School of Economics shows that aid does not increase investment or growth in recipient nations. He also points out that only 14 percent of food aid goes to alleviate emergency conditions; the rest amounts to dumping surplus U.S. agricultural goods on developing countries’ markets. Bandow writes that aid disbursed to Russia through the U.S.-financed International Monetary Fund has helped postpone, not promote, free‐​market reforms.

Alaskan Oil Export Ban Should Go

The Trans‐​Alaska Pipeline Authorization Act of 1973, which opened vast oil reserves around Prudhoe Bay for production, effectively requires that Alaskan oil be consumed domestically, not exported. As a result, writes Samuel A. Van Vactor in “Time to End the Alaskan Oil Export Ban” (Policy Analysis no. 227), petroleum development on the Alaskan North Slope and in California has been greatly restrained. The natural market for North Slope oil is Japan, Korea, and northern East Asia, to which oil can be shipped for about 50 cents per barrel, but North Slope producers are required to use domestic tankers and market exclusively in the United States and its territories, a mandate that has often resulted in shipping costs of $5 per barrel. That price distortion, writes Van Vactor, an economic consultant, has led to artificially low domestic prices for heavy crude on the West Coast, discouraging otherwise profitable exploration and production investments in Alaska and California.

The artificial inhibition of U.S. oil production has severe consequences for jobs and economic growth. Over the coming decades the cost could be as high as $125 billion and the loss of tens of thousands of well‐​paid jobs in petroleum development, oil‐​field services, manufacturing, and transportation. Given the massive costs and paltry benefits of the oil export ban, Van Vactor writes that Congress should act immediately to free the Alaskan oil trade and repeal the prohibition on oil exports.

Critics of Medical Savings Accounts Are Wrong

As the movement for medical savings accounts picks up speed in Congress, critics of consumer‐​based health care reform, led by big insurance companies, are mounting a counterattack. But the criticisms are just plain wrong, writes Michael Tanner, Cato’s director of health and welfare studies, in “Medical Savings Accounts: Answering the Critics” (Policy Analysis no. 228). In response to claims that buying health care is too complex for consumers, Tanner examines numerous studies that show that health care consumers can and do make cost‐​conscious decisions when given a financial incentive to do so. Tanner also writes that studies show that MSAs do not deter preventive care. Rather, savings result from reduced use of optional services and cost‐​based selection among competing providers. There is even evidence that MSAs increase the likelihood of seeking preventive care, particularly among low‐​wage earners.

Tanner answers the criticism that MSAs would drive up the cost of traditional insurance by attracting the healthy away from such policies by pointing out that companies currently using MSA‐​style health plans have not had significant problems with adverse selection. Indeed, Tanner says that the chronically ill may be among those who benefit most from MSAs. Tanner also argues that the poor would benefit significantly from MSAs. He concludes that, while MSAs may not be perfect, they represent a significant step in solving the problems facing the health care system.

GOP Crime Bills Threaten Liberty

The 1995 GOP crime bills introduced in the House and the Senate have flaws similar to those of past Democratic efforts to interject the national government into local crime prevention and law enforcement. So writes Jarett B. Decker, a Minnesota criminal defense attorney, in “The 1995 Crime Bills: Is the GOP the Party of Liberty and Limited Government?” (Policy Analysis no. 229). Moreover, the Republican bills contain unprecedented provisions that would threaten freedom and undermine the fair administration of justice. For example, writes Decker, the Senate crime bill would vest federal prosecutors with the power to have their opposing counsel indicted, without any finding of misconduct by the court, whenever the prosecutor claimed that counsel had made a false statement of fact or law in written arguments filed in opposition to the government. The Senate bill also includes a provision that would exempt federal prosecutors from the rules of legal ethics.

Both the Senate and the House crime bills would enable federal agents to invade homes, raid businesses, and conduct humiliating body searches without legal justification and to use evidence collected through such illegal searches. Victims of illegal searches could seek to recover only civil damages. Decker points out that the Senate bill would further enable federal agents to detain citizens, hold them incommunicado, interrogate them for days or weeks or months, and use any statements extracted during an illegal detention in a subsequent prosecution. He writes that if the crime bills pass, judicial authority will contract drastically, reducing judges to bureaucratic functionaries.

Congressional Remedies for Medicare Reform Fall Short

Congressional proposals to fix Medicare by increasing the payroll tax, raising premiums, pushing the elderly into managed care, and restricting payments to doctors and hospitals will not work, write Doug Bandow and Michael Tanner in “The Wrong and Right Ways to Reform Medicare” (Policy Analysis no. 230). The combination of the latest report from the trustees of the Medicare Trust Fund and the debate over balancing the federal budget has moved the need for Medicare reform to center stage. The trust fund, which finances Medicare Part A, will be bankrupt by the year 2002. Medicare Part B, which pays for physician services, diagnostic tests, and other outpatient services, is funded through general revenues and premiums from the elderly and therefore is not going broke. However, its rapidly escalating costs will add more than $100 billion per year to the federal deficit by the year 2000.

In response, many members of Congress have fallen back on the traditional remedies. But, write Bandow and Tanner, there is little evidence that any of those proposals will succeed in restraining the growth of Medicare spending. Many of those approaches will actually harm the economy, the health care industry, and the elderly. The authors say that Congress should seize the opportunity to fundamentally reform the Medicare system, transforming it from a first‐​dollar insurance plan to a back‐​up catastrophic program combined with medical savings accounts. Only through such a transformation of the Medicare system can the elderly be assured of access to the health care they need.

Cato Scholars work withCongress on Constitution, Social Security

Since the 1994 election, Cato Institute scholars have been working more closely than ever before with members of Congress. Cato staffers have testified more than 30 times before congressional committees.

Roger Pilon, director of the Center for Constitutional Studies, advised freshman Rep. J. D. Hayworth (R‐​Ariz.) on the formation of the Constitutional Caucus in the House, which is designed to “explore ways to return power to the states and the people and restore a limited, constitutional government” and encourage members of Congress to consider whether there is constitutional authority for each piece of proposed legislation.

Jerry Taylor, director of natural resource studies, chaired a task force that made recommendations to House Republican freshmen on the elimination of the Energy Department. He has testified on the issue several times and continues to work with Reps. Sam Brownback and Tom Tiahrt, both Kansas Republicans, on abolition.

Michael Tanner, director of health and welfare studies, is also heading up the new Cato Project on Social Security Privatization, which will be unveiled in August. He briefed the leader of a congressional delegation that recently visited Chile to look into how that country privatized its social security system. The report from the delegation to House Speaker Newt Gingrich urges Gingrich to meet with privatization architect Jose Pinera when Cato brings him to Washington in August. Rep. Mark Sanford (R-S.C.) plans to introduce a privatization bill soon, and Sens. Alan Simpson (R‐​Wyo.) and Bob Kerrey (D‐​Neb.) have included a partial privatization measure in their reform bill. Several members of Congress attended a dinner with Pinera at Cato in April, and Tanner has briefed others on the issue.

Stephen Moore, director of fiscal policy studies, has been a whirlwind of activity on tax issues. He briefed Sen. Richard Lugar (R‐​Ind.) and then acted as host when Lugar spoke at Cato unveiling his proposal to replace the federal income tax with a sales tax. Moore testified before the House Ways and Means Committee on the advantages of a sales tax and briefed dozens of senators and representatives privately. He also took a leave of absence to draft the House Republicans’ book Restoring the Dream, which describes their agenda after the Contract with America.

The Institute’s greatly expanded activities have given Cato’s ideas a real boost toward implementation, but they have also been very time‐​consuming for the policy staff. Fortunately, early in 1995 Cato hired its first legislative liaison, director of external affairs Leanne Abdnor, who has worked to make members of Congress and their staffs aware of Cato’s work and has coordinated dozens of Capitol Hill meetings for Cato policy experts. The Cato Handbook For Congress has been an important part of Cato’s involvement with Congress. It has been widely cited as influential and was seen most recently on two different editions of the CBS television show Sixty Minutes, first on Budget Committee chairman John Kasich’s desk, then on House Majority Leader Dick Armey’s desk.