On Tax Reform, Remember Adam Smith

On Tax Reform, Remember Adam Smith

The only word to describe Friday’s job report is ugly. The private sector created only 118,000 new jobs in September, early estimates of job creation in July and August were lowered, average hourly earnings dropped a tiny bit, the labor force participation rate dropped to its lowest level since October 1977. Nothing here to justify the Federal Reserve Board’s policy gurus in raising interest rates, and much to make them happy that they withstood pressure to raise rates in the past. And a great deal of support for revising the nation’s tax code to get the economy moving ahead at a faster rate. Which all candidates for both parties’ presidential nomination propose to do. With reason.

The current tax code is a nightmare. Spread across 74,608 pages (up from 8,200 after WWII), the code forces Americans to waste 6.6 billion nerve-wracking hours and spend about $200 million filling out the many forms. One estimate has compliance costs at 20 percent of collections, which might have set Adam Smith spinning in his grave. (In Wealth of Nations, he wrote, A tax may take out  of the pockets of the people a great deal [because] levying of it may require a great number of officers, whose salaries may eat up the greater part of the produce of the tax.)

The rates are the highest in the industrial world; the treatment of foreign earnings so draconian that American companies are using a technique called inversion to buy foreign companies and transfer headquarters and jobs to the foreigners’ countries; and the form-filling burden so complicated that the Internal Revenue Service could respond to only 37 percent of befuddled tax-payers’ pleas for assistance, leaving 8.8 million calls unanswered. (Cf. Smith, the time of payment, the manner of payment, the quantity to be paid ought to be clear and plain to the contributor). The principal beneficiaries of the current system are the lawyers and accountants who devise legal means of enabling their rich clients to avoid the full swish of the IRS axe, and lobbyists hired by companies and individuals to persuade legislators to lace the tax code with obscure clauses that reduce the effect of the government’s rapacity on their clients.

Candidates competing for their parties’ presidential nomination have a solution: put me in charge, tax reform and gifts for all, or almost all, will follow. Democratic Santas are offering a variety of goodies  college tuition, more spending on infrastructure, expanded entitlements, single-payer NHS-style health care (this goodie is also on Donald Trump’s sleigh awaiting delivery). The bills will be sent to voters in the form of higher taxes, mostly on the rich. Republican Santas are offering gifts of an entirely different sort  enabling voters to keep more of their own money by lowering a variety of tax rates. Like their Democratic counterparts, they say these gifts will come at no cost, because the growth they stimulate will generate enough new tax revenue to be self-financing.

Perhaps. But if they are being overly optimistic, revenues will be insufficient to prevent the federal deficit from rising. And that means the beneficiaries of the lower tax rates will be passing the cost on to their children, who will face either higher taxes to cover interest costs on the debt, or a reduction in the purchasing power of their pay checks if future governments trigger inflation as a way of reducing the real burden of their inherited debt. In short, raise taxes and redistribute (Democrats), lower taxes (Republicans), and growth will accelerate.

Bernie Sanders, the Socialist vying for the nomination of the Democratic Party, would raise taxes on the rich and on employers to fund some $18 trillion in new spending over the next decade, a one-third increase over the current level of government spending. Hillary Clinton proposes to raise the capital gains tax rate on high earners who hold their stocks for less than six years, and spend it on a variety of new entitlement programs. That, she claims, would end the tyranny of today’s earnings reports and induce business to make the long-term investments needed to support rising wages.

On the Republican side, most candidates would exempt more Americans from paying income taxes, indicating that they failed to consult their undoubtedly dog-eared copies of Wealth of Nations, in which Smith advised, The subjects of every state ought to contribute towards the support of the government. Typically wise advice. Already almost half of Americans pay no income taxes, instead being subject to the horribly regressive payroll tax. With the link between income tax paid and benefits received broken, voters have an incentive to demand more and more costly benefits  to be paid for by someone else.

Donald Trump and Jeb Bush would lower the top personal rate from 39.6 percent to 25 percent, but Trump would apply it only to couples earning more than $300,000 per year, as opposed to $100,000 now. Married couples earning less than $50,000 per year would pay no income tax at all under the Trump plan. But the paper-pushing hedge-fund guys. who are getting away with murder would lose their special tax breaks, a proposal with which most other candidates agree  testimonial to the power of rising income inequality as a hot-button issue.

Jeb Bush would cut the 35 percent corporate rate, the highest in the industrial world to 20 percent, allow immediate 100 percent deduction of new capital investment, and supplement the take-home pay of low-income workers. Perhaps most interesting is Bush’s proposal to eliminate the deductibility of interest paid on corporate borrowing. With such interest deductible, but dividends paid out of taxable profits, corporations have a huge incentive to borrow to finance their expansion, resulting in excessive leverage, in the jargon of Wall Street, and creating systemic risk. Think Lehman Brothers. Florida senator Marco Rubio is sponsoring a similar reform.

Some Republican candidates are more radical. Trump’s closest rival at the moment, neurosurgeon Ben Carson, favors a flat tax, which he originally proposed be set at 10 percent, a tithe on all incomes, because I think God is a pretty fair guy  so there must be something inherently fair about that. When critics pointed out that such a tax would not hoover up enough revenue to run the government, Carson amended his proposal to a flat 11.5 percent income tax rate and a 4 percent value-added tax on all retail purchases. Several other contenders for the Republican nomination also favor some form of a flat tax, in the range of 20 percent. This has great appeal to the IRS-haters among core Republican voters, (Cf. By subjecting people to the frequent visits, and the odious examination of the tax-gatherers, it [a tax] may expose them to much unnecessary trouble, vexation, and oppression.) but has the defect of uniting all those whose benefits are to be whisked away.

Homeowners who now deduct the interest on their mortgages, corporations that deduct the interest on their massive borrowings, philanthropic organizations that rely on the generosity-enhancing effect of the ability of donors to deduct their contributions from their taxable income, and the hedge-fund guys will form a coalition against reform sufficiently powerful to leave the flat-tax proposal where it has been for decades  in the file cabinets of academics and unserious politicians.

So all of these early-day Santa Clauses have promises to keep. But miles to go before the winner, his own stocking nailed to the White House mantle, will face the problem of keeping them. If he remembers them.

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