Taxing Issues

I agree with Mark about converting the estate tax to an inheritance tax. In fact, Mark’s argument is similar to the one made by Mike Graetz and Ian Shapiro in their excellent book, Death by a Thousand Cuts. The advantage of an inheritance tax is that it shifts the framing of the issue from the person who earned the money to the person receiving it. This also puts conservatives in the position of having to defend trust fund babies–Paris Hilton!– rather than virtuous businessmen. By treating money disgorged from estates as ordinary income, this might also have the salutary effect of simplifying the tax system overall, although there may be some important ways that you could game the new system (although so long as the alternative minimum tax stays in place, not many).

Speaking of the AMT, Robert Nelson had an interesting piece in the WaPo on the AMT, basically arguing that it’s not bad tax policy at all, but a stealth flat tax. In effect, the AMT wipes out a great deal of the value of deductions for those in the higher brackets, and with each year that it isn’t changed, more and more middle class people get pulled into the limited-deduction net. Nelson is in favor of the “full Monty” flat tax (that is, a single rate) in addition to having limited or no deductions. (broadening the base). I think almost all the economic advantages of the flat tax are a function of base broadening, and almost none a result of having a progressive rate structure. But I think the political logic works either way. The more (politically salient) middle class voters who have their deductions essentially AMT-ed away, the lower the resistance to doing so formally. The best part of the AMT is that it mainly hits higher earners, so with every year the tax take from upper earners increases. The real danger here is that the still relatively marginal impact of the AMT on the upper middle class will be hijacked by those who really get socked by the AMT, those higher up on the earnings scale (which is exactly what conservatives did with the estate tax).

This is a case where Democrats would do well to take advantage of the creeping flat tax by proposing a radical tax simplication of their own, one which would: eliminate almost all deductions (and if necessary preserve just a few, such as the state and local and mortgage deduction, as limited tax credits); bring back the estate tax as an inheritance tax; create a carbon tax to help deal with global warming without a lot of niggling regulation; attach this to sharply reduced, but progressive tax rates–and critically, make them very noticeably lower for middle class voters (who will be hit in a real way by the elimination of deductions and the carbon tax). This would be a very eye-catching issue for a Democratic presidential candidate (helping to do away with the image of the Dems as being out of big ideas) put the Dems on the side of radical simplification (which is also the side of economic literacy), and force the Republicans to argue directly against progressive rates, without the fig leaf of simplification on their side. Frankly, if I were advising a Democratic candidate, I would tell them to run on this and universal health care and nothing else. It’s even conceiveable that with the elimination of the tax deduction for employer health plans and some of the other deductions, that you could use the tax reform to pay for universal health care (although this might be a stretch, and would also force Congress to reform the health care and tax systems simultaneously, which would be a lot for the Ways and Means and Finance committees to chew). But if the Dems win the House in November, they could spend their first year hashing out the details of this, and then send it across to the Senate and make Republican Senators vote against it, thereby giving every Democratic Senatorial candidate a great issue to run on in 2008. Any takers?

Author: Steven M. Teles

Steven Teles is a Visiting Fellow at the Yale Center for the Study of American Politics. He is the author of Whose Welfare? AFDC and Elite Politics (University Press of Kansas), and co-editor of Ethnicity, Social Mobility and Public Policy (Cambridge). He is currently completing a book on the evolution of the conservative legal movement, co-editing a book on conservatism and American Political Development, and beginning a project on integrating political analysis into policy analysis. He has also written journal articles and book chapters on international free market think tanks, normative issues in policy analysis, pensions and affirmative action policy in Britain, US-China policy and federalism. He has taught at Brandeis, Boston University, Holy Cross, and Hamilton colleges, and been a research fellow at Harvard, Princeton and the University of London.

19 thoughts on “Taxing Issues”

  1. I'm with you – simple and clean. A flat tax and universal healthcare for all! Now how to convince the powers that be? Insurance lobby, hospital lobby, physician lobby. Do you really think they will support a decrease in their income? Universal healthcare will take the profits out of healthcare – currently at 16% GDP – which can be used to fund the system. Democrats cannot win because they are not or cannot be willing to stand up and make an argument – their profit is at stake.

  2. "I think almost all the economic advantages of the flat tax are a function of base broadening, and almost none a result of having a progressive rate structure."
    Since a flat tax, by definition, doesn't HAVE a "progressive" rate structure, I suppose that follows.

  3. Word, Brett. I caught that too.
    I've never gotten the attraction of a flat tax. All it would do, I think, is shift tax evasion to more creative redefinitions of income. Does anyone seriously think that any taxpayer with more than W-2 income is going to fill out the proverbial postcard and let it go at that? Nobody wants to give up the fun of trying to cheat the tax collectors. It's too deeply ingrained. (And I think it's healthy, too.)
    Progressive taxes are good. AMT, on the other hand, feels lousy. The one year I was lucky I really resented having to fill out the effing worksheet even though I didn't pay any extra. It's the unreasonableness of having a parallel system that's the problem, not the money, really.
    AMT maintains progressivity and it ought to be indexed to bring it in line with equivalent incomes to when it was adopted. Then it would just make more billable work for accountants of fairly well-off people instead of making a lot of technical work for relatively ordinary people.

  4. Steven, I'm a libertarian, and I'm not a fan of the universal health care proposal. But barring unreasonably progressive rates (I don't think marginal taxes should ever, ever go above about 40%), I'd support that tax plan all the way. Maybe not the best possible plan, but what is?

  5. What is so special about 40%? For the sake of full disclosure, I will state that I have no respect for libertarians at the outset. Functions of government such as funding basic research, education and similar things have helped bring us into the modern age.
    Though I don't know if it would be politically feasible, I would like to see a proverbial 'CEO tax'. This would basically entail very high marginal rates for "excessive" income. My suggestion would be 70% starting at $50 million and 90% starting at $100 million. A tax like this might be able to be passed if the electorate could be properly informed of what marginal rates actually are, and it would certainly help our deficits.

  6. I pay the AMT. It is time-consuming and annoying because I cannot answer simple questions about what effect it would have if I gave more to charity, etc. without doing lots of calculations. I do not see that it is helping anyone for me to spend lots of time doing calculations.
    I think the major reason for the AMT is to allow them to raise taxes without raising the top rate. We used to have a top tax rate of 92%. The republic functioned. Why is it regarded as ridiculous to suggest that we have it again?

  7. I'd like to see discussion of a flat tax on personal and corporate assets (aka wealth) instead of income. It puts the concept of taxes on a different plane, and contains built-in progressivity.

  8. Two comments:
    One deduction/credit that should be kept in some form is the child tax credit. (Income that goes to basic support shouldn't be taxed, IMO–that's the point of personal deductions and dependent deductions.)
    If you want to noticeably reduce taxes on the middle class, while implementing a carbon tax, you will probably have to cut SS taxes; my proposal would be to exempt half of median income from SS taxes–that would be a big, progressive cut.

  9. "Universal healthcare will take the profits out of healthcare – currently at 16% GDP – which can be used to fund the system."
    I suspect the quote is a massive oversimplification, but if it were true it would be an excellent reason to dislike the proposal–as profits are the best driver of innovation that has been seen in the modern world.

  10. Someone said:
    Insurance lobby, hospital lobby, physician lobby. Do you really think they will support a decrease in their income?
    Hillarycare failed not because it was a bad idea, but because Hillary forgot to let the 600 pound gorilla (the insurance companies) into the room. They didn't like being excluded, and they didn't especially like her proposing it. So they killed it and gave us all the stuff they said Hillarycare would bring.
    The insurance companies will still oppose single-payor versions of universal coverage, because it would put them out of business. In large part, insurance companies act as parasites on the health care finance system. Large corporations and government agencies are self-insured because of the federal incentives under ERISA. They hire Blue Cross, Aetna or whoever to act as their agent in forming preferred-provider networks, handling billing, and approving care. They collect a healthy fee for handling this, and do some insurance business for those can afford it but can't afford to self-insure under ERISA. In conducting this portion of their business, they mostly cherry-pick (defer insuring poor risks) and charge premiums as if they didn't cherry-pick. The insurance companies have what my father described as a "sweet lock on momma's gadget" and aren't going to give it up without a fight.
    Hospitals and physicians on the other hand, have mostly come to realize the problems inherent in the system (I'm reminded of the Monty Python Constitutional Peasant sketch, where Dennis yells, "Can you see the violence inherent in the system? CAN YOU SEE THE VIOLENCE INHERENT IN THE SYSTEM??" But I digress…) Hospitals came to the realization earlier than physicians, because alongside ERISA we have EMTALA (Emergency Medical Treatment and Active Labor Act). EMTALA requires that any hospital with an Emergency Department receiving federal funds in any form (which means to all intents and purposes, every general hospital) stabilize patients in their ER before discharge or transfer, regardless of their ability to pay for the services.
    So we have a libertarian's wet-dream of a health-care finance system for working adults. You are responsible for seeing to it that you're covered for health-care expenses. Except that, if you aren't covered for whatever reason (lost your job, employer decided he couldn't afford to offer health insurance any longer, you can't afford to pay your HI premiums, you were socially irresponsible and decided that you were healthy enough to go without insurance, whatever) and you turn up sick in an ER, the hospital has to treat you at least to the point that you can be safely released. Oh, and if the hospital screws up and you have an adverse outcome, you can find a lawyer to sue them and the physician. Then you'll be able to afford your health insurance premiums, or your family will. In theory the hospital eats the cost of providing this uncompensated care. Except, of course, they don't eat the costs. The charges to payors cover the cost of uncompensated care. That means higher rates to everyone who is paying into the health care finance system.
    Hospitals and physicians (primary care types especially) have recognized the Kafka-esque nature of this chaos (I can't call it a system without exploding my brain), and would like to see some form of universal coverage enacted.
    The problem in the libertarian view is that universal care is seen as inducing rationing of health care. What this ignores is that health care is rationed now. The problem is that our rationing system is based on the access to big pockets (my own or my employers) and not on effective delivery of health care.
    I'm getting off my soapbox now.

  11. Daniel, 40% isn't particularly special, I suppose, but it's a nice round number and in the right ballpark. I suspect 50% is too high; I'm absolutely certain that 90% is (yes, Andrea, the republic functioned, but functioning isn't a very high bar. It functions now. I still have things I want to change, and so do you).
    There are two reasons that tax rates that are really high disturb me. The first is the Laffer curve effect. Right now we're nowhere near the maximum on the Laffer curve, but the maximum has to exist somewhere. I'm told that it's somewhere in the area of 60%; 90% is certainly well over it. Not to mention, when tax rates are that high people are almost guaranteed to cheat, as well as wasting large amounts of resources trying to dodge taxes. The second, and more important, reason is that high marginal tax rates discourage risks. Most of our economic progress comes from people who start small businesses. The payoff structure for founding a startup often looks something like:
    50-60% chance of getting nothing
    30-40% chance of making a couple million
    0-10% chance of hitting the jackpot, making, generally, a few tens of millions.
    Really high marginal tax rates seriously hurt the payoff potential there, but do nothing to ameliorate the risk of loss, and thus act as a deterrent to creating startups.
    Your specific proposal I suppose doesn't effect these payoffs since the kick-ins start so high. However, I doubt you'd increase tax take too much (how many people actually realize an income over $50 million?), and you could easily discourage people from risking their money by investing in those startups—I'm told that most startups get there initial capital from a couple of relatively wealthy investors.
    Bargain Countertenor: I don't know what makes the current system a 'libertarian's wet-dream.' I certainly think that the health-care system is the second- or third-most screwed up area of governmental policy (the drug war is worse; the agriculture subsidy system is stupider but also smaller). I agree that the insurance companies in the current setup largely act as parasites, because what they offer isn't really insurance. I think the current reliance on employer-purchased insurance is amazingly stupid; I'd like to get rid of the tax advantages for company health-care plans (although I'm happy to consider doing this by giving a tax credit to individuals as well as or instead of taking it away from businesses).
    I'd like to see plans become available that have only catastrophic coverage, but come with a fixed annual premium. So I'd start paying in now, when the premiums are absurdly high given my youth and health; in exchange, I can still get affordable health insurance when I'm seventy. I suspect we'd have to work out a lot of details, but they seem to manage it for life insurance, and I think we'd see it in health insurance too if we didn't skew the market toward employer-paid benefits.

  12. Good luck trying to get rid of the mortgage insurance deduction!
    Any politician powerful enough to do that could probably mandate all jellybeans be the black licorice flavor, all senior citizens to wear thong bathing suits to the grocery store, and popular girls can't date anyone for more than three months.

  13. "when tax rates are that high people are almost guaranteed to cheat, as well as wasting large amounts of resources trying to dodge taxes"
    Yes, and when tax rates are low people also try to avoid paying them. Bitching about taxes is a sport; minimizing taxes is a civic responsibility; avoiding taxes is a popular game; and trying to get rid of taxes altogether is a central cultural value in the white South.
    I'm sorry, but these are social realities. There will never be agreement that any taxation system is optimal, no matter what it is. There will always be grumbling and there will always be high-income people who hire others to find ways to minimize their taxes.
    In theory I suppose it's possible that some high-income person is going to avoid investing because of the bogey of higher marginal rates, maybe. But it's a big leap for me to go from the fact that people bitch and avoid, to the idea that they'll actually avoid making money. 30% of an additional dollar is still 30 cents more than I have now, isn't it? And if it doesn't pan out I can deduct the whole wad. Maybe I just don't understand really rich people.
    To me, the Laffer curve is an intuition without any empirical backing that I know of; it takes at face value the bitching we all do about taxes and would all do regardless of the tax regime.
    Taxes, to me, are like any other adversarial system. The adversaries have to be viable. When one of them gets everything it wants and destroys the other, the system is all broken and everybody is worse off. Unions are the best example. Adversarial systems are aggravating and clumsy and never reach equilibrium, and are wasteful too. But they're one of the basic elements of how we do business. We break them at our peril.

  14. Jagadul,
    I said the current system for working-age adults is a libertarian's wet dream. That's actually a mis-statement, because if you consider EMTALA as a stupidly constructed safety net the system isn't anyone's dream.
    What I should have said is that the apparent current system is a libertarian's wet dream. In between the age-eligibility for Medicaid and Medicare (MediCal and Medicare in California) the system basically says you're on your own. Do the best you can.
    That's not the actual system, because we do have safety nets like EMTALA and Medicare for some disabled workers, etc. It's also very sub-optimal in terms of providing health care.

  15. Altoid: the higher tax rates are, the more incentive you have to avoid taxes. There's some tax rate x at which my spending y of my money to shield z of my income from taxes becomes profitable. The higher x is, the higher the y/z ratio goes and the bigger y gets, so the more money will be spent ducking taxes. In other words, we'll never have anyone think his tax burden is low enough, but we can keep it low enough that it's not worth the effort to spend tens of thousands of dollars and hundreds of hours worrying about it.
    The investments I was worrying about were high-risk, high-payout investments. As in, one where I risk five million for, say, a potential payout of fifty million. This might easily be worth it if the fifty million will be taxed at 30%, but not at all if it's taxed at 70%. Since a lot of startups are funded by that model, I'm concerned about the effect of extremely high marginal tax rates even on the extremely rich; and if we follow Daniel's suggestion, we don't even get very much money. Looking at Forbes's list of top-paid CEOs, only three made over $100 million and only thirteen over $50 million. You'd get $340 million taxed at 70% and $210 million taxed at 90% for a total take of a little over $400 million. Now, that's a lot of money for me, but basically wouldn't affect the government's deficit at all— that's what, two bridges? There are probably more people who make over $50 million a year; on the other hand, those guys probably didn't realize all their income, and neither would the others. I'm confident that Daniel's plan would net the government, at most, an extra billion dollars or so. Useful only for rhetorical purposes. If you push the brackets lower, so that they actually affect more than a couple dozen people, you start screwing with entrepreneurs who may be dissuaded from starting businesses by the tax rates that eat into their payouts.
    The Laffer curve in it's most general sense is pretty inescapable. When marginal rates get near 100%, people have no incentive to make more money. So there's some amount below 100% that maximizes total government take. I'm pretty sure that we're well below that number (I hear economists have estimated it at about 60%); I'd like to keep it that way.
    Bargain Countertenor: at least among the libertarians I hang out with, it's hard to find a subject that attracts more bitching than our current health care setup (once again excepting the war on drugs). I almost think universal health care would be preferable to the current system, simply because what we have now is so stupidly designed that I think it would take real effort to design a worse system. Do the things I said already, kill licensing requirements for doctors and allow the pharma companies to sell drugs without FDA approval, and then maybe it'd be a libertarian wet dream. Right now, it's just a pile of crap.

  16. First, an irrelevant point, jadagul, I would argue that you are not necessarily a "true" libertarian. My harsh comments previously stem from the fact that I attend a public university and frequently hear libertarians (who are also students at this university) arguing against the public funding of education. This, astonishingly, strikes me as hypocritical and perverse.
    Now on to more interesting points. My plan would very likely create more revenue than you might expect. According to the IRS (link below), in 2003, the adjusted gross income of people making $10 million or more was $159,126,112. Making a rough guess, I would guess that at the marginal rates I described above, tax returns would hit 40-50% on that income. Obviously, such an amount would not solve our budget problems, but would at least help. Secondly, my reasoning in proposing such a tax is not exclusively for its revenue. The ratio of highest paid worker to lowest paid worker is getting out of hand in this country. I would like to see this tax because it would create a demotivation to earn money above and beyond these obviously excessive levels (hence the moniker I gave it).
    Finally, I would argue that it would not harm business investing as (to the best of my knowledge) the majority of venture capital fudning does not come from individuals. It would seem to me that it would be more fortuitous to set up some other form of financial entity where you can adjust income based on previous losses and investment measure to minimize the volatility inherent in that type of investing.

  17. Jadagul: Yes, higher rates raise the amount of money people are willing to spend in tax avoidance. (I doubt, by the way, that accountants and tax lawyers would agree that the money's being spent unproductively. And in a consumption-based economy they may have a good point.)
    What I'm saying is that we need to do more than rely on complaints and guesswork for learning what the relationship is. Since we've fiddled with rates a lot in the past 50 years, we have some empirical basis for figuring out whether it's roughly linear, or whether there's an inflection point above which avoidance spending takes off, or whatever. Of course historical conditions have changed over that time, but at least the data would be a start.
    In any case, I think understanding the relationship should be *a* factor in determining tax policy but not *the* determinative one. Polities are about much more than economic efficiency.
    On the venture-capital thing, I guess I really *don't* understand rich people. Let's say I can throw 5 mill at something on at least a 10% chance it'll gain me 50 (because if I do it at longer odds I'm probably a gambling addict, right?). If I lose, the whole 5 mill is a write-off against my other activity. If I win, 45 mill X 30% is still 13.5 mill, so I've nearly tripled my after-tax money on a 10% long-shot. That's hard to beat at the tracks. If I do it five times and hit once, a 70% rate still leaves me 7.5 mill richer by my calculation. (By definition, if I do this ten times to hit once, the only tax rate that has me breaking even is zero. But that neglects the write-offs.)
    But while VCs might be an issue, they're certainly not the bulk of high earners. High earners who get dividends (and the bulk of individual stock-holders are, surprise, high-asset, which implies high-earning) already have most of that income favored. Ditto capital gains. Why interest income has escaped is beyond me, unless it's because interest is the one form of non-work income that most people have some access to. (In case you think this is sour grapes, I do benefit a little bit from the favored treatment, but I think it's not a great idea absent some stronger arguments than I've seen.)
    In any event I certainly wouldn't base my national tax policy on the stated needs of a small group of people like VCs who, for the amounts of money involved, can certainly find lawyers capable of developing a reasonably protective corporate, LLC, or partnership structure.

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