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Bipartisan Tax Reform: A Modest Proposal

Irwin M. Stelzer

We are witnessing two absurdities: conservatives who believe that their traditional mantra of smaller government remains relevant in today’s world, and progressives who believe that it makes sense to double down on the policies that create the gravest threat to our systems of economic and political management since the Roosevelt (not really a) revolution saved both during the Great Depression and the run-up to World War II.

Making policy, economic and foreign, becomes a nonsense when the process ignores the context in which policy is made. It is rather like that old joke about travelers stranded on a desert island with only some canned food that has washed ashore. To open the cans, the economist among them advises, let’s assume that we have a can-opener. About as useful as what our political class is suggesting.

We are living in an economy that is growing, but only slowly. An economy in which the unequal distribution of income and wealth is increasing, the already-rich managerial and financial class is getting richer with the help of compensation systems that reward, er, well lots of things that inexplicably often count for more than performance. In which hedge fund managers and venture capitalists benefit from tax advantages that the middle class can only dream of, and corporate profits claim a record share of our national income. In which the central bank has set monetary policy to inflate the value of assets, exacerbating the difference between those who own homes and financial assets, and those who do not. In which workers are being displaced by imports from low-wage countries that subsidize their manufacturers with cheap credit, and by illegal immigrants who drive down wages in sanctuary cities and states that have decided to revert to policies of the Old Confederacy and interpose their wills between the federal government and the people. In which the medical needs of an aging population are increasing and in which young people see little virtue in capitalism and prefer the rantings of an aging socialist who promises free tuition, government health care and other free lunches, free lunches of the sort that welfare beneficiaries who manufacture electric cars for millionaires enjoy, with extra courses (tax breaks) thrown in. In which the federal deficit is pushing the national debt into dangerous, growth-stifling territory.

Disagree with one or two of the items on this list if you will. But try to create an alternative sketch of the economy and I am betting you will fail, just as you will fail if you try to sketch a picture of the world in which we live that is not beyond dangerous: a North Korean dictator we dismiss as mad but who has made the quite sensible decision that he does not want to follow in the path of Muammar Gaddafi, who gave up his nuclear weapons, or of Saddam Hussein, who really did not have weapons of mass destruction—both of them dead, and neither likely resting in peace. And terrorists, many of them home-grown, who are losing territory but not their followings.

In response to this world-as-we-find-it, our political class is offering the equivalent of that economist’s can-opener. The Democrats are concentrating on what the Russians and the Trumpkins did or didn’t do in the last campaign; how they might impeach the President or have him declared non compos mentis; who should have use of which toilets; a variety of gender issues of interest in Nancy Pelosi’s San Francisco; and on holding national defense budgets hostage to their desire to expand the welfare state.

Meanwhile, Republicans have formed a circular firing squad and are blasting away. At a time when income inequality is already on the rise they have culminated seven years of hard thought about health care with a plan that is tilted against the poor. And to cut income taxes mostly for the benefit of the highest earners. At a time when Kim Jung-un is playing with his nuclear toys, Vladimir Putin’s and Xi Jinping’s pilots are buzzing our planes, Iranians in little boats are threatening our giant destroyers and carriers, China is warning us to stay out of large swathes of the South China sea through which 40 percent of the world’s commerce passes while they build a blue water navy, and terrorists are increasingly bold, Republicans are refusing to increase funding for the military unless offsetting spending cuts, politically impossible and many undesirable, are made.

To begin to focus on policies that address real problems, start with this: Obama won. He set out to expand the welfare state in a way from which there could be no retreat, and he succeeded, much as did Franklin Roosevelt and Lyndon Johnson before him. What Obama constructed, no man can tear asunder, at least not completely. We now accept that people with pre-existing conditions are entitled to health insurance, and at rates subsidized by the rest of us, either through higher insurance premiums combined with a mandate to buy unneeded insurance, or higher taxes. In short, we find ourselves where we were after the Roosevelt revolution, where Britain was after the Thatcher revolution: Roosevelt’s expansion of the role of the state could not be reversed by the American Right, Thatcher’s shrinking of the scope of the state could not be reversed by the British Left. Some changes are irreversible, and all the huffing and puffing of the Rand Pauls cannot blow the entitlement house down.

Many years ago, Irving Kristol, the acknowledged Godfather of what came to be called neo-conservatism (before a more aggressive foreign policy was grafted onto that persuasion) argued that conservatives were wasting their energy and squandering political capital by attempting to repeal the New Deal and the welfare state that Franklin Roosevelt erected. “The idea of a welfare state,” he wrote, “is in itself perfectly consistent with a conservative political philosophy…. In our urbanized, industrialized, highly mobile society, people need governmental action of some kind if they are to cope with many of their problems: old age, illness, unemployment, etc. They need such assistance; they demand it; they will get it. The only interesting political question is: How will they get it?”

Kristol’s bottom line: whether you like it or not, live with the welfare state and develop conservative tools to improve its operation—market-based rather than regulatory approaches to social problems, programs that give weight to the problems of what his wife, historian Gertrude Himmelfarb, calls “the deserving poor,” without creating incentives to perverse behavior, such as dropping out of the work force. Now just might be the time for conservatives to treat the bulk of the entitlement state as Kristol urged conservatives to treat the New Deal welfare state: here to stay, ripe for improvement. Accept what’s on offer, concentrate on the little things such as work requirements that might make them more effective, and perhaps grandfather some of them—leave existing beneficiaries with what they have, and make less generous terms available to new entrants to whom the existing social contract has not yet been offered.

This takes on even greater urgency now than it did when Kristol wrote. In addition to the problems then apparent, we have to face the fact that trade unions are no longer sufficiently powerful to protect the interests of any save tax-payer-supported government workers who have been immune to the competition created by globalization—so far (he added in what he hopes is ominously). And that the loophole-ridden tax system is no longer sufficiently progressive to stem the tide of the rising inequality that is sapping support both for capitalism and democracy, nor sufficiently efficient to be other than a drag on economic growth. Turn attention, then, to the unmet needs of the poor and the military. If programs to meet those needs cannot be much reduced, and mounting deficits threaten eventually to trigger inflation that will be far more damaging to those who do not own shares and houses than those who do, we are left with one alternative: raise taxes. Yes, more rapid economic growth would solve a lot of our problems, but our ability to achieve that goal is uncertain. President Trump’s plan to deregulate strangled sectors of the economy will help, unless pushed to excess. And judicious tax reform will help. But to rely on growth to solve all our problems would involve a bet appropriate to the casino, not to the halls in which policy is formulated.

So, raise taxes. Not all taxes. Just some taxes. Leave others in place, or lower them, but only those with the greatest promise of stimulating growth. It is difficult to argue that the tax burden on the very rich is now so onerous as to stifle their incentive to work and take risks. Does anyone believe that failure to lower Warren Buffet’s tax bill will persuade him to give up investing and become a full-time bridge player? That unless we lower taxes on the moguls of Silicon Valley they will end their quest for the next revolutionary device or way of interconnecting, searching for information, delivering packages simultaneously with the receipt of an order, or perhaps even visiting Mars? So start with forgetting direct tax relief for our most prosperous and wealthy citizens. They have done rather well from the rise in their portfolios, a portion of which should be credited to the Fed’s zero-interest rate policy. Keep top rates where they are, and leave the surcharges built into Obamacare in place, which even Mitch McConnell now seems willing to abide.

Then turn to tax increases. It is difficult to mount a sensible argument for not taxing pollution, but the political time is not ripe for carbon taxes (according even to their most ardent supporters), though that time will surely come to meet rising financial needs and replace failed regulatory tools. But given rising inequality, and evidence that existing educational and other policies will make the good life more inheritable than easily earned, it is difficult to find reasons to oppose an increase in inheritance taxes. They affect very few tax payers; they increase incentives for disappointed recipients of inheritances to work and contribute their time and skills to adding to our income and wealth; they stop or at least slow the increase in inequality with which wealth and incomes are distributed. Warren Buffet says he wants to give his children enough money so they would feel they can do anything, but not so much that they would be able to do nothing. Bill Gates told Britain’s Daily Mail that he’ll pay for education and health issues, but his children are expected to find careers and support themselves while making a contribution to society. These billionaires plan to give away their fortunes, a way to privatize the tax system by directing their wealth to causes that they, not bureaucrats, decide is best. Others who don’t follow their example should face the prospect of high inheritance taxes. Not a lot of dollars to be had, but the symbolism of an effort to attack inequality is not unimportant. And while we are attacking inequality, there are a few bucks to be had by eliminating the cap on incomes subject to payroll taxes.

For real money we turn to border taxes. According to Kyle Pomerlau of the non-partisan Tax Foundation, a border adjustment tax “raises more than $1 trillion in revenue [over a decade] with little economic harm.” That is money lying on the table to help avoid politically difficult and in some cases inappropriate cuts in the growth of entitlements such as Medicaid, and to get our military in shape to meet its responsibilities. And, if the numbers work out, to permit increasing the progressivity of the overall system by lowering or eliminating workers’ portion of regressive payroll taxes.

The border tax is a favorite of Paul Ryan, but detested by those of his party fearful of the reaction of their districts’ Walmart voters—and by the President, not least of all, because of the tax’s complexity. It is difficult to imagine reasons for failing to impose a tax on imports from countries that apply Value Added Taxes to American exports. Complicated? What tax isn’t? Will a border tax raise prices on imported goods? Perhaps, but only perhaps. Most economists agree on a chain of relationships that will prevent significant increases in retail prices. Such a tax on imports will lower our trade deficit, thereby strengthening the dollar and making foreign goods cheaper for Walmart et al. to buy—sufficiently cheaper to offset the cost of the border tax. And even if the price of imported goods does rise, and even if that rise is borne in part by lower-income families, doesn’t that group still come out ahead given the enormous social and economic costs of unemployment driven by a flood of subsidized imports from China, and not only China? Put differently: is it wrong to attribute at least part of our $15.5 billion annual auto trade deficit with Germany to the fact that American vehicles sold there are saddled with a 20 percent VAT, while BMWs sold here pay only minor local taxes?

Economists generally agree that lowering corporate tax rates provides a far greater stimulus to growth than reductions in personal tax rates. So a lowering of the rate from its current statutory level of 35 percent (the actual rate after deductions is about 28 percent) is probably a good idea: it is agreeable to both parties, it should stimulate economic growth enough to recover part of the foregone revenue, and it should discourage corporate flight. At the same time, some existing deductions can be eliminated. The idea of lowering the tax rate and broadening the tax base is an unexceptional one, relied on in the days of Jack Kennedy and Ronald Reagan, who garnered bipartisan support for tax reform. Such comprehensive reform is probably beyond our grasp, “things being the way they are,” to borrow from the gamblers’ explanation in “Guys and Dolls” for the reason why “the back of the police station is out” as a site for the next big crap game.

But a few changes seem possible. It is generally agreed that the current system favors debt over equity, borrowing over investing, with the result being an excessively leveraged corporate sector. That can be corrected by eliminating the deductibility of interest on corporate debt, a feature that is driving up borrowing and leverage, and making equity uneconomically expensive. According to the Tax Foundation, ending the deductibility of interest on corporate debt would bring in $1.5 trillion over the next decade. Trump-haters should welcome such a reform, if not for its beneficial effects on the stability of the corporate sector, if not for the crimp it would put in leveraged buy-outs by private equity moguls, then for its damaging effect on the value of the assets the President has refused to disgorge. If Trump vetoes it, well, we tried.

Finally, a word about procedure. As things now stand, any tax cuts that extend beyond a ten-year budget window are forbidden. This, says “the business community” (if there is indeed such a thing), makes such cuts unattractive since businesses’ investment-planning horizon is much longer than ten years. There are two reasons why this rule is, well, ridiculous. First, the same far-sighted businessmen who claim to have a planning horizon that takes their vision beyond a decade know full well that the weight, if any, they attach to years eleven and beyond is slight, especially since by that time they will be sipping martinis at the 19th holes of their golf clubs. Business executives claiming such long vision are in many cases the very same who spend a good part of their time preparing for the next quarterly earnings report. Second, a tax cut once received tends to become permanent, especially one with a projected life of as much as ten years. When the ten-year expiration date rolls around, renewal is the norm, as was the case with George W. Bush’s tax cuts.

There you have a few ideas, none particularly original. Taxes on things we don’t like—tax -subsidized imports; inter-generational wealth transfers that sap incentives to work and increase income inequality; features of the code that result in an excessively leveraged corporate sector. Taxes needed to restore a bit of lost progressivity in the tax code, and to adjust an income distribution distorted by high earnings resulting from fiscal and monetary policies, rather than hard work and risk-taking. None run against the grain of our current economic and security requirements. In combination, they raise revenues that allow military spending and entitlements to meet our expanding needs; make a modest assault on inequality by tipping the playing field more in favor of the middle class and the poor, and away from the better-off; and probably add a bit of oomph to our economic growth rate. Conservatives get a serious assault on deficits and cash to bring the military’s capabilities more in line with its current responsibilities, liberals get taxes on the rich, none likely seriously to reduce incentives to work and invest, and cash to end threats to current funding of entitlement programs, reformed to increase their efficiency. Taken together, a conservative-liberal stew that just might prove palatable to the powers-that-be, palatable enough to give them an incentive to consider coming up with their own proportion of these ingredients.

The alternative is more of the same old, same old. The election of Donald Trump and his hostile takeover of the Republican Party, and Bernie Sanders’ almost-successful effort to have his Socialist Party engineer a hostile takeover of the Democratic Party, are warnings that the acceptability of democratic market capitalism as now practiced is headed to the ash heap of history. Our political class has nothing to lose but the chains that bind it to out-dated policies.

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