Yesterday, Erskine Bowles and Alan Simpson, Co-Chairs of the President’s National Commission on Fiscal Responsibility and Reform, posted a 50 page powerpoint presentation on its website, their Draft Proposal to reform tax policy and put America’s budget back on a sustainable path. In the area of cost reductions, I commend them for the effort. They set forth a meaningful, yet understandable, discussion of the nature of changes which need to be considered and implemented in order to rein in rampant government growth and reduce our federal disbursements. The bulk of their “illustrative cuts” in both Defense and Domestic spending should be implemented immediately. One may quibble with the estimates and/or achievability of certain of the cost reductions, but they require no changes in law or extended debate – they simply require Executive and Congressional action. The fact that they have not been addressed or implemented by Congress or the White House, and need to be articulated by a “nonpartisan commission” is a clear and simple indictment of our governmental dysfunction.
Unfortunately, on the revenue side, I cannot provide Mr. Bowles and Mr. Simpson with a similar commendation. Despite their oft-repeated insistence that “everything must be on the table” they have turned a blind eye to the fundamental inequity of our existing tax revenue policies. They have neither acknowledged nor addressed the fundamental bias our tax policies have in favor of the already wealthy. By ignoring this fundamental problem I believe they have set forth a proposal which would actually increase those inequities. By my reading, their plan has two primary flaws. First, it raises tax rates on investment income in precisely the manner which most economists have advised for years would stifle growth and investment. Second, it makes our existing regressive policies still more regressive and does nothing to slow or reverse the steadily increasing concentration of wealth in our society. I believe their proposals would increase the existing counter-productive incentives which stimulate tax avoidance strategies, thus slowing economic growth, and accelerating wealth concentration.
Buried in a footnote on slide 24 they state that “all options … treat capital gains and dividends as ordinary income”. If they have summarized their estimated impact of that assumption anywhere I did not find it. Nor did I find any discussion of the pros or cons of such an action. But the existing justification for granting capital gains and dividends preferential reduced tax rates is fifty plus years of economic advice and opinion citing higher taxes on investment income as an impediment to economic growth. If the economic community has suddenly stepped forward and rescinded their previous opinions, I somehow failed to receive the memo.
I am a staunch and vociferous critic of preferential tax treatment provided to the wealthy, and I have no doubt that the intention of the Co-Chairs’ proposed increase in tax rates upon investment income is to address this inequity, but I question the judgment behind this proposal. History has repeatedly shown that higher tax rates imposed through our existing structure are counter-productive. Having left the deferral for unrealized gains in place, the Co-Chairs’ Proposal will have the easily foreseeable, though presumably unintended, result of exacerbating existing preferences that obstruct the productive redeployment of capital. Investors will react in precisely the manner economists have been cautioning against for years; those wealthy enough to do so will reassess their capital allocations with an eye sharply focused on tax preferences, hiding income, and trading capital gains and dividends for unrealized gains. So long as they can obtain higher returns at less risk through tax avoidance strategies than via growth strategies, investors will favor tax avoidance strategies. Why has the Commission not addressed these deeply ingrained preferences? Where are the structural changes needed to eliminate these counter-productive misincentives? Where are the pro-growth innovations and reforms we need in order to pull the economy out of the doldrums?
Moreover, the Simpson/Bowles’ proposals do nothing to shatter the Myth of Progressive Taxes. The combination of employment taxes and income taxes will continue to leave the working middle class paying a higher marginal tax burden than the wealthy. For the past roughly fifty years we have collected more in employment taxes than we have paid out in benefits – and we have used it all to fund structural current deficits. But we persist in calling employment taxes “contributions”, and claiming that nearly half the population pays no taxes – thereby derailing productive, rational and honest debate about the true distribution of the costs of government. The Commission is perpetuating these intellectually dishonest misrepresentations. Where is there recognition that the social security trust fund is already devoid of assets? The Commission takes a short step forward by proposing to increase the cap on taxable wages. But why slowly over time? How do they keep a straight face when they state (on slide 46) they will “prevent rapid build-up of the trust fund” – as though that were desirable? The retirement savings funded by the public over the last fifty years has been squandered, replaced with IOU’s backed by nothing more than the government’s promise to raise future taxes or borrow more money. The Commission has devoted the bulk of its discussion of Social Security to suggestions about how to start breaking the promises made over the past fifty years. But they persist in perpetuating the misrepresentations through which government shields the privileged asset-holding elite from bearing a fair share of the costs of the important social programs which now represent half of federal outlays.
Effective tax reform will require a more honest assessment of our current situation, followed by a fundamental shift in the structure of tax revenue policies. (Specific proposals of the type of structural modifications I think are required can be found elsewhere on this site.) The Commission has done a commendable job of illuminating the issues and opportunities which need to be confronted in order to start controlling Defense and Domestic program disbursements. Now we need to send them back to the drawing table to confront and address the inequities of our revenue policies.
Comments, replies and rebuttals are invited and will be welcomed.
Author – A Citizen’s 2% Solution: How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget.