A Citizen's 2% Solution

How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget

Rivlin/Domenici: Political Insiders deliver another Regressive Tax Proposal

In the past month two highly respected, extremely experienced alliances of leaders have set forth competing, yet similar, proposals to reform tax policy.  Alan Simpson and Erskine Bowles, Co-Chairs of the President’s Commission on Fiscal Responsibility and Reform and Pete Domenici and Alice Rivlin, Co-Chairs of the Bipartisan Policy Center’s Debt Reduction Task Force have brought forward plans they claim address our fundamental problems.  I believe both groups have demonstrated the same failing: an unwillingness to confront the deep inequities in our existing tax revenue policies.  I could lapse into anger here and accuse them all of being Crony Capitalists.  But instead perhaps I should take a more generous and forgiving attitude and attribute their failings to too much experience

It is much, much easier for someone who is curious and uninformed to accurately evaluate new facts than it is for someone who brings preconceived opinions to the task – particularly when those preconceptions have been developed based upon erroneous or misrepresented facts.  The reason is simple:  human nature.  As a species we have a remarkable capacity for forcing new facts into our preconceived view of the world.  Changing a fundamental precept of one’s world view is extraordinarily difficult – particularly when doing so requires one to admit personal complicity (whether witting or unwitting) in a longstanding problem.    

Both groups have undertaken to address the elephant in the room – America’s unsustainable budget policies.  Before I become too critical I should note that it is a worthy task and they both appear to have done a commendable job evaluating the disbursement side of the equation – discussing at length the irrational and irresponsible choices that our Executive and Congressional leadership have been making about how to spend our money.  Here their experience appears to have served them well.  Certainly their understanding of the intricacies of specific disbursement programs is much better than mine and while I’m sure there is room for argument and tweaking, I am confident that their cost reduction recommendations are fundamentally reasonable.  I could, of course, complain that there is really nothing new in their proposals; our government’s irresponsible lack of discipline on the spending side is very widely understood.  The absence of disbursement controls does not arise from lack of awareness; it is the result of Congressional irresponsibility and dysfunction.  But a complaint like that might seem churlish.  So I commend the Commissions.  Yet I fear that absent an even-handed approach to reforming our revenue policies their efforts will seem unbalanced and thus will fail to collect required support. 

Unfortunately, in my opinion both groups have formulated revenue proposals which are deeply flawed.  The revenue flaws in both plans, though different between them, arise from the failure to acknowledge or address the Myth of Progressive Taxes, defined and discussed nearby in a separate post.  In fact, both plans make existing policies worse. 

I’ve previously covered my assessment of the Simpson/Bowles plan (see here), so I will focus now on Rivlin/Domenici Bi-Partisan Policy Center’s (“BPC”) proposal – which is, in any event, the more interesting of the two revenue plans. 

Commendably, BPC has recognized that recovery from the recession is a goal that deserves at least equal priority with debt reduction.  However, it appears that they view the recession as a temporary decline in GDP – and thus make the mistake of believing that a temporary stimulus can lift us back to a viable “normal”.  I conclude that to be their belief because their stimulus response is the politically popular “payroll tax holiday”.  The payroll tax holiday proposal has acquired many supporters who believe that by quickly and widely putting more cash in the hands of the working public and operating businesses it will lead to a prompt increase in consumer spending and business hiring without either a) encountering the delay of government implementation planning or b) risking creation of new government spending programs which have a well-known history of self-perpetuation.  If I believed the recession was a temporary blip, I too might favor prompt temporary stimulus.  But I do not.  Let me explain my reasoning. 

As a long time consultant to troubled companies one of the first tasks I generally undertake when stepping into a fiscal crisis is to examine what the true historic norm has been.  All too frequently, particularly when booms suddenly turn into busts, re-evaluation of the facts suggests that reported history has been either misstated or misinterpreted. 

I’ve not seen anybody yet do that with our economic data.  I don’t have the data available at my fingertips to make that analysis in detail, nor the space to illuminate it here if I could.  But the broad strokes are pretty self-evident.  For at least a decade and a half we have been living beyond our means, using artificially inflated real estate equity (created by government and mortgage market policies and practices) to fuel spending.  That artificially inflated spending overstated normalized GDP but the structural under-pinnings of the economy were unsound.  For two years the bulk of our government’s reactive policies toward our recession have been aimed at trying to re-inflate the bubble.  Stimulus programs today are inflating current GDP.  In my opinion we’ve actually prolonged the problem with our reluctance to recognize the need for structural change.  The popular complaint that our problem persists because banks aren’t lending money is largely hogwash.  Most businesses don’t need more credit, they need more customers – and with unemployment at just a hair under 10% it doesn’t require an advanced math degree to see that one out of every ten potential customers is standing forelornly outside on the sidewalk, unable to enter the store.  One out of seven, if you include the “under-employed”. 

So, that being the case, explain to me why we should believe a “temporary” policy which puts more money in the hands of the people who do have jobs is going to change that dynamic?  Do we think they won’t notice that their personal situation and our collective situation both remain tenuous?  Do we think that the employer portion of the employment tax holiday, which will reduce payroll costs this year, will induce employers to add staff now while ignoring the normalized future costs of doing so?   If so, are we prepared to deal with the layoffs that will result as soon as we attempt to end the “holiday”?  Do we think either or both the employers and employees who receive these temporary income boosts will fail to notice they are only temporary in nature?   Temporary programs are not likely to lead to fundamental strength.  We need to be focused on reliable long-term policies.  There are some today who pooh pooh the “uncertainty” argument as explanation for a slow recovery.  But there is no uncertainty about the fact that costs are rising now and taxes are going to rise soon. 

Which of course brings us to the core of the BPC tax proposal – its 6.5% national sales tax which they characterize with a feel-good “debt reduction” designation.  Sales Taxes are regressive in nature – regardless of how you try to characterize them.  They fall heavily upon those among us who consume all their income, while the more fortunate and successful among us who do not need to consume all their earnings are shielded from the obligation.  Thus, the civic sacrifice of contributing to “debt reduction” is to be allocated heavily toward the less fortunate among us.  Rates across the board will fall, tax expenditures will fall, but the benefit of both these changes will tend to also skew most favorably toward the higher earners.  Provision for some protections for the lowest income earners appear to be incorporated in the plan, but by my perspective, if you favor the rich and favor the poor, you must be squeezing the middle class.  If I’ve missed something, please let me know.  But that’s how I interpret the proposal. 

Today, despite a great deal of semantic posturing, we have a very regressive tax system.  Our “progressive” rate schedules, which are subject to more exceptions than compliance, apply to no more than 20% – 25% of the total federal/state/local tax burden.  The wealthy receive far more benefit from social security contribution caps and treatment of investment income than is extracted by those progressive income tax rates.  (I won’t cite my full arguments here, but again will urge you to look at the analysis nearby.)  Rivlin/Domenici on behalf of the BPC have published a proposal I can only interpret as making our policies even more regressive. 

The BPC summary claims its plan is realistic and “politically viable”.  The hope, apparently, is that the temporary gift of a payroll tax holiday for the working middle class (which I believe will be ineffective in stimulating structural economic improvements) will garner broad support.  But I believe the real political viability of the proposal resides in the fact that it offers new long-term permanent preferences for existing holders of accumulated wealth – who (coincidentally?) comprise the politically influential. 

Nearly a century ago, America discerned the fact that over-reliance upon consumption taxes was an obstacle to growth and resulted in an inequitable burden upon the lower classes.  In response our leadership championed a constitutional amendment which led to the implementation of and our current reliance on income taxes.  Today, our tax policies once again are obstructing growth and placing an inequitable burden upon the lower classes.  Balancing the budget by imposing a national sales tax (or a VAT) would be a step backward, not forward. 

I believe that effective reform will require a substantial re-thinking of the existing preferential treatment provided to holders of accumulated wealth and a structural change in tax policies toward investments and investment income.  But unless and until our leaders are willing to confront the facts of those preferences, I see little hope of meaningful progress.  The collective economic judgment that higher taxes on investment income will result in slow growth has been used as justification for allowing our wealthiest and most successful citizens to pay lower tax rates on investment returns than the working middle class pays on the fruit of its hard physical and intellectual labor.  Instead of using smoke, mirrors and semantic nonsense to hide the fact the rich pay lower rates, we need to confront that reality head-on.  If we would, I believe we could find a more equitable alternative. 

If the investment class paid tax rates comparable to what the working class now pays – we would have a balanced budget today.  Make that your new perspective, and suddenly the challenge changes.  It is no longer, “How do we hide (or justify) the fact the rich are paying less?”  Or, “How do we raise taxes without affecting the investment classes and thereby slowing growth?”  It becomes, “Is there a different tax structure we could use which would allow us to normalize tax rates between labor and investments without resulting in recession or slow growth?” 

Elsewhere on this site you will see that I believe there is such an alternative structure, one that taxes accumulated wealth with a nominal constant assessment – effectively taxing its earnings potential at a rate consistent with existing earned income tax rates.  It removes the subsidies paid for non-productive or lower return investments and rewards the most efficient and profitable allocations of capital – thus, hopefully, stimulating more rapid growth.  My proposal may not be the best solution, but at least it addresses the challenge.  But so long as our major reform efforts are guided by insiders who seek to hide the inequities that now exist – don’t expect them to either embrace my proposal or discover a better solution. 

If someone from the economics field would like to step forward and instruct me in the error of my perspective, I’d be happy to listen.  If someone can explain to me the benefit of consumption taxes that overrides their fundamental regressive nature, I’d love to hear it.  If someone can explain to me why the wealthy really should be paying lower tax rates than the working middle class, I’m all ears.  Explain to me if you can, please, why the American public should be expected to support reforms that move toward even more regressive policies.  

Absent such explanations, I would like to urge our leadership to go back and confront the inequity of our current tax structure.  I don’t advocate imposing higher tax rates on the rich than on the middle class.  I’m just tired of subsidizing their lower tax rates – and suggest our leadership ought to be addressing that reality.   

Comments, replies and rebuttals are invited and will be welcomed. 

Douglas Hopkins

Author – A Citizen’s 2% Solution:  How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6

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One Response to “Rivlin/Domenici: Political Insiders deliver another Regressive Tax Proposal”

  1. [...] of the income tax.  They suggest replacing it entirely with consumption taxes.  Others (like the Rivlin/Domenici alliance who broke with the Chairs of the President’s Commission to offer a competing proposal) [...]

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