Taxes: Why tinkering beats wholesale overhaul

November 19, 2012

The fiscal debate which is just beginning in Washington is the political equivalent of trench warfare: the two sides have strongly-held positions, and the confrontations are going to be held on a thousand different fronts. In the end, there will be some tax-code changes here, some spending cuts there — but the baseline is the status quo, and the further that a plan deviates from the status quo, the less likely it is to get adopted.

Fiscal policy, in other words, is like healthcare policy: it’s path-dependent. There are lots of things that in an ideal world virtually everybody would like to see the end of; the mortgage-interest tax deduction is only the most obvious. But you can’t get there from here. What’s more, it’s incredibly difficult to get anything brand-new into the mix. I would love to see a carbon tax, and a financial-transactions tax, and a wealth tax — all of them are more attractive than an income tax, and some combination of them would be much better. But the point is that we’re not starting from scratch, which means that according to the rules of politics, we basically have to go to work only with the tools we have.

And yet, every time there’s a big problem, thinkers start coming out with big solutions. Bloomberg View, for instance, has a classic QTWTAIN headline: “Could 18th Century’s ‘Sinking Fund’ Solve Fiscal Cliff?” And at the NYT, Daniel Altman proposes this:

American household wealth totaled more than $58 trillion in 2010. A flat wealth tax of just 1.5 percent on financial assets and other wealth like housing, cars and business ownership would have been more than enough to replace all the revenue of the income, estate and gift taxes, which amounted to about $833 billion after refunds. Brackets of, say, zero percent up to $500,000 in wealth, 1 percent for wealth between $500,000 and $1 million, and 2 percent for wealth above $1 million would probably have done the trick as well.

In other words, don’t simply add a wealth tax into the mix, but abolish the heart of the tax code at the same time, and use only a wealth tax to try to replace all that lost revenue. He starts with those tax revenues, divides them into an estimate for household wealth, and presto — out the other side comes a solution to all our problems, which would slow the rise of inequality, deliver a tax cut to the majority of American families, and probably improve motherhood and apple pie at the same time.

As I say, I like the idea of a wealth tax. (My proposal: 1% of all wealth over $5 million, each year.) It would diversify the tax base, it would give the rich an incentive to take more risks with their investments, and by definition it would only be paid by people who can afford it. But administering such a thing would be a nightmare, and it’s always best to lower oneself into such waters gently. After all, the IRS has had decades to learn how people avoid income tax; it hasn’t even started to imagine all the different ways they could avoid a wealth tax.

Jill Lepore, in the latest issue of the New Yorker (although sadly not online), has an interesting history of the US tax code, explaining how the antitax tradition, which is rooted in slavery, has weirdly and yet consistently failed to really gain traction in practice. She concludes:

What’s surprising, given how much money and passion have been spent to defeat a broad-based, progressive income tax over the past century, and how poorly it has been defended, is that it has endured—testimony, perhaps, to Americans’ abiding sense of fairness.

The US tax code is already progressive. It could do with higher rates at the top end and lower marginal rates at the bottom end, but in terms of broad architecture it works pretty well — especially in the way that Americans have to pay tax on their global income. America’s fiscal problems come just from the fact that we raise too little money in taxes, rather from the fact that the taxes we do have are in any fundamental way ill-conceived.

Altman’s idea, much like Herman Cain’s 9-9-9 plan, is more than just unrealistic: it deliberately jettisons the one upside we have, which is a decades-long tradition whereby Americans pay income taxes in payment, as Oliver Wendell Holmes put it, “for civilized society”. Income taxes are easy to collect, and for most of us on payroll they’re collected automatically and largely invisibly — by the time we get our paychecks, the taxes have already been paid. We have a smoothly-functioning machine, with tax rates which can be adjusted quite easily. Adding new gears to the machine — a carbon tax, for instance — might make sense in theory, although it’s hard. But dismantling the machine entirely and rebuilding something brand new? That is a very bad idea indeed.


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