Taxes: Why tinkering beats wholesale overhaul

By Felix Salmon
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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How could a federal wealth tax possibly be justified under the Constitution? The US government has two types of taxing powers: indirect taxes (import duties, excises), and direct ones, which either have to be based on population or (under the 16th amendement) on income.

Posted by Hippopotamax | Report as abusive

Probably right about the constitutionality of a direct tax on wealth, though you cuiold, of course, inm principle, tax the change in wealth, i.e., net unrealized capital gain….

Posted by NotoriousBOB | Report as abusive

One hardly knows where to begin with this one, Felix….but what I would do in Washington if I were in charge of the opposition is to call Obama’s bluff big time….enlarge the problem….by countering His measly tax increase to Clinton levels on the top 2% with a combination reform of income AND payroll taxes….eliminating the latter and reducing rates/drastically cutting excluisions, preferences and deductions across the board…all on a revenue neutral basis based on static analysis.

The fact is that the tax regime on income is NOT very progressive…just barely so….when payroll taxes are included it’s a more or less flat tax system….

the payroll tax is an abomination the only purpose of which is to fool the rubes into thinking they have “earned” their erntitlements….

so abolish it, without touching current benefits….create a mildly progressive simplified income tax structure that everybody pays….

the lower income qunintiles would see actual total tax burden reductions, the middle would be a wash and the top fractiles would see modest increases.

A huge win-win economically…and politically it poleaxes the blue states and the Obama coalition on may levels…what’;s not to like?

Posted by NotoriousBOB | Report as abusive

@Hippopotamax: “The United States Court of Appeals for the District of Columbia Circuit has stated: “Only three taxes are definitely known to be direct: (1) a capitation, (2) a tax upon real property, and (3) a tax upon personal property.”"

Non-authoritative source:

Posted by SteveHamlin | Report as abusive

I know that you don’t like mortgage interest deduction, but saying things like “virtually everybody would like to see the end” [of mortgage interest deduction], even qualifying that by saying “in an ideal world” is so patently false that it defies common sense. In opinion polls, eliminating mortgage interest deduction is opposed by ~75% of voters. In today’s polarized politics, it’s quite hard to find a tax change that would be so uniformly opposed in a bipartisan fashion.

Posted by Nameless | Report as abusive

@Hippopotamax, SteveHamlin: a federal wealth tax would definitely be a direct tax, and there is no exception for a wealth tax in the 16th amendment. The only way a wealth tax could be imposed without having to pass a new constitutional amendment is if the federal government were to pass a law along these lines: “we want to collect $2.5 billion in wealth taxes in fiscal year 2014. Assign portions of that $2.5 billion to each state, in proportion to the number of free residents, minus the number of Native Americans, plus 0.6 times the number of slaves, in that state. Instruct states to set their tax rates to reach their targets.”

Needless to say, any kind of wealth tax would be extremely progressive compared to what we have today, even if you don’t build progressive brackets into the system directly (as Altman proposes). Since top 10% of the population control around 85% of total wealth, and top 20% control 95% of total wealth, even a straight 1%-of-all-wealth tax would fall almost entirely on the small wedge of the population at the top. It could be popular among the voters (everyone loves to milk the rich) but it would essentially be wealth redistribution.

One could argue that the problem with the current system is that there’s already too much wealth redistribution. We want all voters to pay their fair share of the cost of government. If everyone were to pay the same fraction of their income in federal and payroll taxes that is paid by the current top quintile (around 25%), we wouldn’t have a deficit problem, we’d have a surplus problem. Instead we’re trying to think up the ways to get some more out of the top 3% or 1% or whatever while cutting taxes for the 97% or 99%.

Posted by Nameless | Report as abusive

In the UK a lot of murmurings are being made about the taxation of multi-nationals that play jurisdictions off against each other and use International Tax Treaties to legally fiddle the tax system out of billions of tax revenues each year. I see a time when many in the west decide enough is enough and change the rules.

Even before then though, how about a direct tax on corporate cash as a separate item? There’s probably trillions sitting uninvested, not being used to stimulate economic growth, and just lying in Corporate Bank Accounts. Companies taking money out of the economy like this is akin to a rise in interest rates or a reduction in credit – in other words, this is a problem that needs to be solved anyway, so might as well use it as a tax raising tool at the same time.

Posted by FifthDecade | Report as abusive

So who would appraise real estate, privately held businesses, LPS, and other illiquid assets? This kind of tax would be so heavily gamed it would be ineffective and would distort investment more than any other tax system we’ve ever had. Are you going to tax tax-free municipal bonds at 1% of their face value, when they are yielding 4%? How do you come up with a model for all of those privately held businesses that can be applied to all the different industries?

If income is taxed as it is converted to cash, it will effectively tax the wealthy, or at least those who are accumulating wealth, without the distortion. Those who build assets and don’t exchange them for cash are helping the economy, and shouldn’t be forced to liquidate their assets, which just extracts more capital from the economy.

Posted by KenG_CA | Report as abusive

Taxing ‘wealty’ annually would be insanely fraught. Forget it.

Taxing ‘wealth’ on death is simple – we do it now. Just take 100% of it after modest allowances for children. Nobody ‘deserves’ anything he or she didn’t earn, children especially; better if the family dog got the dough than the worthless spawn of the plutocrats – Fido wouldn’t be bribing Congressmen with it.

Posted by MrRFox | Report as abusive

Simplest is to tax consumption. “Wealth” means nothing until it is consumed.

Posted by TFF | Report as abusive

TFF, that doesn’t prevent accumulation of cash, which is what is happening now. Not that we haven’t discussed this in the past.

A person who makes $10M a year, and spends only $500K would not be contributing to the economy the same as one who earns $500K and spends it all. The latter is returning all of the cash to the economy while the former is extracting $9.5M (assuming it is being held in a near-interest free account, and not being re-invested), which means that money has to be replaced somewhere else, and the somewhere else has lately been the government.

I like the idea of consumption taxes, but they are ineffective when there is a lopsided distribution of income, as we have now. If the 0.1% were spending more of their income, they would be paying more taxes, but they are just accumulating it.

Posted by KenG_CA | Report as abusive

Agreed, KenG, taxing consumption doesn’t achieve your goals of forcing the circulation of money. Nor is it progressive.

Posted by TFF | Report as abusive

Altman’s suggestion that the entire income tax (and the tax expenditures that go with it) be replaced with a net wealth tax is very tempting, but it leaves the job killing payroll taxes in place. My thinking is that there would be more bang for the buck if we eliminated the payroll taxes and lowered (and flattened) the income tax rate producing the same revenue. While an 8% income tax rate would not be materially different from the approximately 7.5% employee share of the payroll tax, the elimination of the employer’s share of the payroll tax would encourage job creation and also favor U.S. jobs over foreign workers. This revenue neutral solution to unemployment and social security funding deserves a serious look.

Only the U.S. Supreme Court can resolve the Constitutional question but as an attorney I note that most legal scholars believe that a net wealth tax would not require a “direct tax” apportionment (see Fixing the Constitutional Absurdity of the Apportionment of Direct Tax by Calvin H. Johnson, 21 Constitutional Commentary 295, 2004). A major boost to the legal argument also came with the Supreme Court’s recent approval of a tax on the failure to obtain health insurance (not a penalty) without apportionment because it, like a net wealth tax, is not the kind of “direct” or “indirect” tax envisioned when the constitution was drafted. In other words, new types of taxes are not subject to the constitutional apportionment requirement. Moreover, a net wealth tax is generally used as a replacement for estate and capital gains taxes which do not require apportionment. Read more at

Posted by 248TaxPlan | Report as abusive

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