The Dangers of Tax Reform

0:00As Mark mentioned, I'm here from Alabama and I come from a state with a Republican governor elected to cut government in 2002, but who in 2003 attempted to pass the largest tax increase in the history of the state by a very large margin. In the same bill which the state constitution, thy goodness required, be submitted to the voters, The governor sought to change the Constitution to make it much easier for every future governor to raise taxes. The governor invested every bit of political capital he had. During the push, he enjoyed the plaudits of the press and the fawning of the public sector. Of course, he was heralded for his steadfast courage, his refreshing honesty, his hopefulness in the face of cynicism and all the rest.

0:48They even tolerated his religious right vocabulary given his claim that Jesus wants higher taxes. The proposal failed by a vote of two to one and it doesn't take a political scientist to understand why. People figured that they fork over quite enough to the government and they didn't want to give any more money to these birds to feather their nests. was one of the most inspiring moments in politics that I can remember. Interestingly enough, the governor was careful not to call his bill a tax increase. He called it a tax reform. He claimed he was not raising taxes, he was making them more fair. He wasn't increasing the burden, he was lightening it on the neediest among us and merely asking the rich to attend to their civic obligations.

1:38But people saw through this rhetoric. It used to be said that the Democrats were the evil party and the Republican the stupid party. My impression of late is that these monikers have switched. However, not even a conservative Republican who claimed to be devoted to freedom and limited government could pass off an attempted heist as an act of benevolence. There are important lessons here for all of us which I would like to apply to tax politics at the federal level. It's the second term for the President and his friends. two on Republican control of the executive branch, and there was no obvious project brewing on the horizon to serve as a convenient lever to prod the donor base. After the first term, there's always the re-election and the campaign contributions. The Bush administration did better at this than some of the previous second termers, but the strategy of using elections to raise money isn't unique to Republicans or Democrats, of course. It's just the business of Party Politics.

2:37The second term is another matter. It tends to be the period when the big issues die down and the solid excuses for demanding more from the partisan donor base tend to dry up. After all, a political party can't live on tax receipts alone. It needs the hundreds of millions of dollars donated to the party apparatus by companies and individuals. And it's just when the goose starts losing enthusiasm for laying any more golden eggs that the policy farmers begin to poke at with a tried and true stick, tax reform. We saw this in 1984, in 1996, and again in 2004. In each of these years, the second term administration announces that the current tax code needs to be tossed out and a new one put in place.

3:23And so right on cue, the Bush administration is named a nine member panel to look in what should be done to reform taxes with the goal of legislation in 2006. The Bush Panel is chaired by former Republican Senator Connie Mack, and the Vice Chair is former Democrat Senator John Breaux. Other members mostly live off government in one capacity or another, and now live and work in the private, more or less private sector. And so the institutions represented include Brookings, Stanford, MIT, the Carlyle Group, Charles Schwab. Bush himself sent up the spirit, I am firm in my desire to get something done. What this means is that he has every intention of rewriting the tax code, a process that always and everywhere involves winners and losers.

4:11Who ends up winning and losing is not arbitrary. It depends greatly on making one's presence felt within the political process. But that's the underlying message. The public campaign, of course, does not speak of these matters. Instead they claim they will make taxes less complicated and more fair. The reform promises to increase incentives to save and invest, and to stop punishing people for things they should do, and start punishing them for things they should not do. It promises to stop rewarding lawyers and tax preparers, and permit people to plan their own finances. It must also promise not to raise taxes on the middle class, must reassure the rich, and not punish the poor. It must not repeal beloved deductions, but it must hammer abuses.

4:57What all this means in practice is anyone's guess. And truly the point is not to drive a precise plan, or even to pass a plan that does all of the above. In fact, there's no way all these promises can be kept. There's no simple, fair, non-distorting way to collect $2 trillion a year from the population by force. The politicians tell us they will find a way. The problem is not so much the goal, but the means and the process, and that if we can just replace the current ways and means with new ways and means, that two trillion will appear without pain and suffering. As the vice chair of the Bush panel said, quote, our tax code should not scare people, should not threaten people, should not confuse people.

5:42Well, you can try this at home. Go collect two trillion dollars while offering not much in return without threatening, scaring or confusing. So thus do we hear two messages at once. In the first we hear about how bad the current tax code is, and it is this message that compels us. There is more bad to say about the current tax code that could be said by all the politicians in the world. World. It is the second part of the message where the trouble comes, the proposal to replace what we have now with something new. Here is the part that is troubling. The magic tax reform machine that grinds and grinds over the next two years will net billions for the political class, as every pressure group ponies up to make sure that their point of view gets a hearing. In the end, however, the average taxpayer and businessmen will have nothing This is my prediction based on experience and based on the logic of the political situation.

6:42But let's focus on the first part of the tax reform message, the part that is undeniably true. The current tax code is a disaster. The tax panel that Bush appointed will surely conclude this, and who could disagree? Now, if you read the economics text, they will tell you there is such a thing as a neutral tax, A neutral tax, one that does not distort the operation of the market economy. But the neutral tax is a myth. In one way or another, every tax punishes productivity in both seen and unseen ways. It should be obvious that the money individuals pay to Washington could be put to better use in the household budget, whether it is to save or spend or some combination thereof. The double taxation that stems from the corporate tax constitutes a direct hit on production.

7:30But as Murray Rothbard shows, even excise taxes but supposedly tax consumption are really nothing more than taxes on production. Producers have no way to pass on the cost of the tax to consumers. To the consumer, the price plus the tax is just a price and the decision to buy or not to buy follows on that basis. When you go to the pump to purchase gasoline, you do not make a buying decision based on and the price of one dollar and then reluctantly cough up another dollar to pay the tax. No, we consumers make the decision about whether to buy and in what quantity based on the full price, which is to say the market price plus the tax. The two are not easily separated because the price is not determined by the cost, but rather by the interaction of supply and demand.

8:19The tax then cannot be passed on to the consumer any more than any other price hike can be passed on to the consumer. If the consumer is not willing to pay the higher price, he or she will not pay it, regardless of the source. To be sure, taxes cause prices to increase, but the quantity of purchase responds to the will of the purchaser, and those purchasing decisions respond to the law of demand, which is to say that people will demand more at a lower price than at a higher price and vice versa. When consumers purchase less, they are punishing The idea of a consumer tax is something of a myth. It is paid at the retail end, but the effects shoot back through the entire structure of production from the final seller to the most remote producer. Same is true of residential property taxes. The tax is figured into the price of the house, and the judgment of what size house to buy in what neighborhood

9:21is made via calculus that includes everything that goes into the price. The tax is not easily passed on and an increase in the property tax is a tax on the production of houses. There is no such thing as tax shifting. What is interesting to me is that we seem to intuitively understand this in some sectors if not in others. We understand that the cigarette tax is not only a tax on users but a tax on cigarette Makers and Ultimately on Tobacco Growers. And yet, we talk about increasing the tax on homes, luxury goods, liquor and gasoline with little thought concerning the effect on builders, gas stations, drillers and other producers say nothing of the spillover effects on workers and their families. Murray Rothbard's great book Man Economy and State undertakes an analysis of every conceivable form of taxation to demonstrate every way in which this occurs.

10:16I won't march through his detailed and sweeping argument, but suffice it to say that he covers income taxes, corporate taxes, sales taxes, excise taxes, property taxes, capital gains taxes, inheritance taxes, withholding taxes, every form you can imagine. There are many books I would recommend, but I would put this section of Rothbard's treatise at the top of the list for required reading for the political class. If they are going to plunder us, they should at least be denied the luxury of believing that they're doing it for our own good. The point is that there is no such thing as a neutral tax, and no such thing as a tax that is non-destructive to the production process. They all harm the ability of individuals to create wealth, trade and produce.

11:04This means fewer resources available for investing in the future, for donating to charity, for spending on leisure, for Cultivating the Garden of Civilization Itself. It is nothing short of a miracle of our times and of all times that wealth and civilization continue to be built despite the unrelenting assault on our lives and property by the political class. It is a living testament to human ingenuity and creative entrepreneurship of the merchant class that they can function so well despite the advance of the tax state. It is to this class that we owe our wealth, wealth, freedom and all the improvements in health, art and culture generally. We live amidst a great revolution in technology and daily we see being brought to market the most stunning improvements in information technology, transportation, medical care and so many other areas.

11:56But let us be clear that we owe this not to the taxers but to the creators, not to those who live off others but to those who make their own way and dedicate themselves to the and the Improvement of Mankind. At the Internal Revenue Service's headquarters in D.C., you will see a sign above the entrance that says, taxes are the price we pay for civilization. It's based on the Hobbesian theory that in the absence of taxes, there would be a war of all against all. Actually, all of history shows that taxes are a leading cause of the breakdown of civilization. The higher the tax, the less wealth there is to create and Sustained Civilization. We have civilization despite taxes, and it is this fact which is the most notable.

12:45Is there a need to reform taxes? Yes, always and everywhere. You can always make a strong case against all forms of taxation and all tax codes and all mechanisms by which a privileged elite attempts to extract wealth from the population. And this is always the first step in tax reform, to get the public seething about the tax code. And do it by way of preparation for step two, which is the proposed replacement system. Of course, this is the stage at which you need to hold onto your wallet. Hardly a day goes by when I don't receive an email from someone who has a grand plan to reform the tax code, replacing the current system completely with something else. That something is usually the value added tax or the national sales tax.

13:32The people promoting this plan long for a world in which they are permitted to keep all the money they make and only the purchases of goods and services would pay. There are many grave problems with the VAT and the NST, not the least of which they would have to be at least twenty percent, maybe as much as forty percent in order to raise enough revenue. Then there are problems of enforcement. The U.S. would instantly become host to an even larger underground economy which in turn would give even more of a rationale to the central state to invade our businesses, homes, personal finances, be essentially unenforceable and yet lead at the same time to even more of a war over the government against all complete with even more spies, agents and entrapments. But there's another danger to the people promoting a VAT or a national sales tax.

14:21It might actually convince people in Washington they have a chance to give it a try. And instead of replacing the whole tax code, The politicians might try 1% or 3%. If they get away with this, look out. We will inch up year by year as they try to discover ever more ways of looting us. This points to the general danger of the idea of a replacement tax. I hear these plans all the time. People say, let's get rid of the tax I don't like and replace it with one I don't pay. So people will propose getting rid of the capital gains tax and instead increase Taxes on Inheritance, or they say, let's get rid of inheritance taxes and put a higher tax on Americans working abroad. You can think of many of your own variations on this. The danger here is not in advocating the repeal of a tax. That is something we should all favor. The danger comes from advocating a new tax to take its place. And if you know

15:20the way politics works, you know that the new tax has a chance to be enacted and the and the old one not repealed. Another favorite plan that is still floating out there is the idea of a flat tax. Steve Forbes was the last prominent politician to advocate this. His idea was to completely eliminate all loopholes and replace them with an across the board 20% tax or whatever would be necessary to retain revenue neutrality. The story of how his political career melted as a result has not really been told. What happened was this, every time Forbes said flat taxes, voters heard, this crazy man wants to eliminate the deductions I get for my children, charitable giving, mortgage interest. Forbes quickly protested that while it's true he would eliminate these, his plan was to cut taxes elsewhere. But voters were a bit too sophisticated to buy into this. For long and bitter experience suggest the deductions are eliminated, but the new and wonderful This is good thinking, of course. Imagine that a criminal comes by every once in a while to steal some of the furniture on your porch.

16:30Whenever you leave it out, the criminal might come by and grab a piece. But for whatever reason, he leaves all your potted plants alone. Then the criminal rings the doorbell one day and he says, Let's make a deal. Leave all your furniture out, and I won't touch it. I'll just take the potted plants. Overall, he says, you're going to be better off. Now, if you go for this deal, you probably deserve to have both your furniture and your potted plants stolen. Forbes found himself in the position of this criminal, who proposed to start taxing you here, in exchange for which he will stop taxing you there. This is not a deal voters are drawn to any more than they are drawn to politicians who propose to increase any taxes at all. Quite wise.

17:17For my part, I'm a champion of the loophole, as was Ludwig von Mises. He was attending a conference in the 1950s at which economists were all denouncing loopholes, and he rose to their defense. Let us be grateful for the fact that there are still such things as these These honorable gentlemen call loopholes, he said. Thanks to these loopholes, this country is still a free country, and its workers are not yet reduced to the status and distress of their Russian colleagues. A loophole is nothing more than the chance to keep your own money. It's not a subsidy, it's not a tax spending, it's not corporate welfare, it's not a special privilege, it's just a window of freedom. Loopholes should be expanded as much as possible. There should be ever more of them. A completely loophole economy, where there were maximum opportunities for not paying tax, might finally arrive at the idea of freedom.

18:12Thus do I suggest that we never bite when someone dangles on a hook the idea of closing loopholes. And this raises the question of precisely what we should support. The only tax plan anyone should trust is the most simple, the one that proposes to lower existing taxes. I must really say this again because it is the most important single point you can remember when evaluating whether to support a tax reform or not. The only trustworthy plan is that that proposes either to lower or eliminate an existing tax, period. Now an ideal reform would also propose equivalent spending cuts. In fact, in the most strict sense, there can be no tax cut without spending cuts since we must all pay one way or another for the burden of government as measured by spending. But we must leave that aside for now.

19:06As we think about the Bush tax reform, remember to measure it by the strict standard of whether it cuts an existing tax. Tax. If it does not, or if it proposes to raise other taxes along with the cut, to support it is to entrust your future to a political class that has about as much interest in your well-being as the criminal who steals your porch furniture. You're taking a major risk in taking his word on anything. Let's examine the proposal to create what are called private investment accounts within the social security system. This is a major feature of the Bush and the British Administration's tax plan. As everyone knows by now, the idea creates a world-class fiscal headache because it diverts the revenue stream flowing from payers to beneficiaries.

19:54This is the problem called the transition cost. If the costs were to be picked up by the general revenue and otherwise payers were free to do with their money what they wanted, I think every free marketeer would support it. And if we pursued this idea to its end, is abolishing Social Security as we know it, and leaving in its place a straight-out welfare program for older people who need or expect money from the government. I would be for this too, since it would get rid of the idea that somehow Social Security is an insurance program. It is not. It is a transfer program. I would be forgoing this route in baby steps. 50% cut in the payroll tax would be magnificent, the 10% cut would be great, a 1% cut would be great. Any cut would be great because it would mean that people could control more of their own money, businesses would face a lighter burden and there would be more wealth available for people to prepare for their older years via savings and genuine insurance.

20:53There have been so many innovations in the financial industry in recent years that the private sector would be in a perfect position to meet the needs of every citizen without without having to be prodded and browbeaten by the Federal Government. Never before has it been easier to save and prepare, balancing known and unknown factors in our individual futures through a combination of insurance and investment and savings plans. And not only ones that provide an income stream for our own lifetimes, but work to assist our loved ones in the causes we care about after our death. But I'm sorry to report this is not what the Bush administration proposes. Instead of actual private accounts, the Bush administration is proposing to create a brand new program of national mandatory savings, and it wants to create this new program which would have been regarded as socialistic in 1900 and fascistic in 1920 at the expense of the existing social security structure. This, I submit, is not a good idea. Call it

21:53private accounts, individual retirement accounts if you want, but from the point of view of of Individuals, it is still a tax, because it is money that, taken by you from force, by force, that you cannot control, is taken on a promise that it can be returned to you at some day in the future, and in the way the government decides best. Now notice how the campaign to reform Social Security is taking a familiar route. First, the administration makes a strong case against the status quo. When it comes to any tax, This is the easy part. They have rightly said the program is unstable, unsustainable, discourages investment, is a bad deal. Certainly true not only of Social Security but of every other government transfer program. But what about the replacement? Is a new program for national force saving something unheard of in American history a good idea? Is it smart to require that young people fork over money to a quasi-private system? Is it going to invite a great deal

22:54A deal of intrusiveness into the markets that was never in veil and tailed by Social Security. Government will tell you what funds you may or may not put your money in, and how and when you may withdraw that money, or even whether you're going to withdraw it at all or whether they'll purchase a government annuity for you. There will develop a symbiotic relationship between preferred financial groups on Wall Street and the collection bureau for the private accounts, which means a great deal of potential for corruption. There will be a floor put on the account so that they will never be allowed to fall below a certain minimum, thus introducing a too-big-to-fail doctrine. People can reasonably claim that it was not their choice to save this money, so the federal government should take some responsibility for guaranteeing their investments.

23:39To those of you who think this proposed system is a good idea, I might ask this question. Why isn't the Bush administration simply cutting the payroll tax? I can't see that this plan is any more or less viable than a proposed forced national savings plan. The answer is that the Bush administration genuinely believes in creating a new forced savings scheme. It desires such a thing. To observe this is simply to observe that these people do not understand markets, do not accept a basic postulate of the free market idea, and do not trust people to manage their own money. That's the reason. Of course, what you've just heard does not fit in with any analysis you may have heard elsewhere. The left claims that the Bush administration has a secret plan to rob older Americans, while the right wants you to believe that the creation of so-called private accounts is physically sound and consistent with the freedom to choose.

24:34But this is what you get at tax reform time. Partisans sign up on all sides, and you can no longer trust what you hear or read. To make matters worse, it is a very long time before you will ever know what is in the legislation. The White House makes a proposal, it is hammered out in congressional committees, brought to a vote in both houses, and then finally we arrive at the really crucial stage that civics texts never talk about, although Congressman Ron Paul does talk about, and that is the conference committee. This is where all the crucial decisions are made in secret. It's also the stage that for whatever reason the press seems to care less about because the public drama is over. What is the end result of tax reform?

25:19Well, we've had reformed taxes frequently in the last century and you need only look at the rise of federal revenue to see where this has gotten us. Ever more of our earnings going to Washington and ever fewer choices on how we can use what remains. Let me close with a proposal that we abolish the income tax. It took in $873 billion last year. Now if we cut the budget by that amount, we would end up with a completely gutted federal government, right? Actually, we would end up with a federal budget of about 1.5 trillion, which is where it was in the last year of Bill Clinton's second term. If anybody thinks the federal government was too small back then, I can only recommend a complete education in economics, politics, and the truth about human freedom.

26:09Thus do I end this talk with a call not for reform, but for an end to the income tax. It should be replaced with nothing at all. In any case, that would be a good first step. Thank you very much.