Simplify, Simplify

Originally published September 6, 1982

THE NEW tax law[1] is, by and large, a wonder. Wall Street evidently was excited by the revenue-raising aspects of it, but that euphoria is not likely to last. We’ll still have the highest unemployment and bankruptcy rates since the Great Depression, and we’ll still have the largest deficits in history. The market will churn; some people will take a whirlpool bath, and more important, most of the new money that the Fed is expected to relax into the economy will go into that churning market rather than into production or consumption. It takes a lot of money to float a record 455.1-million-share week like the one we had August 16-20.

Nevertheless, the new tax law is a wonder, and Senator Robert Dole of Kansas is a wonder man. Among other things, as chairman of the Senate Finance Committee he demonstrated that lobbies can be licked. The double reverse he pulled on the restaurateurs was a beauty. They thought they had him stopped in his attempt to withhold taxes on waiters’ tips. But he had in his pocket the three-martini-lunch measure that got laughed to death when President Carter proposed it. In the nature of things, there are more people eating on expense accounts than there are waiters serving them. The waiters lost, and Bob Dole must have had a good chuckle.

Other and more significant loopholes were narrowed. I would not have given a wooden nickel for the chance to withhold taxes on interest and dividends, especially with Walter Wriston of Citibank bleeding over the astronomical sums he claims it will cost his little depositors. Nor could I have imagined the registration of Treasury and municipal bonds, impeding what is certainly a significant amount of hanky-panky. Nor would I have expected that high rollers would be required to call attention to their questionable tax shelters.

These are substantial reforms, and they’re expected to capture $21 billion of the $87 billion the IRS estimates the government was cheated out of in 1981 on legally acquired income. Joseph Pechman of the Brookings Institution and some others think the figure too high, but if you add in the cheating on state and local taxes, it will do well enough. Put it in perspective: Demagogues in high places love to make up anecdotes about welfare cheats, yet income tax cheating last year was more than 10 times [editor’s emphasis] the entire cost of the Aid to Families with Dependent Children program-the entire cost, including all the alleged graft and bungling.

Even with the new law, there will remain $66 billion of cheating, and we’re going to hear a lot of talk about how much more effective it would be to simplify the tax law and just have a low, easy-to-understand, flat-rate tax. There are already several such schemes on the table.

Now, $66 billion is real money, and we should really try to collect it. But we don’t have a country just for the fun of collecting taxes; so we shouldn’t design our tax policy with only ease of collection in mind. I fear that is all some of the “reformers” do have in mind. They seem to argue that the way to reduce tax cheating is to reduce taxes. This is a realistic view-as realistic as the notion that the way to get rid of mob-controlled gambling is to legalize gambling. (You can tell that one to Atlantic City.)

I can, nevertheless, see much virtue in simplification. I don’t know of a’ single deduction or exemption I’d not be happy to see go, but I’m a reasonable fellow and ready to compromise. If you’re unwilling to give up the “charity” deduction altogether, I’ll settle for one based on cash only. If you want to hold on to interest expense, I’ll agree if it’s only for a mortgage on one owner-occupied dwelling. As long as your federalism (new or old) makes for wildly various state and local taxing, I’ll go along with deduction of taxes paid. If you push me very hard, I’ll grudgingly assent to some slightly special treatment of long-term capital gains-provided you agree to define “long term” as at least 10 years. Although I’m a little tender on the subject of interest on municipal bonds (I have some laid away for my old age), I can imagine satisfactory solutions here, too. In short, if there’s a tide in favor of simplifying the income tax, let’s take it at the flood.

It by no means follows that a flat rate is a desirable simplification. It’s all very well to dramatize the subject by saying that if there were no deductions or exemptions or tax shelters, the government’s needs would be covered by a flat rate of 16 per cent or whatever. Yet progressive tax rates are not hard to figure out, even without a pocket calculator. That’s not the kind of simplification we need. We can-and should-have progressive rates even after simplifying all the rest, and the progression should be steep, not at all like the 28 per cent maximum proposed by Senator Bill Bradley of New Jersey.

There are two reasons for this, one broadly social, the other narrowly economic. The broad reason-which really should be conclusive-is among the many important issues examined in detail in a powerful new book by Wallace C. Peterson,  Our Overloaded Economy[2] (See Robert Lekachman’s review, “Challenging Corporate Efficiency,” NL, June 14 [pdf link below]). Peterson demonstrates the mischief caused in a democracy by such irrational spreads in income and wealth as we now tolerate.

The narrower reason turns on the indirect inflationary effect of high salaries. The direct effect is of course minimal. The economy is so large that it doesn’t matter much whether the president of Mobil gets $1.5 million a year or twice that or half that. The indirect effect is enormous and pervasive. The second level of Mobil executives cannot be expected to make do with salaries too far below their chief’s, and the third level has to be not too far below them, and so on down to the level of the working stiffs, whose union observes all those dollars up the line and quite reasonably demands a penny or two for its members. Thus to the extent that pay scales are a factor in productivity, and that productivity is a factor in inflation, the top pay scales are a factor – not the only one, but highly significant – in inflation.

If, as some say, take-home pay is what matters (this is what linguists might call the deep structure of the Laffer Curve), you would think that lower taxes would result in lower wage demands. The present law requires the president of Mobil to pay a tax of almost $750,000 on his $1.5 million salary. Under Dollar Bill Bradley’s scheme, the tax on $1.5 million would be something below $420,OOO-a windfall of $330,000. What would the president of Mobil then do? Would he work harder and make Montgomery Ward (conglomerated into Mobil at a loss) finally profitable and thus deserve even a higher salary? Since he probably works right now just as hard as he knows how, would he pocket the $330,000 with a grin on his face? Or would he insist on giving himself a pay cut to $1,041,658 (thus leaving his take-home pay at $750,000 and saving his stockholders and perhaps their customers-almost half a million?

Well, I don’t even know the man’s name so I can’t tell what he’d do, and it may not be fair to single him out for all this attention. His $1.5 million is by no means the highest salary in the country. Last year, according to Mark Green (Winning Back America), there were at least 35 executives who took down a million or more, and even a dozen who made off with $2 million. The CEO of Cabot Corporation (not a household name in most households) led all the rest in the book of gold with $3.3 million for one year’s work. How this happy few would react when brought face to face with a tax cut, I have no idea.

BUT I DO know what happened in the United States of America in a similar situation – when the maxitax of 50 per cent on earned income went into effect. Prior to that time, the tax went as high as 70 per cent, and I knew some people who paid it. The maxitax gave them a pretty plus. You might have expected – possibly some people really did expect – a nationwide reduction of executive salaries to hold their after-tax level more or less constant. What actually occurred was just the opposite – a great leap forward in executive salaries. When the tax was as high as 70 per cent, there possibly didn’t seem too much point to an extra hundred thousand; after the maxitax, a hundred got you fifty. That was more like it. In fact, it was better than the proportion of her earnings a working welfare mother was allowed to keep.

Before the maxitax, it was suspected that the higher a man got, the more time he spent wheeling and dealing, setting up capital gains situations through stock options and mergers, and devising new and more imaginative perks. With the “reform,” you might have expected a renewed and intense devotion to business, resulting in the kind of increases in industry and productivity that only good, old-fashioned American hard work and no-nonsense management can produce.

Again you would have been wrong. The sole industry stimulated by the maxitax was that of lawyers and accountants searching for tax shelters. After all, more executives had more to shelter. And perks expanded. Company limousines clogged the streets; company airplanes clogged the runways; and exhausted executives dried out (or not) in company suites at Sun Belt resorts. I myself have, over the years, had lunch four times at Lutece and twice at Four Seasons. It wouldn’t be hard to get used to.

On the basis of the record, it is easy to guess what would happen if Senator Bradley’s 28 per cent maxitax-or worse, Senator Jesse Helms flat 10 per cent tax were in effect. It is well to remember that the truly indecent American fortunes were gathered in when there was no income tax at all. A future danger in tax reform is that some men who think of themselves as liberals, and who are touted (or attacked) by the media as liberals are taken in by the supposed realism of a low flat tax. Liberals may need more realism; but whatever America needs, it is not more encouragement of the greed that no doubt lurks in all of us.

The New Leader

1982-6-14 Challenging Corporate Efficiency


[1] rescinded some of the effects of the Kemp-Roth Act passed the year before… as created in order to reduce the budget gap by generating revenue through closure of tax loopholes and introduction of tougher enforcement of tax rules, as opposed to changing marginal income tax rates

[2] The original text reads “OurOverburdenedEconomy” but Amazon says “Our Overloaded Economy”

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