Of Deficits and Taxes

By George P. Brockway, originally published October  5, 1987

ANOTHER BUDGET deadline has come and gone and that old devil deficit is still there. What can we do about it? First, we had better consider briefly what would happen if Gramm-Rudman- Hollings were successful in getting the annual deficit down to zero. For we’d have a crashing depression, that’s what would happen. Whether the miracle were achieved by reducing military expenditures or by cutting off the poor or by raising taxes or by all three, somehow $160 billion (more or less) would be abstracted from the economy.

Actually, “abstracted” is the wrong word. The $160 billion would not be taken from the spendthrift government and put in your thrifty pocket to be used in a more propitious time. No, all that lovely money would not exist. Moreover, the possibility of its existence would be gone forever, and with it the goods and services the money might have bought, plus the goods and services that might have been bought by those who would have earned money by producing the first lot, and so on ad infinitum. R.F. Kahn‘s multiplier works both ways.

Or look at it this way: One hundred and sixty billion dollars is about 4 per cent of our gross national product. The average fall in GNP for depressions since World War I has been about 6 per cent. The possibility is more ominous when you consider the unemployment rate. In 1929, the rate was 3.2 per cent. Today, it is officially stated to be 5.9 per cent-and this counts part timers as fully employed, and doesn’t count at all those who are too discouraged to look for work. In other words, we have a head start on any depression we decide to bring about.

Mention of unemployment reminds us of the real point: The vice of depression is not the loss of potential goods and services but the loss of jobs and self-respect. No one can spend much time in the labyrinths of a shopping mall without concluding that we already have more goods and (perhaps) services than we-literally-know what to do with. Our basest beggars are in the poorest thing superfluous. Personal dignity and self-respect depend on the right to contribute to the common wealth. Even without a depression too many of us are denied that right. We are all demeaned by that denial.

Does this mean we are doomed to run deficits forever? Won’t all that debt bring double-digit inflation back again? And isn’t it irresponsible to pass on to our children the consequences of our fecklessness?

When you look at the record, you wonder how these staples of campaign oratory and editorial punditry get taken seriously. In 1980, the deficit was $73.8 billion (or 2.7 percent of GNP), and the gross Federal debt was $914.3 billion (or 33.47 per cent of GNP); the inflation rate was 12.4 per cent. Last year the deficit was $220.7 billion (or 5.2 per cent of GNP), and the gross Federal debt was $2,132.9 billion (or 50.68 per cent of GNP); the inflation rate was 1.1 per cent. There is no way these figures can be tortured to support the claim that a deficit causes inflation (see editor’s chart below).

Well, the states balance their budgets, so why can’t the Federal government? Of course, it could-provided we accepted one of two outcomes: Either private businesses and private individuals would have to increase their indebtedness to match the Federal decline, or we would have to have that depression. The reason for this is simple: The flip side of debt is credit, and credit is money. (If you want to be fussy: not all credit is money, but all money is credit.) Without debt, no credit; without credit, no money; without money, no business. That’s the way the capitalist system works. That’s the golden-egg-laying goose that myopic conservatives want to kill.

But what about our children and theirs? As Keynes observed, it is no favor to our children to neglect our natural and civic and domestic environments and thus save our children from the perils of indebtedness in their adulthood at the expense of forcing them to spend their childhood in squalor.

The foregoing merely suggests ways in which the anti-indebtedness argument is false. It does not claim that the present is the best of all possible worlds, that the level of our current deficit is exactly right, that we might not better buy different things with our money, or that we might not do better by financing the deficit differently.

Let it be said at once that the appropriate level of the deficit is a matter of trial and error. In spite of the most sophisticated programs run on the most powerful computers, Pandora’s box remains closed to us. Consequently, to say that we can fine tune the economy is an exaggeration. It is, however, a fact that we have, in the record of the past 40 years, proof that some kind of tuning can have significant results.

This brings us to the probability that at some time-perhaps tomorrow, perhaps the day after-we may want to tinker with the new tax law we hailed so proudly only yesterday. We may, in any case, want to remind ourselves that taxation is not necessarily for revenue only. Attending a debate in the Academy of Laputa[1],  Lemuel Gulliver was struck by a proposal “to tax those qualities of body and mind for which men chiefly value themselves …. The highest tax was upon men who are the greatest favorites of the other sex; and the assessments according to the number and nature of the favors they have received, for which they are allowed to be their own vouchers …. But, as to honor, justice, wisdom and learning, they should not be taxed at all; because they are qualifications of so singular a kind that no man will allow them in his neighbor, or value them in himself.”

That excellently bitter proposal is not explored in the 291-page Description of Possible Options to Increase Revenuesrecently prepared by the staff of the Joint Committee on Taxation with the staff of the Committee on Ways and Means. Part I examines what it discreetly calls” Revenue Areas [it would be lese majeste to call them tax increases] Addressed by the President’s 1988 Budget Proposals.” Adopting all of them would increase 1988 revenues by about $3.7 billion-scarcely noticeable in the shadow of a $160 billion deficit. Part II, taking up the document’s remaining 257 pages, examines “Other Possible Revenue Options,” most, if not all, having been suggested by members of the Committee on Ways and Means. These naturally reflect the various members’ interests and capabilities, and many are nutty (as are some of the President’s), while others are politically impossible, at least for now. Though it is likely that, as a whole, they exceed the magic $160 billion goal, there is no point in adding them up because many of them would work at cross purposes, and because nowhere in the pamphlet is there a discussion of the leading weakness of the 1986 tax law.

This weakness is the almost complete abandonment of progressivity. The great strength in the new law is that the grossest shelters were blown down. But, as is well told in Showdown at Gucci Gulch by Jeffrey H. Birnbaum and Alan S. Murray, the Senate Finance Committee grudgingly accepted the strength in order to achieve the weakness.

The attack on progressivity has been going on for several years. It was not so long ago that the top bracket in the personal income tax was 85 per cent. Then it was reduced to 50 per cent on “earned income.” Then to 50 per cent on all income, except for capital gains, which were taxed up to 35 per cent. Then capital gains were dropped back to 20 per cent. And now the top rate is 28 per cent across the board, with a complicated proviso that need not be of concern to you unless your taxable income exceeds $200,000. (The proviso, allowing for certain deductions at the lowest rather than at the highest rate, was one of the few good ideas of the original Bradley-Gephardt proposal. See “A Cautionary Tale of Tax Reform,” NL, January 27,1984.)

HOPE OF CHANGING the tax law’s rate of progressivity was abandoned by everyone who entered the Congressional conference rooms. It was insisted from the start-by Bradley-Gephardt in 1983 as well as by Reagan- Regan in 1986- that a reformed tax law would be revenue neutral. This shibboleth meant not merely that the total revenue raised under the new law would be the same as that under the old, but also that the various quintiles of income recipients would pay the same proportions of the total tax under both laws. An exception was that certain of the poorest of the poor, who had been added to the rolls in the reactionary surge of 1981-82, would now be dropped again.

The new law is certainly better than the old in that whatever is unreasonable or unjust in it is plainly stated rather than shoddily sheltered. But that is not to say it is more reasonable or just. It may, in fact, lead to greater injustice. It is probable that throughout the corporate world executives will demonstrate an increased eagerness for high salaries because they will be able to keep a higher proportion of them. It is probable, too, that the kind of investment banking that leads to raids and takeovers and greenmail will be stimulated, and that so will the securities and commodities and futures markets. It is even probable that the changes in the corporation tax will encourage many companies to increase executive perks, on the ground that the tax collector would get the money if it weren’t spent on limousines and Lear jets.

It will be noticed that the foregoing probabilities are to some degree contradictory. It is something of a paradox that lower personal and higher corporate taxes can be expected to result in both higher executive salaries and perks as well as higher winnings from speculating in the securities of the companies whose earnings are reduced by paying the salaries and perks.

This can happen all at once through an accentuation of the polarization of the American economy. The rich can become richer by keeping the poor in their place and by pushing more of the middle class down to join them. The trend can continue for a damnably long time without arousing much political reaction. The possibility of an economic reaction is more immediate. As Jean Baptiste Say, in one of his acuter moments, wrote, “There is nothing to be got by dealing with people who have nothing to pay.”

Our economy is bad because our morale is bad. For too many years, greed has been admired in high places and doing good has been sneered at. A steeply progressive income tax would be a sign of a shift in morale-which would be far more important than whatever increased revenue might be raised, and vastly more important than the size of the deficit.

The New Leader

---

[1] Readers with a bent for trivia may recall that one of the targets of Major Kong’s B-52 in the movie “Dr. Strangelove” was Laputa. According to IMDb, “Major Kong’s plane’s primary target, is an ICBM complex at Laputa. In Jonathan Swift‘s 1726 novel ‘Gulliver’s Travels’, Laputa is a place inhabited by caricatures of scientific researchers.”

The Chicken and the Egg

Originally published September 9, 1985

 

As I WRITE, the great deficit debate is out of the headlines, and it may still be out when you read this. The news of the fall season is tax reform, and a determined effort is being made to separate the two issues. In a more rational world, one might expect taxes and the deficit to be intimately related, but in the lame-duck Presidency of Ronald Reagan the sloganeering calls for a “revenue-neutral” tax bill. Though convinced that the Republic hangs in the balance because the deficit doesn’t, even the Senate Majority Leader, Bob Dole of Kansas (perhaps reflecting on what happened last November to Fritz Mondale’s campaign for fiscal responsibility), is muting his austere determination to raise some taxes somehow.

It would be a mistake to consider the deficit merely a nuisance. It will continue to pop in and out of the news because it has us in what Gregory Bateson termed a “double bind.” Our situation is not so obvious as the classic example (“Have you stopped beating your wife?”); nonetheless, it is binding. If we do something effective about the deficit (such as raising taxes or cutting expenses across the board), we will almost certainly turn the current” growth correction” into a full-fledged depression. If we don’t do anything effective about the deficit, we will almost certainly induce a rate of inflation (and, probably, stagflation) far worse than anything we have yet experienced. That, in turn, simply because of our size, will place the entire free world at risk, not to mention those nations that former UN Ambassador Jeane Kirkpatrick taught us to view as authoritarian but not totalitarian.

Bateson developed the idea of the double bind in connection with his studies of schizophrenia. The pathology takes three recognized forms: paranoia (e.g., Secretary of Defense Caspar Weinberger’s and the Russians’ suspicions of each other), hebephrenia (endless absurd chatter, such as President Reagan’s call for a constitutional amendment mandating a balanced budget), and catatonia. The last has two states: agitated

(New York Republican Congressman Jack Kemp’s manic insistence that there’s no taxes like no taxes), and stuporous (Vice President George Bush’s silences on his best days). The periodic alternation of paranoia, hebephrenia and catatonia is what causes the deficit to be a media event one day and a nonevent the next. But the pathology remains.

It must be recognized that we are in a true double bind. We are damned whether we do or not. One has only to listen carefully to the pronouncements of Federal Reserve Board Chairman Paul Volcker to appreciate how hopeless our situation is. To be sure, Volcker continues to voice confidence that we will pull through. He bases his confidence on Congress’ success in cutting $50 billion from the 1986 budget. This is what he asked for as a signal to the financial markets (a.k.a. the speculators of the Wall Streets around the world) that we are serious about putting our house in order. He got his $50 billion plus a bit more, depending on whether you believe Bob Dole or House Speaker Tip O’Neill of Massachusetts. But now in September it is expected that the 1986 deficit, with the cuts, may be greater than it was predicted to be last January, without the cuts. Nevertheless, Volcker remains cautiously hopeful.

What can a rational man or woman make of that? I think you and I have two choices: We can head for the storm cellar because disaster is about to strike, or we can conclude that Volcker and the rest were in some way mistaken in their understanding of the significance of the deficit. Speaking for myself, I will confess that I am at least taking the precaution of scouting my route to the storm cellar. I’m allowing myself the dim prospect, though, that the almost universal misunderstanding of our distressing situation may suggest a way out of the double bind.

A double bind cannot be broken so long as you wrestle with it on its own terms. As Paul Watzlawick, Janet Beavin and Don Jackson put it in their classic Pragmatics of Human Communication, you have “to step outside the frame and thus dissolve the paradox by commenting on, that is, metacommunicating about, it.” Let us, therefore, do a little commenting on – or metacommunicating about – our predicament and the reasoning behind it.

Judging from the actions of our leaders and the dicta of our opinion makers, it would appear that our economy has three points of reference. One is a high gross national product, the second is a low rate of inflation, and the third is a high rate of saving. It would appear, further, that the rate of saving is understood to control the other two. On the first point, saving is assumed to lead to investment, which leads to increased production. On the second point, whatever is saved is seen to be withheld from consumption, thereby decreasing the number of dollars chasing whatever goods are produced. Hence the rate of saving is, as the mathematicians say, the independent variable: save that and you save all.

It will be observed that practically everyone who counts (with the possible exception of Tip O’Neill) believes this. The spectrum of believers stretches from Jack Kemp and his supply-siders, through Bob Dole and the sound money men, through Paul Volcker and the bankers of every size and shape, through the surviving New Frontiersmen and their investment tax credits, to Gary Hart and the New Industrial Policy of the Atari Democrats. And over them all arches the rainbow of President Reagan’s smile.

Let’s metacommunicate first about the rate of saving, that allegedly independent variable that is supposed to make the system go. We have, constant readers will remember, commented on this before, prophesying in “Why Deficits Matter” (NL, March 8, 1982) that the Kemp- Roth tax cuts and the associated accelerated depreciation allowances would not have the intended effect of increasing the rate of saving. Then, in “The Savings Bust” (NL, October 17, 1983), we diffidently called attention to the fact that our prophecy had come true. Now, as Coach Lombardi used to say, let’s get down to basics.

To illustrate the importance of saving, standard textbooks note that someone has to save seed corn if we are to have a crop to eat next year. This is surely true, and it seems to make saving prior to production. It is true as well that someone has to have harvested this year’s crop if we’re to have any seed to save, and that makes production prior to saving. It’s also true that no one would have planted this year’s crop (farming being uncompromisingly hard work) if we weren’t experiencing diminishing returns from hunting and gathering, so that someone could anticipate a strong demand for a substitute food. And anthropologists show that the demand was increased by an increase in population resulting from our prior success at hunting and gathering.

We have here four truths, independently valid, and they seem to be arranged in a straightforward cause-and-effect order. Accordingly, it would follow that if we want to grow more vegetables, we’d better stimulate hunting and gathering.  No one, however, is likely to see much sense in that, except perhaps the National Rifle Association[1]. Where’s the fallacy?

IN FACT, there are several fallacies here. For our purposes the most important lies in the assumption that living systems – systems composed of people – operate in the same way as the systems of classical physics (see “On Political Arithmetic,” NL, April 4, 1983). The idea of independent and dependent variables – a supremely powerful idea in its own domain – simply does not apply. With living systems you cannot learn much from experiments where you vary one factor, holding the others unchanged, and observe the outcome. The rate of saving depends on the GNP, as much as the other way around; moreover, a high rate of saving often depresses the GNP, while a rising rate of inflation may have a favorable effect on the GNP and on the rate of saving, too. But in other times and places it may not. Everything depends on the historical conditions of an actual place and time.

In a 1928 article that was a significant precursor of Keynes’ General Theory, Professor Allyn A. Young argued that in order to understand economic progress, “What is required is that industrial operations be seen as an interrelated whole.” (Or, in the terminology of the communications theorists, the economy is a system of interrelated feedback loops.)

In this connection Young made an observation that would have saved us all a lot of grief if it had been taken to heart by the late Mohammed Reza Pahlevi (and by Messrs. Richard Nixon and Jimmy Carter, who backed him, and George Shultz and David Rockefeller, who did business with him). “An industrial dictator,” Young wrote, “with foresight and knowledge, could hasten the pace somewhat, but he could not achieve an Aladdin-like transformation of a country’s industry so as to reap the fruits of a half-century’s ordinary progress in a few years.”

Although Young concluded that Adam Smith was right in emphasizing the importance of the division of labor, he cautioned: “The division of labor depends on the extent of the market, but the extent of the market also depends on the division of labor.” In short, in a living system it is nonsense to wonder whether the chicken comes before the egg.

What is not nonsense is to be concerned with people. All three of the points that define our double bind – the GNP, the rate of inflation, and the rate of saving – are measures of things. To break out of our double bind, we will have to shift our attention to measures of people: the number of unemployed; the number of men, women and children living below the poverty level; the spread of living conditions between the poor and the rich. If we did this, we would take a vastly different attitude toward Social Security, Medicaid, Medicare, and all the now-denigrated hopes of the New Deal, the Fair Deal and the Great Society. We would even find that we could afford these decencies once we abandoned the notion of a revenue-neutral tax law that leaves unchanged the taxes paid by the various levels of our society.

Of course, it may be nearly impossible for us to make the necessary moves to break or even weaken the double bind. That is a political problem, and a public opinion problem, and it would be pretty to think that our politicians and our opinion makers will rise to the challenge. Yet, as matters stand at the moment, they are, with a few exceptions, part of the problem.

The New Leader

---

[1] In the original it was the “American Rifle Association.”  The editor has decided this was an error.

The Bottom Line on Tax Reform

Originally published November 26, 1984

I SUPPOSE I should say something about Secretary of the Treasury Donald T. Regan‘s recent Federal tax simplification proposals. As it happened, I was vacationing in Florida when they were announced and for a couple of weeks thereafter, so my initial information was limited to the local newspaper’s reports and the charismatic pronouncements of NBC’s Tom Brokaw.

The story filtering through to me and my neighbors was sufficiently vague on the interest-expense question to allow me to hope that one of my private ideas had a chance of becoming public law. It seemed that interest expense (with the exception of that on a primary-residence mortgage) would no longer be deductible. This certainly exercised the Sunbelt real estate operatives. It seemed, too, that the change would cover the interest expenses of businesses as well as of individuals. The latter, I have since discovered, is not the case. But I was briefly delighted for the following reasons, which I now offer in the event anyone asks you how the law should be revised.

Contrary to general opinion, the interest-expense deduction works mostly for the benefit of people with money to lend. It does nothing much for those with the need to borrow – especially not for those in the lower tax brackets. The first fact to bear in mind is that the interest rate is in one respect like other prices: It can’t go higher than the market will bear. You can’t get blood from a stone. If lenders attempt to set the rates too high, they will be left with idle money on their hands. If they do nothing with that money, they will be like the unfaithful servant in the Parable of the Talents. To get their cash out and working, they must lower the rates to levels that businesses and individuals are able and willing to pay.

Although borrowers are subject to euphoria, businessmen are restrained by the necessity to make a profit, or at the minimum to make ends meet. For some months now, despite the well -advertised recovery, profit rates have been falling. And so have interest rates. The connection between the two is indirect, not direct. Interest rates have been coming down partly because the Federal Reserve Board has slightly relaxed its control of the money supply, but mainly because there has been a declining demand for loans. Many businesses have not been pursuing loans for the simple reason that business isn’t good enough for them to afford the rates asked.

The second fact is that the corporate tax deduction for interest expense cuts the cost of business borrowing roughly in half, at least for the bigger borrowers. In other words, at the present time some businesses are able and willing to borrow money effectively costing them, say, 6 per cent, not the 10.75 per cent (or a point or two more) they pay their friendly bankers before taxes. It is consequently reasonable to foresee that, if the interest-expense deduction were abolished, the demand for loans at 10.75 per cent would truly plummet, callable bonds would be called, refinanceable loans would be refinanced, lenders would be drowning in money to lend, and the interest rate would have to drop until solid ground was reached again. For various reasons (including, we may be sure, inappropriate reactions of the Federal Reserve Board), the rate would probably not fall quite to the present effective rate of 6 per cent. Nevertheless, observe the outcome: Abolition of the interest-expense deduction would leave borrowers about where they were, while the take of lenders would be cut almost in half. To repeat for emphasis, the interest-expense deduction mainly subsidizes those with money to lend, not those eager to put it to work[1].

Obviously, introduction of the change in a hurry would hurt many individuals, businesses and banks. The suffering of most individuals and businesses would be assuaged by the promised reductions in the tax rates, but the crisis in banking might be acute. Don’t get me wrong.  If it were not for possible damage to the economy (and this could be mitigated by phasing in the change-over two or three years), I could regard a pit full of squirming bankers with a fair show of equanimity. My point has nothing to do with my feelings for bankers, some of whom are my best friends (though not always when I need them). My point is that the interest-expense deduction makes usurious rates seem tolerable. It is a prop holding up those rates for the enrichment of money lenders. I therefore thought Regan was absolutely right in trying (as I mistakenly understood it) to knock out this deduction.

Of course, I feared there wasn’t a prayer that he would prevail, despite the fact that everyone -everyone in the whole wide world (except for big lenders) – is longing for interest rates to come down. Last year, even with a more docile Congress and strong support from a not-yet-lame-duck President, the Secretary couldn’t get the banks to withhold taxes on interest – a measure that would have hurt only cheaters and the people who encourage cheating.

ALSO DOOMED (I thought, and still think) is Regan’s proposal to get a rein on the charity deduction. The churches and the colleges, the foundations and the funds, the museums and the libraries, the clinics and the think tanks – all the eleemosynary institutions in the land – are up in arms about this one. It is very sad and disillusioning. Many undoubtedly worthy, dedicated and, yes, necessary citizens have been tricked by the issue into making fools or hypocrites of themselves. Two pitiable examples turned up in the Florida paper I read.

An official of the local United Way observed that the median income thereabouts is $17,000, and he worried that the vast majority of its contributors would not be able to continue their generosity if the law were changed. The United Way does its supporters an injustice. For it is surely true that practically all taxpayers with a gross income of $17,000 take the standard deduction and make most of their contributions because they want to, not because it is a way of diddling the tax collector.

A local parson had a clearer under-standing of finance – and of his parishioners. He argued that Secretary Regan’s proposal to cut the top tax rate from 50 to 35 per cent would greatly reduce the value of the charity deduction to those in the top bracket. He is certainly right. Rich people are in (if the parson will forgive me) a hell of a fix. We’ve been told since New Deal days that high taxes sap their incentive to work and save. Now we discover that low taxes sap their incentive to be charitable. Of such is the Kingdom of Heaven.

The local Salvation Army made a more responsible observation. It noted that the talked – about budget cuts (a.k.a. “freeze”) in welfare programs would increase the calls on private charity, while the tax changes would reduce contributions. Indeed, one wonders (to introduce a little of the spice of argumentum ad hominem into the discussion) what the President himself might be expected to do in these circumstances. You will remember that the Treasury proposes to count only contributions in excess of 2 per cent of adjusted gross income. You will also remember that the President’s tax returns have rarely (if ever) shown contributions up to or much beyond that level. Add to this the fact that he promises to cut his own pay, and I am led to suspect that his favorite charities won’t be able to count on him (and on many like him) as they have in the past.

There is no doubt that the charity deduction is grossly abused (mostly in ways I haven’t discussed). There is little doubt that Secretary Regan’s modest proposals for its reform will fail. Then we have the matter of no longer allowing the Federal deduction for state and local taxes. Here I think the Secretary has his best chance of succeeding.

The proposal has drawn fire from New York’s Governor, Mario Cuomo, as well as from both of its Senators, Democrat Daniel P. Moynihan and Republican Alfonse D’ Amato, and it is easy to rally the rest of the country in opposition to the Empire State. I’m opposed to this part of Regan’s plan, too, however. As I have argued in this space (“Eliminating Frictional Unemployment,” NL, March 7, 1983), the most rational approach would make state and local taxes a 100 per cent offset against Federal taxes. In brief, that would put an end to the game of beggar my neighbor states now play as they try to lure corporations away from each other with inadequate taxes. No chance.

Perhaps the most important single change advanced by the Treasury would eliminate most of the corporation investment credits and rapid-depreciation dodges. These allow companies like General Electric to have profits in the billions and pay no income tax at all, but instead receive rebates of a hundred million or more. The change was not deemed worth mentioning by my Florida paper. Maybe the editor foresaw that lobbyists would not have much trouble explaining to the President that his major campaign contributors would hardly be amused.

THE FOREGOING are only the principal ways the Secretary of the Treasury has gotten people mad at him. An indicator of the wrath he has incurred is that as staunch an Administration ideologue as William F. Buckley Jr. finds the program a disaster. This being the case, why did Regan make his irritating tax proposals?

In answer, I’ll venture the guess that he is playing the game perfectly straight, yet that the result will neutralize the Democrats. For the Regan plan is very close to (actually more liberal than) the one put together by Senator Bill Bradley of New Jersey and Representative Richard Gephardt of Missouri (see “A Cautionary Tale of Tax Reform,” NL, January 23), which has wide verbal support, especially among neoliberals. It would thus seem that with a substantial majority of Republicans and a scattering of Democrats, a melding of the plans – including the somewhat similar scheme of Republican Representative Jack Kemp of New York – might have a good chance of sailing through.

If it does, the new law will certainly have the nice low rates that have been proposed. You should not be surprised, though, if the lobbyists manage to keep most of the loopholes open. For my part, I’d not be surprised if Republicans and Democrats started bidding against each other, as they did in 1981, to see who could give the lobbyists more of what they want. The not impossible result could be both lower taxes and wider loopholes.

What then?

The first consequence would be, as in 1981, an upward surge of the deficit. The second consequence would be, as in 1982, a move (over the obviously sincere opposition of President Reagan) to increase Social Security taxes (although they have no bearing on the budget deficit) and reduce Social Security and Medicare benefits. The third consequence would be, as in 1983, the realization that controlling the deficit requires some brave new taxes. It would be explained that the campaign pledges of no tax increase have after all been honored, since the income tax rates actually were lowered. But something had to be done.

What would it be?

Few fortunes have been made by people acting on my prophecies. Still, if I were a betting man, I’d wager that we would start hearing a lot more about the value added tax – how widely it is used in Europe, how invisible it is in comparison with the sales tax, how comparatively easy it is to collect, how it taxes consumption rather than production (a fallacy I have discussed more than once).

I know the smart money says that former Democratic Representative AI Ullman of Oregon was defeated in 1980 because he supported a value added tax; that references to it in the last campaign drew a strongly negative response; and now even the Treasury has come out against it. Nonetheless, with the income tax rates down and the loopholes wide open the pressure to act would be very great. On other occasions Secretary Regan has argued for a tax on consumption, and so have people as far to his left as Senator Gary Hart of Colorado. The American Enterprise Institute and the Brookings Institution similarly want to tax consumption.

My prophecy stands. What we get won’t be called a value added tax, but what’s in a name?

The New Leader

---

[1] Editor’s emphasis

A Bad Idea from Brookings

Originally published August 6, 1984

A COUPLE of months ago I had occasion to mention Gary Hart’s search for “a better title” for the radically new form of taxation he referred to as an “expenditure tax” or a “consumption tax”. (“Voodoo on the Primary Trail,” NL, April 20). Well, the Brookings Institution (described by the New York Times as” a liberal think tank”) has solved Hart’s problem. In a long pamphlet entitled “Economic Choices 1984,“ the scheme is called a “cash flow tax.” If it is adopted, the person who thought up the new name will be as much to blame as anyone.

The Brookings pamphlet, edited by Alice M. Rivlin, distinguished former director of the Congressional Budget Office, concerns many issues besides taxation. Parts of it remind one of Claude Rains’ line at the end of Casablanca: “Major Strasser has been shot. Round up the usual suspects.” In the opening sentence of the opening chapter we learn that “High deficits in the Federal budget, together with high interest rates, are endangering the future growth of the U.S. economy and undermining the ability of American industry to compete in world markets.” Following this, we are told that fiscal policy and monetary policy are at cross purposes, that Medicaid and Medicare cost more than expected, that many a father shirks his responsibilities to his children and their mother, that the B-1 bomber, the MX missile and various flocks of airplanes and schools of warships are a waste of money.

Now, I am persuaded that all of these suspects are guilty as charged, and I have no doubt that the list could be considerably extended. But none of this is news, as the cash flow tax is purported to be.

The first thing to note about the Brookings statement of this tax is a disclaimer.

“It does not,” the authors say, “propose any shifts in the tax burden among economic classes.” And a complementary proviso declares that if the scheme should prove to be heavier on corporations than the present law, rates would be revised to restore the “balance.” You will remember that similar disclaimers and provisos are included in the plan put forward by Senator Bill Bradley (D.- N.J.) and Representative Richard A. Gephardt (D.-Mo.) (“A Cautionary Tale of Tax Reform,” NL, January 23). You may also have noticed that when the Reaganites undertook to remake the tax laws they had no compunction whatever about shifting the burden from the rich to the poor or reducing the share paid by corporations (the corporate share had already declined from 26.5 per cent in 1950 to 12.4 per cent in 1980; it is now less than 10 per cent).

On the basis of the foregoing I propose a new law of political science: In any confrontation between neoconservatives and neoliberals, the neoconservatives will always win, because the neoliberals will allow them to keep whatever they have previously gained, regardless of when or how they gained it.

It would not be difficult to convince me that the neoliberals have their priorities precisely wrong. As John Maynard Keynes said, “The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.” I hold these truths to be self-evident, and I therefore hold that the first test of any tax law is whether it contributes to the rectification of these faults.

The proposed cash flow tax deliberately fails this test, except to the extent that it pays some attention to gifts and bequests. The Brookings people insist that this feature distinguishes their levy from a straight consumption tax. In fact, the straight consumption tax people could take the same step without breaking stride, so it is a distinction without much difference. (Brookings, by the way, proposes that each household have a lifetime exemption of $200,000 for such purposes. Try that on your recordkeeping problem.)

What, then, is a cash flow tax? To keep my bias from showing, let me quote from the pamphlet: “Each taxpaying unit [household] would be taxed on all cash receipts, minus net saving… Receipts would include all wages and salaries, rent, interest, profits, dividends, transfer payments, gifts received, and inheritances. Savings would include all net payments into certain ‘qualified accounts,’ including all financial assets (stocks, bonds, and other securities), all accounts in banks and other depository institutions, the cash value of life insurance,  and real estate (except owner-occupied housing) …. Just as additions to saving would be deducted from income, such dissaving as the sale of stock or withdrawal from a bank account would be added to the tax base… Personal exemptions would be allowed as under the present personal income tax, although the amount should be modified… For joint returns, existing revenues could be matched with a 5 per cent tax on the first $10,000 of taxable expenditures, 20 per cent on the next $30,000… and 32 per cent… over $40,000 per year.”

All right. Now listen to me. I will make just three points:

1. Those seductively low rates are achieved, not because of the miraculous properties of the cash flow tax, but because none of the deductions – other taxes paid, charitable donations, interest paid, and the rest-would be allowed. If an income tax were similarly astringent (I’ d be in favor of that) it could achieve still lower rates, for it would not have made that massive deduction for saving.

2. Since the paperwork necessary to complete a cash flow tax return would hardly be much less than that for the present return, the new tax would not be substantially more “efficient” than the existing one. Indeed, if the present tax eliminated deductions and the special treatment for depreciation and capital gains, the return would be a piece of cake for almost everyone, like the present Form 1040A.

3. The switchover from an income tax to a consumption or cash flow tax would present horrendous problems. I’ll take a little space to explain one that is near and dear to my heart: What do you do about recently retired individuals like David Rockefeller, Walter Wriston and me? For the rest of our lives we’re going to be dissavers. We got taxed on the salaries from which we saved to make our nest eggs; we got taxed on much of the income earned by those eggs; and now we’re going to be taxed a third time when we use the income to live on.

Well, you know what would happen. We senior citizens are not so easy to kick around anymore. We belong to the American Association of Retired Persons and the Grey Panthers and such. We have the clout to insert a little provision in the law to the effect that those who have to be dissavers because they have no other income would not be taxed. This would only be fair. After all, if David Rockefeller, Walter Wriston and I don’t spend our income, we don’t live. But for you poor slobs who still work for a living the rates would have to go up.

The Brookings people are aware of this difficulty, and they have a solution whereby “each household could calculate the aggregate cost of all assets accumulated from savings out of previously taxed income (‘basis’ in current tax law) and claim an exemption spread over a number of years for consumption until the aggregate cost had been recovered tax free.”  Messrs. Rockefeller and Wriston might be able to live with that, too, because they have probably had accountants working for them night and day all their lives. The rest of us, who can read the words of the “solution” but are not even quite sure what they mean, and who certainly do not have meticulous records stretching over 65 years and more, might wonder what happened to the advertised simplicity of the new tax.

WHY DO THE Brookings people want to make what would be a fantastically complicated change? They have two principal reasons, both ideological. First, they have got hold of the notion that the trouble with the American economy is a lack of saving. But their own figures show that private saving (both individual and corporate), as a percentage of GNP, was 16.2 per cent in the 1950s and 16.3 per cent in the 1960s. True, these were the allegedly prosperous years. Yet in the 1970s, when things are supposed to have fallen apart, the rate was 17.1 per cent; and it is projected, under the existing law, to rise to 17.5 per cent in 1986-89. Given the inherent imprecision of these figures, they are nothing to bet your life or livelihood on. Nevertheless, one thing is certain about them: They do not support the view that the economy has been in trouble because of a lack of private saving. And of course everyone knows that the current recovery has been led by consumption, not by saving.

The other ideological notion is that the ideal economy would be one without taxes,  and that the cash flow tax is similarly” neutral.” This is nonsense. It is doubtful that a state of nature would be ideal for anyone; but there is no doubt  that a civilized state must have taxes, that just taxes are levied in accordance with ability to pay, and that ability to pay turns on income and wealth, not on savings.

There are many other things to be said about consumption taxes and consumption-like taxes. For further information I refer you, as I have before, to Robert S. McIntyre of Citizens for Tax Justice, 2020 K St. NW, Suite 200, Washington, D.C. 20006. Here I want to conclude with a reference to a table in the Brookings pamphlet, whose burden, as I mentioned at the outset, is that the deficit is going to destroy the economy unless we do something drastic in a hurry.

With that in mind, let’s look at Table 2-4. The first line of this table shows “Projected surplus or deficit under policies in effect January 1, 1981” (that is, when President Reagan took office), and the last line shows the projections “under policies in effect January 1, 1984.” The projection for 1989 on the first line is a surplus of $29 billion, while that on the last line is the now-familiar deficit of $308 billion.

Remember those figures when President Reagan tries to tell you that the deficit was caused by Democratic spending. He can, if he wants, blame the recession on Federal Reserve Board Chairman Paul Volcker. The deficit, however, is Reagan’s very own.

The New Leader

A Cautionary Tale of Tax Reform

Originally published January 23, 1984

SOMETHlNG over a year ago, Senator Bill Bradley of New Jersey and Congressman Richard A. Gephardt of Missouri put forward a new scheme for the Federal Income Tax. Last summer they unveiled a revised and more thoroughly worked out version of their proposal. It should now probably be taken seriously because it has been substantially incorporated in a document entitled “Renewing America’s Promise,” released by a group calling itself the National-House Democratic Caucus. In any case, what has happened to Bradley-Gephardt during its gestation period is an instructive and cautionary tale.

First off, let it be stipulated that Bradley and Gephardt are men of good will – probably of liberal will – and that their plan is less harmful than many others that are being noisomely noised about. Among the latter is one by Republican Senator Jesse Helms of North Carolina, who would tax everyone at a flat rate of 11-12 percent. Another, by Democratic Senator Dennis DeConcini of Arizona, would be more generous with exemptions and therefore would have to set its flat rate at 19 percent. Various banker-sponsored proposals would abolish the income tax altogether, substituting sales taxes or the more sophisticated (and insidious) value added tax. Then there are nutty ideas like those of Robert Nozick, a professor of what passes for philosophy at Harvard, who thinks you ought to be allowed to choose the government activities you want to support, if any, and how much.

Bradley and Gephardt start with the premise that the present law is unfair and overcomplicated; on this no one is likely to say them nay. The current tax code, Senator Bradley observes, “spans more than 2,000 pages” and has more than 100 major loopholes that “will be worth at least $250 billion this year.” He doesn’t tell us how many of those pages and loopholes and billions are attributable to the personal tax and how many to the corporation tax, nor does he estimate how many of the loopholes he will close. If he closed them all, we’d be worrying about a surplus of $50 billion instead of a deficit of $200 billion. Don’t count on it.

In their original scheme, the Senator and the Congressman proposed to throw out practically the whole shooting match – medical deductions, veterans benefits, interest deductions, charity deductions, local tax deductions, shelters, the works. In place of the existing rates (which aren’t so progressive as they were a few years ago), they offered a three-step schedule: zero up to certain income, 14 per cent to another point, and 28 per cent thereafter. (I don’t remember – if I ever knew – what they planned to do with the corporation profits tax.)

The new version of their scheme isn’t quite so radical. Let’s let Senator Bradley explain it as he explained it last summer to the National Press Club: “For individuals the simple progressive tax would have three rates-14 per cent, 26 per cent, and 30 per cent. Roughly four out of five taxpayers will pay only the bottom 14 per cent rate. The only people paying the higher rates will be individuals with adjusted gross incomes above $25,000 and couples over the $40,000 mark.

“Our bill makes another significant change which is directed primarily at low-income people. Putting it simply, we want to increase the amount of money that a person can earn before having to pay any taxes at all ….

“To make this approach politically possible, we recognize that it is necessary to preserve certain deductions, credits and exclusions generally available for many years to most taxpayers. We thus propose to retain the $1,000 exemptions for dependents, the elderly and the blind. We also want to permit deductions for home mortgage interest, charitable contributions, state and local income and real property taxes, payments to IRAs and Keogh plans, some medical expenses, and employee business expenses. Lastly, we favor continued exclusion of veterans’ benefits, Social Security benefits for low and moderate income persons, and interest on general obligation bonds. These personal exemptions and itemized deductions would apply against the 14 per cent rate.”

As I look at the two versions, I see three main differences: (1) The new rates are slightly higher, though still far less progressive than even the present law; (2) practically all deductions and exclusions and exemptions are back in; and (3) regardless of your tax bracket, the deductions are limited to 14 per cent.

The first difference is no great shakes. The third is a grand idea that could and should be incorporated in the law. But the second difference gives the game away.

It is plain that Bradley and Gephardt have heard the insistent drums of The War March of the Priests – and of the college alumni associations and veterans’ organizations and senior citizens’ lobbies and real estate operators and IRA bankers and municipal bond holders and all the rest. Having heard that stern impassioned tread, and being practical politicians, they have fallen back on what they call “the best means available” and have surrendered-before the committee hearings-the issue of the complicatedness of the tax law as it relates to the ordinary taxpayer. H. & R. Block and all the tax accountants and tax lawyers, great and small, have nothing to fear from Bradley and Gephardt.

I hasten to stress that their bill includes provisions I’m ready to cheer. One is the abolition of special treatment for capital gains, which, as they point out, is scarcely necessary, since their regular rate is so low. They would also repeal indexing, another thing I’m always grumbling about. On the other hand, it seems to me that their treatment of depreciation is as cozy, for tax sheltering purposes, as anything now going, although it may be a slight improvement on the corporation side.

Now, you may wonder what the net effect of all this coming and going would be. The answer, in a word, is nil. At least that’s its declared effect, and one that the New York Times has (typically) praised it for. The sponsors themselves say that each “income class” will carry” approximately the same tax burden as under the present law.” I’m not sure how they square this statement with their claim that they “want to increase the amount of money that a person can earn before having to pay any taxes at all.” I further note that the proportion of Federal taxes paid by corporations would be unchanged, staying at the present 5.9 per cent (down from 26.5 per cent 30 years ago).

The exemptions and the loopholes and the corporate provisions of the present law are important because they exacerbate the unjust and uneconomic distribution of income in this country. Everyone knows that the Reagan-Kemp-Roth ironically entitled Economic Recovery Act of 1981 was intended to make the rich richer and the poor poorer, and that it succeeded in its intention. Yet Bradley and Gephardt, in what they called the Fair Tax Act of 1983 (now necessarily some other year), ultimately proposed to confirm this brutal unfairness and, by the title of their bill, to certify that it really is fair after all.

THIS IS, as I said at the beginning, a cautionary tale. What started out as a drive for reform (perhaps a misguided drive, but still an honest one) has become a desperate search for something some sort of majority will somehow agree to. Thus the really important reform – a redistribution of the tax burden – was abandoned at the outset: The gains rich individuals and corporations have made in the past 30 years – and particularly in the past three – are not to be disturbed, while for a few they will surely be increased. Thus the arguably useful reform of eliminating special exemptions and deductions was abandoned. Thus the certainly needed reform of deroofing tax shelters was scarcely attempted. In trying to get a comprehensive law that might be passed, Bradley and Gephardt have come up with one not worth passing – and this before being ground down by the legislative process.

The conclusion must be that comprehensive liberal revision of the tax laws is not possible in the present – or foreseeable – political climate. It will be hard enough to get piecemeal reform, as has been shown by the inability of President Reagan to muster even a Republican majority in favor of the innocuous withholding of taxes on bank interest, and by the inability of House Speaker Tip O’Neill to muster even a Democratic majority in favor of limiting the windfalls the rich got from the third round of Kemp-Roth.

On the record, the scary probability is that any enacted” reform” of the income tax will be in the direction of abolishing it altogether. If you’re not scared, ask your friendly banker what he hopes for, and remember that Treasury Secretary Donald Regan has already opined that “A move toward consumption taxes will probably be an absolute necessity.”

Senator Bradley and Congressman Gephardt have, as I’ve mentioned, a handful of good ideas that are worth trying to incorporate into the present law. Let them concentrate on those and forget their grandiose scheme. In any case, let Senator Bradley reflect on the fact that no sponsor of major tax legislation has ever been elected President, though there would be a certain piquancy in a race between a former professional basketball star and a former professional quarterback[1].

The New Leader

---

[1] For those who’ve forgotten, the author refers here to Jack Kemp, he of Reagan-Kemp-Roth

At the Top of the Tax Pyramid

Originally published October 4, 1982

LAST MONTH, in this space, in the course of an argument against a flat-rate income tax, I offered some reflections on the way a chief executive officer’s high salary tends to produce high salaries down the line, with inflationary results. Let’s now start at the other end, toward the bottom, and look up, to see if we can find justification for the high CEO salary in the first place.

Suppose (that is what economists do) a bright and well educated young man of 21, who was thought to have “management potential.” He started work in 1952 for a Fortune 500 company, not as an apprentice sweeping the factory floor, nor even as a clerk running errands in accounts receivable, but as a management trainee. Although he was by no means at the bottom of the ladder, it was still a long way to the top, and at every rung he was in head-to-head competition with others like himself, many from outside his company. When he got to be CEO at age 51, he had survived perhaps 10 such contests.

It may be noted that this competition, while stiff, is not so stiff as that of a tennis tournament, which would require 512 starters to produce a winner after 10 rounds. It is more like a club ladder, where one periodically challenges the player above or is challenged by the player below.

At any rate, our man finally made it to the top. The question now is how much better was he than his competitors? The difference may be thinner than a double-edge razor. Jimmy Connors is undisputed Wimbledon Champion, but he and John McEnroe won the same number of games in the final match and even scored the same number of points. Beyond that, it is, as the announcers like to say, a game of inches.

Let’s grant our man all the credit we can by assuming that at each rung of the ladder he showed himself 10 per cent better than his competition. That is, one must admit, a pretty big margin if he ran into any competition at all. Considering the vagaries of personnel interviewing and executive recruitment, his margin of superiority is likely to have been greater in the early years than in the later, just as Connors could beat a hacker like me with his right hand, but had to use both hands to subdue McEnroe. So if we give our hero an even 10 percent superiority at every stage, we’re not understating his attainments.

On this assumption it is reasonable to claim that when he finally pulled himself to the top, he had proved himself l.1¹º, or 2.59 times-better than the losers in the first contest. Thus it would seem proper for his pay to be 2. 59 times better than theirs: If the first losers, with modest seniority raises, got themselves up to $30,000 at age 51, the winning CEO should be earning 2.59 times that, or $77,700. Giving him the breakage, it would be $77,812.

That’s right: we’ve justified a salary of $77,812 for the CEO of a Fortune 500 company. Good grief, they’ll be jumping out of windows all over town.

I haven’t bothered to check, but I’ll wager that there isn’t a Fortune 500 CEO who doesn’t pull down a good deal more than twice that. And as we noted last month, at least a dozen men rake in $2 million a year or more, counting only “earned” income. That makes these miracle-men 25.7 times better than our winner, or 66.7 times better than our losers, who were no fools to begin with.

Does anyone really believe that?

Well, I’m afraid that a great many do. Their reasoning goes something like this: As a man climbs the corporate ladder, several important things are being tested beyond his ability to calculate sums in his head and his cheerful willingness to do what his boss tells him. Perhaps most important of all, he is exhibiting his ability to learn, and especially his ability to understand at a glance how things work. If he’s going to get ahead, he’s got to have a quick ear and a sharp eye.

Having had some experience in business, once even with a Fortune 500 company, I’m ready to acknowledge that the quick ear and the sharp eye are far from common. At the same time, it occurs to me that we may have here another of those nature vs. nurture problems, like the debate over whether women are naturally slow at mathematics or merely are brought up that way. One’s genetic composition (whatever that may mean), home environment, and formal education may be of the most promising, but a few years in the lower reaches of a large organization that happens to be riddled with office politics can be devastating. I know, because I’ve been there. The winner in such contests proves himself adept at politics; and if he’s good at his job, too, that’s a plus. The losers’ talents never have a chance to develop.

The winner, in fair contests as well as in foul, gains something more than a pay raise. He gains experience. He has increased opportunities to practice the use of his eyes and ears. He learns by doing. Perhaps more important, he joins C. Wright Mills’ “Power Elite” and gradually expands his business connections so that he is eventually on familiar terms with the most “useful” people among his firm’s customers, suppliers and competitors. All of this makes him many times more valuable to his firm than the inexperienced, dispirited, though almost equally talented, losers and is said to justify the enormous difference between his salary and theirs.

There is also, in the minds of the directors who set the high CEO salary, another justification. They argue that they must pay their CEO well or he will decamp for some more generous rival, thereby subtracting his skills from their company and adding them to the competition. It is altogether probable that this reasoning is sound, especially since an extra $100,000 is a drop in a Fortune 500 bucket. Moreover, if he can increase his firm’s profit by $100,001, or prevent the loss of $100,001, or some combination of the two, he will have proved, as neoclassical economists say, the marginal utility of his raise.

This logic may remind you of the free agent auction in baseball; and indeed the same principles operate, with the same results: astronomical salaries for a few, whopping raises to keep the most important and most powerful of the rest in line, and higher prices for the paying customers.

ASSUMING that enormous pay differentials are a weakness in, if not a threat to, democracy (I refer you, as I did in my previous column, to Wallace C. Peterson’s Our Overloaded Economy), what can be done to change the situation? First, it must be recognized that the situation, being indeed rational, is not likely to change of itself. Second, it must be recognized that raising the consciousness of the losers might improve their self-respect (or perhaps the contrary), but is not likely to do much toward improving their lot. In this regard the problem is again analogous to that of women, who, even after overcoming their math anxiety, still need the ERA if they’re to get a fair shake.

There are, I think, two practical possibilities. Since we already set a minimum wage, there would seem to be no reason in principle why we might not set a maximum. Nonetheless, there are good reasons for avoiding rigidities where possible. That leaves the possibility of a steeply progressive income tax, coupled with the elimination of deductions and shelters, and probably with radical reform of inheritance taxes.

Now, it will be protested that a steeply progressive income tax – especially one frankly intended to rein in the drive for high executive salaries – is an interference in the workings of the free market. If there is a demand for a man’s services, it will be said, he should be rewarded with what the market will bear.

This objection has a fatal flaw, for it assumes that labor is a commodity like any other, and like the others is subject to the law of supply and demand. Marx, of course, charged that the capitalist mode of production depended on making labor-power a commodity. To fit the scenario of Capital (Chapter VI), labor-power had to be “free” (by which Marx meant unrestricted) and the laborer had to be “free” (that is, unconnected and without resources). It may be doubted that such a drama was ever staged in its pure form. In any event, since Marx’s time, the capitalist nations have all enacted not only minimum wage laws, but also laws governing hours and conditions of work, vacations, unemployment compensation, old age security, freedom to join labor unions, and much else; and all these laws implicitly recognize that labor is different from, and should be treated differently from, ordinary commodities.

It is, to be sure, a sad fact that those to whom we have entrusted present control of our economy actually think of labor as a commodity, just as they think of money as a commodity. Consequently, they vainly try to reverse inflation by raising the “price” of money to force the “price” of labor down. (For a justifiably caustic refutation of their theories, see Sidney Weintraub‘s Capitalism’s Inflation and Unemployment Crisis.)

But neither labor nor money is a commodity. Both are essential – primary, original – to our social and economic system. Neither can be explained in terms of something else. (See “Let’s Put Indexing on the Index,” NL, April 5.) We do with labor and money what we will; it is a moral act. It is a flaw in us – an ethical failure – that our current tax laws encourage greed. A low flat-rate tax, regardless of its ease of collection and all the other rationalizations of the editorial writers, is subject to the same indictment.

[Editor’s note:  For more on this subject read Executive Salaries and Their Justification in the Journal of Post-Keynesian Economics]

The New Leader

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”