A Simple Government (9 page)

So the tax stayed in place, and with it the British essentially told Americans, “We’ll tax you as we see fit.” So on the night of December 16, 1773, colonists who’d had enough of taxation without representation boarded three East India ships docked in Boston Harbor and sent 342 chests of tea to sleep with the fishes. That was both the first time Americans showed righteous indignation and the last time anyone even thought about drinking water out of Boston Harbor!

The Bostonians didn’t launch a very risky blow against the most powerful government in the world just because of high taxes. They did so because they were outraged by the idea that an out-of-touch government, worried more about supporting a bureaucracy than about supporting liberty or even fair trade, could force a trifling little tax down their throats without any say on their part. The Boston Tea Party was a protest of the notion that a government could use taxes as a means to control and manipulate, rather than a means to actually govern or administer the affairs of the state. Lord North sent his message, all right, but I suspect in hindsight that was three pence per pound he wished he’d just written off the books.

Even today, fights about tax rates are proxy fights. As with the Boston Tea Party, we’re not really arguing about the burden of taxes but about the burden of government. Oppressive taxes and oppressive government go hand in hand. When we talk about raising or lowering taxes, that’s just code for expanding or contracting the welfare state, for increasing or decreasing dependency on the federal government. The more of our money we give to the government, the more control we cede to it and the more power it has over us.

The income tax has become the most burdensome example of this notion. The nine states without an income tax—Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming—expand much more quickly, in terms of both population and economic growth, than the states with the highest income-tax rates. But the burden isn’t just in the paying of the income tax; it’s in the paperwork behind the paying of the tax. According to a survey by the National Association for the Self-Employed, small businesses will have a 1,250 percent increase in paperwork for their taxes by 2012 because of expanded Form 1099 reporting requirements. The more time businesses have to spend on these forms, the less time they will have to produce or sell anything, which threatens our economic growth and job creation. Not only is the government demanding more of our money starting in 2011, when the Bush tax cuts are set to expire, but it’s demanding even more of our time and energy.

And the tax code actually affects how we act—in business and in life. Veronique de Rugy of the Cato Institute elaborates:

So not only are we taking home less money in our paychecks, but our economy is suffering under the time, cost, and energy burden placed on us by our complicated tax system. There has to be a better—a simpler—way.

Art Laffer, an economic adviser to President Reagan and the father of supply-side economics, believes that the business profits we’re seeing for 2010 are artificially inflated because of tax incentives. He says that because taxes are set to go up in 2011, companies are trying to show as much income and profit in 2010 as they possibly can. He expects profits to “tumble” in 2011 because of this shift. That’s just what an economic recovery doesn’t need.

Laffer believes that individuals also will shift as much income as they can to 2010. He anticipates that the rise in taxes from the expiration of the Bush tax cuts (with income, dividend, capital gains, and estate taxes all going up) will cause a “crash in tax receipts” from both individuals and businesses, causing even higher deficits and unemployment.

Scott Davis, the CEO of UPS, thinks we should encourage long-term investments (investments of five years or longer) by taxing them at a lower capital-gains rate. He understands that the rise in the capital-gains rate from 15 percent to 20 percent on January 1, 2011, and to almost 24 percent in 2013 will stunt the growth of our GDP and jobs and divert long-term investment from this country. We need to do away with the capital-gains tax, but as long as we tax capital gains, I strongly agree with Mr. Davis that we should have tiered tax rates that go down the longer you hold the investment. He points out that giving investors an incentive to keep their investments longer will create capital to grow our private sector.

Presidents Coolidge, Kennedy, and Reagan didn’t have a lot in common other than having “Hail to the Chief” played when they entered a room. But all three presidents understood the value of putting more money—or should I say
leaving
more money—in the pockets of working Americans. That money isn’t a “gift” from the government, remember. You had to work and earn it. The example each of these leaders gave us was that tax cuts increase investment, jobs, and income and generate more revenues.

When President Coolidge cut the top rate from 70 percent to 25 percent, revenues went from $719 million in 1921 to $1.164 billion in 1927. Hey, in those days, a billion dollars was a lot of money! He also lowered the national debt by 33 percent and ran a surplus every year he was in office. “Silent Cal,” as they called him, may not have said much, but in this case, actions spoke louder than words anyway.

When President Kennedy cut the top rate from 90 percent to 70 percent, revenues went from $94 billion in 1961 to $153 billion in 1968. His tax cuts led to a three-billion-dollar surplus. President Kennedy was neither a conservative nor a Republican, yet he recognized that “the soundest way to raise revenues in the long run is to cut the [income tax] rates now.”

When President Reagan cut the top rate from 70 percent to 28 percent, revenues went from $517 billion in 1980 to over a trillion in 1990. When the Reagan tax cuts took effect in 1983, real growth (not just inflationary growth) jumped 7.5 percent in 1983 and 5.5 percent in 1984, after no growth in 1981 and 1982. Our GDP grew by a third during Reagan’s two terms.

And the Reagan cuts didn’t just benefit the rich, as some would have you believe. Americans at all income levels prospered during his presidency. From 1981 to 1989, the number of Americans making less than ten thousand dollars fell by almost 3.5 million. By 1989, 2.5 million more Americans earned upwards of $75,000 than had in 1981, and almost six million more Americans earned more than fifty thousand dollars. African Americans saw their incomes rise 11 percent under Reagan, compared to 9.8 percent for whites.

Given these examples, there’s no question that it’s wrong to let the Bush tax cuts expire in 2011 for high earners while we are trying to get our economy expanding again. Those earners are responsible for a great deal of the consumer spending that accounts for 70 percent of our economy—spending we need to emerge on a strong and sustainable footing from the Great Recession. Further, higher tax rates mean less money available for investment and job creation, since half of all business profits, particularly those earned by small businesses, are taxed at personal rates rather than the corporate rate.

Nicole Gelinas of the Manhattan Institute notes that newly enacted tax increases (the top tax rate going from 35 percent to 39.6 percent in 2011 and the new 3.8 percent tax on investment income of upper-income people starting in 2013 to help pay for ObamaCare) will, perversely, shift money away from the private sector, where we need it to go, while encouraging state and local governments to keep spending instead of getting their houses in order. That’s because the tax increases will cause upper-income Americans to put more money in tax-exempt local and state bonds, so those entities will just keep growing. But as she points out, eventually the rich will be so squeezed that taxes will be raised for everybody.

Most Americans I know understand that corporations shouldn’t be tax mules for the government. Corporations are like the canary in the coal mine of the US. economy—when they do well, it’s a sign that workers will do well, and the economy thrives. However, the opposite is often just as true. Michael Boskin, who is now an economics professor at Stanford and a senior fellow at the Hoover Institution and was chairman of the Council of Economic Advisers under Bush 41, explains: “Reducing or eliminating the corporate tax would curtail numerous wasteful tax distortions, boost growth, in both the short and long run, increase America’s global competitiveness, and raise future wages.”

The U.S. statutory corporate tax rate is 40 percent. The
effective
corporate tax rate (when you add state corporate taxes and deduct federal tax breaks) is about 35 percent—higher than in any of the other thirty-three countries in the Organization for Economic Cooperation and Development (OECD). It’s significantly higher than the
average
OECD effective rate of 19.5 percent or the average G7 effective rate of 29 percent.

In the last ten years, twenty-seven of the thirty-three other countries in the OECD have reduced their corporate tax rates by an average rate of about 7 percent. This makes that “level playing field” you always hear about when people discuss international trade a little less level. It makes us less able to compete. And as capital becomes ever more mobile, this inability to compete will just become more pronounced unless we do something about our tax rates.

To create more investments, we would be much better off reducing the corporate tax rate than making the targeted and temporary tax cuts (such as bonus depreciation) that Congress typically does. Companies and their investors need to be able to rely on tax rates, rather than hoping for special, occasional breaks at Congress’s whim.

If we cut corporate taxes, companies would have less incentive to move their investments and profits overseas, foreign companies would have more incentive to invest here, and we would increase jobs, wages, and tax revenues in the process.

Data from the past sixty years have shown the close relationship between federal tax revenues and GDP. The government can raise tax rates, but it can’t make revenues rise to more than about 19 percent of GDP. Kurt Hauser of the Hoover Institution first pointed out this ratio about twenty years ago, and it has remained just as true ever since. When the government predicts that it will get more revenue through higher rates, it is always wrong because it doesn’t account for the ways people change their behavior and manipulate the tax code in reaction to the higher rates. When we look at the CBO’s projections for the next decade, we can safely assume that its assumption of increased tax revenues from the higher rates starting in 2011 is wrong, which of course means its projections about deficits are wrong.

As of this writing, Congress is in the process of raising the tax rate on “carried interest” from the capital-gains rate (which itself is going from 15 percent to 20 percent) to as high as 38.5 percent. This is going to discourage long-term capital investment just when we should be encouraging it.

When we want to discourage a behavior, like smoking, we tax it more. Why on earth would we want to penalize long-term investment in one of America’s largest industries, whether automotive or steel, now, as we are trying to get companies going and growing and Americans back to work? If you were trying to come up with a counterproductive tax increase to slow growth and kill job creation, this would be it.

This reduction in after-tax returns means money will be diverted from the partnerships that are our main source of long-term investments. Venture capital will dry up. Nothing ventured by investors, nothing gained by American workers. This change is a dangerous abandonment of our long-standing tradition of taxing long-term investments at a lower rate than short-term investments, to reward those who are willing to invest in America and wait patiently for results rather than just pursue the quick buck. It makes you wonder whose side Congress is on. Do they really prefer money going out for unemployment benefits, food stamps, and Medicaid, rather than money flowing in from more working Americans?

A 2008 study from the OECD found that the taxes “most harmful for growth” are corporate taxes, followed by personal income taxes. Consumption taxes are least harmful. Nobel laureate Robert Lucas believes that eliminating corporate and personal income taxes in favor of a consumption tax is “the largest genuinely true free lunch I have seen.”

As many of you may know, I am a longtime supporter of the FairTax. Why? The answer is in the name—it’s
fair
! Imagine a world where you could chose how you spend your money—where you could choose how much tax you pay based on what you buy instead of the government deciding how much you owe based on what you earn. That’s the FairTax. In a nutshell, the FairTax would levy a nationwide national sales tax while doing away with the federal income and payroll taxes, as well as estate, gift, capital-gains, self-employment, Social Security/ Medicare, and corporate taxes. Beyond that, it would repeal the Sixteenth Amendment, allow Americans to take home 100 percent of their paychecks (unless they live in a state with its own income tax), and end compliance costs built in to the goods and services we buy. Not to mention, the IRS would be dismantled, as the national sales tax would largely be handled by existing state sales tax infrastructures.