February 16, 2005,
In a 2003 New York Times Magazine interview, former Clinton chief of staff John Podesta talked about the formation of his Center for American Progress, and his hope that it would eventually serve as a liberal counterweight to prominent right-of-center think tanks in Washington such as the Cato Institute and the Heritage Foundation. Well, if Podesta was going for a liberal counterweight to conservative thought, he has succeeded. Perhaps he should think of his center as an extreme liberal counterweight.
Take, for instance, “A Fair and Simple Tax System for Our Future,” the sixth in a series of policy papers that Podesta’s center hopes will shape the Washington debate. While the document is serious in tone, it is full of naïve and contradictory proposals that, if implemented, would reduce investment and employment, and in the process set in motion an economic contraction that will harm the very people it is intended to help: the poor and the middle class.
The plan’s authors first off want to “simplify” the tax code by raising the top rate on incomes above $120,000 to 39.6 percent, while dropping the rate on incomes below $120,000 and $25,000 to 25 percent and 15 percent respectively. Unsurprisingly, the thinking of the authors is “that the most successful among us should contribute a greater share to support the collective services we all enjoy,” especially since “the tax share has shifted away [with the enactment of the Bush tax cuts] from those who can best afford to pay.” This might surprise those in the top 1 percent of taxpayers who presently account for a record 34 percent of all federal revenues. Then again, much of what’s in the plan is pretty shocking.
The authors fail to understand one of the most basic economic lessons of the 20th century: that the best way to get money out of the rich is to tax them the least. A New York Times editorial as far back as 1923 showed an understanding of this paradox. In analyzing the tax cuts proposed by then Treasury Secretary Andrew Mellon, the Times noted that Mellon “wants in reality to get more money out of the rich than they are now paying. But he proposes to do it by making their rate of taxation lower.” The editorial went on to point out a behavioral truth that seemingly eludes today’s class warriors: The rich always find ways to escape “the heavy taxes placed on them.”
The Times editorial was proven correct three times in the 20th century. In The Economy In Mind, the late Warren Brookes showed that in the 1920s, when the top tax rate was 25 percent, the majority of U.S. taxpayers accounted for 4.5 percent of federal revenues while the top .02 percent paid nearly half the taxes.
Shifting forward to World War II, when the top tax rate was lifted to 91 percent, the richest .05 percent of taxpayers accounted for 5 percent of federal revenues, according to Brookes, while the lowest-income taxpayers were “shouldering 48% of the burden.” Calvin Coolidge once said that when “the taxation of incomes is excessive, they tend to disappear.” Or, as Arthur Laffer later put it, “if a dog is beaten, his whereabouts will not be known.” History has proven them all right.
In the 1960s President John F. Kennedy said “it is a paradoxical truth that tax rates [the above-mentioned 91 percent] are too high today and tax revenues are too low and the soundest way to raise revenues in the long run is to cut rates now.” Kennedy’s tax cuts were passed after his assassination. But as the Mellon tax cuts in the 1920s could have foretold, the rich, in paying a lower nominal rate after the Kennedy tax cuts were enacted, ended up paying a lot more in total taxes. Indeed, just as the top taxpayers saw their tax rate fall from 91 percent to 70 percent, the total taxes they paid rose 72 percent in 3 years.
When Ronald Reagan was elected president, the top tax rate was 70 percent, and the top 1 percent of taxpayers accounted for 15 percent of federal revenues. By the time he left office, after cutting the top tax rate to 28 percent, the top 1 percent of taxpayers generated 28 percent of all federal revenues.
Just as the tax-reform proposal of Podesta’s group fails to account for the disappearance of incomes when they are taxed at higher rates, it also fails to see that as the top tax rate in a country rises, the workweek often shrinks. Nobelist Edward Prescott showed this in a recent paper he wrote for the Minneapolis Federal Reserve. The French, as Prescott reasoned, aren’t “laid back” because of some genetic quirk; the country’s top tax rate is 50 percent higher than the top tax rate in the U.S., so there’s not much of an incentive to earn that extra dollar. According to Prescott, the average French workweek was actually longer than the average U.S. workweek in the 1970s. Back then, our top tax rate was 70 percent. As that rate fell throughout the 1980s, revenues and hours worked climbed.
Higher tax rates are not a magic bullet they will rarely throw off the revenues that policymakers predict. Remember: The surpluses under Bill Clinton materialized after, not before, the 1997 capital-gains rate cut that caused revenues from that source to skyrocket.
As for capital-gains taxes, the Center for American Progress plan would raise the rate for the “rich” to 39.6 percent. In making this proposal, the authors once again show an astonishing lack of historical knowledge. A similar tax on investment was tried before.
In 1969, Congress raised the top capital-gains rate from 25 percent to 50 percent. As Bruce Bartlett noted in Reaganomics, “the effect of this tax change was immediate and dramatic.” After the 100 percent hike in the capital-gains rate, the number of IPOs dropped from 1,298 in 1969 to 18 in 1978. There were 698 equity capital issuances for even smaller companies in 1969. In 1978 there was just 1. When the capital-gains tax rate was reduced to 28 percent in 1978, IPO issuances jumped once again, with 144 occurring in 1979 alone.
Podesta’s tax reformers see capital-gains tax cuts as “tax giveaways for the wealthiest taxpayers.” Again they miss the point. The rich, by virtue of being rich, have more capital than the poor and middle class to invest in tomorrow’s companies. The “rich” won’t get richer if the capital-gains tax is raised. Instead, the “rich” guy will be more likely to buy a Rolls-Royce than fund the next Google. A lot of good that will do the poor and middle class.
The dividend tax in the Center for American Progress plan would also rise to 39.6 percent. The authors make this proposal despite the fact that since the 2003 tax cut on dividends was enacted the rate was lowered to 15 percent corporate dividend payouts have increased from $146 billion to $172 billion. The authors almost completely ignore the behavioral implications of their proposals.
Moving to Social Security, Podesta’s crowd believes that the payroll tax is the biggest burden on taxpayers. For once, they’re right. But rather than fixing this problem, the Center for American Progress plan would make it even more difficult for Americans to get on payrolls to begin with. The proposal would shift the 6. 2 percent burden that employees now face over to the employers the same people who are already paying 6.2 percent on wages up to $90,000.
This is perhaps the most glaring contradiction in a tax-reform plan filled with glaring contradictions. Early on in the report the authors express their displeasure with corporations that are shifting “investments and profits overseas.” What do they think U.S. corporations will do once the already high cost of hiring workers becomes even more onerous?
Lastly, apparently unaware that the Social Security trust fund is little more than a myth, the authors propose setting aside 2.25 percent of U.S. GDP each year for that same “trust fund” so that the government can keep its “full commitment” to financing Social Security’s guaranteed benefit structure. The “lockbox” lives!
The tax-reform proposals of Podesta’s group range from the questionable (deficits result from revenue shortfalls) to the wrong (budget deficits cause interest rates to rise) to the downright silly (the current tax code is advantageous to the “rich” by virtue of the fact that they pay a higher rate and so get larger tax deductions when they put money in their 401(k)s).
John Tamny is a writer in Washington, D.C. He can be contacted at firstname.lastname@example.org.