How Our Broken Tax System Drives the Economy

Bruce Bartlett is a tax curmudgeon – and I mean that as a compliment. It is hard to spend as much time as Bartlett does studying the U.S. tax system and not get grumpy. Bartlett writes with such “can you believe those idiots?” glee that you feel like smirking at the same time you’re pulling your hair. So, if you are looking for a kind word about the U.S. income tax system and the people who have fashioned it, Bartlett’s book, The Benefit and the Burden: Tax Reform – Why We Need it and What it Will Take is not the place to begin. But if you are looking for a forthright and full-throated call to both parties to join in a campaign to reform that system, you could do much worse.

Bartlett joins a long list of critics who point to the needless complexity of the current income tax. He documents the damage to economic efficiency resulting from an Amazon jungle of special tax provisions. He explains the unfairness resulting from countless provisions justified as increasing fairness. He blames both parties, faulting Presidents Obama and Bush (the second) for contributing to the current mess by advocating narrowly targeted provisions which Congress unwisely approved. He does not extend the indictment to Presidents Clinton and Bush (the first) who, in my view, were at least as culpable.

Although both parties come in for some sharp criticism, Bartlett reserves his harshest language for fellow conservatives — he is an alumnus of the Reagan administration Treasury Department. Reading the book, one often feels as if Bartlett wants to grab fellow conservatives by the arms, shake them up, and tell them to start making sense. One can almost feel his fists clenching with frustration when he writes that he’s “never once heard a conservative admit that there is a level of taxation below which it would be unwise to go.” He scorns those who say that tax cuts pay for themselves. He derides the idea that the budget deficit can be lowered to a sustainable level without tax increases. Toward that end, he calls for enactment of a tax, but he does so only after reviewing the reasons many oppose it. He would use the revenue from such a tax partly to lower the budget deficit and partly to pay for lowered personal income and payroll taxes. On Senator Orrin Hatch’s dismissal of the concept of tax expenditures, Bartlett minces no words: “This statement is complete nonsense.”

He devotes an entire chapter to Grover Norquist’s fanatical opposition to any tax increase, even ones that close loopholes. With impeccable logic, Bartlett observes that conservatives should deplore unjustified loopholes at least as much as liberals do because loopholes require higher rates to collect a given amount of revenue and conservatives detest high rates. Rather too fatalistically for my taste, he treats Norquist like the bull-necked hulk standing behind the rope at an exclusive night-club, ‘no tax reform admitted until and unless I say so.’ Surely, if even a few of those who have signed Norquist’s infamous ‘no tax-increases’ pledge break ranks, the rest can tell him with impunity to take his pledge and stuff it. The problem, in other words, is not Norquist’s petty tyranny, but the pusillanimity of the petition signers.

But scolding fellow conservatives is not what this book is primarily about. Most of it is about the myriad and irrational ways the tax system influences just about everything — how much housing we buy, how we pay for our health care, who gives how much to what charities, and on and on. Part of the reason for the deterioration of tax policy, Bartlett suggests, is the reduced role of the Treasury Department’s once-formidable Office of Tax Analysis, which at one time bestrode tax policy. But, as Bartlett points out with devastating clarity, the blame mostly lies elsewhere. The tax system was comparatively simple immediately after enactment of the Tax Reform Act of 1986. Most of the superb professionals who had staffed the OTA for decades and who drafted TRA 86 were still in place. Creeping clutter took over the Internal Revenue Code, not because OTA staff relaxed vigilance or decamped for well-paying jobs elsewhere, but because successive presidents and members of Congress of both parties wanted to use government to accomplish objectives they (or their campaign contributors) deemed worth doing, but were afraid to be charged with abetting “big government.” After all, spending equals big government, and cutting taxes shrinks government. Right? Of course not, Bartlett points out. Tax credits to encourage historic preservation uses government power fully as much as does an expenditure for the same purpose. Both raise the deficit. Both distort private decisions. The bookkeeping difference, however, although cosmetic, is politically seductive. And members of Congress are easily seduced (there is a name for that; but let’s not go there).

The book contains some rather juicy factoids, as well. For example, readers will learn that the average rate paid by the 400 highest-income filers has fallen by more than one third since 1995. They will also learn that, far from being unusual, Mitt Romney’s seemingly low average tax rate is only a tad below the less-than-18 percent average rate of these super-high-income taxpayers during the period 2004 through 2008.

While there is so much in The Benefit and the Burden to admire — the abundance of information, the general good sense about what is wrong with the tax system and how to fix it, and, not least, its clear and readable prose — there are some serious shortcomings about which prospective readers should be warned.

First, it is marred by bald assertions, some of which, in my view, are demonstrably wrong. Bartlett incorrectly states that current revenue estimates fail to take account of behavioral responses. Many do. He states that high corporate tax rates are bad for economic growth, but presents no evidence for this proposition. What matter far more than the rates are the differences in tax treatment of different forms of investment. It is the differences that lead to investment in tax-favored activities even if real economic returns are inferior. Comparatively high rates levied equally on all investments would harm growth much less than do much lower rates applied unevenly – and could even help growth if the revenue were applied sensibly to growth-enhancing research, education, or infrastructure. He asserts that income can be taxed progressively or proportionately, ignoring the fact that the largest tax for most Americans is the payroll tax, which is levied regressively. The definitions of economic concepts such as ‘income’ and ‘substitution’ effects are incomplete or wrong.

Second, certain topics that are critical for understanding the impact of taxes are mentioned little or not at all. One of these is tax capitalization, the tendency for tax breaks to boost the price of durable goods to which they apply. The favorable tax treatment of owner-occupied housing, for example, boosts housing prices. To that extent, they increase what people pay for housing not how much housing they consume. Current owners may enjoy little or no real break because they paid previous owners for the value of that break when they bought their house. That explains, in turn why it is so hard to get rid of this provision: Doing so will lower housing prices and inflict unjustifiable harm of those who paid prices inflated by the tax breaks, particularly if they borrowed heavily to finance their purchases. The same sort of problem exists with many other tax breaks that made and make little sense. Even if the provisions made no sense in the first place, legitimate arguments can now be made for protecting people who bought assets or entered into contracts believing these provisions would endure. From these arguments emerge transition rules. These rules mean that the old system and the new coexist side by side. This duality may add to complexity for years, even decades. Because transition rules may be seen as necessary, are extremely difficult to draft, and are a source of increased complexity, the reform measures often seem more trouble than they are worth.

Bartlett treats cursorily, if at all, not only transition problems, but also tax complexity, much of it inescapable, that arises from the intentionally different tax rates and rules applied to various enterprises including insurance companies, banks, charities, foundations and other non-profit entities. He devotes little time to the inescapable difficulty of taxing transactions spread out over time or space, involving income and expenses denominated in dollars worth different amounts because of changing prices or in currencies of different countries whose relative values change over time. Experts agree that the current system handles these problems much less well than is possible. They also disagree on which reform would be best. And, once again, myriad investments and other contracts have been undertaken based on these rules, so that all changes produce windfall gains and capriciously random losses. Tax reform could correct some of these complexities. But no tax system in a world of independent sovereign nations populated by individuals and companies engaged in distinct activities can be simple or entirely free of opportunities for manipulation.

As a sophisticated student of the tax system, Bartlett is quite aware of these complexities. He left them out of this book, presumably because they are numbingly complex and can be — let’s be frank — soporifically dull. How many readers, for example, would want to invest the time necessary to understand the rules regarding how taxes paid to foreign nations should influence the tax owed to the U.S. Treasury, how shifting exchange rates should be handled, and where the income should be taxed of a complex multinational corporation that raises capital in several countries for investment in several others to produce goods for sale in yet others? But on such issues hinge hundreds of billions of dollars of potential U.S. tax revenue and trillions of dollars of investment decisions of the world’s largest corporations.

Finally, the book gives far too little attention to what I think is the linchpin of tax reform — the corrupting influence of the current dependence of candidates for political office on private contributions. The fact that all incumbents and candidates know that their chances of winning or retaining office depend on contributors with large stakes in how tax laws are written means that citadels of money defend current provisions, however ill-considered they may be. Even before the Citizens United decision, the corrupting clout of those who benefit financially from current tax provisions was deplorable. After that decision, it is scandalous and acutely threatening to American democracy. Yet Bartlett mentions the power of money only in the context of charitable contributions and think-tank corruption, and more briefly with respect to the research and development tax credit (not made permanent, Bartlett asserts, so that members of Congress can extract campaign contributions for its renewal).

In the end, therefore, Bartlett has produced a book that is easy and fun to read, that provides a great deal of information, and that will inform many readers – but may also leave them thinking they know more than they actually do about a formidably complex subject. It is a splendid initiation into the tax system and why it needs reforming. But readers would be well advised not to end their study here.