Taxes and Capitalism, a Few Rules for Honest Tax Cutters

It’s possible, just possible, that Thursday’s White House meeting between President Barack Obama and congressional leaders from both parties will lead to a deficit-cutting deal.

The president, after all, has promised cuts to entitlements like Medicare in exchange for Republican support on tax increases. With the outlines of genuine progress on the horizon, it seems like a good time to review a few principles about taxing and spending.

Some people appear to believe that the government can run on zero revenue, just borrowing whatever is needed to pay the bills. They never put it that way, but that’s the implication of what they say. The folly is bipartisan. These people include conservative Republicans who have never seen a tax cut they didn’t like, and liberal Democrats who see any expression of alarm about the deficit as part of a plot to repeal the New Deal.

That is not our position. We take the radical view that revenue is sometimes necessary. This is one of those times. Given that tragic necessity, what is the best way to go about collecting it?

Start by acknowledging that the conservative supply-siders have a point: Any tax depresses the activity being taxed. Sometimes, you want to use the tax system to affect behavior. The cigarette tax is an example. But in general, if you believe in free markets (and the endless tax debate illustrates how many people pretend to believe, but don’t), you want taxes to change people’s incentives as little as possible.

In other words, you want them to behave as closely as possible to the way they would if there were no taxes. This means two things: Tax rates should be as low as possible, given the government’s revenue needs, and tax rates on different ways to use your labor or your capital should be as similar as possible.

Nefarious Subsidies

Too much attention is given to the first of these considerations (low tax rates) and not enough to the second (consistent tax rates). In fact, Congress puts much energy into making the second factor worse, by the profusion of different tax rates and tax breaks for this and that. Government subsidies through the tax system are especially nefarious because they operate under the radar. They don’t appear in annual government budgets, state or federal, they don’t require an appropriation, and there’s no limit to how much they can cost.

Every tax break for some industry or activity means higher taxes for everyone else. People who call for or defend such breaks -- from tax credits for car buyers to the favored treatment for capital gains -- are, in effect, saying they (and the government) know better than the market how best to allocate capital in the economy.

Skewed Tax System

Even as the distribution of income in the economy has become skewed in favor of the well-to-do, the tax system has become skewed as well. We believe that the tax system should be progressive, with people who have been more fortunate paying a bigger share. Opponents of progressivity often note that the rich, however that word is defined, pay an increasing percentage of the income tax. Indeed they do: That is because they earn an increasing share of the income. As a percentage of their income, affluent people’s taxes have gone down.

Getting out of the fiscal hole the U.S. has dug itself into (along with other nations that should have known better) will require not just “the rich” but also the middle class to pay more of their income in taxes.

Increasing numbers of Americans agree. According to a recent Bloomberg National Poll, more than 75 percent of those surveyed -- Republicans, Democrats and independents -- believe that an increase to bring down the deficit is inevitable. That could be resignation rather than conversion, but in any event, it’s a start. Many more people, we believe, would find this medicine easier to take if they had more faith that the money was being spent wisely.

In short, spending must also take a hit. And not just “waste,” either. On the spectrum between “nice to have” and “essential,” many Americans have moved their private spending closer to the latter, and they want the government to do so, too. We agree.

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