by T. R. Reid
There’s a libertarian appeal to tax provisions that aim to nudge people to do the right thing. The taxpayer retains the liberty to make personal choices—to smoke cigarettes, to commute by car, to wash down a bag of Chili Cheese Fritos with a pitcher of beer. To pass a law prohibiting such behaviors smacks of the nanny state. It’s less intrusive to let people decide for themselves whether to engage in these behaviors. But government imposes a tax penalty to offset the social cost of those personal choices, and that penalty may have the added benefit of steering people away from undesirable choices. Similarly, offering a tax break for insulating a house is less invasive than passing a law requiring that every homeowner install insulation.
Even when they’re effective, though, there’s a clear downside to all these tax preferences and penalties: they increase the complexity of any country’s tax code. Each new tax break or surcharge requires adding one more line to the tax return—or maybe twenty more lines, or maybe a whole new schedule, like Form 6197 for the gas-guzzler tax. Each tax deduction forces taxpayers to gather and keep track of the necessary documentation. Each one forces the taxing agency to perform audits to make sure the taxpayer is really entitled to the deduction she’s claiming. In Britain, for example, anytime a taxpayer takes the deduction for a charitable contribution, both the donor and the charity have to provide a notarized piece of paper to substantiate it. An Australian can deduct the cost of uniforms for her job, but first she has to obtain a certificate from the Register of Approved Occupational Clothing.
Beyond that, tax breaks tend to last forever. Every new preference spurs an army of interest groups and lobbyists who will fight to keep it in the code long after the economic rationale for it has expired. And each eternal deduction, exemption, or credit reduces the government’s revenue, eternally.
Stimulate Economic Growth
Taxes consume a significant portion of the total national wealth in every wealthy country. So it seems entirely reasonable that a nation’s taxes would have a significant effect on the overall economy. Accordingly, politicians constantly try to design tax regimes that promote investment and job creation and thus prompt greater economic growth.
But different politicians have different theories about what kind of tax change will stimulate the economy. These differences were particularly sharp as the developed world responded to the Great Recession that spread around the globe beginning in 2008. In the United States, the initial idea was to cut taxes so that people and companies would have more money to spend; then consumer spending and business investment would haul us out of the economic swamp. The United States issued an income tax rebate and cut the employee’s share of Social Security by 2%, providing ready cash and increased take-home pay for all working Americans. Most of Europe went in the other direction, raising the VAT to offset government deficits. Britain, where the tax rate had been 17.5%, cut it for one year and then reversed course, raising it to 20%. Hungary, which already taxed purchases at 25%, raised it to 27%, giving it the distinction of charging the highest sales taxes on the planet; Ireland’s VAT went up in stages from 21% to 23%, Spain’s from 16% to 21%, Italy’s from 20% to 22%. This was a sort of stealth tax hike; most consumers who have to pay the VAT don’t realize that it has been increased.
At first glance, it would appear that America’s program of stimulus through tax cuts worked better than Europe’s austerity through tax hikes. The United States came out of the Great Recession much sooner than Europe, and American growth rates since then have been higher than those in most European countries. But it’s not clear that America’s economic growth was due to lower taxes. In fact, most of the post-Recession growth in the United States happened after taxes were raised. That 2% cut in the Social Security tax was repealed after two years, lowering every worker’s take-home pay. Congress and the president cut a deal to increase taxes on top-bracket earners in 2013. Yet the U.S. economy continued to grow at a moderate pace with the higher taxes; the unemployment rate fell from 8% at the time those tax increases took effect to 5% three years later.
Despite this ambiguity, politicians have no hesitation about claiming that any tax policy they champion will be a major stimulus. They say that when they raise taxes; they say that when they cut taxes. When Britain hiked the VAT rate to 20%, the chancellor of the exchequer explained that this tax increase would let government reduce its borrowing, which would increase private-sector capital and spark a major economic boom. When President George W. Bush proposed across-the-board tax cuts in 2003, the White House predicted that this tax reduction would create 2.1 million new jobs and spark a major economic boom. (In the event, both the British and the American predictions proved wrong.) In the United States, Republicans frequently predict that tax cuts will “pay for themselves,” because the resulting economic growth will lead to higher tax revenues. This something-for-nothing theory, first proposed by Arthur Laffer, sounds enticing in a campaign speech. Sadly, it has never worked in practice.
Economists, for the most part, are considerably less confident than politicians about the economic effects of raising or lowering taxes. Two experts at the University of Michigan, Joel Slemrod and Jon Bakija, surveyed the data and the academic literature on this point. “The first thing to note about recessions and recoveries is that they generally occur for reasons that have little or nothing to do with taxes,” they report. Does a tax cut increase job creation, as the Bush White House asserted? “In a word (okay, two words), not much. . . . [C]laims about the effects of tax cuts on the number of jobs are suspect,” Slemrod and Bakija conclude. Can a tax cut really increase revenues? “A reduction in tax rates does not cause the economy to expand enough to recoup the revenues . . . at least in recent U.S. history,” Slemrod and Bakija explain. Do lower taxes stimulate economic growth? The two economists point out that over the last half century several countries with much higher tax burdens than the United States have had better growth rates, and here at home “the strongest growth period was when the top tax rates were highest.”8
Nonetheless, in all the developed democracies, right-of-center parties (they’re called “Conservatives” or “Christian Democrats” or “Republicans”) consistently push for tax cuts as a way to improve economic growth. All the Republican candidates in the 2016 U.S. presidential race promoted this idea. “We’ve got to lower the tax burden,” candidate Jeb Bush said on the stump, “to get this economy moving again.” Meanwhile, the left-of-center parties (“Social Democrats” or “Labour” or “Liberals” or “Democrats”) often take the opposite stance, pushing for tax increases—on the rich, that is. That brings us to the next major mission of the tax code.
Offset Inequality
The president of the United States declared in 2013 that economic inequality has become “the defining challenge of our time,” one that poses “a fundamental threat to the American dream, our way of life, and what we stand for.” Barack Obama was referring to statistics showing a large and growing gap in wealth and income between the richest Americans—the so-called 1%—and the rest of us. The phenomenon that the president was talking about is not limited to the United States; income inequality has been increasing sharply in almost every industrialized democracy.
“Redistribution of wealth” has become a controversial concept in the United States in recent years. Obama got himself in hot water during his 2008 presidential campaign when he told a voter named Joe Wurzelbacher (aka “Joe the Plumber”) that “when you spread the wealth around, it’s good for everybody.” The political press declared this sound bite a blunder, and Republicans made it a key campaign issue for weeks. “This sounds a lot like European socialism,” said the GOP candidate, John McCain. In fact, though, the idea of spreading the wealth around through taxes is hardly limited to Europe. Tax codes almost everywhere have been designed to achieve this goal. “If income redistribution is considered a desirable social goal, then taxation is clearly an important means to this end—and moreover one that every coun
try in fact utilizes,” notes the tax economist Richard M. Bird.9 Even countries experimenting with a single-rate flat tax have preserved some element of redistribution by exempting low-income workers from paying the tax.
The mechanics of redistribution are fairly simple: you raise taxes on the richest citizens and use the added revenue to provide education, health care, jobs, or straightforward cash payments to the poor. To do that, a country needs a tax structure that works the way Christ recommended to his disciples on the day they went to the temple—a system that taxes people in proportion to their ability to pay.
In America’s current political discourse, it is the conservatives who complain about progressive taxes that place the greatest burden on the rich. Traditionally, though, economic conservatives were strong defenders of this principle. None other than Adam Smith said that “it is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in proportion.” F. A. Hayek, the Austrian economist who has become an idol for many American conservatives, made the same point in his classic work The Constitution of Liberty. The rich should be expected to pay more, Hayek reasoned, because “a person who commands more of the resources of society will also gain proportionally more from what the government has contributed.”10
Edwin R. A. Seligman, a professor at Columbia who helped lead the charge in the United States for a progressive income tax at the start of the twentieth century, maintained that the course of history was moving all modern countries inexorably toward a tax code based on ability to pay—or “tax justice,” as he called it. In his 1914 text, The Income Tax: A Study of the History, Theory, and Practice of Income Taxation at Home and Abroad, Seligman set forth his argument in majestic prose:
Amid the clashing of divergent interests and the endeavor of each social class to roll off the burden of taxation on some other class, we discern the slow and laborious growth of standards of justice in taxation, and the attempt on the part of the community as a whole to realize this justice. The history of finance, in other words, shows the evolution of the principle of faculty or ability to pay—the principle that each individual should be held to help the state in proportion to his ability to help himself. . . . Even where actual fiscal institutions represent more or less thinly disguised efforts of the dominant economic class to roll the burdens on the shoulders of the weak,—even here it is rare to find a cynical disregard of all considerations of equity.11
Those considerations lay at the heart of the first tax law ever written in the United States. In 1634, the elders of the Massachusetts Bay Colony decreed that each man was to be assessed “according to his estate and with consideration of all other his abilityes whatsoever.”12 But that principle was forgotten in nineteenth-century America, where “the dominant economic class” successfully fought back efforts to institute progressive taxation. When Congress enacted a graduated income tax in 1894, the Supreme Court quickly voided the statute. The justices were almost apoplectic at the idea of asking the rich to pay more. “If the Court sanctions the power of discriminating taxation,” Justice Stephen J. Field wrote for the majority, “. . . it will mark the hour when the sure decadence of our government will commence.”13
The hour of sure decadence commenced sooner than Justice Field probably expected. By 1913, the United States had changed the Constitution (via the Sixteenth Amendment) to get around the Supreme Court, and the income tax became law. From its first day, the whole point of the U.S. income tax was to redistribute the tax burden from farmers and small landowners to the new class of tycoons and robber barons who had sprung up during the Gilded Age. The first income tax had a progressive rate scale, with the top rate at 7%. It was so carefully aimed at the richest Americans that less than 4% of households had to pay at all.14 Recently, there has been considerable public concern about the fact that 47% of Americans pay no income tax; the presidential candidate Mitt Romney opined that these are people “who are dependent upon government, who believe that they are victims, who believe the government has a responsibility to care for them. . . . These are people who pay no income tax.” In fact, though, the U.S. income tax was initially designed to apply only to those in the top income brackets; its primary purpose from the start was to offset inequality.
Enhance the Legitimacy of Government
It may be difficult for Americans to understand that a tax system can be an important tool for building citizenship. A regime of taxes considered fair and reasonable, and an honest, efficient agency to collect them, can give people confidence in their own government. Because taxes hit just about every citizen in one way or another, everybody has a stake in effective taxation. This is particularly true in young nations or in countries where corrupt government has traditionally been a fact of life. Achilles Amawhe, the man who gave me that baseball cap from Nigeria’s revenue service, is acutely aware of this tax function. “When we won our independence, we had to prove to ourselves, and to the world, that we could carry out self-government,” he told me. “I always knew that an honest tax agency would be a symbol of that.”
In fact, a promise of rigorous universal tax collection can be a winning political strategy. When Alexis Tsipras and his Syriza Party challenged the longtime incumbent government of Greece in 2015, he ran on a pledge to “fight the oligarchy that is evading taxes,” and he won, in a country where ducking the tax man had long been considered standard operating procedure. As prime minister, Tsipras appointed an “anticorruption czar” with a mission to make all Greeks, rich or poor, pay the taxes they owed. The czar himself, Panagiotis Nikoloudis, saw his role as something considerably bigger than just bringing in revenues. Rather, it was his duty to convince the people of Greece that government can work. “If people see that I’m clean, and the prime minister is clean,” Mr. Nikoloudis said, “and that those who are not clean will eventually go to jail, I like to hope it will inspire a change in Greek society.”15
The theory that good taxes make good citizens (who then demand good government) has spawned a considerable academic literature in the field of political science. In a 2014 study, Lucy Martin of Yale University set up experiments to test the proposition that people insist on better government—and get it—if they have to pay for it through taxes. In a series of field tests in Uganda, Martin set forth a situation where both taxpaying and untaxed citizens were told that a public official was corrupt. Those paying taxes proved to be far more indignant about this and were more inclined to punish a guilty leader. In poor countries that depend primarily on foreign aid for their revenues, Martin found, citizens tend to tolerate poor government and official corruption. But that attitude changes when taxes become due. “Taxation generates a significant increase in the level of accountability citizens demand from leaders,” she concluded.16
In modern society, taxes go far beyond the basic mission of paying for government programs. This may be one reason why the U.S. tax code has become so ridiculously complicated; for each new mission, there’s a new privilege or penalty or preference written into the law. This complexity is exacerbated by the enormous impact of money on American politics. Each year, hundreds of different contributors, each with his own pet cause, manage to persuade Congress to insert a particular loophole or exclusion into the Internal Revenue Code. America’s tax system is like an old inner tube that has been patched a dozen times—and still leaks.
And this is exactly the wrong way to design a tax system. It violates the most important rule of good taxation—a principle the economists call “BBLR.”
4.
BBLR
The modern world has tens of thousands of international organizations, ranging from the Fédération Aéronautique Internationale (based in Lausanne, Switzerland) to the World Association of Zoos and Aquariums (based in Gland, Switzerland). Some are more than a hundred years old. The first wave of internationalization occurred in the late nineteenth century, when amazing innovations like elec
tricity, telegraphy, steamships, and railroads created a need for global agreements on time zones, power grids, weights and measures, and so on. The drive for standardization came from Europe, which is why we still measure time and longitude based on a meridian running through Greenwich, England, and why the global standards for the meter and the kilogram are stored in a vault in Sèvres, France. In the twentieth century the United Nations, the World Health Organization, Interpol, the International Olympic Committee, the International Committee of the Red Cross, NATO, and the like were created.
In recent decades, the Internet and the smartphone, Facebook and Snapchat, have sparked a new rush of international organization creation. There’s an international Video Electronics Standards Association and an International Programmers Guild. There are global fan groups for dozens of video games you’ve probably never heard of. There are hundreds of global associations for specific industries, ranging from the International Federation of Beekeepers’ Associations to the International Society of Sugar Cane Technologists to the International Association of Wood Anatomists.
Inevitably, there’s also an international organization of international organizations: the Union des Associations Internationales, based in Brussels. In 2015, its annual directory (published in English, Spanish, German, and Esperanto) listed 68,029 global groups.1 Several of the international associations listed in that huge directory focus on issues of national finance and taxation. There are world federations of accountants and investment advisers, of tax law professors and import duty collectors. There’s the World Trade Organization, which struggles to get countries to agree on rules of cross-border commerce.
