Posted by Tod Lindberg on September 25th, 1995
The Weekly Standard
The chairman of the House Ways and Means Committee was among friends the evening of June 5, 1995, when he invited a small group of like-minded conservatives to his office in the Cannon building to talk taxes. One of those in attendance at Rep. Bill Archer’s soiree might have been more libertarian than the others, another more of a monetarist than a supply-sider, but everyone present agreed on the basics. No one was there to discuss raising taxes to reduce the deficit, thank you very much. Nobody wanted to figure out how government could do more for people, or how to add funds to the enforcement budget of the Internal Revenue Service in order to improve ” voluntary compliance” with the tax code. No. What was under discussion was how to change all that — the Big Picture of conservative, Republican tax reform.
Take the Sixteenth Amendment, which enabled the federal government to levy an income tax directly on Americans. Chairman Archer, you see, would like to get rid of the Sixteenth Amendment.
Well, not just get rid of it. As Archer explained to his guests, many constitutional scholars argue that the Sixteenth Amendment was not necessary – - as other scholars thought back in 1913 — to establish the constitutionality of some form of income tax. Thus, repealing the Sixteenth Amendment may not be enough. We may want to think about drafting a new constitutional amendment that positively forbids the imposition of a federal income tax.
That is how conditions are in Washington these days. In a corner office on a bright, late spring evening in June 1995, a conversation unimaginable a year before was taking place: the chairman of the House committee in charge of federal taxation trying to sell his ideological comrades on the way he would like to get rid of the federal income tax. Mind-boggling.
The plan Archer outlined in his office calls for getting rid of individual and business income taxes and replacing them with a tax on consumption; you pay when you spend, not when you earn or save. The consumption tax is one of two Big Picture tax overhaul ideas making the Republican rounds. The other is the flat tax — more specifically, a fiat-tax plan of House Majority Leader Dick Armey to eliminate all deductions in exchange for a 17 percent tax rate across the board and thereby allow an American taxpayer to submit his return on a postcard.
These ideas are already making their presence felt in the 1996 presidential election cycle. Richard Lugar is in favor of a consumption tax; Arlen Specter has a modified flat-tax proposal that has a higher rate than Armey’s to maintain the deductions for home-mortgage interest and charitable contributions. Higher-profile candidates are preparing to enter the fray in the fall. Phil Gramm is close to Armey and has a penchant for Big Picture declarations of his own. And Robert Dole is positioning himself to accept the recommendations of a tax commission headed by Jack Kemp that will surely look fondly on the flat tax.
It should come as no surprise that this is the year for a wide-ranging debate on taxes, nor that some of the ideas floating around are so far- reaching. They are, after all, based on credos right out of GOP 101.
Credo #1: High tax rates bad, low tax rates good. Credo #2: High taxes bad, low taxes good. As a matter of fact, in accordance with Credo #1, high tax rates have an inhibiting effect on economic activity and make us all poorer. As a matter of sentiment, in accordance with Credo #2, the government takes too much out of people’s wallets, i.e., Washington is too damn big.
The first thing to understand about the Armey-Archer tax plans is that they are not tax cut plans. The government will need $ 1.88 trillion in revenue in 2002 to pay the bills. That’s how much the current tax system is supposed to deliver, and that’s what any reform plan must deliver in these anti-deficit days. (Armey’s plan does feature a small tax cut, but that’s hardly its purpose.) Of course, some people’s taxes would go down. But there’s a very simple corollary to that:
Some people’s would go up. This is worth thinking about.
The intellectually honest selling point for each plan is that it is a vast improvement over the current system: better for the economy and easier on the people who have to comply.
The liabilities of the current system are well known. High capital-gains tax rates restrict capital formation and economic growth. Taxes on savings have helped cause a lower savings rate than in most other industrial democracies. High top marginal tax rates discourage additional labor by the most productive sector of society. And the current tax code is a nightmarishly burdensome thing, requiring more than 5 billion man-hours per year in compliance time at a total cost of over $ 200 billion. The IRS itself can’t give consistent answers to taxpayers’ questions. Fear of audits drives people to distraction.
What to do, what to do? Well, get rid of it — either altogether (in the case of the Archer plan) or of the system’s most noxious features (in the case of the Armey plan). Then watch the economy grow like gangbusters.
Archer has spelled out his criteria for a good tax system. He wants the IRS out of people’s lives. He wants the least possible disadvantages for saving. He wants the tax system to reach the now-untaxed underground economy. He wants a way to remove the costs of U.S. taxes from the price of goods leaving the country, and he wants foreign goods entering the country taxed at the same rate as U.S.-made goods.
A consumption tax fits the bill, he thinks. We’re talking about a levy of, say, 17 percent on all goods sold. In this scheme, the IRS ceases to exist. It no longer monitors income because there is no longer any tax on income. Save as much as you like; you won’t pay any tax on what you save and there will no longer be any tax on interest. For those who have grown accustomed to evading their income tax liabilities, the news is this: You can’t buy a product without paying your fair share of taxes.
For Dick Armey, the four cardinal virtues of his flat-tax plan are simplicity, honesty, the promotion of economic growth, and fairness. He proposes to achieve it by imposing one single tax rate on all income, individual and corporate, of 17 percent. So, in April, here’s what your average American will do: He will write down his total income. He will multiply that number by 0.17, and then he’ll mail it in before midnight on the 15th. Under the Armey plan, all the current deductions are gone: no deductions for state and local taxes, no mortgage interest, no charitable contributions, no moving costs, nothing.
Businesses will add up the wages they pay and the costs of purchases they make from other businesses, then subtract the total from gross sales, and multiply the result by the same 0.17. And this will be the last taxation on dividends: Individuals will no longer pay. Nor will they pay on interest income or capital gains.
The flat taxers and consumption taxers alike were both compelled to deal with the question of what happens to poor people if their plans were to become law. If you’re only making $ 10,000 a year, should the government really have a claim on 17 percent of that, whether in the form of a fiat income tax or a consumption tax? (After all, if you make only $ 10,000, it’s a good bet that virtually all your income will go toward consumption.)
The answer, obviously, is no. So Armey exempts the first $ 22,700 of income for a married couple from taxation altogether, and allows a deduction of $ 5, 300 for every dependent. In other words, a family of four with income of $ 33, 300 pays no federal income taxes, and just 17 cents on the next dollar. In Lugar’s plan, there would be an exemption in the consumption tax of $ 5,000 per individual — in other words, the first $ 5,000 in consumption would go untaxed. (How to do this? Well, the simplest way would probably be for the government to send everyone a check for $ 850, which is 17 percent of $ 5, 000in effect a rebate of the tax on the first $ 5,000 in consumption.)
Any number of economists support the flat-tax plan, others the consumption- tax replacement. Study after study purports to show the beneficial economic effects of a dramatic overhaul of the tax code along either line. For purposes of argument, let’s stipulate those beneficial effects without getting bogged down in their details. It is a fine thing to sit and contemplate the ways in which life would be different under either of these regimes. Sensible policy making requires no less.
But politics must come before policy. Conservatism in Washington no longer resides in the age of the “thought experiment,” to adopt the term Charles Murray used in his classic 1984 book Losing Ground. Murray conducted a ” thought experiment” by imagining a world without welfare, then contrasting the choices facing a pregnant teenager in that imaginary world with the choices facing such a teenager under current welfare policies.
The result was highly illuminating, but we are not seeking illumination here. It is one thing when a then-obscure intellectual proposes that we think about something differently — or when an economist lays out his forecast of the economic effects of this tax reform plan or that. It is something else again when the chairman of the tax-writing committee of the House of Representatives wants to do away with the income tax and replace it with a consumption tax — or when the majority leader of the House wants to switch to a flat tax.
If ideas have consequences, then some ideas have more consequences than others — and certainly, the ideas of more consequential people have more consequences than the ideas of others. In 1984, Charles Murray couldn’t end welfare. In 1997, Archer or Armey or both, in conjunction with a Republican president, can make a serious run at bringing fundamental change to U.S. tax policy.
Such an effort will have real-world political consequences, and they will be far more profound than any economist’s model can possibly predict. So while there may be all sorts of principled answers to the question of what kind of tax system we should have, they will be incomplete unless they also address how exactly we get there from here. That is, after all, the essential question of practical politics.
There have already been some tough questions raised about each of the two GOP tax overhaul schemes. Here are just a few: Are we ready for a world in which those — the pejorative term is “idle rich”who live solely off their interest and dividend income pay no taxes, or pay taxes only on the tiny fraction of their living they must devote to consumption? True, the money they have has already been taxed, and one of the most attractive aspects of the Armey proposal is that it will do away with the current system’s appetite for doubly and triply taxing the very same dollar. Still, there’s no question that these are the people who will benefit most from the institution of a flat tax. Are Republicans and conservatives really ready to defend the proposition that someone who gets $ 200,000 of interest and dividend income a year should pay no taxes, while a family of four making $ 60,000 is ponying up $ 4,500 a year to the feds?
What will happen to home prices if the mortgage interest deduction is eliminated? According to orthodox economic theory, houses will surely depreciate in value, perhaps as much as 15 or 20 percent. It’s a great opportunity for first-time buyers, but those who happen to have substantial equity in homes will be hurt. They are voters. They are voting Republican these days. They have participated in the decades-long American commitment to the idea that home ownership is so desirable, the tax code must reflect its benefits. Can, or should, politicians be involved in a wholesale alteration of this deeply held belief?. Should conservatives be rolling the dice like this with the economic fortunes of tens of millions of Americans?
What happens to charitable giving if people can’t deduct their contributions? The theory goes that ensuing economic growth will result in more people having more to give, and Americans are traditionally generous. However, virtually all major charitable organizations are convinced this change will cripple them. And, once again, there has been a consensus for decades that there is value in expressing a national commitment to the idea of charity by having its virtue reflected in the tax code. That may be economically impure, but Americans cannot live by macroeconomics alone.
How much difference is there, really, between the current 1040EZ and a return that fits on a postcard? The complications of tax forms themselves will not be enough justififcation for a major overhaul of the system, complete with whatever unforeseen complications may ensue.
What happens in that final few months between the end of the income tax and the beginning of the consumption tax? The final quarter before the consumption tax takes effect ought to be a pretty good one for retailers, car dealers, boat salesmen, etc. (The next quarter or two might be a little more difficult.) What about people who crank up their credit cards to the limit to get in as much of next year’s consumption in advance as they can? What will front-loaded consumption do to overall revenue, compared with projections?
Should the young and the old bear the burdens of a consumption tax because Americans don’t save enough? People’s consumption patterns vary with age. When you are just starting in the workplace, you are likely to devote a relatively high proportion of your income to consumption. Similarly, when you are old. These are therefore the people the system will tax most. Even those who don’t like the whole concept of “fairness” as a basis of policy might find this unpalatable.
Are we ready for the end of non-cash benefits from business? Under the fiat tax, businesses will no longer be able to deduct the cost of non-wage benefits for workers, such as health insurance premiums. Will businesses continue to offer insurance to workers? What will workers think about the possibility they won’t?
And, ultimately, how will Republicans offer any son of affirmative government policy without a politicized tax system? Since Republicans are, generally speaking, averse to spending public money in pursuit of conservative social engineering, they have usually pursued it by encouraging tax breaks to reward behavior of which they approve. Are they prepared to bid farewell to that strategy once and for all?
The visionary quality of the tax reform ideas is a mark of how deeply Republicans and conservatives have thought about these issues. The plans are brilliant, and perhaps they will result in a better system of taxation and government. But it is precisely the visionary aspect of these ideas that should give Archer, Armey, Lugar, and their fellow Republicans some pause.
After all, the first two years of the Clinton administration offer a dramatic cautionary tale of the risks of attempting to bring a policy vision to practical life without considering the politics of it first — the healthcare catastrophe.
Bill Clinton campaigned on reforming the healthcare system, and in the course of doing so made some rather grand promises about health coverage for all Americans, dramatic savings in both the federal budget and in overall health care expenditures, and so on.
Once elected, Clinton had myriad choices. He might have articulated his core goals and turned the matter over to Congress to work out the details of a plan. He might have submitted various pieces of legislation each aimed at addressing discrete problems. He might have drawn on reform proposals that Congress had already considered to some degree — in some instances, measures that Congress had already voted on — and gathered them into a single reform plan.
Or he might have decided to turn the matter over to his wife, allow her to work in secret for 10 months at the head of a task force with working groups numbering over 1,000 people, and then unveil the One True Plan for fundamental reform — a 1,400-page legislative behemoth outlining a hitherto unprecedented federal role in one-seventh of the U.S. economy.
The One True Clinton Plan was a brilliant and comprehensive overhaul of the health-care system, as well thought-out as the Republican tax reforms that would overhaul the system by which the government collects its revenue. A National Health Board was to establish a national, comprehensive benefits package. All employers were to pay for insurance. The national board was to set a level for total American health spending and enforce it. It would have been a criminal offense to seek care outside the system.
So Bill Clinton, having had success making health care an issue in 1992, proceeded to make his Health Security Act the issue in 1993. The result was devastating. The plan’s elaborate, quasi-socialist mechanisms ran afoul of mounting popular sentiment against bureaucratic Washington-centered approaches to problems. “Universal coverage” — something Americans supported in the abstract — suddenly paled in importance compared with the loss of certain features of the current system that people had taken for granted (the right to choose their own doctors, for example).
It wasn’t long before “Clinton plan” itself became a pejorative — enough even to discredit plans styled “Clinton Lite.” At one point, the Democratic leadership of the House unveiled a new proposal that, on inspection, was little more than the Clinton plan with the “Clinton” removed in an attempt to enhance its political palatability. It was too late. If, as some Democrats said, “health insurance for all Americans that can never be taken away” was the final unfulfilled promise of the New Deal, it’s lucky for FDR that he didn’t have Ira Magaziner, Mrs. Clinton’s task-force leader, on hand to assist him with the earlier promises.
The Democratic electoral disaster of 1994 had a number of causes, but it is hard to overestimate the role of the failure of the administration’s health- care reform initiative. The Clinton plan brought the ideological premises of the party’s agenda — centralized planning and control from a Washington presumed to know best how to meet people’s needs — into the sharpest possible relief. And people recoiled from it.
Republican tax overhaul plans also offer an unvarnished view of the party’s ideological premises. They are, to be sure, antithetical to those of the Democrats — and Republicans believe public opinion is moving their way. But health care reform a la Clinton and the leading GOP tax reform plans have this in common: They are radical and they are theoretical.
It’s by no means clear how the real political world will react if confronted with a conservative effort — to avoid an oxymoron, we had better make that “a right-wing effort” — to implement a radical theory. But for all the talk among Republicans in Washington this year of a Revolution, it is very diffcult to sustain the argument that the American people are ever very radical, especially when they are being asked to allow themselves to be herded down a path neither they nor anyone else has ever gone down before.
It may be that there are or will be elegant theoretical answers to all of the questions the various tax reforms raise and tidy theoretical solutions to the problems they pose. But if one or another of these plans or some variant becomes The Plan, the centerpiece of a GOP political agenda, the people asking the most pertinent questions — the questions that will determine political success or political failure — will not be theorists. They will be bitterly partisan political opponents. And highly motivated interest groups, many with livelihoods to protect. And ordinary people wondering, with the common-sense skepticism Republicans have long professed to admire, how these bold notions will affect them, their financial security, their families’ well- being.
It need not be this way, of course. The tax code is too burdensome, the IRS too intrusive, top marginal rates too high, the disincentives to savings and capital formation too great, the marriage penalty a disgrace. And, of course, as Republicans well know, there are ways to address these matters — principally by rolling up the sleeves and legislating.
The Clinton health plan bespoke many, many late-night sessions whose main illumination came from the gleam in the eye of Hillary Rodham Clinton, Ira Magaziner, and their acolytes. They dazzled themselves with the beauty of their health-care machine, not knowing it was a Rube Goldberg contraption and bound to self-destruct. The question that ought to haunt Republicans as their tax-reform notions come to the fore of the national discussion is whether their visionary ideas may result in the same sort of explosive consequences.