Retirement and Social Security Reform
The Ripon Forum
Volume 42, No. 1, March/April 2008
By Ernest S. Christian and Gary A. Robbins
Reducing tax paperwork is important,
but minimizing government's impact on the economy is key
Talk of taxes and tax reform abounds, and it
has ever been thus -- especially when election time rolls
around. The story of the tax code -- insofar as yet written
-- is also the story of government and politics. In the beginning,
taxes begat government; government begat spending; and spending
begat more taxes, more government and more spending.
Tax reform is about good economics. Politics, on the other
hand, has been about bad economics since the 1930s, when FDR
created the modern day version of the Jacksonian spoils system.
In 1938, Harry Hopkins said: "We will spend and spend,
tax and tax, and elect and elect."
Nevertheless, as the damage done by taxes that are too high
and badly structured becomes ever greater and more obvious
- even to Washington - there are glimmers of hope. Circumstances
may be combining to make good economics good politics - in
which case tax reform in its broadest and truest sense may
be upon us.
Consider the following apocryphal news report from sometime
in the future -- perhaps next year or possibly never.
"Flash! The minimalist school of tax policy has prevailed.
Gone is the extravagantly baroque tax structure of the past.
In its place there is a new one of stark, utilitarian efficiency.
"The large and once powerful "tax industry"
is recoiling in shock. Thousands of lawyers and accountants
are having to make the painful transition to productive employment.
Lobbyists are seeking disaster relief for themselves.
"There is real human suffering all across America. Severe
environmental degradation is occurring. Smoke fills the air
as mountains of discarded tax forms burn out of control. Noise
levels are becoming unbearable, as the clatter of commerce
replaces the soothing sibilance of shuffled paper.
"The toll of disaster victims is mounting. Unable to
endure, some have broken under the weight of despair. Bands
of stricken bureaucrats wander the streets of the nation's
capital, befuddled and bereft. How could this happen? Where
will it all end? Then, the unthinkable happened:
"Minimalism began to spread."
Emotionally (*note -- emotion is a force not to be discounted
in any political upheaval), tax reform is about the "mountains
of discarded tax forms". Some of the most enthusiastic
warriors see the battle solely as one against paperwork and
a prying IRS. In reality, however, like most things governmental,
taxes are about money -- and the first purpose of reforming
taxes is to enable the noisy "clatter of commerce"
to provide more jobs and higher incomes for everyone.
Because of the dynamic relationship between taxes and spending,
and their destructive effects when applied in excess, tax
reform writ large is also about reforming government itself,
the way it decides to tax and spend, why and how much -- and
ultimately, it is an attempt to change the practices of politics
The Cost of an Unreformed Tax
A few definitions may be helpful, starting with the meaning
of tax reform.
Taxes have large and powerful effects on behavior and, therefore,
on economic performance. An unreformed tax is one that has
the most adverse effect on economic performance and, therefore,
costs the most, per dollar of revenue yield to the government.
A reformed tax is just the opposite. It has the least adverse
effect per dollar of revenue yield. A large amount of any
tax - even a reformed tax -- is bad for the economy, and a
large amount of an unreformed tax is disastrous.
The current federal income tax, individual and corporate,
is quite clearly on the bad side of the line, unredeemed by
the fact that in the past it has been even worse. Had not
the extraordinarily high marginal tax rates that prevailed
in the 1950s and 1960s been reduced to the more tolerable
but still too high levels of today, and had not the nearly
prohibitory double and triple taxes on saving and investment
been ameliorated somewhat, it is probable that the U.S. economy
would today be no more than 60 percent or so of its present
Even with current rates and less destructive multiple levies
on capital, taxes cost the private economy two to three times
more than the revenue yield to the government. On average,
$1 of revenue ends up costing $2 -- and at the margin, a $1
increase in revenue from additional taxes on capital costs
the private economy $3 to $4. (See Martin Feldstein, "The
Effect of Taxes on Efficiency and Growth" (Cambridge,
Mass.: National Bureau of Economic Research, 2006) and N.
Gregory Mankiw and Matthew Weinzierl, "Dynamic Scoring:
A Back of-the-Envelope Guide" (Cambridge, Mass.: National
Bureau of Economic Research, 2006)).
There are two components of "cost". First, there
is the $1 of tax. People no longer have this money; the government
does. Second, there is the lost income -- perhaps as much
as $3 -- that the economy would have produced had not the
government intervened. People do not have it to save or spend,
but neither does the government. It's gone, never produced
Economists may argue around the edge about the exact size
of the "deadweight" loss, but it is an iron law
that taxes do cost the economy more than the revenue yield
to the government. This powerful fact alone -- although conveniently
ignored by politicians -- is the central reality of governance
in our free market economy today. It means that unless government
is continually to make people worse off, each dollar of spending
must by some measure be said to produce a benefit to society
that is greater than a dollar.
Some dollars do, but most do not. And the more government
grows, searching for more things to do and spending ever more
dollars on more projects, the more likely it is that an ever-larger
portion of government spending will be worth less than its
cost. Many of government's hot new spending programs may be
highly worthwhile -- times change and everything government
does is not bad. But instead of paying for the new expenditures
by cutting back funding for one of yesterday's supposedly
hot new programs (that didn't work and is now nearly useless),
the government almost invariably keeps that old program and
imposes more high-cost taxes to pay for the new one. The absurdity
of this practice is obvious.
If every time the Congress sought to raise taxes, the 100
most inefficient preexisting government spending programs
were put at the margin and -- out in public - matched up with
the high cost of a tax increase, it would be clear that the
combination of government taxing and spending is making Americans
worse off. A recent study by the Office of Management and
Budget shows that over 400 federal spending programs with
a total annual budget of $650 billion received grades of "D"
or "F" for lack of performance.
Strictly mathematical measures that weigh the amount spent
against discernible results produced obviously do not capture
all the benefits of all government programs. In some cases
they do and in some they don't. Who can fully measure the
value of educating a child or of national defense? But it
is also the case that the true cost of taxes exceeds the $2
to $4 per $1 of revenue that most economists compute. Who
can measure the real cost of jobs lost, raises not received,
mortgages not paid, education foregone and healthcare not
obtained because of the economic damage done by taxes?
When one looks at the dynamic interactive relationship between
taxes, spending and economic growth, the second critical reality
of governance in a free market economy is as arresting as
the first: many of the problems that modern liberal governments
in the United States and elsewhere seek to cure by increasing
public spending are the result of taxes imposed by government
to pay for existing levels of spending. The lesson to be learned
from this self-perpetuating (and self-magnifying) circularity
is not that government should stop taxing and spending; but
it is, rather, that the government should stop falsifying
its books of account in an ongoing process of misleading both
itself and the voters.
Keeping Spending to a Minimum
Presently, the federal budget first assumes that a dollar
of taxes costs only a dollar, and then most politicians pretend
that each dollar of spending produces more than a dollar of
benefit. (If it did not, what excuse could there possibly
be for them having spent it?) The better politicians -- of
which there are many -- know about the high cost of taxes
and the measurably low value of most government spending,
but they are swept along by the force of tradition and the
inability of any one member of Congress (or in most cases,
even a President) to alter the onward and upward sweep of
a federal government now more powerful than they.
Tax reform in the broad sense is unlikely to occur until the
government fundamentally changes its financial accounting
by adopting a Cost-Benefit Budget that, out in the open and
with full public participation, systematically weighs the
benefits of all government spending programs -- both existing
and proposed -- against the true cost of taxes necessary to
pay for them. Cost-benefit budgeting would not mean that the
public would receive less services from government that are
truly important. Indeed, cost-benefit budgeting would enable
the government to do more of the things for which it is uniquely
suitable -- and a growing economy would greatly reduce the
number of people in need of assistance from government.
The case for a growing economy, a minimalist government concentrated
on achieving the best with the least, and presided over by
a President and Congress content to do their limited constitutional
duties quietly and efficiently, is impeccable. It has been
made elsewhere far more expertly than here. But the ruling
combine in Washington, made up mostly of entrenched incumbents,
lawyers, lobbyists, and others to whom the government is a
vital source of profit, has for many decades been moving in
the opposite direction. It will not and probably cannot voluntarily
give up its power or change its character.
Change will occur when the voters rise up in righteous anger,
smite the offenders and replace them with public servants
who have but one standard by which to measure everything:
"Is it good for America?"
Mr. Christian, an attorney, was a deputy assistant secretary
of the treasury in the Ford administration. Mr. Robbins, an
economist, served at the Treasury Department in the Reagan
administration. Both are adjunct fellows at the Heritage Foundation.