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March 30, 2012

Bartlett on Tax Reform

David R. Henderson on The Benefit and the Burden: Tax Reform — Why We Need It and What It Will Take by Bruce Bartlett

Bruce Bartlett. The Benefit and the Burden: Tax Reform — Why We Need It and What It Will Take. Simon & Schuster. 260 pages. $26.00.

Bruce bartlett has gone through an interesting intellectual and career odyssey. He earned a Masters degree in history from Georgetown University and wrote his thesis on the origins of the Japanese government’s attack on Pearl Harbor. But after graduate school, he quickly moved into the economic arena, becoming an aide to Republican Congressman Ron Paul of Texas in 1976 and, after Paul’s defeat in November 1976, an aide to Republican Congressman Jack Kemp of New York. In the latter job, Bartlett helped draft the famous Kemp-Roth tax cut bill, which did not pass but did become the basis for President Ronald Reagan’s tax cut bill of 1981. In the 1980s, Bartlett worked on Capitol Hill for Republican Senator Roger Jepsen of Iowa, for Polyconomics (an economic consulting firm run by Jude Wanniski), for the Heritage Foundation, and in the Reagan White House as a domestic policy adviser. In the late 1980s and early 1990s, he was the deputy assistant secretary for economic policy in the U.S. Treasury under Reagan and then under President George H.W. Bush. He then worked for the National Center for Policy Analysis, a conservative think tank based in Dallas, until he was fired from that job in 2005 for writing Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy.

Bartlett’s bitterness about his firing has turned into contempt for Republicans and conservatives. For that reason, I wondered how well he would, in his newest book, separate his own upset from his subject matter of taxation. He mainly succeeds. It’s true that in the book he disdainfully identifies certain arguments as conservative; I, a libertarian, found some of those arguments compelling. But when he puts his contempt aside, Bartlett’s analysis is usually first-rate.

Bartlett is a largely self-taught economist — and not in the superficial “Ben Stein” sense of someone who knows a little about economics and calls himself an economist. On taxation, especially, Bartlett truly has mastered both the big picture and the intricate details of each topic he addresses. In the 24 chapters, which average only about ten pages each and contain extensive bibliographies, Bartlett usually hits the nail on the head. On the history of U.S. federal taxation; the relationship between tax rates and tax revenues; the comparison of U.S. taxation with European taxation; tax-reform proposals such as the FairTax and the flat-rate tax; the effects of federal taxation on health care, housing, and state and local government; and the value-added tax, Bartlett’s analysis is illuminating. However, there are two huge problems with the book. First, despite the book’s title, Bartlett only tersely discusses taxation’s benefits. Second, and closely related to the first, Bartlett’s argument for higher taxes comes down to the need for revenue to keep government spending up: He doesn’t really try to justify that spending.

Bartlett points out that before the Civil War, 90 percent of federal revenues came from one tax: a tariff on imports. Lincoln introduced a federal income tax in 1861, but its unpopularity led to its expiration in 1872. In 1894, federal Democrats introduced an income tax on high-income people, but the next year the Supreme Court found it unconstitutional. In 1913, after the 16th Amendment was ratified — allowing an income tax — Congress quickly imposed the tax only on high-income people. The lowest rate, one percent, was on income above a personal exemption of $3,000, $66,000 in today’s dollars. The top tax rate was seven percent on incomes above $500,000 ($11 million today). By the end of World War I, the bottom tax rate had risen to six percent and started at an income of only $1,000, and the top tax rate was 77 percent on incomes over $1 million. Under Presidents Warren Harding and Calvin Coolidge, Treasury Secretary Andrew Mellon brought the bottom rate down to 0.375 percent and the top rate down to 24 percent. Then, Herbert Hoover more than doubled marginal tax rates at every level, making the bottom rate four percent and the top rate 63 percent.

Changes continued. Franklin D. Roosevelt made the top rate 79 percent in 1935 and 94 percent during World War II. Bartlett quotes an ominous statement from Roosevelt that sounds like one that Elizabeth Warren, a Democratic Party candidate for the U.S. Senate from Massachusetts, made recently. In his 1935 message to Congress, Roosevelt said, “People know that vast personal incomes come not only through the effort or ability or luck of those who receive them, but also because of the opportunities for advantage which government itself contributes.” Roosevelt then added: “Therefore, the duty rests upon the government to restrict such incomes by very high taxes.”

The younger Bruce Bartlett who helped draft Kemp-Roth would likely have commented critically on this fdr message, pointing out that even if government does contribute to earning power, it’s hard to see how it contributes 79 cents to each additional dollar of earnings. He probably also would have pointed out that fdr’s last line gives away the game: fdr’s true motive seemed to be not to make people pay for their great government services but to restrict income. But the older Bartlett does neither. I think this reflects his increasing unwillingness to criticize those who advocate large, expensive government.

Bartlett then walks us through history to date, pointing out that the top tax rate fell to 82.1 percent in 1949, then increased to 91 percent in the early 1950s, fell to 70 percent under Lyndon Johnson, fell to 50 percent and then 28 percent under Ronald Reagan, rose to 31 percent under President George H.W. Bush, rose to 39.6 percent under President Clinton, and then fell to 35 percent under President George W. Bush.

You can’t read Bartlett’s chapter on understanding tax rates without understanding the important distinction economists make between average tax rates — the amount of total tax you pay divided by your income — and marginal tax rates — the tax rate on your last dollar of income. Even Warren Buffett fails to make the distinction; he often claims that his secretary’s tax rate exceeds his. Her marginal tax rate may well exceed his because hers is probably 25 percent, while his (because his marginal income is from capital gains) is closer to 15 percent. But it’s very unlikely that his average tax rate — also 15 percent — is below hers.

Bartlett addresses the issue of tax progressivity, the degree to which one’s tax rate rises with income. He seems to favor progressivity but doesn’t take a strong position. The closest he comes is when he writes, “Philosophically one can argue that the last dollar earned by a millionaire isn’t worth as much to her as the first dollar.” This is true, but Bartlett then claims that those with lower incomes value their dollars more than higher-income people do. To make that case, though, you must compare one person’s utility with another’s, something that can’t be done. Bartlett doesn’t mention that fact. He does point out, though, one practical argument against progressivity made by classical liberal economist Friedrich Hayek: that higher taxes on “the rich” would lead to higher rates on everyone else. Interestingly, in one of his best chapters, “How Other Countries Tax Themselves,” Bartlett, focusing mainly on European countries, points out that those countries tend to have higher tax rates but less progressivity than the United States. Why? Because they tend to use huge value-added taxes (vat) to tax consumption heavily, and those taxes take a large percent of income from lower-income people.

Bartlett seems to want the United States to be more like Europe. For a few years now, he has argued that the United States should adopt a vat, and he continues that argument in his book. Conservatives and libertarians tend to oppose a vat on the grounds that it is a “money machine” for the federal government. Indeed, Bartlett writes that he had opposed the vat on those grounds. So why did he change his mind?  Because he no longer sees “any hope of controlling entitlement spending before the baby-boom deluge hits.” He writes, “The United States [he means the U.S. government] needs a money machine.”

What about a flat-rate tax, that is, a tax that is the same marginal rate for everyone above some basic exempt level? Bartlett has a nice, terse analysis of the tax, drawing on work by Hoover Institution fellows Robert Hall and Alvin Rabushka. He points out that the more deductions the government retains in the tax law the higher that one rate must be. He also notes that because many low-income people pay negative taxes due to the Earned Income Tax Credit and other tax credits, even a low-income family that paid zero taxes under the flat-rate tax could be worse off if it were implemented. This is not enough of an argument against the flat-rate tax, of course, but it is something to be aware of.

On the so-called FairTax, Bartlett is brutal, and rightly so. He points out that the 23 percent retail sales tax rate that its advocates envision as a replacement for all current federal taxes is really a 30 percent rate. He also notes that when the Treasury Department, Congress’s Joint Committee on Taxation, and the Brookings Institution have tried to estimate the revenues from such a tax, they find that an even higher tax rate would be needed

.

In his discussion of the pros and cons of taxes on capital gains, Bartlett writes:

Conservatives will respond that poor people do not create jobs and that many of those benefiting from the capital gains preference are entrepreneurs who start businesses or finance new start-ups. They will also argue that many of those with high incomes may have been in that group only for a single year, when they sold a farm or business and realized a large capital gain that may have represented a lifetime of small, unrealized annual gains.

This passage illustrates a problem I referred to earlier. I call it the Fortune style of writing. In the 1980s and 1990s, when I wrote a lot for Fortune magazine, I noticed that “liberal” writers would use this kind of formulation when they wanted to undercut a good argument. Rather than making the argument outright, they would say that conservatives make the argument. But that still leaves the reader wondering whether the writer would make the argument. And if not, why not?

By adopting this formulation, Bartlett avoids taking a position. My interpretation of this choice of writing style is that Bartlett is currying favor with liberal reporters. They often call on him now when they want to cite a “conservative with integrity,” who will attack this or that Republican or conservative policy or position. I would bet that not only “conservatives,” but also Bruce Bartlett, would make the above arguments for lower tax rates on capital gains. But by choosing the formulation he did, he covers his bases by introducing the argument while still not upsetting his newfound journalist friends.

One common conservative argument that Bartlett does refute effectively is the idea that we should cut taxes to “starve the beast” — that is, constrain the federal government’s ability to spend. He points out that in 1993, President Bill Clinton and a Democratic Congress “raised taxes by about 0.6 percent of gdp.” If the starve-the-beast theory were correct, he notes, government spending would have then risen as a percent of gdp. What actually happened? It fell from 22.1 percent of gdp in 1992 to 18.2 percent in 2000.

The biggest letdown in the book is his chapter on government spending, titled “The Need for More Revenue.” Bartlett starts out well, identifying correctly what he calls the “central problem,” namely that “a large and growing share of spending” is on Social Security and Medicare. The Congressional Budget Office, he notes, estimates that spending on these two programs alone will rise from 8.5 percent of gdp in 2011 to 12.8 percent of gdp by 2035. Meanwhile, the cbo expects, consistent with the last 60 years’ experience, that federal government revenues will average about 18.4 percent of gdp. That leaves under 5.6 percent of gdp for everything else, including interest on the debt and defense, and no one thinks that anything close to 5.6 percent will be enough to cover all of that. Something’s got to give.

Bartlett is justifiably pessimistic about the chances of cutting spending much, and so he wants substantially higher taxes. But he never argues that this higher spending on Social Security and Medicare is justified. Instead, he argues that the political power of seniors will prevent such cuts. In short, his argument for taxing people more is that it’s easier to bully unorganized taxpayers than to cut benefits for seniors, who vote at a higher percentage than any other age group.

But what about default on the debt? San Jose State University economist Jeff Hummel has written that government default would be “a balanced budget amendment with teeth” because it would be hard for the feds to borrow after stiffing their creditors. Bartlett argues that default “would constitute a grossly immoral theft of trillions of dollars from those who loaned money to the federal government in good faith.” Really? It’s worse to default on creditors who took a risk than to forcibly take money from taxpayers who have no choice?

Bartlett predicts that “the debt will be paid.” I think his prediction is wrong. I think that the government will default before 2025 and that we should prepare for it. Meanwhile, let’s not make the spenders’ job easier by passing a vat, which, as Bruce Bartlett himself noted, would be a “revenue machine” for the federal government.


David R. Henderson is a research fellow with the Hoover Institution. He blogs at www.econlog.econlib.org.