The day is almost upon us—April 15. For Americans, this is tax day. Yes, we pay taxes throughout the year, every day: property taxes on our homes, sales taxes in most states, excise taxes, gasoline taxes and of course income taxes. A nation’s expenditures of public funds, which are inevitably finite, reflect the priorities of its people. How a nation collects revenue—its tax structure—reveals how its people think about motivations and incentives, concerns and fears, about the most effective ways in which private property might promote the common good.
In the months leading up to elections, issues of economy and taxation are presented in 30-second television commercials for our consideration. But taxation is a complex issue, an integral part of the nation’s economic and social structure, as Catholic social teaching consistently recognizes. In an encyclical marking the 100th anniversary of “Rerum Novarum,” St. John Paul II wrote in “Centesimus Annus” (No. 43):
The church has no models to present; models that are real and truly effective can only arise within the framework of different historical situations, through the efforts of all those who responsibly confront concrete problems in all their social, economic, political and cultural aspects, as these interact with each other.
April 15. It is fitting on this particular date that we reflect on our nation’s system of taxation. There must be something in our DNA that produces both sensitivity to taxes and a tendency to ignore that sensitivity in others. In 1775 Edmund Burke urged his colleagues in the British Parliament to try to patch things up with the colonies, especially in the matter of taxes. He pointed out this hereditary trait:
The colonies draw from you, as with their life-blood, these ideas and principles. Their love of liberty, as with you, fixed and attached on this specific point of taxing. Liberty might be safe or might be endangered in twenty other particulars without their being much pleased or alarmed. Here they felt its pulse; and as they found that beat, they thought themselves sick or sound.
That was on March 22, 1775. The following day, Patrick Henry, unaware of Burke’s speech, told his colleagues in Virginia, “Give me liberty, or give me death.” Parliament did nothing. Less than a month later, shots rang out at Lexington and Concord.
The authors of the Constitution acknowledged this sensitivity. Article I provides that all revenue bills (taxes, tariffs, etc.) must originate in the House of Representatives, and House members were the only federal officials directly elected by the people, with two-year terms. If “We the People” did not like the taxes, those responsible could be quickly replaced.
Nonetheless, taxes have always been a sore point. In 1794, years of resistance to an excise tax culminated in the Whiskey Rebellion. Henry David Thoreau went to jail rather than pay a poll tax—not out of any particular complaint, but just to “refuse allegiance to the State, to withdraw and stand aloof from it.” By 1913 a desire to move away from tariffs inspired the 16th Amendment, which allowed a direct federal tax on personal incomes. We are still experimenting with that device, vacillating from Franklin D. Roosevelt’s “soak the rich” policies to Ronald Reagan’s radical tax cuts and everywhere in between. The only constant has been taxpayer vigilance. Numerous studies have documented that Americans at every income level make their decisions about spending, saving, investing, whether or not to work and even where to live with one eye on the tax code. Economists refer to this innate sensitivity as the elasticity of taxable income. That reliable pattern of behavior helps Congress shape public policy. If Congress wants more people to install solar electric panels, a tax credit is enacted. If boosting home sales would promote the common good, then a first-time home buyer’s credit is passed. Want people to quit smoking? Raise the tax on cigarettes. Taxation is a powerful tool for change precisely because of our innate sensitivity.
As a sovereign nation, we set our own tax policy as we deem best. Many profess that we should further increase the personal income taxes on upper-income households to be more like Europe. Some want to close loopholes in our corporate taxes. Let us explore the possibilities, with that elasticity of taxable income sensitivity in mind.
The American Exception
Some important features distinguish the approach of the United States to corporate taxation from those of other developed nations. To remain competitive and ensure the timely delivery of goods in overseas markets many corporations operate foreign plants. If a German-based corporation operates in, say, Singapore, serving local and regional customers, and earns a profit there, the Singapore government taxes that profit. The remaining profit can be sent back to Germany with no additional tax. So any money not needed for operations in Singapore can be repatriated to Germany for investment there. Every nation in the Organization for Economic Co-operation and Development, also known as the O.E.C.D., allows this tax-free repatriation of foreign-earned profits or imposes only a nominal additional tax—except the United States. A U.S.-based firm that earns a profit in Singapore pays Singapore’s income tax and must also pay U.S. income tax, nominally at 35 percent, on profits it brings back to the United States. Rather than lose additional profits to this second round of taxation, U.S.-based firms leave the money overseas, either invested locally in new plants and equipment or deposited in local banks that invest it in the foreign economy. Our unique approach to taxing foreign-earned profits leaves, at this date, more than two trillion dollars of profits sequestered overseas, producing no investment in America and no tax revenues for our coffers and leaving the United States disadvantaged in a world competing for investment and jobs.
Our corporate tax code has other implications. Many nonprofit organizations enjoy income from endowments that invest in corporate stocks. The endowment receives dividends, which are a distribution of the corporation’s after-tax profits. If the corporate income tax were abolished, nonprofits and other shareholders would benefit from the larger amount of corporate profit available for distribution as dividends. The nonprofit enjoys tax-exempt status and does not pay income tax on the dividends received; but in our current tax scheme, the nonprofit organization’s income is reduced by the corporate income tax. Any revenue lost by abolishing the corporate tax could be recaptured by increasing the personal tax rate on dividend income.
Robert Reich, who served as Secretary of Labor in President Clinton’s administration, points to other benefits of abolishing the corporate income tax in his book Supercapitalism. Companies could stop lobbying for tax shelters, preferences, deductions, etc. They could make investment decisions on economic merit, without the distortions produced by the tax code. We have the freedom to ask ourselves: Should we liberate billions of dollars in investment income for the 47 percent of American households and the pension funds, charitable foundations and university endowments that own shares of stock—or cling to a corporate tax structure that leaves us complaining about corporations lobbying too much and paying too little in taxes? Would such a change benefit the unemployed and underemployed by boosting investment in new plants and equipment?
The personal tax structure in the United States also differs from those of other countries. The Organization for Economic Cooperation and Development found in 2012 that household taxes—broadly defined to include the combined effect of taxes on sales, properties and incomes—are more progressive in the United States than in almost any other O.E.C.D. country. And that was before the expiration of the Bush-era tax cuts for high-income households and the Affordable Care Act’s higher taxes on top-bracket incomes and investment earnings. In contrast, the value-added tax, a form of consumption tax common in many O.E.C.D. countries, is strongly regressive. A brief review of the major turning points in the American experience with the federal income tax will help to illuminate how we got to this point.
President Herbert Hoover signed the Revenue Act of 1932 to boost employment through construction stimulus projects and to provide unemployment relief grants to the states during the Great Depression. The plan was simple: higher rates and reduced exemptions should produce more revenue. But people who were still working, traumatized by the sight of neighbors in bread lines and Hoovervilles, reduced their spending and investing (but not their charitable giving) when faced with an increased tax burden. Nine months later, unemployment had soared to 25 percent and many who still had jobs worked only a few hours a week. Income tax revenues for the fiscal year 1933, with the new tax law in effect, were $746 million, compared to $1.1 billion in 1932. The planners had failed to consider the sensitivity that economists call the elasticity of taxable income.
In 1935 Congress raised tax rates on incomes in excess of $50,000, in response to Franklin Roosevelt’s proposal for a “very sound public policy of encouraging a wider distribution of wealth.” The majority of families that year had incomes of less than $1,250. A year later, the Civilian Conservation Corps, the Public Works Administration and Works Progress Administration were in full operation—programs that were confidently predicted to provide a job for everyone who could work. But the unemployment rate was 17 percent and the federal debt was rising. The Revenue Act of 1936 focused again on corporations and upper incomes. The exemption of dividend income from personal taxation was eliminated, thus beginning the practice of double taxation of dividends, which is still in effect today. Revenues increased, though the annual deficits persisted and the nation’s debt soared. By 1939 the unemployment rate was still 17 percent. The relief rolls had increased by 400,000 people. The massive experiment with redistribution failed to work as planned.
Presidents Truman and Eisenhower maintained this income tax posture after World War II. The economy grew as soldiers returned home, married and bought homes, cars and appliances, and Eisenhower started construction of the interstate highway system. But the limitations of an economy based on housing, highways and high taxes were becoming apparent by the late 1950s. President Kennedy’s inauguration took place in the midst of the fourth recession since the end of the war, with the unemployment rate that month at 7.7 percent—the highest rate since the end of World War II. The nation’s poverty rate was 22 percent. For African-Americans, it was a staggering 55 percent. The tax cuts that President Kennedy urged were enacted after his assassination. Lower tax rates were followed by faster revenue growth for the government. In the three years prior to these cuts, federal income tax revenues had increased at an annual average rate of 5.3 percent. In the three years following these tax rate cuts, federal income tax revenues increased by 10.4 percent annually. In the same years, the unemployment rate dropped from 4.5 percent to 3.6 percent.
But by 1980, after 45 years of high income tax rates, the former heartland of American industry had become known as the Rust Belt. Inflation was at 13.5 percent. Unemployment was again at 7 percent and had been stubbornly high for six years. The “golden age” post-war period was long gone and certainly had not been universally enjoyed.
The tax cuts voted by Congress in 1981 and 1986 were a radical change, not the minor tinkering with deductions, exemptions or a few points of tax rate that many members of Congress and presidents offer as tax reform. The top corporate income tax rate dropped from 48 percent to 34 percent. Individuals and households at every income level kept more of their wages. The rate on the top personal bracket fell from 70 percent to 28 percent. The lower rates produced more total income tax revenue, not less. The Statistical Abstract of the United States for 1993 shows that from 1986 to 1992, revenue from personal income taxes grew at an average annual rate of 3.3 percent and corporate income tax revenues grew on average 9.8 percent annually. Deficits actually fell until 1989, when Medicare spending started to rise 13 percent annually and other federal health outlays rose 28 percent annually. Even with President Clinton’s tax rate increase (the rate on top personal bracket raised to 39 percent, still far lower than the 70 percent rate pre-1981) the country experienced one of its longest periods of economic growth. By 2000, the unemployment rate was 4 percent, and the poverty rate reached a historic low of 11 percent, inflation was at 3.4 percent, and the federal budget was balanced.
We Have Choices
Dr. Christina Romer, professor of economics at the University of California, Berkeley, served as chair of President Obama’s Council of Economic Advisors during 2009 and 2010. She and her fellow researcher and husband, Dr. David H. Romer, studied all the tax changes passed since the end of World War II. In a paper published in The American Economic Review in 2010, they described the powerful impact of taxes on the economy:
In short, tax increases appear to have a very large, sustained, and highly significant negative impact on output…. The key results are that both components [investment and consumption] decline, and that the fall in investment is much greater than the fall in consumption.
Congress has been testing this conclusion in recent years. The top one percent of households incurred a Medicare income tax rate increase and investment income surcharge as part of the Affordable Care Act. An even smaller upper-income group had their marginal tax rates increased again in January 2012, when the Bush tax cuts were extended for most Americans, but not for them. The nonpartisan Tax Foundation recently ranked our overall tax system 32 out of the 34 O.E.C.D. countries on its International Tax Competitiveness Index, which considers more than 40 variables in five categories: corporate taxes, consumption taxes, property taxes, individual taxes and international tax rules, i.e., the home country’s taxation of income earned in other countries.
Today the wealth of the rich and the upper-middle class increases as stock prices soar. The real U.S. gross domestic product continues to grow, though more slowly than the average rate that has prevailed since World War II. The Federal Reserve has supported middle-class home prices with a trillion fiat dollars in bond purchases. But millions are without work or underemployed—trapped by slow job growth. Many still employed have lost all momentum in their careers and all bargaining power for their wages.
In the light of our historical experience and the research of economists, how might we best put forward the “decisions, programs, mechanisms and processes specifically geared to a better distribution of income, the creation of sources of employment and an integral promotion of the poor” that Pope Francis calls for in “The Joy of the Gospel” (No. 204)? This is difficult work. Warren Buffett wants to adjust the income tax. Bill Gates suggests that we no longer tax labor (wages) but shift to a progressive tax on consumption. What changes do “We the People” want?