The Taxman Cometh : Why taxes loom large in the American imagination

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):

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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?

Unintended Consequences

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?

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Chuck Kotlarz
2 years 6 months ago
“The massive (FDR) experiment with redistribution failed to work as planned.” On the contrary, FDR’s experiment exceeded expectations. Beginning in 1933, nearly three million eighteen year old young men went to work in FDR’s Civilian Conservation Corp. Eight years later, in 1942, the average US soldier turned 26 as America’s greatest generation saw its WWII role grow dramatically. In the sixty years prior to FDR’s presidency, sixteen economic downturns occurred with unemployment ranging from 12% to 25%. After FDR’s last term, unemployment has never once reached 12%. Median income increased over 60% during the “housing, highways and (FDR’s) high tax” economy. Median income has otherwise typically declined in the “low tax economy”. The percentage increase in median income with Clinton’s tax increase was nearly double that of Reagan’s tax cut. “But the limitations of an economy based on housing, highways and high taxes were becoming apparent by the late 1950s.” Bush 2 perhaps made apparent the limitations of an economy based on tax cuts. Bush 2’s Great Recession was the ninth worst economic contraction since 1856. Of the eight worst economic contractions since 1856, all eight contractions had a Republican controlled Senate, seven had a Republican controlled House of Representatives and six had a Republican president. The nine worst economic contractions since 1856 are perhaps the greatest waste of all, the waste of idle plants and workers.
Joseph J Dunn
2 years 6 months ago
Mr. Kotlarz-- Thanks for your comment. Let me respond to the points that you raised. The paragraph numbers below align with your paragraph sequence: 1. FDR’s announced goal in the spring of 1935 was to provide employment for all who could work before the end of 1935, through government programs until the private sector fully recovered. The redistribution was to pay for those programs, which included continuing the CCC, as you point out, and Hoover’s PWA, and establishing the new Works Progress Administration (WPA) and Agricultural Adjustment Administration (AAA). The redistribution was to flow through those programs. The standard is also relevant because CST focuses on a preferential option for the poor, and concern for workers. My point is that the Administration’s own standard (all back to work) had not been met even by 1939, with all these employment-stimulus programs and the higher tax rates at full throttle. Unemployment rate was still 17 percent, and 400,000 new names were on the relief rolls, and the high taxes had stifled the private sector. I share your admiration for America’s greatest generation. I wonder if they might have suffered less during the 1930s with better monetary and fiscal policies. 2. Most economists credit Social Security, state unemployment insurance and federal extensions of unemployment insurance as the principal reasons for the reduced severity of post-1935 recessions. One might also give credit to more enlightened monetary and fiscal responses when a recession becomes visible, thus avoiding the worst mistakes of 1930-32 that contributed to the severity of the Great Depression. Fortuitously, Ben Bernanke had long been a student of the Depression, and that knowledge kept the 2008 debacle from becoming far worse. 3. The post-war rise in inflation-adjusted median incomes clearly falters in 1970 and throughout that high-tax decade. The balance between available workforce and available jobs is a powerful factor affecting median income. So we might consider the entry of baby boomers into the workforce beginning in 1964, the reduction of active military by one million in the early 1970s, and the increased presence of women in the civilian workforce beginning in the 1970s. Slow job growth due to high taxes also contributed. See JFKs 1963 State of the Union Speech, John Kenneth Galbraith’s “New Industrial State” (1967). Consider also that the sharp decline in births after 1930 and the loss of 440,000 service personnel in WWII and Korea reduced the available labor force beginning in the late 1940s, which would tend to push median incomes up. 4. Most economists point to deregulation of the financial industry (especially the 1999 repeal of FDR’s Glass-Steagall Act), lax lending standards and excessive use of financial derivatives as causes of the Great Recession. Tax rates don’t seem to have been a factor. I try to look beyond political party affiliations for causation of large events. America entered the four deadliest wars of the 20th century under Democratic presidents, but that does not make Democrats warmongers. We need to look at the totality of circumstances with an open mind. Again, thanks for your comment.
Chuck Kotlarz
2 years 6 months ago
“I try to look beyond political party affiliations for causation of large events.” On some issues, there is no better clarity perhaps than party. Party gerrymandering can provide a goldmine of legislative legacy. For example, the two worst states for black education attainment are Wisconsin and Louisiana. Governors Walker and Jindal are now proposing deep budget cuts in higher education for both states. Overall, deep blue states have a 40% higher black education attainment rate than deep red states. Also, deep red states have a 40% higher black incarceration rate than deep blue states. In lieu of further comments, I plan to acquire the above referenced book that I suspect will be interesting reading.

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