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The Fiscal Cliff Deal: Two Views on Growth and Taxes

February 1, 2013 9 minute Read by Amity Shlaes

A New Cynicism About Taxes The big question about the fiscal cliff settlement is what that settlement will do to growth. Another day, we'll address what the effort to raise revenue does to balance the budget — too little. Today, though, just wanted to mention a disturbing phenomenon, the convergence of the marginal and average tax rates. Historically our tax structure has been progressive, with rates rising as income does. A top earner might pay 10% or 15%, a base rate, on the first thousands he earns, and higher rates as his income climbs. Therefore, someone whose earnings take him into the top bracket does not pay the rate of that bracket on every dollar. All the discussions and legislation tend in the same direction, whether they are "Pease Provisions," a phrase we hoped never to hear again, or rate changes. That direction is to make more income of the highest earners subject to their top rate. The result is a kind of flat tax dystopia: You're paying a flat tax, but a much higher one than you, Art Laffer or Alvin Rabushka, ever imagined. That flat tax in turn reduces your interest in working or creating jobs. It will punish, especially, people like dentists, or radiologists, who make most of their money in income, rather than investment. People who have spent long years investing personal capital in learning their profession will see their capital eaten away by the new high income tax. They will become cynical. They will tell their children: between Obamacare and these tax rates, it's not worth it to go to medical school. The question is whether the lower-than-expected increase in capital gains rates offsets the income-tax increases for top earners when it comes to growth. Many economists will focus on the capital gains and dividend treatment. My own interest is in quantifying the cost that the new cynicism imposes on economic growth.

— Amity Shlaes

Who's the Fairest of Them All? Last-minute negotiations have spared government from falling over the “fiscal cliff,” at least for the moment. What remains on the table for the foreseeable future is the issue of “fairness.” At the heart of the matter is, of course, the “Buffett Rule,” which the White House’s National Economic Council announced as a “basic principle” in April 2012:

[N]o household making over $1 million annually should pay a smaller share of their income in taxes than middle-class families pay. Warren Buffett has famously stated that he pays a lower tax rate than his secretary, but as this report documents this situation is not uncommon. This situation is the result of decades of the tax system being tilted in favor of high-income households at the expense of the middle class. Not only is this unfair, it can also be economically inefficient by providing opportunities for tax planning and distorting decisions.

A different view of what counts as “fair” taxation comes from the National Taxpayers Union. According to its calculations, the top 1% of taxpayers (with annual adjusted gross incomes of more than around $380,000 during the past five years) have already been paying around 38% of all federal personal income tax collected. The top 5% of taxpayers (with annual AGI of more than around $150,000) have already been paying about 60% of the total, while the bottom 50% of taxpayers (with annual AGI of less than around $33,000) have been paying less than 3% of federal personal income tax collected in that period. So what’s “fair”? The “Buffett Rule” embodies what the philosopher John Rawls — in his influential 1971 book, “A Theory of Justice” — called the “difference principle”:

The intuitive idea is that the social order is not to establish and secure the more attractive prospects of those better off unless doing so is to the advantage of those less fortunate.

This sentiment is, of course, familiar to readers of Luke, who (in the King James Version of the New Testament) said:

For unto whomsoever much is given, of him shall be much required: and to whom men have committed much, of him they will ask the more.

On the face of it, this seems like a fair description of “fairness.” Yet, as any parent of small children knows, “That’s not fair!” can mean different things coming out of different mouths at different times. There is an equally compelling and “intuitive,” though competing, view of “fairness.” This is the idea of justice as “merit,” captured in Proverbs: “to the righteous good shall be repayed.” That is, there is a connection between effort and reward that reflects personal responsibility. Of course, this does not imply that virtue should be rewarded by high income and low marginal tax rates. But it does suggest a moral justification for some inequality, based on the principled view that individuals own the fruits of their labor. As Robert Nozick put it in his pointed rejoinder to Rawls, “Anarchy, State, and Utopia”:

Whether it is done through taxation on wages or on wages over a certain amount, or through seizure of profits, or through there being a big social pot so that it’s not clear what’s coming from where and what’s going where, patterned principles of distributive justice involve appropriating the actions of other people. Seizing the results of someone’s labor is equivalent to seizing hours from him and directing him to carry on various activities. If people force you to do certain work, or unrewarded work, for a certain period of time, they decide what you are to do and what purposes your work is to serve apart from your decisions. This process whereby they take this decision from you makes them a part-owner of you; it gives them a property right in you…. These principles involve a shift from the classical liberals’ notion of self-ownership to a notion of (partial) property rights in other people.

Nozick was attacking, avant la lettre, the assumption behind the president’s much-derided remarks, “If you’ve got a business, you didn’t build that. Somebody else made that happen.” In this view, the products of an individual’s efforts do not redound to his credit. Justice is seen as a matter of distribution, or redistribution, and fairness turns on the obligation of an individual to keep filling that “social pot” available to everyone else. But when justice is seen as a matter of production, then fairness involves not just the relative contribution of individuals but the intrinsic worth of what they have created that makes any contribution to the aggregate wealth possible in the first place. How does that “social pot” get filled, after all, unless there are incentives for individuals to work for their own reward? And if some respond to incentives while others do not, or produce more while others are “free riders,” is not some inequality inevitable? Is it “fair” that freeloaders and featherbedders enjoy the fruit of the labor of the industrious? In the end, the debate over “fairness” obscures that fact that no one actually believes that “soaking the rich” will go very far to reduce the budget deficit, much less solve the problem of long-term debt. And the National Economic Council’s attempt to set the rich against the middle class defies the Willie Sutton-like reality of tax revenues. Just as the infamous robber focused on banks, government inevitably targets the middle class — “because that’s where the money is.” The subtitle of the (liberal) Third Way report, “Necessary but Not Sufficient," issued this past fall, said it all: “Why Taxing the Wealthy Can’t Fix the Deficit.” The report concluded:

[F]ixing long-term deficits without touching entitlements may be possible in theory, but would punish the middle class with higher taxes.

What’s called for, in the end, is some dialing back on the rhetoric of tax “fairness.” The “Buffett Rule” is hardly a rule; it’s a political statement of faith in redistribution, not an impersonal principle of economic science. The question of who’s the fairest of them all is not going to be decided on the edge of the fiscal cliff, or even in the delayed sequester debates in the months to come.

— Robert Asahina

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