The Joy of Tax Cuts

A poll in March reported that most people would prefer "deficit reduction" to "tax cuts." Polls and the media lie all the time, but this one refutes itself. If people really wanted to be taxed, they would pay up without being threatened by audits, fines, special agents, and jail terms.

No need to speculate on the result of funding the feds voluntarily, however. Americans would not send huge chunks of their income to D.C. if the tax police didn't make them. Taxes rely on force – by definition – because they coerce exchanges that otherwise would not take place. And every year, the government increases the number of prosperity-killing "exchanges" between the public and the distant rulers who live off our taxes.

How much have taxes increased? Let's set aside the brutal and wasteful income tax and consider a relatively "minor" levy. This year the government will loot $14 billion from the dead in the form of the inheritance tax. That amount would have funded the entire pre-World War II federal government of 1941. Today, the inheritance tax funds a mere 0.8% of federal spending.

Total federal outlays in 1940 were $10 billion. Customs, duties, and fees will collect twice that amount this year. The total revenue collected by the New Deal federal government in 1935 was $3.7 billion. That's what the federal telephone tax will collect this year.

The corporate income tax this year will collect $140 billion, more than total government spending in 1966. The tobacco tax brought in $5.6 billion last year. At the end of the Roaring Twenties, this amount would have funded the whole federal government and put the budget in surplus.

Set aside Federal Reserve dollar debasement, and total government spending has doubled every ten years since 1953. Taxes have kept pace. Textbook public finance theory says these taxes approximate the market because we get services in exchange. Hah.

Every year, average Americans pay more and receive less. That's why voters and taxpayers have good reason to be wary of any new tax reform. Despite all the promises, the government always ends up with more revenue and the public with less.

That's why every proposal for tax reform should be evaluated apart from the typically exaggerated claims. How to think about any given tax reform? Here are four rules:

1) If a bill reduces taxes through lower rates or increased deductions, it should be supported;

2) If a bill increases taxes through raising rates or repealing deductions, it should be opposed;

3) If a bill includes tax increases as well as tax reductions, it's intellectually incoherent and therefore probably a trick;

4) If a bill promises to reduce taxes and increase revenue, it should be rejected out of hand.

In the light of these rules, let's consider some recent proposals. The House Republicans were right to pass a $500 per child tax credit. In conventional economic theory, tax credits for children are not considered productive. It doesn't cause people to open new businesses or invest in new stocks. It only makes children less costly and therefore, on the margin, more numerous.

But economists who say this should think more broadly. Every policy change that allows people – individuals or families – to keep more of their own money is a good one. Tax policy shouldn't be judged solely by the incentives or disincentives it creates. We must also evaluate whether the changes result in more resources in public hands (meaning wasted) or private ones (meaning invested, saved, or spent on useful goods and services).

Who spends a dollar better? HUD or the Jones clan next door? We know the answer, which is why the House Republican tax cut is both good for families and good for the economy. And money rescued from the tax state is potentially saved and invested, which raises living standards and lowers the cost of borrowing for everyone else.

Private money might be invested in a business or given away to charity. Even if it is "blown," as Mr. Clinton warned it would be, it's far better to have individuals waste their own money than to have government use it to control and distort the economy.

Children are much more costly to rear these days. Both parents now typically work. Child care costs must be figured in the family budget. Medical care and clothing have gone way up. Schooling is more expensive, and public schools are no longer up to the job, if they ever were. Child labor laws prevent kids from adding to the family income.

Parents not on welfare are forced to "purchase" children the way they buy a new car or house. It's something they think about long and hard, with an accountant nearby to run the numbers. That's why no one is more deserving of tax cuts than American families.

But don't family tax credits "subsidize" families at the expense of single people? Not at all. It is not a subsidy to allow people to keep their own money. A tax credit comes at no one's expense but the government's.

But doesn't the House plan "discriminate" in favor of families with children over everyone else? Sure, but we should celebrate whenever anyone gets a tax break. It is in the public interest that the government take less and spend less. The only legitimate response to the objection that families are "getting" too much is for the Republicans to extend tax credits to all, and make them much more generous.

The problem is this: $500 is a tiny amount. It should be at least 20 times that, just to keep up with inflation and tax increases. That's why the proposal didn't generate much excitement and no family felt gratitude, nor should they. To restore economic and family well-being, much more must be done.

Some Republicans have ridiculed Bill Clinton's proposal to make the price of college tuition deductible up to $10,000 per year. In fact – using the rules above – it's a great idea. State funding, government student loans, and affirmative action scholarships have driven up the price of college tuition at a rate much faster than inflation (which is bad enough!). At the very least, parents should be allowed to deduct tuition from their taxable income.

But will this increase the demand for education and drive the price even higher? Not necessarily. We should remember that removing the tax penalty does not "subsidize" education any more than charitable deductions "subsidize" charity. Moreover, we should abolish all subsidies to education, which will drastically lower the cost.

We should love all tax deductions. If someone proposes that the cost of a dozen roses on Valentine's Day be deductible, great! Pass it forthwith. The same goes for deductions for penny loafers, cheeseburgers, or home computers. Make them all deductible. The more deductions, the freer the economy.

The flat tax, a proposal again popular on Capitol Hill, actually takes us in the opposite direction. Back again are the attacks on "loopholes" and deductions. We went through this in 1986, with a reform that eliminated many loopholes and promised lower taxes. But look what happened. Commercial real estate was devastated, and taxes have gone up. It's not surprising why. A small increase in rates yields vast amounts of new revenue.

Nor is there a "neutral tax" that affects all income the same way. A flat 20% rate means the rich are forced to pay a higher dollar amount than the middle class or the poor, which is hardly fair. And like all income taxation, the flat tax punishes work relative to leisure and breaks down the division of labor.

What we need is lower overall taxes and ever more deductions. We especially should not be repealing the mortgage-interest deduction, as Dick Armey has suggested. And on a practical level, repealing this deduction would do to the home real estate market what the 1986 deduction destruction did to commercial real estate.

The mortgage-interest deduction, moreover, has a solid constituency in its favor, no doubt soon to be denounced as a "special interest group." But far from being criticized, special interests for lower taxes should be encouraged and rewarded. If the mortgage-interest deduction is repealed, and then traded for deductions on earned interest from savings, that new deduction could easily be repealed too.

By far the best course is to scrap the income tax, which discourages savings, induces consumption, punishes work, and discriminates against the productive. It is costly to pay and costly to collect, and it subverts our privacy. It shortens time horizons and makes everyone a slave to the federal government. Worst of all, it has funded the expansion of Leviathan.

The first income tax was levied by Abe Lincoln to fund the invasion of the South. When the tax was later found unconstitutional, Congress eventually passed the 16th amendment. Most people didn't know where it would lead. Now almost everyone works nearly five months out of the year for the feds.

If we abolished the income tax this year, an additional $600 billion would be available for productive private investment. The standard of living would zoom. Savings would increase and interest rates would fall. The phony system of "withholding," a relic of wartime statism, would also be abolished. The increase in overall prosperity would be astounding.

How would the government raise money? Already other taxes will raise $753 billion this year, which is larger than the fiscal 1982 budget. And the budget of 1982 was far larger than any free society should tolerate. Add taxes and borrowing, and subtract the income tax take, and we are left with a 1987-sized budget. Would recreating that be so difficult?

What about revenue neutrality? Fie on it. Those serious about cutting the budget should welcome a huge tax cut. Where to cut? Eliminate the welfare state and save $320 billion. Drop foreign aid, and subsidies to energy, agriculture, mails, banking, and technology, and save $110 billion. Another $170 billion can be divided between means-testing Social Security and cutting Medicare and military spending (why spend as much as the rest of the world combined?).

Thanks to some House Republicans, the idea of abolishing the income tax is no longer considered loopy. But unfortunately, the same people talk about replacing it with a national sales tax. Such a tax would be terrible for small business. If we think the present system is cruel, wait until the federal sales tax police demand the records of every seller and consumer in the country. Enforcing this tax would make the present system look compassionate.

The point of all tax reform should be to keep more private property private. No matter how it is collected, a tax is a tax, and therefore economically destructive. Taxes should be cut anywhere and everywhere, and never be "replaced."

The ideal tax would be one just big enough to run a constitutional-sized government. That way we could abolish the Social Security tax, the income tax, every tariff, duty, and fee, the corporate tax, the inheritance tax, and the capital-gains tax. The revenue from the telephone tax is more than they deserve anyway.