100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States

100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States

by Michael J. Graetz

ISBN: 9780300122749

Publisher Yale University Press

Published in Law/Taxation, Business & Investing/Accounting, Business & Investing/Taxation

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Sample Chapter

Chapter One

The Case for Fundamental Reform

The current tax system is an abomination not worthy of an advanced society. -Paul H. O'Neill, former Treasury secretary

Except in extraordinary circumstances, the minimal requirement for a tax system should be that it raises sufficient revenue to pay for government expenditures. A good tax system ought to do so fairly, keeping its costs of compliance and administration as low as feasible. It ought to be conducive to economic growth. Finally, it ought to promote freedom by interfering minimally with private decision making. Our nation's tax system fails on every count.

It is time we do something about it. At present, our country faces enormous challenges at home and abroad: military conflict in the Middle East, health care and education systems that are universally considered broken, and bitter partisan division in our national politics. In such a climate, comprehensive reform of our tax system may seem a dry and rather abstract issue, a problem to leave to experts and number crunchers who will, we hope, keep our country's finances afloat long enough for us to attend to all our other problems. But in fact, if we don't solve the problem of a grossly inefficient system of raising revenues, all the other challenges our government faces will eventually be overwhelmed by one overarching reality: we will have too little money and will lack the means to raise it without damaging our economy.

Tinkering around the edges, giving a tax break here and raising a rate there, as politicians have done for decades, was never sufficient to the task and certainly won't solve our problems now. The time for fundamental reform has come. In a world immeasurably more interdependent than the world of the mid-twentieth century, when our current system of taxation took shape, a vital question for any reform proposal is: Will it make American workers and businesses more competitive in the global economy, while maintaining the progressive structure consistent with our nation's historical insistence on fairness? The proposal I offer in this book-what I will call the Competitive Tax-does just that. Unlike many of the alternatives currently being discussed in the halls of Congress, this proposal will have major benefits for businesses of all sizes and for all Americans. Perhaps most important of all, at a time when the federal government has strayed far from any sort of discipline in taxation or spending, it will help ensure that we fulfill our basic obligation to our country and our children: to responsibly fund our democracy.

The Mess We're In

When George W. Bush first took office in January 2001, the Congressional Budget Office estimated that the federal government would enjoy budget surpluses totaling $5.1 trillion in the decade ahead. That month Federal Reserve Chairman Alan Greenspan famously told Congress that the looming surpluses were so large that the federal government would soon pay off all its debt and would then have to invest in private assets like corporate stock, a scenario Greenspan abhorred. That problem has been solved. Congress enacted significant tax cuts in 2001 and in every year since until 2007. The nation's economy in 2007 was much stronger than it was in 2001, but the government's financial situation much weaker. The United States government now borrows nearly $3 billion every day. In January 2006, when Alan Greenspan left the Fed for private life, the federal debt exceeded $8 trillion, more than $2 trillion greater than when George W. Bush took office, and Congress was about to raise the federal debt limit to $9 trillion so that the government could continue to pay its bills.

Thus when Congress tackles tax reform, as it will eventually be forced to, it will not have the luxury of federal budget surpluses that might be tapped to finance an overall tax cut to sweeten the bitterness from the inevitable reduction and elimination of many tax breaks. This option was available in 2001, but George Bush took a different path.

During the past decade or so, our politicians have become complacent. Congress has not increased taxes since 1993, when Bill Clinton raised the top income tax rate in an effort to eliminate deficits. He did so then without any Republican votes. Clinton's policy may have worked-when he left office the budget of the federal government was in surplus for the first time in thirty years, and economic growth was strong during his second term-but its politics failed. The 1994 election gave Republicans a majority in the House of Representatives for the first time in forty years. George H.W. Bush had learned a similar political lesson a few years earlier when he lost his 1992 reelection campaign after breaking his "no new taxes" pledge in an effort to control federal deficits.

It should be a simple truth that tax revenues ought to be adequate to finance the government's spending. Economic conditions, to be sure, may occasionally call for deficits to provide a short-term economic stimulus. And unforeseen circumstances-a terrorist attack or a devastating hurricane, to name two-may create a temporary shortfall in government collections that will take time to correct. But routinely financing government with borrowing simply shifts the taxes to our children and grandchildren, and running up interest on the federal debt will inevitably require higher taxes from someone down the road. But because "someone down the road" does not yet vote, deficit finance is catnip to politicians. As Herbert Hoover put it, "Blessed are the young for they shall inherit the national debt."

Deficit finance increases our economic vulnerability when it is coupled with a substantial imbalance in trade. Because we import far more than we export, other nations accumulate dollars, which they use to purchase U.S. assets, including government debt. In 2006, for example, China held more than $300 billion of U.S. government bonds and about $1 trillion in total dollar reserves. And with its enormous trade surplus with the United States, China is accumulating many more dollars every day. If it were to dump those bonds or dollars on the market, a precipitous decline in the value of the dollar would result, possibly destabilizing our economy. Allowing foreign governments such control over our economic well-being may someday prove harmful not only to our economic health but also to our national interest and security. As the Harvard economist Benjamin Friedman puts it: "Government deficits, sustained year after year even when the economy is operating at full employment, reduce net capital formation and induce foreign borrowing. Both effects accumulate over time. Both are harmful."

But Congress has been unwilling either to pay for the government we have or to fashion a substantially smaller government. The time has come to put our fiscal house in order. We must stop pretending that we can continue to live with a tax system inadequate to finance what we are spending. Controlling that spending-and cutting it down wherever we can-should be a priority. Our federal government cannot continue to spend 20 or 21 percent of GDP while raising only 16 to 18 percent in taxes.

Unfortunately, as time passes, the pressures will be for more spending, not less. Over the decades ahead, demographic changes will put great additional pressures on the budgets of both federal and state governments. Our nation's population is aging. In 2011 the oldest of the baby boom generation turns sixty-five. Life spans have been increasing and will continue to increase. The fastest-growing segment of the population is the so-called old elderly-those over age eighty-for whom the costs of health care and of long-term care rise exponentially. People age eighty-five or older now constitute less than 2% of the population; they will account for 5% in 2040.

Today many people retire for about one-third of their lives. A man who retires at age sixty-two can now expect Social Security to provide income and Medicare to pay for health costs for seventeen years; the average woman, twenty years. These numbers have been rising over time. To limit our receipt of those benefits to the span of retirement of the average worker of the 1940s and 1950s today would require people to keep working until they are seventy-four.

In addition, fertility rates are much lower than in the 1950s and 1960s, leaving fewer children to help care for elderly parents. Immigration will account for most of our population growth in the years ahead, but immigration cannot solve our long-term fiscal problems, and, in any event, the public is ambivalent about increasing immigration.

As the elderly constitute a significantly greater share of the nation's population, new pressures will emerge in improving our nation's well-being. The elderly tend to be spenders, not savers. Most personal savings occurs when middle-aged workers save for their children's education or their own retirement. But even now, before the baby boom generation has begun to retire, our nation's savings rate is inadequate. According to the Commerce Department, in 2006 the U.S. personal savings rate was negative 1 percent, the poorest rate since 1933, during the Great Depression. During only four years in U.S. history have the American people spent more than they earned: 1932, 1933, 2005, and 2006.

Why is this important? Because there are only two sources of funds for business investments: national savings and capital imported from abroad. Lower business investment will over time reduce our nation's productivity and our level of national income. Going forward, other nations, whose populations are also aging-many much faster than ours-will have less savings to lend us or to invest here. Our need for investment capital demands a competitive tax system-one that encourages investments here by both Americans and foreigners. We want Americans to save and invest more and multinational companies to invest here rather than abroad.

A competitive tax system is also necessary because the aging of our population will put enormous budgetary pressures on Social Security, Medicare, and Medicaid (the last of which is the major source of funding for long-term care today). One should always be skeptical of long-term projections, and I certainly am. Seventy-five years ago we were just coming out of the Depression. Imagine what the projections for today would have looked like from that perspective. But as Douglas Holtz-Eakin, former director of the Congressional Budget Office, told the Congress, "Doing nothing is not an option. The United States is highly unlikely to 'grow its way out' of the burden of the projected spending growth." Yet nothing is precisely what we are doing. President Bush called for making the tax cuts of his first term permanent. In the meanwhile, Democrats accuse Republicans of favoring the rich and running large deficits, but have failed to offer any real alternative plans. It is as if Congress were paralyzed. Figure 1.1 illustrates the scope of the potential long-term fiscal problem.

Two things are clear: first, relying entirely on government borrowing to fund the fiscal gap is not sustainable-it will crowd out private investments, inhibit productivity, and increase interest rates, ultimately limiting Americans' standard of living. Second, government spending down the road is likely to be greater than it is today and higher than its historical levels. Social Security, Medicare, and Medicaid benefits will probably have to be reduced somewhat, and those programs may even be dramatically restructured, but it is foolhardy to assume that taxes will not also have to be raised. Although, as we shall see in Part II, not all tax reformers agree on how to proceed with fundamental reform, there is now broad consensus that our situation is sufficiently grave that we must act. And, in today's global economy, we should act in a way that enhances the competitiveness of workers and businesses in the United States.

Governance by Deduction

In our current system, presidents and other politicians use the income tax the way my mother used chicken soup: as a magic elixir to solve all difficulties. Special-interest lobbyists swarm Congress to get their special breaks. This explains why there have been more than fifteen thousand changes to the tax law in the past two decades. Meanwhile, politicians use it to try to direct businesses' investments and people's spending and saving. If the nation has a problem in access to education, child care affordability, health insurance coverage, or the financing of long-term care, an income tax deduction or credit is the politicians' answer. When Newt Gingrich became speaker of the house in January 1995, one of his first acts was to urge the House Ways and Means Committee to enact a tax credit for laptop computers to help "poor children" become more effective in the new "third wave" information age. That idea was so bad that Gingrich himself soon called it "nutsy." But the tax code is laden with nutsy ideas.

Both political parties use the tax law this way. President George W. Bush and Congress, for example, in 2005 enacted a laundry list of income tax credits and deductions for energy production and conservation. In July 2006 Hillary Clinton unveiled her "American Dream Initiative" to the Democratic Leadership Council. It was larded with "targeted tax cuts," including a $5,000 refundable tax credit to help fund down payments for owner-occupied homes, an expanded tax credit for "savers," tax credits for employers enrolling employees in retirement accounts, a $3,000 college tuition tax credit, a new fringe benefit exclusion for housing, and a multipurpose tax-preferred "American Dream" account. All of these ideas have been poll-tested and no doubt are quite popular with the American public.

To keep track of all the ideas that actually become law, the federal budget each year is required to contain a list of "tax expenditures," defined as all tax credits, deductions, or exclusions that deviate from a "normal" income tax. The number of these tax expenditures has grown enormously in recent years. Forty-five percent-66 of 146-listed in the 2006 budget have been added since 1986. Their total cost in lost revenues is estimated at about $700 billion a year. We are not talking here about narrow special-interest tax loopholes to benefit this company or that. These are tax breaks widely available to broad segments of the general public-tax cuts for the large middle class. The largest of these are very popular: tax advantages for employees' payments for health insurance and retirement savings, and deductions for home mortgage interest, state and local taxes, and charitable deductions. We have reached the point where Republicans in the Congress never see a tax cut they will not embrace, and Democrats view income tax benefits as practically the only way to achieve domestic policy goals without being labeled big spenders.

And yet we know that trying to solve the nation's problems through "targeted tax breaks" does not work. Take health insurance, for example. Our nation, contrary to others throughout the world, has long relied on a tax benefit for employers and employees as its main mechanism for covering Americans who are neither poor nor aged. What has been the result? Our health care costs are the highest in the world, and more than forty-five million Americans remain uninsured. Moreover, these costs are making American businesses and products less competitive in the world economy and are gobbling up wage increases of American workers. Nor has our tax-based energy policy produced better results. Nor do tax credits for working parents produce affordable child care. I could go on and on.


Excerpted from "100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States" by Michael J. Graetz. Copyright © 0 by Michael J. Graetz. Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher. Excerpts are provided solely for the personal use of visitors to this web site.
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