Time to debate taxes

The Democratic candidates are all fighting about taxes but in a very unsatisfying way. It's "middle class" this, "rich guy" that, and "deficit, deficit, deficit". The problem is not the topics but that not even Messrs Kerry, Dean, Clark and Edwards seem to take what they are saying especially seriously.

May we suggest some campaign reading? Perhaps they might like to pick up David Cay Johnston's Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Rich and Cheat Everybody Else (Portfolio/Penguin).

Free market liberals, or the Bush campaign for that matter, will have some problems with Mr Johnston. He says the rich pay too few taxes, a somewhat difficult argument to sustain in an economy where the top half of earners pays 96 per cent of the income tax.

He assails corporations, especially Stanley Works, for example, for being so unpatriotic as to consider locating their headquarters everywhere. This is a little harsh, since many companies have tried to establish paper headquarters abroad precisely to spare jobs at home.

Lastly, Mr Johnston presumes, and hence the title of his book, that somebody is intentionally and scientifically planning a "campaign" against the worker and keeping it "covert". Here the author overrates his opponents: governments and corporations. Governments do not plan, at least not when it comes to taxes. They react as strongly and intelligently as pachyderms. As for corporations, they are just pass-through entities. They can claim about as many intentions as a piece of kidney dialysis membrane.

But Mr Johnston exposes some fundamental problems with the tax code that Campaign 2004 seems to be overlooking. The first is with the Alternative Minimum Tax. Originally established as a sort of penalty box regime to ensure the idle rich do not deduct their entire tax bills, the AMT has over the years evolved - not, again, that it was anyone's intention - into a tax punishment for middle class people.

A reporter at the New York Times, Mr Johnston won a deserved Pulitzer a couple of years ago for describing some of the more compelling AMT casualties.

One example was the Klaassen family, famous in tax annals. They had income under $90,000 and claimed their children as dependents, a standard practice. They claimed medical costs. Also standard. Because the family had ten children however, the AMT bells and whistles went off. The Klaassens took "too many" tax breaks, and must pay thousands extra.

Falling victim to AMT is relatively unusual now but it will shortly become a national bugaboo. By 2010, as Mr Johnson points out, as many as 30 per cent of filing households will find themselves in the AMT regime. While lawmakers take stabs from time to time at the AMT, they have not penned a repeal.

Another problem area correctly identified by Mr Johnston is America's New Deal pension system, social security. As he points out, social security represents a double tax; the payroll tax is levied on income that has already been subject to personal income tax.

What's more, payroll taxes are high, much higher than they used to be. In 1970, the maximum amount one could pay in a year towards the government pension programme was $327. In 2003, it was $5,400.

For the majority of households, social security is the largest tax. Today, every worker pays social security tax at a rate as high as income tax rates as they applied to millionaires 90 years ago. If the returns on workers' social security investments were great none of this would matter, but they aren't.

Then comes the issue of corporate inversions, Mr Johnston's pretext for going after Stanley Works. These are also a big problem, albeit not one of patriotism, as he claims. US companies, from the erstwhile Chrysler to Stanley to the many unknown names, face a disadvantage next to their corporate counterparts. They pay US tax under the US worldwide system and very often they pay tax in the locality in which they operate. This hurts US competitiveness.

Last and, I would argue, most important, Mr Johnston rails against complexity. The tax crowd tends to pretend complexity does not matter. Henry Bloch, H and R Block's patriarch, used to try to convince people that complexity meant fairness, a peculiar equation.

In fact, tax complexity is a corrosive force, for civic reasons more than any other.

If people cannot understand the terms of their principal interaction with the government - paying taxes - then they cannot trust government.

When it comes to the conclusions, Mr Johnston and free marketeers diverge again. Still, even they will concede that his general point is strong: "Our tax system was designed in a bygone era. It worked reasonably well for a national, industrial wage-based economy". These days, however, it "needs more than tinkering; it needs overhaul".

What a fine subject for a Super Tuesday debate.

© Copyright 2004 Financial Times

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To book Amity Shlaes for a speaking engagement, contact Jamie Brickhouse at the Red Brick Agency, 646.281.9041.
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