Obama Tricks Voters Like Enron Hoodwinked Public

Sept. 22 (Bloomberg) -- The debate concerning the top tax rate for wealthier Americans is so difficult in part because most people only pretend to know the actual figure.

Sure, we all know Republicans want to keep the top rate at its current level while Democrats prefer to let the George W. Bush-era rate cuts expire. And some of us may even know that the tax code's current 35 percent figure would rise to 39.6 percent if President Barack Obama gets his way.

Beyond that, we get hazy. And no wonder: other sections of the tax code combine with the statutory rate in mysterious ways, creating a different effective top marginal rate. These include, for example, phaseouts known as Pease and PEP, under which itemized deductions and personal exemptions fade. If you really want to capture the top taxpayer's situation, you have to add state taxes into the mix. So what's the exact top rate? Nobody knows. Or, maybe, nobody wants to know.

I asked the biggest, baddest tax mind I know, former Congressional Budget Office director Douglas Holtz-Eakin, to tell what he thinks the top tax is. Even Holtz-Eakin approximated, texting back a formula that might serve as the theme song for tax year 2011: "39.6 + 2 (phaseout of pep and pease) + 3.8 (Medicare net investment income tax) = 45.4. Add in state-level taxes and 50 is easy to reach."

Holtz-Eakin is a genius. If he's approximating, it's because he can't bear to feel the pain of the precise reality.

Illusion of Fairness

So how did we get here? Politicians love progressive rate structures. First, they appear to be fair. We've all heard President Obama invoking fairness in defense of the 39.6 rate he seeks. A second, greater advantage of progressive rates is their complexity. The staircase concept of rates rising on successive income tranches is hard enough. Add in all the traps and breaks and taxpayers become truly confused and give up protesting.

What's at work here is the same phenomenon that caused otherwise sentient members of Enron's audit committee to go along with executives Andrew Fastow and Jeff Skilling: fear of looking stupid. Given a choice between seeming like dummies or paying more money than they think they should, people often choose the latter.

For the first quarter century or so of its existence, lawmakers didn't dare impose the income tax on the average earner. Only when World War II broke out did this class tax become a mass tax. And then two extra tricks were necessary for the transition. First, many taxpayers were hardly in a position to resist a shift in the code since they were already government captives: draftees. Second, withholding was introduced. Soldiers never knew how much they were taxed because part of their income never even made it into their pockets.

Selling the Structure

After the war, the feds found new ways to justify and complicate our tax system. They marketed progressivity as a necessity for the nation's general welfare. The very name itself helped. Many people don't want to oppose political progressives, so they go along with the idea of a progressive tax structure. Even those who reject progressive politics may not want to be caught opposing something that sounds like progress. The progressivity brand was so successful that government was able to keep the top rate at more than 70 percent for decades.

But did postwar Americans really endorse, or even understand, that progressive principle? This was less clear. Two skeptics were Harry Kalven and Walter Blum of the University of Chicago. They set out to make the case for progressivity but found the argument so weak they titled their 1953 book "The Uneasy Case for Progressive Taxation."

Taxing Experiment

In the 1990s, scholars designed an experiment to see whether people understood the difference between progressive structures, under which rates go up as people earn more, and proportional ones, under which higher earners pay taxes at the same rate as lower earners.

Michael Roberts, Cassie Bradley and Peggy Hite asked college students abstract questions: "Are progressive tax rates more or less fair than flat tax rates?" By a margin of almost 4 to 1, students said they preferred a progressive rate system for society. Next the researchers gave the same students concrete examples of a paired set of two earners with different salaries and possible tax bills for those earners, asking which tax amount the earners should pay. By a margin of 4 to 1, the same students picked tax amounts for the higher earner that corresponded to a flat rate, or even a regressive, system. Remarkably, these subjects were accounting students who had already studied these various systems.

The point isn't that taxpayers are stupid. Rather, they are stupefied and conflicted. On a gut level, they may not necessarily agree with the basic principle of modern taxation. "Overall, our results indicate the existence of a norm for proportionality…" concluded Roberts, Bradley and Hite. Lawmakers may want to drag the country into a new higher tax era. But they shouldn't console themselves that there's consensus for such a change, when there may not be.

(Amity Shlaes, senior fellow in economic history at the Council on Foreign Relations, is a Bloomberg News columnist. The opinions expressed are her own.)

To contact the writer of this column: Amity Shlaes at amityshlaes@hotmail.com

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net.

© Copyright 2010 Bloomberg

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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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