Get Rich, Pay Lower Taxes, Boost Federal Revenue: Amity Shlaes

To clean out and start over right.

That's the great impulse that Americans act on each spring. We tell ourselves there's nothing wrong with this process repeating annually. In religion, the cycle is always there: sin, repent, purge. These days the impulse gets its most vivid individual expression in the realm of personal health: "sin, repent, spinning class." Or "sin, repent, detox drink." The worse the year, the greater the repentance required.

Spring also brings a collective impulse to reform. That usually gets expressed in a resolve to make the tax code more progressive. Some of the demand for more progressivity is revenue-related. The government needs the money, or thinks it does.

But some of progressive reform is just the annual expression of that spring impulse to make life clean, fair and right. To "maintain or increase the progressivity of the tax code" is, for example, one of the recommendations being quoted right now from the report by President Barack Obama's bipartisan National Commission on Fiscal Responsibility and Reform.

Ritual isn't always logical, however. It can be destructive, precisely because it repeats. Too much sin-and-repentance, and even we don't believe ourselves any more. Too many detoxes, and you're poisoning yourself.

Nowhere is this clearer than in the case of tax progressivity.

Graduated Rates

The first modern expression of the progressive impulse came in the springs of the early part of the last century, when the Treasury Department fashioned the Form 1040. The tax formula was progressive, with a graduated rate structure going from 1 percent to 7 percent. Since only a few people paid federal income tax, that rate structure was a model of progressivity.

But of course it wasn't. Making the code progressive felt good to lawmakers, just the way the detox does. World War I and its costs strengthened the general mood of sacrifice. So they made the code even more progressive, taking the top rate up all the way into the 70s.

The results taught lawmakers a quick lesson. Raise the rates too high, and you get a perverse result: less money from the rich than you expect. Lower the rates, and the rich pay a greater share of the taxes. Treasury Secretary Andrew Mellon found that when he cut rates down to 25 percent, he got the most revenue of all.

But logic couldn't always suppress instinct. Each year, lawmakers felt that need to demonstrate they were increasing progressivity even more than they felt the need to get an optimal result. Each year that need had to find expression. Within a generation the top rate was back in the 70s, reaching 91 percent in the 1950s. This proved inefficient. Taxpayers found ways around the statutory rates. Again, the reform didn't work.

Progressive Outcomes

In more recent springs, both Democrats and Republicans have developed a compromise repentance to accommodate some reality. The lawmakers discovered, as Mellon had, that by talking about helping the poor, but keeping the actual top rates lower, they got an outcome that was splendidly progressive.

In 1980, the top 1 percent of earners paid 19 percent of income taxes, and the bottom half of earners paid 7.1 percent. A decade later, with a lower maximum rate, the top 1 percent paid 25 percent of taxes, while the bottom earners paid just 5.8 percent. By 2008, top earners paid 38 percent of taxes, the bottom half 2.7 percent.

What about today? It might make sense to cut taxes even more, down to, say, a top rate of 20 percent. Then the rich would pay all the taxes. And there would be more revenue, as foreigners came in.

Burden of Rich

But here tax sanctimony gets in the way of tax reform. In a progressive rate structure, the rich almost always get bigger tax cuts, because their rates are higher to begin with. So their cuts sound unfair. The more progressive a tax structure, the more unfair its dismantlement appears.

The reality is that this year in tax terms, the U.S. isn't a sinner. The country is already clean. The very rich shoulder far more of the collective burden than their share in the population warrants.

Yet in his recent debt speech, Obama clearly wanted to make the point that the rich don't pay their share of the collective costs of government, whatever the data showed. So he retreated to another datum: the share of individual income that a taxpayer gives up in taxes.

"At a time when the tax burden on the wealthy is at its lowest level in half a century," the president said, "the most fortunate among us can afford to pay a little more."

World of Problems

That ratio is indeed lower than at some other points. You can find a way to make America look like a sinner even if it isn't sinning. Tax increases may be appropriate as a last, worst resort. But we are not at the last, worst moment this spring.

Why then did Obama ignore the record of lower rates bringing more revenue? Because there's a lot wrong in the world, starting with the federal debt, and continuing on to joblessness, war in Libya, and Japan's nuclear crisis. So the general urge to purge is greater, and it's being channeled into tax sanctimony. But that doesn't mean this particular ritual is worth honoring.

(Amity Shlaes, a senior fellow in economic history at the Council on Foreign Relations and author of "The Forgotten Man: A New History of the Great Depression," is a Bloomberg News columnist. The opinions expressed are her own.)

© Copyright 2011 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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