Book Review: The Benefit And The Burden

Bruce Bartlett published "The Benefit and the Burden: Tax Reform -- Why We Need It And What It Will Take" in 2012. The book offers an introduction to how tax policy is set in the United States. The political situation has obviously changed since the book was published, but the historical background is useful to provide context. The text is definitely not "in paradigm" with Modern Monetary Theory (MMT), but this does not matter when discussing the narrow topic of tax reform. This article also explains why I am skeptical that tax reform will be passed any time soon.

Book Description

The Benefit and the Burden was published in 2012 by Simon & Schuster. The book consists of 24 chapters, divided into three parts:

1. Part I: The Basics
2. Part II: Some Problems
3. Part III: The Future 

The text explains the technical issues involved in plain language; further sources of information on the topic at hand is given at the end of chapters. The printed edition ISBN is 978-1-4516-4619-1, the ebook ISBN is 978-1-4516-4626-9.

Bruce Bartlett worked as a senior analyst for conservative politicians in the 1970s and 1980s, including Senator Jack Kemp and President Ronald Reagan. He has since fallen out with the conservative movement, and I mainly see him ridiculing Republicans on my Twitter feed. Although he does his best to be non-partisan, this politics in this book may be disliked by:

• conservatives to the right of Ronald Reagan (which is most of the Republican party at this point); and
• liberals who are still mad about the Reagan administration.

What is Income?

The book starts off with the fundamentals of taxation. And we discover that the problems with setting tax policy are fundamental. As Bartlett notes at the beginning of Chapter 3:

To tax income, one has to know what income is. That may seem obvious, but it becomes complicated the more one thinks about it. That is a key reason that the term "income" is nowhere defined in law. Section 61 of the tax code is a tautology: it says that gross income "means all income from whatever sources derived" and then lists a few examples. ... In practice, "income" is whatever the Internal Revenue Service says it is.

He argues that the difficulty of defining incomes reflects the history of the income tax: it was slapped into place in response to various wars, and was not the result of first-principles discussion. He notes that most economists have accepted the notion of Haig-Simons income, but that definition has obvious problems when applied to the real world.

This theoretical incoherence causes a few fundamental problems with tax policy.

• Are capital gains income?
• What is the unit of taxation: the individual or the household? Since all income taxes are progressive in terms of average tax rates (including so-called "flat taxes", which only have a flat marginal rate above the income threshold), there is an advantage of dividing the same income among two people.
• What is the time period of taxation? Individuals with highly irregular incomes on a calendar year basis are penalised over their lifetimes versus those with regular incomes.
• What can be deducted from income? For example, the United States allows a deduction for income for mortgage interest; Canada does not (for primary residences). 

The Process of Passing Tax Laws

Bartlett offers an even-handed description of the process of passing tax laws in the United States. Although one might summarise the current situation as being a mess, this was not the result of malice. Most of the changes to procedures that cause problems are the result of previous attempts to improve the process, and make it more fair.

He is quite positive about the role of tax lobbyists, which may surprise some readers. I am a Canadian Prairie Populist, and so I have a natural dislike of lobbying. That said, in the context of tax law, the American system appears reasonable. Everyone has a dog in the fight over taxes, and so there is a great diversity of represented interests. These lobbyists have technical skills, and may be the only people with a global view of the political alignments in Washington. This diversity of views is lacking in other areas of governance. If Evilcorp wants to dump PCB's into a creek near an elementary school, the only lobbyists who have an opinion are those from Evilcorp and environmental groups. Since everyone knows what those lobbyists have to say -- and how many votes they can deliver -- they are more easily tuned out.

Spending Through the Tax Code

Chapter 10 has the title "Spending Through the Tax Code." He discusses a problem that is missed in most discussions of fiscal policy: we cannot think there "is a clear delineation between taxes and spending."

By giving credits to tax payers if they follow some course of action, the government achieves the exact same thing as paying the taxpayer to take the action (which falls under the traditional definition of spending). Such pseudo-spending is called "tax expenditures." It is therefore possible for backers of small government to act exactly like the "tax and spend" old Keynesians of earlier eras.

This habit destroys the internal coherence of the tax code, which increases the need for tax reform (discussed next).

Tax Reform

Bruce Bartlett uses a standard, narrow definition of tax reform: moves to make the tax code internally consistent (fair), without attempting to increase or decrease revenue. This is known as being revenue neutral. (It might be possible to clean up the tax code while at the same time increasing or decreasing the tax burden, but that seems to be more difficult to pull off.)

The need for tax reform became apparent in the 1960s. Governments worldwide (including the United States) had extremely high marginal tax rates. (In the United States, from 1954 to 1963 the top tax rate was 91%.)

These tax rates were politically very useful; it gave the impression that everyone was "paying their fair share." They helped keep radicalism at bay, and resulted in a nice flat income distribution -- when that income distribution is based on incomes reported for tax purposes. (Which is why I have some doubts about inequality research based on income tax data.)

By the 1960s, it was becoming apparent to most that the capitalist class was not paying taxes at rates that were even close to the statutory rates. The only people stuck paying those high tax rates were people who could not structure their affairs to avoid them. In particular, stars of popular culture with high royalties were caught up.

This created the artistic genre of "rich left-wing artists complaining about tax rates," the classic example being the Beatles' "Taxman." When a liberal policy loses the hippies, you know there is something wrong. (I am unsure whether this observation about pop culture was in the book; this was a common observation in the 1970s.) 

The release of data on tax payments provided the impetus for tax reform. At the end of the Johnson administration, a Treasury investigation noted that for 155 tax files with adjusted gross incomes above $200,000 ($6.5 million in 2012 dollars) paid no income taxes in 1967. Needless to say, that piece of information killed the story that everyone is paying their fair share.

This led to a series of tax-reform measures in which the tax code was realigned so that realised tax rates were closer to statutory rates. Loopholes were closed, in exchange for lower tax rates. The usual objective of tax reform is that they are revenue neutral: the projected net effect on the fiscal balance is zero. (Since the argument was that reforms would make the economy more efficient, the expectation is that they would reduce fiscal deficits as the result of stronger growth.)

Observations from Canada

The problems with inconsistencies in the tax code are only obvious if you are filing taxes. As a Canadian, I am not in a good position to discuss the fairness of the American tax code.

The Canadian personal tax system has largely been reformed; if there are problems, it is in the treatment of the taxation of multinational corporations, and the super-rich who set up complicated international trusts to shelter wealth. In both cases, the common denominator is the international aspect, which is a global issue.

The situation in Canada historically paralleled the American one. There were a lot of really bad Canadian films produced in the 1970s; these were the result of tax shelters. The anger with high income tax rates led to the attitude that it made sense to lose $2 to pay $1 less in tax. Furthermore, the treatment of business income versus earned income was seen as widely unfair, as the result of tax measures to boost small businesses.

However, tax reforms have been continuously carried out. The Canadian Federal Government has few internal checks and balances if the ruling party has a majority (which it usually does); the de facto check on federal power comes from the provinces. (The situation of Quebec ensures that this stalemate continues.) The current Republican Party tactic of obstructionism would be suicide: if you do not attempt to govern when elected, you are not going to get re-elected. As a result, it is much easier for the Canadian Federal Government to ram tax reforms through.

As I noted earlier, this meant that the personal tax code is cleaned up, and consistent with the treatment of incomes for domestic businesses. I am a consultant (not a particularly great one, admittedly), and the tax savings I would get from incorporation are almost exactly equal to the cost of incorporation. The few attempts at abusive personal tax shelters only make the news when they are crushed by Revenue Canada. (Revenue Canada court losses typically are on the business side.)

This means that tax reform is not a major political issue in Canada. Although it is easy to be outraged by international corporate tax shenanigans, it is difficult to formulate a useful policy to counter it. Canadian populism is distinguished from the hapless populist movements in other countries by having a track record of arising only around a potential reform to a problem, and not just the result of disgruntlement.

Returning to the United States

The current situation in the United States appears worse than Canada, but it still is improved versus the 1970s (at least on the personal income tax side).

The book was written before the Republican takeover of all elected branches of the American federal government. On paper, everyone wants tax reform, and it should be possible to enact.

The problem is that the Republican party is a coalition, and the free market wing of the party appears unable to make any form of productive compromises. Furthermore, the objective of tax reform is to eliminate loopholes that are created by tax expenditures that were put into place by Republicans.

The most likely possibility is that the Republicans will cut taxes; whether they can weed out some of the inconsistencies in the tax code along the way remains to be seen.

The book has a long discussion of Value-Added Taxes (VAT), which Bartlett favours. Although such a tax might be a good idea, it's completely off the political radar at present. In my view, these taxes are a good policy step; part of the problem of governance in the United States is the result of the lack of a VAT.

Why Tax?

Most of my regular readers are in the MMT camp. Many MMT-ers are hard-line believers in Functional Finance, and many of them would be completely stressed out by Bartlett's discussion of why the government should tax. Very simply, his logic is standard old school fiscal conservatism, and he even cites economist Robert Barro's nonsensical theory of "Ricardian Equivalence."

I think the book is worth reading, so long as you ignore those parts of the book. A lot of the online arguments about Functional Finance devolve into arguments about semantics. Some of the critics of Functional Finance end up arguing that an "inflation constraint" and a "financial constraint" is the same thing. That's a view that makes no sense whatsoever, but arguing with someone who insists that two different things are actually the same is just as logical as me having a debate with my cats regarding the timing of the morning feeding.

We need to get beyond semantics, and ask ourselves: where are the operational differences between views? If we are doing economic analysis, there are a lot of differences that make the Functional Finance approach superior to the "financial constraint" based approach used by the mainstream.

In the case of debates about the tax code, the main insight of Functional Finance is that we cannot measure the economic impact of policy changes using dollars. I gave a simple example in an earlier article: "Effects of a Tax Cut in a Simple SFC Model." I will not go through that discussion here, but I will just republish a chart showing how two policies that appear similar on a revenue basis end up having differing effects on the economy.

Although the realisation that dollar values of differing policy mixes are not comparable on a 1:1 basis is useful, this is not true for most of the debates around tax reform. The objective of tax reform is to make sure that tax rates paid by the same taxpayer are the same regardless of how that income generation is structured. Since different tax flows are fungible for a taxpayer, we need to compare policies on a dollar-for-dollar basis.

More generally, politicians need a common yardstick for discussing the trade-offs between various policies. Money is useful precisely because it provides such a common yardstick. It is very difficult to replace monetary values for measuring political horse-trading.

The realistic solution is accept that politicians are going to use dollar values to measure the effects of fiscal policy, but the political rules of the game should have a realistic view on deficits. (I discussed how the Canadian government inched in this direction recently.) That is: there should be no belief that the budget must be balanced on any time horizon; at most, we should have realistic estimate of the trajectory of the debt-to-GDP ratio (or similar ratios). (The Congressional Budget Office is in a tough place: they are just doing what Congress told them to do. That said, their projections are pretty much the opposite of realistic. The complete and utter incoherence of mainstream economics analysis of fiscal policy means that reform of the CBO's methodology is a pipe dream, even if the political will existed for such reforms.)

Any realistic analysis of macroeconomics should tell us that forecasting is difficult; the theory that activity is perfectly forecast by a representative household (on average) is worthless. We have to accept that we are not going to stabilise the economy with active fiscal policy. Politicians may step in during a crisis (which is what happened in 2009), but such moves are not going to prevent downturns. We need adequate fiscal stabilisers, and a safety net to blunt the effect on those with lower incomes. (The rich have a proven capability to take care of themselves.) So long as the government is not continuously making radical changes to tax policy, we can judge whether fiscal policy is too tight or too loose just based on back-of-the-envelope calculations. Meanwhile, the central bank is there to help control inflation (for those of you who believe that monetary policy controls inflation).

The net result is that it is easy to disagree with Bruce Bartlett with regards to why taxes are set where they are, but discussions of how they should be set are going to be more productive.

Concluding Remarks

Bruce Bartlett's book provides a useful historical context on the development of tax policy in the United States. The political environment has moved on since he wrote it, but the underlying issues remain. Although I do not agree with his fiscal conservatism, it would still be possible to have useful policy discussions with him.

(c) Brian Romanchuk 2017