Friday, February 03, 2012

Is It Possible to Have a Productive Discussion About Taxes?

-- Posted by Neil H. Buchanan

I have done a lot of writing about taxes, and especially about distributive justice, over the years. One of the most frustrating aspects of the never-ending tax debates is the profound level of dishonesty among far too many commentators, who are willing to use any statistical trick or framing device to score cheap points. In that context, one might reasonably think: "If only there could be an honest debate among people of good faith, we could at least find the areas of genuine agreement and disagreement. Then, maybe we could find a decent compromise."

That very Obaman attitude has the most honorable roots, and one hopes that it will someday be possible to have such a discussion. (I am not, of course, holding my breath.) I am now, however, beginning to despair, suspecting that even that lofty discussion could lead nowhere. In the latter part of my new Verdict column, "The Buffett Rule Is an Imperfect Form of Tax Justice, but an Important Step in the Right Direction," I begin to confront the sources of that despair.

The most obvious barrier to finding agreement on questions of tax justice, it seems, is that people can reasonably disagree about what is a fair distribution of burdens. As I readily acknowledge in my defense of Obama and the Buffett Rule, there is nothing magical about Obama's proposed principle that everyone with an income of at least one million dollars per year should pay at least 30% of their incomes in taxes. Thirty percent is an arbitrary number, of course, and it seems most reasonable to view Obama's suggestion as a stand-in for an important underlying policy goal: that the tax system should at least be progressive (rather than continuing to allow higher-income people to pay a lower proportion of their incomes in taxes than middle- or lower-income people do). Shockingly, we need to have that fight once again, with one major party taking a position that I once thought was beyond the pale in U.S. politics: that rich people should pay less than everyone else.

Even if we could get everyone back on board the progressivity train, reasonable people could still differ about how the tax burden should be distributed. A system in which the rich would pay, say, 21% in taxes and everyone else pays between 18% and 20.99% would be progressive, but it would not meet my definition of justice. I suspect that I am not alone. How high should the highest average tax rate be? Again, it is difficult to imagine that people will have a Platonic debate and then agree on an ideal level.

All of which is true, but so what? The beauty of constitutional democracies is that we can find ways to satisfy everyone by satisfying no one. If the only problem were that people reasonably differ about their ideals, there would be no reason to despair.

Another aspect of the problem is that the dishonest tactics used by many advocates rely on underlying questions with which even honest people struggle. The question of "tax incidence" -- that is, who really pays a tax, notwithstanding the party from whom it is collected -- continues to confound analysts. Is the corporate tax ultimately a burden on workers, through lower wages, or on shareholders, through lower dividends? Moreover, there are issues of "implicit taxes," such as the lower interest rates that holders of municipal bonds receive due to the tax-favored status of those bonds. Does it even mean anything to say that person X pays y% of her income in taxes?

Much of the policy justification for reduced tax rates -- especially for reduced taxes on the rich, in the hoary "trickle-down" theory -- is that tax rates affect economic behavior, possibly reducing incomes in a classic equity/efficiency tradeoff. Although this is an important question, it strikes me as neither theoretically nor morally problematic, because it is ultimately an empirical question. The debate over the economic consequences of tax policies should always be robust, but it seems to me that the evidence is clear enough for honest people to find common ground. (The evidence is simply not there, for example, to support the claim that favorable rates on capital gains encourage productive investment.) Moreover, it is possible to experiment with changes in the tax code and rates, making it possible to have a healthy policy environment, with new evidence always ready to be gathered and added to the debate.

All of these familiar concerns are daunting, individually and collectively, for anyone who hopes that the tax policy debate will return to something approaching rationality. Even so, these concerns (even collectively) should not lead one to despair. They suggest that we should commit to engaging in robust debate, taking account of imperfect evidence, and weighing it against competing notions of fairness. As a policy wonk, how could I not feel excited about that?

The major stumbling block, the problem that prevents the debate from going forward, is that tax rates themselves are a meaningless way to measure distributive justice. Regular readers of this blog know that I have been working through the implications of the "baseline problem," which is my label for the observation that measures of economic efficiency are inherently meaningless, because the designation of an efficient baseline (against which all other points are measured and found wanting) is arbitrary. If we have no way of designating a baseline, then even well-meaning debaters are at sea in determining the best outcome.

The tax-specific version of this phenomenon is now commonly referred to as the Murphy/Nagel problem, reflecting the important work of NYU philosophers/law professors Liam Murphy and Thomas Nagel. Murphy and Nagel clarified and popularized (among tax academics) the important theoretical point that before-tax income is an inherently meaningless concept, because the government that helps to determine incomes must be financed with taxes. This makes it arbitrary to say that a person has $X in income until a government comes along and takes y% of that income, because that income could not have been earned in the absence of the government. That government, in turn, could set tax rates (and other laws) in ways that would change X for everyone in the economy.

Why does the Murphy/Nagel point now bother me more than it ever has before? In my Verdict column, I point out that the entire thrust of the Occupy Movement (as now filtered through the Democratic Party's establishment) is based on before-tax incomes. If before-tax incomes were meaningful, then we could at least imagine a robust political debate in which people propose and defend various tax rate structures, leading to a reasoned compromise. Because before-tax incomes are not meaningful, however, it is at best misleading to commit to any particular tax rate (or structure of rates). I could easily support a tax system that looks relatively non-progressive -- or even regressive -- as measured against before-tax incomes, if the rest of the economy (and the government's other policies) added up to a just society.

In short, I have no moral commitment to any set of tax rates, as measured on a before-tax basis. I doubt anyone else does, either, even if they think they do, because before-tax income has no meaning. This means that all policy commitments in the area of taxation are necessarily contingent, easily changed in response to changing background facts. Thus, a person who strongly supports the Buffett Rule today might view that rule as hopelessly retrograde tomorrow. Even honest commentators, therefore, could appear to be opportunistic and fickle.

Even so, there is no choice but for people to commit to specific rate proposals. President Obama is now on record supporting the 30%-for-millionaires Buffett Rule, and he will not be able to back away, even if there is good reason to do so later. (G.H.W. Bush committed to a particular rule about before-tax income, and his change of mind arguably cost him his presidency.)

In short, the tax debate -- even if carried out by honest, well-meaning people, with access to the best available data and analysis -- must be engaged on the basis of before-tax rates, which ultimately do not mean anything. While I can easily support policies on a contingent basis, it seems to me that the long-term health of the debate is severely compromised, because the immediate focus of debate on an arbitrary set of numbers makes it nearly impossible to talk about how to achieve real distributive justice. This might be the best we can do, but the shadow boxing makes it especially difficult to keep our real goals straight.

9 comments:

David Ricardo said...

I have also written about this, and I think the starting point is an agreed upon set of guidelines and standards. Some of these could be the following.

1. Define Effective Tax Rate as Taxes Paid/Gross Income.

2. Recognize that it is the effective tax rate that is the target variable, not statutory tax rates.

3. Define Progressivity as Effective Tax Rate Increases when Income increases. Progressivity is not when the higher the income the greater proportion of total taxes paid.

4. Recognize that even a revenue neutral change will mean higher taxes for some groups.

5. We need a standard set of "income cases" in order to determine the tax impact of any change. For example, Case 1 might be single person with $15,000 gross wage income, Case 2 married couple, no children gross income $25,000 etc. Probably 10 cases would do. You would then test any tax proposal as being the change in current taxes vs the new tax structure. This way you can see who benefits and who is harmed.

If everyone could agree on the way we talk about tax changes a rational discussion is possible.

Gnash said...

I agree very much with you about the problematic concept of pre-tax income, a topic I have commented on before. (I had independently come to the same view, and you once pointed to Murphy & Nagel in a response to my comment.)

However, I am not convinced that the lack of inherent meaning of pre-tax income implies a problem with the concept of tax rates. Can we agree on the following premises: (1) After-tax income is inherently meaningful, and (2) there is a two-way mathematical transformation between tax rates based on pre-tax income and those based on after-tax income? If so, tax rates are meaningful and relevant, although they may typically be stated in wrong units.

To expand on the premises:

(1) After-tax income is something you actually receive and have permanent control over. It is also what people (at least those who live in economics textbooks) consider when they enter into transactions through which they earn their income. This seems like a meaningful and relevant concept of the rate of increase in a person's wealth - i.e., the person's income.

(2) This seems obvious as long as each type of tax is progressive or flat throughout the range of incomes. Off the top of my head, I would conjecture that it holds whenever the amount of tax (rather than just the rate) is non-decreasing in income for each type of tax. I think this holds for all common taxes and credits except the EITC. The EITC may require a relaxation of the premise (the mapping may not be one-to-one), but I think we can deal with the worst case - a multiplicity of solutions.

Now, if (1) and (2) hold, then we can restate the tax rates in terms of after-tax income. The "pre-tax income" is then interpreted as the artificial construct equal to the sum of after-tax income and the tax paid, or the product of after-tax income and (1 + the "correct" tax rate).

P.S. I do wonder if it may be a little more complicated due to the timing of income when all complexities of the tax code are considered (unrealized/realized capital gains, depreciation, gift/estate taxes, etc.), but I don't see that those complications would invalidate either premise.

P.P.S. I am sure that we also agree that the "pre-tax income" does have a meaningful interpretation, albeit not as income: it is the cost to entities that provide the income (employers or users of capital). The pointis, rather, that this cost has no inherent primacy over the (after-tax) income that workers and investors receive. Income + tax wedge = cost is a simple mathematical equality that has all the symmetries as such.

Neil H. Buchanan said...

My belated thanks to both The Dismal Political Economist and Gnash for their comments. I expect to write one or more posts soon, building on your suggestions. In any case, I sincerely appreciate your engagement with my post.

David Ricardo said...

The recent release of the new Romney proposal is an excellent example of why we cannot have an honest, open, and objective debate on tax policy.

The only real details in the plan are the reduction in rates. Mr. Romney promises a bunch of other changes that will make the plan revenue neutral and distributional neutral but without the details on those changes no discussion is possible.

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