 Welcome to Free Thoughts from Libertarianism.org and the Cato Institute. I'm Aaron Ross Powell, editor of Libertarianism.org and a research fellow here at the Cato Institute. And I'm Trevor Burrus, a research fellow at the Cato Institute Center for Constitutional Studies. Joining us today is our colleague Dan Mitchell, senior fellow at the Cato Institute. America got its start in anger about taxes. So what would that founding generation think of our tax regime today? I would like to think that they would be very upset. It's not just that government is so much bigger in doing so many things that are so contrary to the animating spirit of the American Revolution. But the income tax, the way we collect money, the intrusiveness, the nosiness, the way you have to lay your life bare to the IRS, I assume for a generation that had very, very small government and what little government that did exist back then was financed by a few excise taxes and trade taxes. I would think they would go ballistic over the income tax. What they actually did to the tax collectors, I find this to be fascinating, when the stamp tax and the Townsend Act, they tore these people's houses down. The mob got up, went to their houses, tore them apart by their hands, tarred and feathered people, not condoting that. But how against taxes they actually were? But then the income tax comes along. What year did the income tax come along? Well, we had an income tax during the Civil War. I think it lasted from 1862 to 1872. But that was always said to be temporary and it turned out to be temporary. We then had another income tax come in in 1894, but that was ruled unconstitutional in 1895. And then we got the Income Tax Amendment, the 16th Amendment in 1913 on a terrible dark day. The income tax began, at least the modern version of the income tax began, with a top tax rate of 7%, one two-page tax form, 14 pages of instructions, and that has morphed into the monstrosity that we have today. Yeah, what is that? Let's get about the monstrosity today. What is the top tax rate? How many tax rates are there? How bad is it? Well, probably the simplest thing to look at is that 75,000 change pages long. If you go to the IRS website, last time I checked, you could download about 1,000 different forms. And the number of tax rates, which actually is almost a trivial issue in terms of the complexity of the tax code, the actual number of tax rates I think right now is 7%, but that's nothing compared to all the exclusions, deductions, credits, exemptions, preferences. Those are the things that make the tax code the nightmare that it is today. What's motivating all that nightmare? I mean, taxes could be very high, but they could be radically simpler than what we have now. I mean, if you want to collect a lot of money, you just write a one-page law that says we're going to take x% of whatever you earn. So all of those exemptions and loopholes, they're often called, are those there to raise more money or hide taxes or what's the motivation behind all of this? I think the simple way to think about it is in 1913 we had this relatively simple introductory income tax and it was like a ship going out to sea. Well, 102 years later, there are layers upon layers of barnacles on that ship. And in theory, episodes like the 1986 Tax Reform Act were designed to scrape the barnacles off the ship. Of course, they only scraped off about maybe one-fourth of the barnacles and in some cases they were the wrong barnacles because one thing to understand about all these different provisions of the tax code is sometimes the complicating provisions are designed to mitigate a penalty that shouldn't exist. For instance, you shouldn't be double-taxed on income that is saved and invested. Well, I don't know how many thousands of pages of the tax code are designed to things such as IRAs and 401ks, but I'm glad those pages are there. Now, what I would prefer to have is no pages because we wouldn't have any double taxation of income that's saved and invested, but some of these provisions are better than nothing, but of course many of the provisions are there to put in penalties, to put in loopholes that don't have any justification, and those exist because over decades the different lobbyists that go to the Ways and Means Committee in the House and the Finance Committee in the Senate, they've succeeded in having provisions that benefit their clients. And maybe these are provisions that lower taxes but only for one very narrow group of people. Well, as a libertarian, I like it when government gets less money, but I don't really like it if government gets less money just because someone hires a good lobbyist and gets the playing field tilted in their direction. Is there also an attempt to social engineer via the tax code? Well, there's certainly an attempt to social engineer in the sense of trying to control or steer behavior or bribe people into doing things that politicians like. So the charitable contributions deduction and the tax code, well, don't we all care about churches? Don't we care about symphonies and ballets and art museums and the Salvation Army? Well, yeah, okay, we all care about those things. Well, do we need something in the tax code to bribe us? Well, only one-third of people roughly itemize on their tax return. On their tax return, so obviously two-thirds of people who are giving to charity in this country are doing it even though they're not getting a charitable deduction. So I think that a lot of the mess that's there, people rationalize and decide after the fact, well, oh, if we didn't have this provision, nobody would buy a house or nobody would give to their local church. I think that's nonsensical, but it's in some sense been absorbed into the collective consciousness of tax people in Washington. Now, you mentioned the phrase double taxation, which can you clarify exactly what that means? Yeah, it's very important economically, but it's a term that requires some explanation. In theory, what we should have is a tax system that doesn't have any bias between income that you consume today and income you consume in the future. Now, what's income you consume in the future? It's just a tax geek way of saying saving and investing. But right now, in our tax code, if you consume your after-tax income today, because think about it this way. You earn income, you pay tax on your income, and you have some after-tax income. What are you going to do with it? Well, there's really only two things you can do with it. Consuming in the future, as I said, is saving and investing. If you consume now, the federal government by and large leaves you alone. I mean, if you fill up your tank with gas, there's a federal excise tax. But other than a few little penny-any things like that, the federal government doesn't tax you for consuming income right away. But if you consume your income in the future, we have all these examples of what are called double taxation between the corporate income tax, the capital gains tax, the double tax on dividends and the death tax. If you save and invest, you can be subject to as many as four different layers of tax that you don't get hit with if you consume your income right away. So obviously, there's a huge bias against savings and investment in the tax code, a huge bias in favor of consumption. Why does this matter? Because every single economic theory, even the Marxists and the Socialists would agree that you have to have capital formation for economic growth. You have to set aside some of today's income to finance tomorrow's prosperity. And yet our tax system treats people who do that almost like they were criminals. You mentioned earlier, though, that we often tax things that we want less of and we give tax breaks on things we want to encourage. But it seems like saving and investing are things that unquestionably we want to encourage. So why are we taxing them more? Ah, that's because who does the saving and investing, those evil, bad, awful, rich people. And when you have a tax system that is so driven politically at least by a lot of the class warfare discussions, well, we can't get rid of the death tax because only rich people pay that. We can't get rid of the capital gains tax because that's for the rich. And if you go through all the different debates and the discussions we've had about the various forms of double taxation in our country, it largely is driven by class warfare. The politicians want to collect a certain amount of money and who's the easiest target? Those evil, awful, bad, rich people. But that – I mean, one of the common things we hear especially from people on the left is that the rich, because they can get accountants who know all of the loopholes or because they're politically connected, are paying much less tax than they ought to and they're certainly not paying their fair share. So aren't all those things – I mean, we want the rich to pay their fair share, right? Well, from a libertarian perspective, the fair share is that the law should treat everyone equally. That's etched above the Supreme Court equal justice under law. To me, that's a just a flat tax. Now, of course, as a libertarian, ultimately, I'd like to shrink the federal government so we didn't need any broad-based tax whatsoever. We got along just fine before 1913 without an income tax. But if we're going to have an income tax, I do think it should treat everybody equally. When you look at the treatment of rich people, it's a bizarre combination. I mean, the rich, as defined by, you know, say, the top 20%, top 10%, however you want to classify it, they do pay a disproportionate share of the tax burden. Now, it depends. Are you measuring just the income tax? Are you measuring all taxes? But no matter how you slice it, the top 10% are paying way more than their share of income and they're certainly paying a disproportionate share of the overall tax take and a huge share of just the income tax take. Now, that being said, the definition of taxable income matters a lot because when you're measuring income, what happens is a lot of rich people, if they want to, they can just go into their financial accounts on a computer. Within nanoseconds, they can change their entire investment portfolio to tax-free municipal bonds. The federal government does not tax municipal bonds. So you could be a billionaire and your federal income tax can be zero because all your investments are in municipal bonds. So that's one of the costs of high tax rates. Go back to, say, to the 1950s. Is that why Warren Buffett played a less rate than his secretary? That was going around. Warren Buffett, I paid a lower tax rate than my secretary. Is it because she was paying income tax and he probably wasn't? No. In that case, it was because Warren Buffett was bad at math. It's a simpler answer. I don't actually think he was bad at math. I think he was just willing to make a political point and pervericate a little bit because what Warren Buffett wasn't counting, he was looking at back then we had the 15% double tax on dividends and capital gains. And Warren Buffett was saying, oh, look at this. I'm paying 15% and my secretary is paying whatever it was at the time 25% or 28% and saying, oh, my tax rate's lower. Well, what Warren Buffett wasn't including is the fact that capital gains and dividend, that was already taxed 35% of the federal level, not to mention there was a 40% death tax waiting at the back end. So he was just being political and not being terribly honest. But rich people, if they want to, I thought you were going to give the example of Ross Perot when he ran for president in 1992. He was saying, oh, my tax rate is very low. Well, the reason his tax rates were very low, almost all his portfolio was municipal bonds. The same thing with Theresa Hines-Carrie. That came up a little bit in the 2004 campaign. So rich people, if they want to, can choose to pay zero tax or they can put their entire portfolio in what are called growth stocks. Those are ones that don't pay dividends. Why would somebody buy a stock that doesn't pay a dividend? Because they expect that the stock's going to rise in value. So it's called the growth stock. Well, the one thing the federal government hasn't figured out how to do yet is to tax unrealized capital gains. So if you're a rich person and you're watching your fortune build up because you've bought stocks that are rising in value, until you sell those stocks, the government can't impose any double taxation. And so they're not getting any revenue. So rich people, if they want to, if you push tax rates up to the levels we had in the 50s and 60s and 70s, they're simply going to change their behavior in ways where the federal government doesn't get any money. Can you expand on that, on how the data that we have about how rich people change their behavior in response to the tax rate? I know that's happened a lot in history. Well, I think the most persuasive data is from the 1980s. The IRS every year puts out something called the statistics of income bulletin. And if you're a really wonky tax geek, it's very fascinating reading. You can see by income levels how much different people earn. Not individual people, but in terms of the aggregates. How much did people over a million dollars make? How much did people over 100,000 make? How much did people between 30 and 40 thousand dollars make? Not only that, you can see the sources of their income. Was it wage and salary income? Was it dividends, capital gains? You can see what deductions they took. How many people in different income classes took the home mortgage insurance deduction and so on and so forth. So it's a wealth of data. But the one thing I noticed is I went back and I looked at that data for 1980 because that's when we had a top income tax rate of 70%. And you can look at the rich and traditionally in Washington that gets defined as $200,000 or above. You look at the rich people in 1980 who were affected by the 70% top tax rate and you can see how much money they paid. The IRS collected about $19 billion from those people. By 1988, Reagan had lowered the top tax rate all the way down to 28%. And a lot of our left-wing friends said, oh, this is unfair, the rich won't pay anything, the Treasury is going to be starved of revenue. Well, what does the statistics of income bulletin from the IRS showed? Rich people, again, making more than $200,000 a year or above, in 1988 at a 28% tax rate paid five times as much money to the Treasury. Now, it's not all because of the lower tax rate. Some of it was because of inflation, population growth. You know, who knows how many different factors were involved. But there's no question we had a steroid version of the Laffer curve going on in the 1980s because rich people decided, hey, at a 28% tax rate, I'm going to earn more income. I'm going to, and this is critical, I'm going to report more income and the IRS wound up getting a lot more money. So if you want to soak the rich, keep tax rates reasonable so that they don't have incentives to pile their money into municipal bonds and just do tax-motivated types of investing. You mentioned the Laffer curve. Can you tell us what that is? The Laffer curve is simply the notion that if you have a 0% tax rate, the government's not going to collect anything. If you have a 100% tax rate, well, guess what? The government's probably not going to collect anything because outside of, unless you're maybe a genetic communist, if the government's going to steal every penny you make, you're not going to make any money. So the notion of the Laffer curve, and by the way, even Paul Krugman would agree that there's a Laffer curve, the whole debate on the Laffer curve is what's the shape of the curve. In other words, somewhere between 0% and 100% is a tax rate that will maximize revenue. Now, by the way, I should stress, I have zero interest in maximizing revenue for the government. I want the tax rate set at the growth maximizing point, which is going to be a very, very low rate, which is necessary to finance the few legitimate functions of the federal government. But the whole point is, is that the Laffer curve is simply an intuitive way of telling people that, hey, 100% tax rate is going to be too high, 90% too high, 80% too high. Maybe at 70% Paul Krugman raises his hand and says, oh, yeah, I think that's a good idea. But most sensible people, you're going to get down 40, 30, 25 before they say, okay, that's where you maximize revenue in the long run. And then people who actually care about freedom and liberty and economic growth are going to say, oh, but let's go down to a tax rate of 5% or 10% because that's what's going to maximize growth and freedom. Has that changed a lot in the sense that the kind of tax rates we have had in the past, 90% I think before Kennedy took office and 70% before Reagan took office? Are those really discussed anymore? Have we kind of won the battle for over 50% tax rates being a good idea? I would like to say yes, but at several times in my adult life, I thought we won the battle against Keynesian economics, but it's like a Freddy Krueger movie. It comes out from the grave whenever there's a downturn and politicians have an excuse to spend money. On the notion of very high tax rates, let me give you an example of why I'm worried. I told Thomas Piketty about where he is explicitly arguing that you should have tax rates of 70%, 80% and wealth taxes and death taxes and, of course, lots of double taxation on top of that. And the Paul Krugman types of the world seem to be for that. Obama has never been asked, what do you think is the highest tax rate anybody should ever pay? But I wouldn't be surprised if in his heart of hearts he thinks it should be way up at that level because for every question he's ever asked, what do you think of the sunny weather today, he says the rich should pay more. I'm exaggerating, but only slightly. So I do think that there are, on the left, we had made a lot of progress in the 1980s. We hadn't won them over on the issue of double taxation, but we had won them over on the issue of tax rates. So you had Bradley and Gepard and other sort of reasonable, centrist Democrats. I mean, even Bill Clinton sort of said, well, you don't want tax rates to get up too high. I'm not sure that Hillary Clinton or Barack Obama today would be able to pinpoint when tax rates get too high. It has to clarify something. We talked about we've graduated income taxes and so we're talking about these really high rates, the 90% or the 70%. Do we mean like if there was the 90% tax rate in the past that people making a lot of money paid a full 90% of everything that they earned? They paid 90% of their taxable income above wherever the income tax bracket kicked in, but they didn't earn and report nearly as much taxable income. One of the reasons that Reagan supposedly became a supply sider is that back when he was a movie star, he learned that if you made more than a certain number of movies a year, there was no benefit because, you know, there probably weren't that many effective tax shelters when you were a movie star and so you get up to that 90% tax bracket, what's the point? We see that when professional athletes, free agents, will sign for a lower amount in a low tax state because it comes out to more than a much bigger contract in a higher tax state. Is that something that people really do? I mean, some people would be thinking, okay, look, you say we're going to talk 70% of your income above $300,000 a year. Well, if you're a salaried employee, you don't have the ability to stop working on whatever, November, you know, and just be like, well, the rest of my year is going to the federal government so I'm going to go to Tahiti. That's not how salaried employees work. So does that kind of dissuading actually come in for people who aren't hourly employees or picking up work on it? Well, it's not just that you would stop working. It's that, I mean, even at 90%, you're still taking home 10% of that. So if your boss says, hey, I'd like to give you a raise, I mean, even 10% of that raise getting kept is better than not taking the raise, right? No, this is something when I first got involved in tax issues, I confess, I wondered about two because I was getting my salary and, okay, well, if my tax rate goes up, I'm not going to be happy. What am I going to do if my tax rate goes down? I'm going to be happy. But it's not like I'm going to type faster when I'm writing a paper about fiscal policy. But here's the thing I eventually learned. The rich are not the same as the rest of us, or at least they're not the same as me. Maybe you two are millionaires and you should be buying me dinner every night. But if you look at, again, those same IRS statistics of income bolts and that I talked about, you look at that data and what you find is that rich people don't rely on wage and salary income. For those making more than a million dollars a year, two-thirds of their income is from business and investments. And when you get business and investment income, guess what? You do have a lot of control over the timing, level, and composition of your income. So you can decide, okay, it's November. I'm going to go to Tahiti. Now, I can't decide that working for Cato, not to mention the fact that the people on the seventh floor might say, we're Stan Mitchell, but it doesn't save me anything on taxes because, okay, I got the salary and certain amounts being taken out by the IRS and I don't have any flexibility. But if you're one of these people making over a million or heck, over 10 million dollars, 81% of your income, the last time I checked anyhow and I can't imagine it would have changed, is from non-wage and salary sources. And so you're one of those people who can get onto your computer, to your financial accounts and invest in municipal bonds. If you have business income, you have tremendous ability to accelerate and defer and recharacterize and you can decide, okay, I'm going to take this pile of money and invest it rather than declare it as income, which by the way is a perfectly legitimate thing to do because if it's being invested, it's no longer income going to you. But the point is that you have all that flexibility so, yes, you can respond in a very significant way to changes in tax policy and it really has a big effect on savings and investment decisions for the economy. So far, most of what we've discussed has been stuff that's bad for rich people. But does the tax code, the high level of taxes, those 75,000 pages harm low-income Americans as well? Low-income Americans don't really pay federal income tax. Matter of fact, they get a wage subsidy called the earned income credit through the federal income tax so it's like a negative tax for them. For lower middle income and middle income people, they're by and large wage and salary people so a lot of them can file like a 1040 EZ. It's not overly complicated for them. It probably does cause them stress and anxiety because even if you have a simple tax return, people just tend to get very nervous, well, am I missing something? Is the IRS going to come after me? And so even people like that will go to H&R Block or buy TurboTax or something like that just because they're nervous about what the tax system holds for them. I would say the main reason that lower and middle income people are hurt by the tax code is not what's happening to them in terms of their direct tax liability. It's not what's happening to the economy in terms of long-run economic growth. It seems like the economy grows 3% next year instead of 2% or 2% instead of 3%. We don't think of that as being a big thing and actually if we're planning on dying next year, it's not a big thing. We probably wouldn't notice the change to our living standards if the economy grew 2 versus 3 or 3 versus 2. But when you go out a couple of decades with the power of compounding, it makes an enormous difference. If the economy grows, say 1% a year, let's say you're France or Italy, you're growing 1% a year, it takes you 70 years to double your GDP. On the other hand, if you have 3.5% growth, which is what America almost averaged for much of our nation's history, you double your GDP in 20 years. Now think about it from the perspective of a lower-income person. You're not comfortable. You have to work every day or at least five days a week. You can't really afford to take a lot of breaks. If your economy is growing 1% a year, 20 years down the road, that's an enormous difference versus an economy growing 3 or 4% a year. And so I think we don't appreciate how important economic growth is. I sometimes use examples of this. If you go back to 1964, and this staggers people, I didn't believe it when I first saw it, but I checked the numbers, you go back to 1964, Singapore and Jamaica had the same level of per capita GDP. Singapore and Jamaica. Singapore and Jamaica. And now Singapore is well above the United States, and their per capita GDP is something like 15 times as high as Jamaica. Why is simply the difference of compounding of 5% to 6% economic growth year after year versus 1% to 2% economic growth year after year? So when I think about lower and middle-income people and I think about the tax code, I think about the fact that we are shooting ourselves in the foot with high tax rates and double taxation and that's slowing down our rate of growth. And even though in an advanced, mature industrial economy like ours, it might only be the difference between 3.5% growth and 2.5% growth in the long run, it adds up to a lot for people's living standards. Is that data pretty clear in the sense that we look at a place like Scandinavia where there's lower growth rates but higher taxes? Is it a pretty open and shut case that higher taxes kill growth rates and higher government spending is not good for growing the economy? Is that a pretty open and shut case? Well, I think it's an open and shut case. But here's the reality of it. If you look at, say, the Economic Freedom of the World Index published by Fraser in conjunction with Cata and other think tanks around the world, you'll notice that they have five major categories for what determines a nation's prosperity. Physical policy is only one of them and it only counts 20% of your grade. You also have rule of law and property rights, you have trade policy, regulation policy, and monetary policy. So if you're Sweden or Denmark, you get a very bad score on fiscal policy but you get a very high score on the other categories. As a matter of fact, countries like Denmark usually score above America on these non-fiscal policy measures. So I think that Sweden and Denmark and some of these other Nordic nations, I think they're hurting themselves with high tax rates and a big welfare state, but they tend to be very free market in other areas. Now, it's still hurting them. If you go back to 1970, Sweden was one of the richest countries in the world in the top five, or maybe in some cases, top 10, depending on who's doing the measuring. Well, now Sweden's dropped about 15 places. Not because they're poorer today than they were in 1970, but because they've been growing 2% a year and other countries have like, well, Hong Kong and Singapore 5% to 6% a year, but other countries say 3% to 4% a year. So you'll slowly fall behind other countries once you adopt the big government, the high taxes, the welfare state. Now, I will say at least Sweden and Denmark did it right. They did the wrong thing in the right way. They got rich first when government was small and then they adopted the welfare state. Now, if you're already rich and you adopt a welfare state and you start growing only 1% to 2% a year compared to 3% to 4% a year, well, you're a rich country and it's still nice to live in Sweden and Denmark. They're very civilized places. They have actually better rule of law and property rights than we have in America. It might get a little bit cold in the winter, but no one's going to complain about living in Sweden and Denmark if your other choice is to live in Paraguay or Botswana. You mentioned previously and something I think is related to this or might be just an entirely different topic in terms of growth. You mentioned the corporate tax rate, which you call double taxation. Sometimes we hear about the corporate tax rate being either extremely high for America, which is bad for growth, one of the highest in the world if not the highest in the world. Other people have argued that the corporate tax rate maybe shouldn't even exist at all. What is your take on corporate taxation? Well, the bad news is that we do have the highest corporate tax rate in the world. And that's taxing the profits of corporations. Taxing the profits of corporations. Some people sometimes say, well, no, no, it's really the United Arab Emirates, but that's a tax only, it's only a severance tax on oil companies. If you have some regular company, there's 0% corporate income tax. So we have the highest corporate income tax in the world. We used to be second, but Japan lowered their rate. That's a bad thing, unquestionably, because corporations are mobile. Corporate investment, business investment, it can cross borders relatively simply. But then, of course, we compound the damage of the high corporate tax rate because we then double tax dividends and capital gains. And of course, I already mentioned we have the death tax on top of that. Now, having said that, assuming you have an income tax, I do think business income should be taxed, but I think it should be taxed only one time. So you can make a choice, well, do you tax that income one time at the level of the company? Or do you follow it to shareholders and tax it one time at the level of the shareholder? Administratively speaking, it's easier to tax the company rather than track down, in some cases, hundreds of thousands of shareholders. But you could do it either way. But don't do it both ways, and whatever way you choose to do it, have the rate be competitive and low. Well, we're on the topic of corporations who can move, can shift to countries that have lower taxes. One of the things you've written about in the past is tax competition. Tax competition is simply the notion that, especially in a globalized economy, labor and capital, jobs and investment can cross national borders. And I think this really kicked off in a big way back about 1980 when Reagan and Thatcher cut individual income tax rates. And you saw a change in global investment and migration patterns. But then it really began to also take effect on corporate taxes, where Ireland deserves a lot of credit. They used to have a corporate tax rate of type at 50%. Then they lowered it to this bifurcated 30 and 10 system. The European Union said, oh, that's unfair to have a bifurcated system. So Ireland sort of stuck a finger in their eye. It said, OK, we'll just have one low rate for everything of 12 and a half percent. And you saw big benefits for Ireland of that. And other countries were forced, not only to lower their individual income tax rates because of Reagan and Thatcher, but they were forced to lower their corporate income tax rates because of Ireland. And then, heck, it's even applied to things like dividend taxes and capital gains taxes because if you're a well-to-do investor in Europe and you're being taxed at very high rates and being double taxed, what are you going to do? You're going to move your investments to Switzerland or Luxembourg or Miami or Cayman or something like that. And so countries had to lower their double taxation. A lot of countries got rid of their wealth taxes and death taxes. Heck, the richest person in Sweden had moved to Switzerland, the head of IKEA, the founder of IKEA. And guess what? Sweden recently got rid of their death tax and wealth tax. He moved back. So that's just an example of one person where it makes a difference in terms of what your tax policy is. So I think tax competition is a very important liberalizing force in the global economy because it sort of handcuffs politicians and tells them, you may want to rape and pillage rich people, but guess what? The geese that laid the golden eggs can fly away if you're mistreating them too much. And I think what we saw from 1980 till about, you know, end of last decade was a very positive cycle of tax competition. What worries me now is operating through international bureaucracies like the OECD, high tax governments have gotten together to try to constrain tax competition. They want to create something akin to an OPEC for politicians. I've heard you often say that one of the most important characteristics of a tax code is that it's neutral. What do you mean by it being neutral? Well, I suppose I should first say there's no such thing as a neutral tax code because if you're going to tax people for earning income, you're obviously changing the trade-off between labor and leisure. That being said, you should minimize the distortions in the tax code so that you are as close to neutral as possible. Now, we already talked about double taxation. Well, what's that about? It's about creating neutrality between income that's consumed today and income that's consumed in the future. That's why you want to get rid of double taxation on saving and investing. But you also want neutrality in the sense that you don't want politicians saying, okay, if you earn money as a carpenter, you have zero tax. If you earn money as a plumber, you get taxed 50%. We're going to have way too many carpenters then. That's a hypothetical example of a distortion. But in that 75,000-page tax code, we have lots of real-world examples of distortions. And sometimes these distortions are very technical dealing with what's the so-called depreciation schedule of the business investment versus another type of business investment. Sometimes it's distortions, as I said, in the form of double taxation. Sometimes it's, well, actually, one of the worst and biggest distortions in the absence of neutrality in the tax code is the healthcare exclusion. If you had Michael Cannon or Mike Tanner here, they would wax poetic about how this causes a third-party payment or a payer problem because people have this artificial incentive to get as much of their compensation as possible in the form of tax-free fringe benefits. And that has messed up the healthcare system in addition, of course, to Medicare and Medicaid and other government interventions. But you want neutrality because you want... If you want growth and prosperity, you want people making decisions on the basis of what makes economic sense, not on the basis of what minimizes their tax bill. But if you have high tax rates in a complicated system, guess what? That's what people are going to focus on, at least to some degree. Would a flat tax be better than what we have now? It would be infinitely better than we have right now because everyone thinks the flat tax is about having a low rate. And yes, that's part of it. But really, the biggest part of the flat tax is neutrality because it gets rid of not only all the double taxation, but it also gets rid of all the loopholes, preferences, deductions, credits, exemptions, and so on and so forth. So obviously, if you have some type of income tax with a rate above zero, it's not going to be perfectly neutral. But for whatever amount of money the government's going to raise, the flat tax does it in the least damaging, least distortionary, most neutral way possible. Which, of course, is why politicians don't like it because they like having that power. I mean, the whole reason politicians spend their lives in Congress trying to get on the ways and means and finance committees because you don't even have to hold fundraisers, lobbyists come up and they throw checks at you, PACs seek you out to give you money. Whereas if you're on the post office and civil service committee, nobody cares about you. Well, the reason that those tax rating committees are so powerful is because we have this complicated but very important, very intrusive 75,000 page tax code. You get rid of that, replace it with a flat tax and guess what? Ways and means and finance turn into harmless oversight committees. I've heard too sometimes libertarians talk about economists in general, but a consumption tax would be better. What is a consumption tax and would that be better than an income tax? A consumption tax is simply any tax system that doesn't double tax saving and investing. Now, normally we think a consumption tax is something that you pay at the cash register like a national sales tax. Well, that is a consumption tax because there's no double taxation. A value-added tax. You don't pay it at the cash register. It's paid at each stage of the production process but it's a consumption tax. Why? Because there's no double taxation. The flat tax is a consumption tax. Why? Well, it has sort of a vaguely similar approach to our current tax system that you file an annual tax return. It'd be a postcard instead of a thousand different forms. But it's a consumption tax because there's no double taxation. So what a consumption tax really means because that's a public finance term, what it really means is simply a tax system where income is taxed only one time. Now, why is that consumption? Because over your life cycle the amount you earn tends to be the amount that you spend. Now, some people say, well, hold on a second. What if you leave some money to your kids? Well, your kids are going to consume that. So at some point, any income you earn is going to get consumed and if you tax that income only one time, you're taxing consumption one time. Among the kinds of consumption tasks, what do you think of a national sales tax or a value-added tax? If. And this is a giant if. If we could take the 16th amendment, repeal it, replace it with something so ironclad that even Ruth Bader Ginsburg and John Roberts couldn't decide an income tax was ever constitutional again, yes. A national sales tax or a value-added tax would be better than our current system just like a flat tax is better than our current system. They're all in theory low-rate, neutral, no double taxation tax systems. The reason I tend to be especially suspicious of a value-added tax is because most politicians who talk about the VAT, they're talking about adding it on top of the income tax. Well, what do you get there? You simply give the government more money to spend and I think that's one of the reasons why when Europe adopted the VATs in the late 60s, early 70s, I think it led to an expansion in the size of government. And I'm very glad we don't have a VAT because I suspect our politicians would do the same thing. Do you see it as a real possibility though? Does that come up in a serious way? I view that as the Armageddon battle of fiscal policy and I do think it will take place sometime soon. As a matter of fact, I'm actually afraid it's more likely to come about when Republicans are in office because if you're a Republican, especially if you sort of tend to be a big government Republican, you're looking at the corporate income tax and you're looking at our current income tax and you have some vague understanding boy, this system is kind of anti-growth but you're also thinking that small government person, well, we do need to raise more money because we have all this Medicaid and Medicare and Obamacare and Social Security spending and the Baby Boom Generation retiring. So boy, we want to raise more money but we don't want to do it with this tax system that we already have that's very bad for growth so let's put in this other tax system because somewhere I thought I heard somebody telling me that consumption taxes aren't as bad for growth. Okay, that's right. They're not as bad for growth but that doesn't mean that they're good for growth. They're just not as bad for growth and on top of a system that's already very anti-growth, well, then you become France. It seems like a national sales tax or value-added tax would be particularly harmful to lower income Americans though because right now they're not paying much of anything in federal income tax but they also spend a huge chunk of their income on retail goods, on food, on the various things that would suddenly cost a lot more whether they're paying a higher sales tax or the cost was baked into their retail price. That fortunately is why Democrats have been a little bit hesitant about pushing a VAT. I think most Democrats at the end of the day will want a VAT because they're not going to want to reform entitlements and something's going to have to give and so they'll decide, okay, let's get this new source of revenue but they're reluctant or at least they express reluctance because they say they don't want poor people and lower middle income people being subject to tax. Now the people who propose a national sales tax as a replacement for the income tax and those are people I actually view as allies they have something called a pre-bate. Now it's called a pre-bate because the government would send a check to households once a month based on projected sales tax revenue on spending up to the poverty line and that would in effect be sort of like the family-based allowance that we have in the current system a family-based allowance that's in the flat tax. So everyone gets to earn a certain amount of money to keep hearth and home together before taxes kick in and if you have a national sales tax you can only really do it through a pre-bate system. Under a value-added tax system in Europe they don't really have anything to protect low income people. So if you're one of these countries like Denmark or Sweden where the value-added tax is 25% it's hidden from you. You don't know you're paying that much because you never see it on a sales register or a receipt or anything like that but boy does that have a negative effect on living standards for everybody but of course it's especially hard-hitting for people with low incomes. So what does the ideal tax policy look like then? There's a lot of these that we've thrown out. It needs to be neutral and not double taxation and other than not wanting that much taxation in terms of policy what is the best way to run any size of government with taxation? Well as I said in my fantasy world we have the central government back where the founding fathers envisioned where you don't need any broad-based tax whatsoever but my fantasies usually don't come true I'm sad to say and so if we have anything even approaching the current government we have now or God forbid the Leviathan that's sort of baked into the cake because of poorly designed entitlements and demographic change some sort of lowest possible rate consumption-based tax is the least damaging way of raising any particular amount of money you're trying to raise now obviously if you have a government like France that's consuming 57% of GDP that's still going to be a very damaging tax system on the other hand if you're a Hong Kong and your government's consuming 18% of GDP well then you can probably raise money without having it have too much of a negative effect on growth. So you'd be looking to at one where you're balancing the budget on your revenues over time even if it's 57% of GDP but that's still going to hurt growth to balance those revenues would still hurt growth. Yes, well for several reasons first of all government spending in and of itself hurts growth because you're diverting resources from the productive sector of the economy and usually when governments are spending money they're doing things like subsidizing people for not working so a lot of government spending when capital spending the economic evidence on that tends to be more mixed but transfer and consumption spending as public finance economists categorize these things those types of outlays definitely have a negative effect on the economy even if tax revenues sort of float it down from heaven and you didn't have to have a tax code that type of government spending would still be bad for growth but then in the real world because money doesn't float down from heaven at least not that it's never coming to my pockets when you have a tax code well it's simply a question of how much damage you're doing on top of the damage caused by the government spending if you have a the lowest possible rate consumption based tax and of course in France it would still need to be a very high rate but if you try to raise revenue in the least damaging way well then the additional damage on top of the damage caused by the government spending is going to be X whereas if you raise your tax system with a class warfare tax code with lots of double taxation then the economic damage might be 3x or 4x. In 1986 we had this you know we've mentioned a couple times we had a very good reform that turned I think it was like 14 tax brackets into 2 basically right 28% and 14% as a top rate now it's been creeping up in different ways with George H. W. Bush and now we're sitting at about 39% or so and we have books like the Piketty book and we have national debt substantial size and we have this idea of becoming social security entitlements crisis and like a loss of the consensus possibly that low taxes are good and always more and more spending the possibility of a VAT so are you what are you going to see what are we going to see in the next 10-20 years are you expecting a real push for higher taxes because of where the left is moving a real push for more revenue with all these things is it going to get worse before it gets better or is it just going to keep getting worse yeah well if I had to bet money I think it will keep getting worse like a lot of libertarians I tend to sometimes be dour and pessimistic because you just look at the public choice incentives of politicians to make government bigger and bigger but on an operational day-to-day basis I try to be optimistic because I do think there is still a streak of independence and libertarian type thinking among the American people you look at these cross-country polls where they ask people is it government's responsibility to give you a job, a house and so on and so forth Americans do answer those questions in a much more favorable way to liberty than say Europeans will answer those questions so I do think that it's not hopeless and I come to work every day at Cato because I think the fight is very much worth having and I think it is possible to win but winning that battle means we have to at some point reform the entitlement programs we have to at some point figure out how to decentralize those entitlements back to the state and local governments because they don't belong in Washington and we are never going to achieve these spending reforms that politicians think there is new revenue coming to Washington and that's why fighting the value out attacks I referred to it earlier as an Armageddon battle I really think it's an Armageddon battle because if the other side gets a vat then not only will I sort of have the usual libertarian pessimism about corrupt politicians big spending politicians but then I think oh my god we have just given up the keys to the liquor store and at that point okay well let's see do I move to Australia, Estonia, Cayman Islands you know what could I do because I'll really really be pessimistic at that point and here's the dirty little secret about fiscal policy and taxes behind closed doors I think a lot of leftist politicians actually understand you can't raise that much money with class war for taxes they talk about it they demagogue about it but they understand to some degree that if you put in place these 1970s style tax rates of 70% or going back to the 1950s 90% they know people are going to change their behavior and so if they want to finance the giant welfare state that's sort of baked into the cake they better come up with a vat it doesn't mean they won't also try to increase other tax rates as well but they know on the other side that a vat is the only way we can have a European sized government in the US thank you for listening if you have any questions you can find us on twitter at Free Thoughts Pod that's Free Thoughts P-O-D Free Thoughts is produced by Evan Banks and Mark McDaniel to learn more find us on the web at www.libertarianism.org