Obama to Meet with Senate Leaders on Deficit Plan

Obama to Meet with Senate Leaders on Deficit Plan
"One day ahead of a meeting with President Obama, the Senate's top Republican insisted again Sunday that tax increases would not be a part of any deal with Democrats and the White House to raise the nation's $14.3 trillion debt ceiling…. Mr. Obama is scheduled to meet separately at the White House with the Kentucky Republican and with Majority Leader Harry Reid, Nevada Democrat, to try to jump-start the debt talks that broke down on Capitol Hill last week." ( Washington Times)

No new (or higher) taxes!

The Progressive Income Tax
John Chamberlain
April 1981 • Volume: 31 • Issue: 4 •

This article, reprinted from the November 1961 Freeman, will help regular readers of "A Reviewer's Notebook" better appreciate John Chamberlain's firm grasp of the basic principles of freedom.

Expenditures, says Parkinson in his famous Law, always rise to meet income.

It is too bad that Parkinson, that canny man, wasn't around way back in 1913 when the progressive income tax was first adopted in America. If he had been on the scene, he might have shocked at least a few people into sobriety by observing that his Law, as it applies to government, must be phrased this way: "The expenditures of the State always rise to meet potential income." In other words, the politico, with the people's total earnings at his potential legal disposal, will inevitably move toward taking it all. In return for votes the politico will, of course, hand most of it back as welfare­or as legalized patronage. But even in handing it back there will be strings attached to it: following Galbraith, the politico will tell the people how the money is to be spent.

Looking back on 1913, one can only be amazed at the incredible innocence of that generation of Americans. When the Sixteenth (the progressive income tax) Amendment to the Constitution was formally ratified, the Congress responded by adding a seemingly quite inoffensive federal income tax rider to the Underwood Tariff Act. The rider called for rates running up to a maximum of 7 per cent on the last bracket of a $200,000-a-year income.

Although the principle of the income tax had been subject to a long controversy (it had been declared unconstitutional by the Supreme Court in 1894), the legislators took it lightly. When famed attorney Joseph Choate remarked ominously that, in time, the tax could go to 50 per cent or even higher, Senator William E. Borah arose and shook his massive head. The very idea that anyone could ever be taxed at a 50 per cent rate seemed silly to the Progressive Republican from Idaho. Hurling his rhetoric directly at Choate, Borah asked: "Whose equity, sense of fairness, of justice . . . does he question?"

As things have turned out, Joseph Choate was altogether too moderate a prophet: today [1961] the top income tax rate is 91 per cent, and the 50 per cent rate begins at the $16,000-a-year level. In 1913 dollars, $16,000 a year is worth a mere $5,350. During World War I the tax took its first swift leap upward, only to fall back after the Peace of Versailles. Ever since the revenue act of 1934 first turned the full fury of a depression-ridden generation on anyone and everyone with an income of $25,000 a year or more, the rates at the top have been deadly.


Just to Keep Pace

The change in the tax temperature over the span of the past thirty years can be most graphically perceived if we consider what a Babe Ruth would have to be paid today to give him a take-home purchasing power comparable to his 1931 earnings. Out of a salary of $80,000 in 1931, Babe Ruth had $68,535 after federal income taxes. If "The Babe" were alive in 1961, he would need a salary of about $960,000 to give him as much purchasing power, after inflation and other federal income taxes, as he had in 1931.

Long before Joseph Choate voiced his prophecy, English economists were taking a dim view of what might happen under progressive taxation. Said Ramsay McCulloch in 1845: "The moment you abandon . . . the cardinal principle of exacting from all individuals the same proportion of their income or their property, you are at sea without rudder or compass and there is no amount of injustice or folly you may not commit." And he continued: "The reasons that made the step be taken in the first instance, backed as they are sure to be by agitation and clamor, will impel you forwards . . . . Why not take 50 per cent from the man of two thousand pounds a year, and confiscate all the higher class of incomes before you tax the lower? . . . . Graduation is not an evil to be paltered with . . . . The savages described by Montesquieu, who to get at the fruit cut down the tree, are about as good financiers as the advocates of this sort of taxes."

It was only three years after McCulloch's warning that Karl Marx and Frederick Engels, in the Communist Manifesto, advocated a heavy progressive tax as a means of despoiling the "bourgeoisie" and softening middleclass society up for the dictatorshp of the proletariat. Walter Bagehot, editor of the London Economist, feared that the Marxians would prevail: he predicted that the progressive tax, in combination with the principle of universal suffrage, would result not only in the destruction of the rich but in the very dissipation of the productive capital which gives society (the poor included) its margins of comfort.

The predictions of McCulloch and Bagehot have not yet come to pass in their ultimate direness; maybe they failed to reckon with the adaptability of man. Psychologically speaking, there is obviously some point where the progressive tax must recoil upon itself, destroying the base from which it might hope to achieve a maximum of "take." Just where the point is we cannot tell: there is no way of measuring businesses that are unborn, or energies and creative enthusiasms that simply fail to well up. But when a progressive tax dampens the impulse to generate income, then the tax base itself must narrow and diminishing returns set in.


A Theory of Justice

To make a tax acceptable, it must be levied in accordance with a theory of justice that is an article of faith with the majority. When justice, or the appearance of justice, fails, revolt is inevitable: the Puritan Revolution in England, the American Revolution of 1776, and the French Revolution of 1789 are all cases in point. The theory of justice behind the progressive income tax is that it imposes "equality of sacrifice"­and as long as this is believed, the tax will be palatable to a majority. "Equality of sacrifice" is the democratic way.

Time was when the progressive tax would not have been accepted as equitable even by a majority of the poor. Traditional equity required that taxes should be levied proportionately, not progressively. This was in accordance with the belief that' a man's property, or his income, was an index of deserving achievement, or of value contributed in the market place to society. True, some men inherited their property or incomes -- but that was something to be handled or regulated under laws of inheritance. In any case the erosion of time could be counted on to take care of the inefficient use of inherited fortune­"shirtsleeves to shirt-sleeves in three generations" expressed the common wisdom in this matter of luck in the choice of one's parents.

Under the proportional theory of tax equity, a rich man would pay more taxes than a poor man, naturally. But every dollar of assessed property value, or of income, or of spending, would be taxed in equal amount, at flat 'percentage rates. Dollars would be treated equally, no matter who owned them, or spent them. Thus the citizens would be accorded the "equal protection of the laws" -- and their "privileges and immunities" would be equal, as provided for in the United States Constitution. Any other way of treating taxation was regarded as discriminatory, or as putting penalties on ability, ambition, and success.

It was Marxian socialism -- "From each according to his abilities, to each according to his needs" -- which fathered the great attack on proportional tax equity: a "heavy graduated income tax" is a salient feature of the Communist Manifesto of 1848. But the Marxians would have made little headway if non-Marxian economists had not come unwittingly to their support with the theory that "it is not equal to treat unequals equally." In cases of charity, this is undoubtedly true, but no comprehensive legal system can be reared on a rule which begins by regarding everybody as an exception.


The Value of the Last Dollar

To rationalize their inapposite view, these economists sought the support of "marginal utility" analysis; they argued that the "utility" of the rich man's "last dollar of income" must be considerably less to him than the utility of the poor man's last dollar to the poor man. To take more of what the rich man valued less was, to these economists, a way of achieving tax justice. They based their theory of tax gradation from bracket to bracket on the old pleasure-pain calculus of the English utilitarian philosophers: obviously, so they said, there must be more pleasure and pain involved in satisfying (or in failing to satisfy) basic hungers than in buying a Rolls-Royce or subscribing for a seasonal box at the opera. By taking more of the supposedly less-valued "Rolls-Royce dollar" than of the highly-valued bread-and-beer dollar, "equality of sacrifice" could theoretically be translated into a law which would satisfy the ethical sense of the majority.

Superficially considered, there is a certain amount of rough practical justice in this way of regarding the "last dollars" -- or the upper brackets -- of a man's income. If it is merely a question of satisfying the basic hungers for food, shelter, clothing, and the minimal cultural decencies, "last dollars" undoubtedly mean much; they may even mean life and death. But this is an argument for a basic exemption from taxation, not for levying progressively steeper surtaxes in the middle and upper brackets.

Beyond a certain subsistence and cultural minimum, the idea that "last dollars" can be rated in accordance with a scale of "marginal utility" to the individual becomes a fiction. Since men differ by inherited temperament, by circumstance, by ambition, and by training, every living human being values his "last dollars" differently. If intensity of avarice could be measured, the French peasant clutching his franc of profit and Hetty Green clutching her millions might come out at the same place. A Huckleberry Finn­or an ascetic St. Simeon Stylites seated on his column­will care little enough even for a "first dollar," whereas a Major Armstrong, intent on raising the money needed to protect his patent rights to a radio amplifier, may desperately value­and need­his "last million."

Who is to say whether the "last dollar" of a poor man taking a flyer on the "daily double" at the race track is worth more to the individual than the "last dollar" of a biochemist who wishes to buy a year's leisure to experiment with rare bacterial cultures? Who is to say whether the last dollar spent by a housewife on a new Easter hat is worth more to its owner than the last dollar thrown into the kitty by a Rockefeller to plant Easter lilies or tulips at Rockefeller Center?


"Equality of Sacrifice"

Money has such protean uses that its personal valuation can take a thousand-and-one turns. It can command leisure, freedom, security, adventure, education, veneration, esthetic gratification, and appendicitis operations­plus the whole economic gamut of ordinary goods and services. It can command both power and the protection of the individual against power. As a cynical wit has put it, though you may be able in some instances to buy happiness with money, you can't buy money, with happiness­which could conceivably give the "last dollar" of income a "one-up" position even to a man in love.

To make the attempt to force "equality of sacrifice" by taking more of what the well-to-do man presumptively values less is, then, to pursue a chimera into a quagmire. The utility of a dollar­any dollar­to an individual is a purely subjective phenomenon, and cannot be measured in any known unit. One cannot multiply quantities by qualities and get a mathematically respectable answer, as Sir Isaac Newton observed long ago. To suppose that anybody values his "last dollars" less than anybody else is to substitute mind reading (and emotion reading) for objective measurement. It puts a self-righteous and wholly tyrannical power into the hands of a majority, or into the hands of the politicians who represent what they think is the majority.

As for the value of an individual's last dollar to society, this depends wholly on the uses to which it is put. It is the responsibility, the ingenuity, and the creativity of the individual which establishes the social "marginal utility" of the last dollar of income. But here, also, utility cannot be expressed in a priori terms, by taxing a man because he might waste his tax dollars.

The pleasure-pain calculus is wholly impotent when it comes to comparing a poor man's ticket to the dog races (theoretically of little use to society) and a rich man's investment in a job-creating business. Or, for that matter, the poor man's contribution to the Red Cross and the rich man's evening dissipation at the Copacabana. Even where the comparisons are freighted with seemingly unarguable moral distinctions, there are quicksands within quicksands. A night club might support a struggling musician while he is composing a great rhapsody, and a dog track could conceivably lead to far-reaching discoveries in canine genetics. On the other hand, charity -- or a newly-created industry -- may result in prodigious waste.

Used in price analysis, marginal utility has something objective to work on: the amount of goods which clear the market when the price is either raised or lowered. By utilizing theoretical supply-and-demand curves, one can even make reasonable guesses about the future. But marginal utility, which is of no use whatsoever in judging the intensity of personal feelings, cannot legiti mately be used to give society a right to political dictation of the social uses of "last dollars." To tax possible investment capital on the theory that "society," as represented by government, might invest it better is to indulge in a wild guess. Measurement (via a tax) cannot be undertaken before the dollars are spent. This is why men have traditionally been left the use of their dollars to spend them or to invest them as they please. When the market decides, there is no uncertainty about the comparative rating of men's desires.


An Equality of Misery

Equality is an idea that leads inevitably to contradictions, depending on the values of the individual who advocates it. One can begin with the theory that everyone should start with the same advantages in life: such advantages as equality before God and the law, equal opportunity for education, and a basic subsistence that will keep one from being warped or stunted during the growing period. This is an idea of equality that is firmly imbedded in the American dream; it has also been roughly attainable in American practice. Granted this equality, however, people who are clever, able, persistent, or merely persuasive must soon outdistance the rest. As a people we have accepted this, traditionally, as being eminently fair.

It does not, however, result in an equalitarian society. Does true equality consist, then, of pulling everyone who has exceptional abilities back into the pack at stated intervals? Does it entail the consistent discouragement of excellence by means of periodic cancellation or retraction of rewards? If it does, then mankind must automatically be deprived of the benefits normally ac cruing to it from the natural variation of human beings. With the fostering of a widespread "what's the use" attitude, new inventions, new qualitative changes, new theories, ideas, and fashions, must falter; the standard of living must recede; the birth rate must drop; and the equality thus achieved will be an equality of misery.


Periodic Redistribution, Motivated by Envy

Insofar as it results in "equality," the progressive income tax is a spawn of the second idea. It attempts to pull the exceptional at least part way back into the pack by canceling a good part of the previous year's gain every April 15. Since it is not a tax on capital, the progressive income tax cannot do the whole job of diffusing a more or less complete equalitarianism throughout society. But it keeps newcomers from amassing capital on their own out of savings -- and, taken in conjunction with stiff inheritance taxes, it could carry out a revolutionary job of leveling within the space of a few generations.

How "moral" is this approach to equality via the tax collector? If the end to be achieved were a benevolent brotherhood, then there might be something to be said for it. But the means are neither relevant to nor consistent with such an end. Equality via the tax collector operates through the social motive of envy, not love or charity. It begins with the politics of "soak the rich." Soon the definition of "rich" is expanded to include the middle classes. And it all ends with the exaltation of the bureaucrat, who is in charge of spending the spoils. Minorities are inevitably put at the mercy of majorities­and everybody is at the mercy of the politicos, who get first whack at the resources of the state.


A Psychology of Depredation

Instead of fostering brotherhood, then, the progressive income tax introduces a psychology of depredation into society. Pressure groups everywhere go for their share of the spoils. The arid states want big dams-at the expense, not of willing investors, but of the common people who have chosen to stay in greener, though more densely populated, New Jersey and Connecticut. Everyone has his pet scheme for spending other people's money, and empires grow in Washington as the politicos cater to the schemers. As money income is taxed away, there is a tremendous competition to get income in terms of social services (untaxed). The state is called upon to provide more money for schools, medical services, pensions, what-not. Producers, who have their own corporate income taxes to worry about, struggle for special tax write-offs; every different productive group, from agriculture to labor, wants exemptions. The result is an intense materialism which is rendered all the more ugly because it puts guns into the hands of any group which thinks it has a chance of transforming a minority into a majority by the mere offer of a trade in votes.

The depredation psychology has its reflex within voluntary associations which are compelled to sly expedients in order to retain assets, earning capacity, or mere utility. Businesses are diverted from thinking about productivity; decisions are often made with a primary eye to "tax advantage."


Capital Gains as a Way Out

Take the case of a small sponge rubber company in Connecticut's Naugatuck Valley, for example. It has been built up by hard-working partners. But the partners find their only way of cashing in on their creation in their old age is via capital gains. So they sell their business to a big Akron, Ohio, rubber company, with their sons receiving stock as their inheritance instead of a going share in a family business. A somewhat similar instance of a small business firm disappearing into the maw of a larger, forms the substance of Cameron Hawley's novel, Cash McCall.

Many a small businessman is tempted to sell out for capital gains rather then continue to work for an annual income. The result is that big companies grow as small family businesses disappear. In the big companies salaries are paid partly in cash, partly in "future income" via such things as pension rights, commitments to retainers for "advisory aid" in the years after retirement, and stock options leading to capital gains. Expense allowances go up as entertainment, housing, car use, medical examinations, and va-cations-cure-business trips are all allocated to "business costs." For its own part, labor devotes a great deal of its organizational energy into fighting for "fringe benefits" that will not appear on the ordinary tax forms as income. "Fringe benefits" result in an uneven diffusion of gains among the workers, for, while everybody foregoes a possible raise in order that the company may finance a fringe benefit, not everybody collects on the benefit to the extent of his due.


Undistributed Profits

As a defensive reflex against the depredation psychology, high individual tax rates result in the retention of earnings by corporations. The proof of this is objective: undistributed profits made up some 30 per cent of corporate profits after tax in 1929 and some 50 per cent in 1959. By leaving potential dividend money in a business, the investor gets a capital appreciation that is taxed at 25 per cent of income limit if he chooses to sell his stock. In addition to helping the shareholder stay out of a higher tax bracket, this also provides a method whereby ownership can duck the effects of double taxation of dividend money. While it may be immaterial to a given company that it chooses to finance its future growth out of retained earnings (or undistributed profits) instead of going into the market for share capital, this method of financing robs the investor of his flexibility of decision. The investor sticks, perforce, to his "old company" instead of surveying the field for new options. And the "old company" may do the diversifying which the investor used to do for himself; it may branch out into unrelated lines, which can have good or bad effects depending on the ability of management to handle diversification within a single corporate set-up. In any event, business must pay some cost for being tax-oriented, not production-oriented. Some efficiency is lost if only because tax lawyers come high.


Tax Avoidance

If the need to defend against a depredation psychology has its subtle effects on voluntary associations, it also puts a premium on slyness as practiced by the individual taxpayer. A well- known book company advertises a "Federal Tax Course" and offers a special report guaranteed to show what deductions can legally be claimed for business expenses such as transportation, entertainment, lodging, gifts, theatre tickets, club dues, and bills, and "your wife's expenses if she travels with you." Another special report is advertised as showing how "men in the $20,000 to $100,000 class can virtually cut their tax in two" by dividing income among the family. In come can be transferred to minor children; property used in a business can be turned over to a member of the family and leased back (at a rent deduction); income-producing property can be sold from one member of a family to another to gain a depreciation advantage; and so on. All of this comes under the heading of "tax avoidance," which is perfectly legal. Nevertheless, a great deal of energy is necessarily diverted into the business of defending oneself against the government­a loss of energy which might be put to far more productive purposes, with society the richer for it all around.


Tax-Exempt Securities

Finally, to protect against depredation psychology, the rich seek refuge in tax-exempt bonds. Thus potential risk capital disappears into the sink of dead-horse debt. This is the ultimate commentary on progressively taxing "last dollars." Ironically, it would take a "degressive tax," i.e., one that taxed "last dollars" least, in order to bring money from tax exempts back into the pool of risk money that should be available to the man with a new idea.

The late Professor Henry Simons of the University of Chicago economics faculty argued that the case for drastic progressions in income taxation "must be rested on the case against inequality." If the human race has a natural interest in human variation, then the case for progressive taxation is indeed "uneasy" (to use the phrase of Walter Blum and Harry Kalven, Jr.). But if equality (in the leveling sense) can by any stretch of the imagination be considered the touchstone of the good society, then the progressive tax falls into place as a relevant means to the achievement of social justice. But it is only one relevant means, and if it is left to operate alone it will not achieve its leveling end.

For better or worse, the progressive income tax in America has obviously not achieved an equalitarian result. This does not mean, however, that it should be written off as socially innocuous. Instead of introducing a leveling principle into society, it has resulted in some strange distortions of the social pyramid. While it has not produced equality, it has resulted in a very practical denial of the old American ideal of "equality of opportunity."

The reason for this is that it tends to stratify classes as they are. Since it is a tax on income, not a capital levy, it leaves old ownership intact without encouraging new -- or additional ownership. The rich (within inheritance tax limits) tend to keep their fortunes. But Joe Doakes can hardly aspire to amassing a fortune -- or even a sizable nest egg -- on his own if he attempts to do it out of saving for investment purposes. (The fact that millions have risen into "middle income status" since the time of the income tax amendment has been due to the fecundity of American production, with its fantastically efficient machine development, not to any "redistribution" effected by the tax.)


The System Favors Present Owners of Large Fortunes

What the progressive income tax cannot do is to cut down the money-mobility of the rich. A man with a fortune can protect his equity by moving money about on the board of opportunity. He can invest his money in supermarkets in Venezuela, or buy oil rights in Western Canada, or become a partner in swiftly growing industries such as plastics, electronics, or aviation. Thus he can circumvent the ravages of inflation and expand his fortune via capital gains.

But while the well-to-do have a continuing access to opportunity (which they can also open to their sons by making them partners in expansive situations), the middle classes are denied the chance of building fortunes in the first instance to protect. Under progressive taxation an Averell Harriman, a Joseph P. Kennedy, a John Hay Whitney can keep their financial status (and even become ambassadors to the Court of St. James). But the deck is stacked against the emergence in our times of new ambassadorial material. During the past generation the "middle condition of man" has been ground between the upper and nether millstones of inflation and steeply rising progressive tax rates. Reckoned in terms of "disposable income" in "1939 dollars," the purchasing power of the $18,000-a-year man in 1961 is no more than that of the $6,000-a-year-man of 1935. If the middle income man has been committed to insurance payments, his equity in saving has been cut in half. But the rich, who have invested in the insurance companies, have preserved their equities intact.


Soak the Middle Class, Penalize the Erratic Earner

The fairness of the tax even within its own "ability to pay" rationalization is entirely questionable. The tax exempts the poorer taxes them at such a low rate of progression that it is negligible. And, as we have seen, it tends to exempt the rich, who have ways of compensating for loss of dividends by the capital appreciation route. It is the people in the middle income brackets who do most of the paying. Thus what started as "soak the rich" has become "soak the middle class."

Moreover, the tax bears down with peculiar cruelty on the erratic earner, who may be compensated in a single high-tax spurt for years of patient effort. An author or a playwright may struggle for a decade to master a technique (or a subject) and then produce a single best-seller. But the gains for which the years have been preparing will not be commensurate with the effort and dedication involved. A doctor spends his young manhood in medical school, internship, and building a practice: then, relatively late in life, his income may hit the stratosphere without leaving him much after taxes for his old age. To gain crude equity for himself, the doctor will, in turn, grade his fees on an "ability to pay" basis, taking more from the rich and less from the poor.

Then there is the case of the public performer whose income is clearly related to the state of his muscular reflexes, or the youthfulness of his (or her) face and figure. Ballplayers are lucky to last in the big leagues (and the big money) after the age of 33 or 34. A Joe Louis may earn millions in a brief heyday as heavyweight champion­and then spend his middle age in .irretrievable hock to the government for back taxes for the mere sin of having depended on altogether-too- sanguine income tax accountants. A Sugar Ray Robinson may be forced back into the prize ring after retirement to recoup a fortune which will prove to be just another mirage when the tax collector is satisfied. In the case of the professional tennis player, a single year in the big money is the most to which the average-good-amateur-turned-pro can aspire. Once the crowds have seen him on one round of the circuit, he is through.

As for movie stars and Broadway performers, they may be able to make the jump from ingenue charm or youthful agility to middle-age character parts. But not every starlet becomes a continuing star­and in such an event the high earnings of youth will never afford the basis for a middle-age income.

Since the onerousness of the present progressive tax rates are becoming obvious to too many voters, a trade has been proposed: let the many present legal "loopholes" (big expense accounts, the oil depletion allowance, and so on) be closed in return for an across-the-board cut in the progressive rates. Vain delusion! The closing of the "loopholes" will mean more income for government. But (to invoke Parkinson once more), expenditures rise to meet income. So why should the state give any of that "loophole" money back in the form of a tax cut? The "loophole" money will support lots of bureaucratic job holders­and as Parkinson's Other Law says, work expands to fill up the time of those available to do it.

No, we as a people are on the rack for having accepted an unjust Constitutional Amendment in the first place. We will remain right where we are until a limitation is placed on the principle of the progressive income tax itself.


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