The Roots of the Tax Debate: Why Tax At All?

This post was written by Edward Mahee. Writing under a pen name, Mr. Mahee is a legal analyst and political commentator. This is his 13th posting for the site.

On November 30, President Obama invited leaders of both houses of Congress, including the leadership of the incoming Republican majority, to discuss whether and to what extent current tax rates should be extended beyond December 31, 2010.  Leaving aside the last minute timing of such an important issue, it is surprising that with anemic economic growth, persistently high unemployment, and general malaise, that some would even consider raising taxes. But, when viewed through the prism of a fundamental philosophical divide, the issue becomes clear.

Andrew W. Mellon, Treasury Secretary from 1921-1932, stated unambiguous principles he felt ought to guide tax policy: “The problem of the Government is to fix rates [of taxation] which will bring in a maximum amount of revenue to the Treasury and at the same time bear not too heavily on the taxpayer or on business enterprises. A sound tax policy must take into account three factors.  It must produce sufficient revenue for the Government; it must lessen, so far as possible, the burden of taxation on those least able to bear it; and it must also remove those influences which might retard the continued steady development of business and industry on which, in the last analysis, so much of our prosperity depends.”  The underlying principle, then, is very simple—the purpose of taxation is to raise revenue for the maintenance and operation of the government, but in a manner that does not inhibit personal liberty or private enterprise. 

Mellon’s principle is sound, given that the role of taxation is only to raise essential and necessary revenue for the government.  There are many, however, including the current Administration, that fundamentally disagree with that premise.  Rather than raise revenue for the government, taxation provides a vehicle by which the government can control behavior, payoff special interests, and punish or reward certain constituencies as the political class sees fit.  For proof, look no further than the debate of candidates for the Democratic presidential nomination in 2008, featuring then-Senator Barack Obama: When informed that his policy of raising the capital gains tax rate may actually reduce revenue to the federal government, Senator Obama retorted that raising the rate of taxation on capital gains was a question of fairness, not just revenue.

With the United States running more and more into the red, and consequently closer and closer to bankruptcy, the primacy of revenue among the purposes of taxation has reemerged as a lodestar concerning tax policy.  Economist W. Kurt Hauser, a leading thinker on the subject, recently observed that since the end of the Second World War, tax revenues as a percentage of gross domestic product (“GDP”) have averaged fewer than 19% regardless of the top marginal income tax rate.  This is an astonishing observation, since during the period in question the top marginal tax rate on personal income was anywhere between 28% and 92% (currently the top marginal rate is 35%).  How can this be?  According to Mr. Hauser’s November 26 article in the Wall Street Journal:

“Higher taxes discourage the ‘animal spirits’ of entrepreneurship.  When tax rates are raised, taxpayers are encouraged to shift, hide and underreport income.  Taxpayers divert their effort from pro-growth productive investments to seeking tax shelters, tax havens and tax exempt investments.  This behavior tends to dampen economic growth and job creation.  Lower taxes increase the incentives to work, produce, save and invest, thereby encouraging capital formation and jobs.”

Which brings us back to Mr. Mellon’s principle of taxation.  Given that the federal government’s intake of funds from personal taxation is roughly 19% of GDP, shouldn’t its tax policy be aimed at maximizing GDP?  That is, its policy should be able to raise revenue for the government while at the same time not “retard[ing] the continued steady development of business and industry.”  If the government is going to take in 19% of the GDP pie regardless of the top rate, its focus should be on growing the pie, not trying to take a larger slice of a shrinking pie.  Meaning, the government’s tax policies should encourage investment, enterprise and profit. 

Of course, this all hinges on the belief that the goal of the federal government’s tax policy is revenue for the maintenance and operation of itself. Unfortunately, for many on the progressive left, the goal of tax policy is not revenue, but societal control and redistribution.  Which is why, even as it becomes more and more clear that the government is sinking into bankruptcy and the country into malaise, the progressive left will continue to argue that some people “deserve” to have their taxes raised.  If progressives succeed in raising taxes on the “rich”, they can be satisfied that they were able to use the weapon of class warfare successfully.  As more people lose their jobs and capital dwindles, the progressives will look over the decaying world they helped create and console themselves by saying that at least they stuck it to the “rich” man.

-Edward Mahee for TruPolitics.net