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Lies, Damned Lies, and Revenue Enhancements

Apparently, the people in Washington didn’t get my memo about the difference between tax rates and tax cuts. And beyond that, the new euphemistic buzzphrase in the ongoing rhetorical class war over the deficit -- other than “balanced approach,” which as far as I can tell seems to mean that spending increases will be balanced with tax-rate increases on corporate jet owners (rhetoric that even the writers of The West Wing didn’t take seriously), hedge funds, and oil companies -- seems to be “revenue enhancements.”

Now, many have argued compellingly that the problem with the deficit is that spending has ballooned, not that we aren’t collecting enough money. Hence the Republicans’ reluctance to play Charlie Brown with the Democrats’ Lucy once more as she holds the football of spending cuts in exchange for tax-rate increases, and then pulls it away by taking the increase in rates but never cutting spending (Reagan’s mistake).

But let’s assume for the moment that revenue is at least part of the problem. Despite the demagoguery of many, including David Brooks (who has since recanted), that the Republicans were holding the nation hostage because they were unwilling to put any tax increases on the table, and thus not willing to sit on their end of the playground teeter totter, Speaker Boehner seemed to be willing to concede almost a trillion in new revenue as of Friday.

But there are multiple ways to increase federal revenue, some of them more predictable than others, and some of them more “fair” than others.

First, one can succumb to the traditional Democrat demand — that we increase tax rates on “the rich,” where that term seems to be quite elastic, and subject to inflation in the future if the rates aren’t indexed. But ignoring whether or not this is “fair,” the results are unpredictable. As I wrote two-and-a-half years ago:

When a politician says that he’s going to either cut or increase your taxes, he is engaging, wittingly or not, in a conceit and a deceit. He says it as though he has the power to do any such thing, when in fact he does not. He has no power except to reduce or increase the rate at which you pay taxes, whether on property, income, or whatever.

Think of it as the difference between a joystick and a mouse. With a computer mouse, you can point directly to the place that you want to be on a screen. With a joystick, you can only control the rate at which you move toward it, and in so doing, the target may move, and it may move faster or in a different direction than you can keep up with using your rate control. Politicians talk about tax cuts as though they have a computer mouse that allows them to pass a law and a specified amount of revenue will roll in, but the reality is that they have a slow joystick, with a nebulous relationship to the eventual goal.

They calculate the effects of this rate change using “static scoring,” that is, they assume that there will be no change in behavior among the taxed, which means that they are guaranteed to be wrong. Beyond that, as Richard Epstein points out, by putting more and more of the taxation burden on “the rich” (who tend to create most of the jobs in the country) and unloading it from “the poor,” we reach a tipping point (and we’re not far from it) in which most of those voting for and receiving federal largesse don’t have any skin in the game. As de Tocqueville noted, this is the inevitable end of democracies.

Another way that revenues can be “enhanced” is to reduce or eliminate “tax expenditures” (a euphemism for allowing people to keep more of their own money). Otherwise known as “tax breaks” or often simply deductions or credits, many of these could in fact be eliminated with not only no harm, but to the betterment of the republic (ethanol being a shining example). But many of them (including the dreaded “corporate jets” that the man with the biggest corporate jet in the world lectures us about tirelessly) are legitimate business expenses.

For instance, consider an example that many use to demonstrate the absurdity of deductions: a pole dancer who is allowed to deduct the cost of mammary enhancement before paying taxes on her tips. But in fact, it may very well be that absent such an inducement to revenue enhancement on her own part, she wouldn’t be able to make a living, given all of the unenhanced competition continually coming into the market. In general, if one redefines “profit” to the point that one is not allowed to deduct from it the things that allow one to generate the income, then a business will not survive for long, and raising “revenue” by taxing a company out of business is counterproductive.

The best way to enhance revenue is in two ways. First, grow the economy, and increase everyone’s income. This is done not be spending ourselves into oblivion (the failed and misshapen Keynesian theory to which Obama, Pelosi, and Reid cling), but by ending the war on the job creators, in terms of both tax rates and regulations. The second is to increase the number of taxpayers by both putting them to work, and including them in the system (see the comment above on de Tocqueville) by flattening the rates. This has another salutory benefit on the outlay side, as Epstein says:

Human nature what it is, most ordinary citizens will be tempted by government largesse, despite the potential losses from hamstringing the economy with higher taxes. It is for that reason that whenever there is a revenue shortfall, political forces now clamor to “tax the rich.” In the end, this is a plea for steeper progressivity, which in turn cuts deeper into long-term economic growth.

The willingness to call for tax increases is dulled, however, when rates are flat. Then, the proponents of tax increases know for certain that they will have to foot their part of the bill for each new program.

In short, the Democrats’ “progressive” class-warfare nostrums depress revenue as they increase government spending, while the solution is to actually increase revenue and reduce spending by moving to a flatter system in which everyone has a stake. This is the battle that the Republicans seem to be winning for the moment, but only because we are on the verge of fiscal catastrophe. If this really is their Gettysburg moment, they shouldn’t let up now.