The Fiscal Commission And Conservative Tax Policy

When asked about the Bush tax cuts, Milton Friedman, in characteristic piercing style, remarked, “I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it’s possible. … [T]he big problem is not taxes, the big problem is spending. … The only effective way I think to hold it down, is to hold down the amount of income the government has. The way to do that is to cut taxes.”

While many have preemptively dismissed the Fiscal Commission draft report, the influence of conservative members on the commission—Sen. Tom Coburn, Sen. Judd Gregg, and Rep. Paul Ryan—is evident on taxes, where, as Friedman suggested, things should begin.

Friedman is perhaps best known on fiscal policy for proposing that a single flat-rate tax on personal income replace all taxes, deductions, and loopholes. Disarming the government of tax manipulation as a tool to guide economic behavior would unleash the creative spirit that drives capitalism.

Coming tantalizingly close to Friedman, the Commission’s report recommends abolishing the alternative minimum tax (AMT), eliminating most exemptions and deductions, and consolidating personal tax rates into three lower brackets.

The report offers some useful purposes. First, it ventilates all that is wrong with our current tax system: a complexity that breeds uncertainty and that discourages entrepreneurship and investment. Details about exemptions and deductions should not obscure the fundamental principle that what is to one man a deduction is to another man a subsidy.

Second, it avoids, for the most part, the economic fallacy of tax progressivity—the liberal fantasy that to have graduated rates results in contributive fairness. Friedman demonstrated that graduated tax rates “… are much less a tax on being wealthy than on becoming wealthy … [because] they impede … the accumulation of wealth.”  [Capitalism & Freedom, 1962]

Third, the fiscal commission’s report launches a conversation about the disadvantageous misalignment of our corporate tax with those of the world’s advanced economies.  Their recommended reduction, while lacking boldness and clarity, is a tepid step in the right direction.

What they miss, what most politicians miss, is that corporate taxes derive from the illusion that a corporation is a person, rather than what it truly is: a collection of people.  That the law treats it as a “juristic person” provides no economic justification for taxing its profits first at the corporate level and second at the stockholder level in the form of capital gains and dividends taxes. 

“Few measures,” Friedman said about abolishing double taxation of business, “would do more to invigorate capital markets, to stimulate enterprise, and to promote effective competition.”

After ending the corporate tax and attributing all business profits to the stockholder, Friedman calculated that the flat rate of 23½ % levied equally on all personal income, less standard exemptions and allowable deductions, would produce the same tax revenue as that resulting from the unintelligible labyrinth in the then extant tax code.

Present numbers yield the equivalent result.  In 2009, IRS collected $1.9 trillion net from all tax sources (IRS Data Book).  Applying 23½ % to the previous year’s aggregate adjusted gross income (AGI), $8.2 trillion, produces precisely $1.9 trillion. The flat tax raises the same amount as all individual, corporate, estate, AMT, and excise taxes combined.

And because AGI includes deductions for health-savings accounts, IRAs, Keoghs and 401(k) accounts, we could preserve such savings vehicles.

The closest we have come to the flat tax was during the second phase of President Reagan’s cuts in 1986, when only two brackets, 15% and 28%, remained.   This system followed the 1981 Kemp-Roth bill that lowered all marginal rates. 

The two cuts, or combined flattening, worked so well that the economy grew 30% in the eight years of Reagan’s presidency, unemployment fell from a peak of 10% to 5%, government revenue doubled, and—what will be difficult for liberals to swallow—the burden of taxation shifted more to the wealthy, according to a 1996 study by The Joint Economic Committee of Congress.   

Friedman observed the graduated tax is but “a clear case of coercion to take from some in order to give to others and thus to conflict head-on with individual freedom.” 

His genius was always to see matters of freedom first in problems of economics: a principle that should guide consideration of any tax or fiscal proposal.