The Magazine

Tax Americana

The latest reform plans fall short of the Reagan vision.

Nov 14, 2005, Vol. 11, No. 09 • By JOHN D. MUELLER
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There are two political obstacles. The first is general confusion, even among experts. On the day the Mack-Breaux panel's report was delivered, two of the panel's members, Edward P. Lazear and James M. Poterba, framed the basic choice this way in the Wall Street Journal: "Tax systems are income-based or consumption-based. Income taxes apply to labor earnings and capital income. Consumption taxes apply to spending, and they do not tax the return to saving or investment." Here is the confusion: The same analysis applies to people (so-called human capital) and to property (so-called nonhuman capital), yet the panelists would tax the investment spending or income of the first more heavily than the second, as if only property were capital and as if spending were synonymous with consumption. Even worse, because of a general failure to take seriously the issue of human capital formation, much spending on children that should properly be considered as an investment in human capital would be taxed as consumption.

The first obstacle, confusion, feeds and is fed by the second, factional ideology. As James Madison pointed out, faction is endemic to representative government, and faction depends on what we now call ideology. Ideologues are constantly vying to take over political parties, and their ideologies are fictions designed to serve the interest of a faction. Generally speaking, the Democratic party's constituents have depended disproportionately on labor income and the Republican party's disproportionately on property income. Democratic party ideology assumes that you can tax the bejeezus out of property income and yet somehow investment in property will take care of itself. The corresponding Republican ideology assumes that you can tax the bejeezus out of workers' income without reducing investment in people. I refer to this as the "Stork Theory," because it assumes that workers will just spring from out of the blue as if brought by a large stork. This theory is belied by plummeting birth rates in Europe and Japan, where labor income is heavily taxed.

The choice between taxing property and labor income equally or favoring one over the other cannot be finessed. As both Abraham Lincoln and Ronald Reagan knew in their bones, because both had switched parties themselves, the way to beat the other party is to attract, not destroy, its constituents. The recent GOP tax reform record is not inspiring, but despite the stumble on Social Security, President Bush still has three years to pick up Reagan's economic mantle. If not, it will remain on the ground waiting to be picked up by 2008 presidential candidates--from either party.

John D. Mueller is director of the economics and ethics program at the Ethics and Public Policy Center. He served as an adviser to the 1995 National Commission on Economic Growth and Tax Reform.