Why Taxing the Rich makes no Sense

...For the record, this guy wrote a book titled "Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy"... this goes beyond simple "conservative vs. liberal" rhetoric.

A Surtax On The Top 1%

Bruce Bartlett, 07.31.09, 12:00 AM EDT

This is a very bad way to pay for health care reform.

It seems almost certain at this point that whatever health reform legislation is ultimately enacted by Congress, its principal funding will come from a surtax on the top 1% or so of taxpayers. This is a very bad idea for reasons that have little to do with the economic effects of taxation.

It's wrong in principle to enact a government program with broad benefits that is so narrowly funded. It ensures that the financing of health reform will be precarious and its political support will rest on a weak foundation. This will make it easier for a future conservative government to gut the program or abolish it altogether as was done with welfare in 1996.

For more than 200 years, economists have generally accepted Adam Smith's basic principles of taxation. The first and most important is this: "The subjects of every state ought to contribute towards the support of the government ... in proportion to the revenue which they respectively enjoy under the protection of the state."

This has come to be called "the benefit principle"--that there should be a linkage between the taxes one pays and the benefits one receives from government. Of course, some taxes will necessarily fund programs for which no direct benefit exists--national defense being the classic example--and some spending will aid those who lack the ability to pay. But that still leaves a lot of government programs that can be financed largely by their beneficiaries.

The best examples of the benefit principle in action are Social Security and Medicare, which are financed by payroll taxes dedicated solely to financing those programs. This linkage has enormous virtues, both political and economic. Economically, the burden of the payroll tax is significantly reduced because the vast majority of workers know they will get back every penny they pay plus a significant return. Thus they tend to view the payroll tax less as a tax and more like the deductions from their pay for a 401(k) or health insurance. Rather than discourage work effort, the payroll tax actually reinforces it.

Politically, the payroll tax has made Social Security virtually invulnerable to attack, as we saw just recently when George W. Bush was completely unsuccessful in generating support for privatizing a portion of Social Security. This is precisely why Franklin D. Roosevelt insisted on such a conservative financing mechanism even though many of his advisers argued strenuously in favor of general revenue financing, which would have been much more progressive.

As Roosevelt told one of those advisors, Luther Gulick, "I guess you're right on the economics. ... We put those payroll contributions there so as to give the contributors a legal, moral and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program. Those taxes aren't a matter of economics, they're straight politics."

Another good example of the benefit principle at work is the gasoline tax. Since the roads are primarily used by drivers, it's appropriate that they pay the bulk of the cost of construction and maintenance. At the state and local level many taxes are largely paid by those who benefit from them. According to a National Conference of State Legislatures study, about a fourth of all state taxes are earmarked for particular programs. At the local level, property taxes are the principal funding source for education, police and fire protection--services that largely accrue to homeowners.

There are other problems as well in financing health reform with a surtax on the rich. One is that health spending is likely to rise much faster than revenue from the surtax. The Congressional Budget Office has warned about this problem, noting that its own estimate of the health legislation significantly understates the long-run cost.

That is because CBO doesn't estimate program costs out more than 10 years due to unreliability past that point. Unfortunately, Congress is able to use this constraint to game the system. It often phases in new programs very slowly so that their cost is low in the early years, with the true cost only reflected in the out-year estimates.

In the case of the House bill, the 10-year cost is a little more than $1 trillion, implying a cost of $100 billion per year. In fact, spending in the first three years is virtually zero. By the 10th year spending will be more than $200 billion and rising at 8% per year. This suggests that the cost of health reform will be more than three times greater in the second decade after enactment than the first.

However, CBO notes that revenue from the surtax is not likely to rise faster than the economy as a whole or about 5% per year. As a consequence, relative to current law, "the proposal would probably generate substantial increases in federal budget deficits during the decade beyond the current 10-year budget window."

This problem will be worse if the wealthy are more aggressive in their use of tax planning than CBO thinks. As I noted in a previous column, self-incorporation alone would reduce a wealthy person's marginal tax rate to 35% from a proposed 45%. Economist Robert Carroll of the Tax Foundation thinks revenue from the surtax will probably be 40% less than CBO is estimating.

Former Clinton Treasury economist Len Burman notes a basic unfairness in the way the surtax is calculated. Normally, taxes are assessed on net income, but the surtax will be assessed on adjusted gross income, thus depriving rich people of perfectly legitimate business deductions. In addition, the use of AGI as a tax base will raise the maximum tax on capital gains and dividends above the 20% rate proposed by Barack Obama in his budget.

Burman, who has no ideological qualms about raising taxes on the rich, thinks this is a "stupid" way of raising new revenue since we have the Alternative Minimum Tax that already takes away many deductions from the rich, such as that for state and local taxes. The result, Burman says, will be to make the income tax system "even less coherent than it is now."

Economist Bill Gale of the liberal Brookings Institution also objects to using a surtax to pay for health reform. If we are to raise income taxes, he thinks it should be for deficit reduction, not to finance additional spending. Like most economists, Gale thinks it is insane for Congress to do health reform without touching the vast tax subsidy for health insurance that has created many of the problems it is trying to fix.

Finally, as a political matter, Democrats need to ask themselves whether they really want to become known once again as the party of class warfare. Mark Penn, who was Bill Clinton's pollster, has warned that this could drive wealthy voters, who shifted heavily toward the Democrats between 2004 and 2008, back into the arms of the Republicans. (According to exit polls, only 36% of voters making more than $200,000 voted for John Kerry in 2004; 52% voted for Obama in 2008.

Penn says that Clinton's 1993 increase in the top tax rate was "a major factor" in the Democrats' loss of Congress in 1994. In 1995, Clinton himself admitted publicly that he raised taxes "too much" when he boosted the top rate to 39.6% from 31%.

I continue to believe that if we are to expand health insurance for the uninsured, it should be with a dedicated funding source that is largely financed by the beneficiaries. I think a value added tax would be the best way to do this, but there are certainly other alternatives that can be considered, such as raising the payroll tax. The worst option would be a surtax on just 1% of taxpayers.

Bruce Bartlett is a former Treasury Department economist and the author ofReaganomics: Supply-Side Economics in Action and Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy. He writes a weekly column for Forbes.com.

Translating Obamacare into Plain English

By Bill Frezza

Forget for a moment whether you believe healthcare is an inalienable right like freedom of speech or a service one purchases like auto repair. Do you prefer honestly debating the issue or hiding behind Orwellian doublespeak?

Do you support open and transparent deliberation or do you believe that "change" justifies the use of misinformation, intimidation, and obfuscation?

Are you thinking through the likely consequences of the detailed healthcare "reforms" being proposed or are you more invested in making sure that your tribe - be it Red or Blue - "wins" this particular legislative fight?

Do the questions above matter or is your remedy for one screwed up presidency piling on another one?
How happy were you when our last President bamboozled the country into a hasty war in search of non-existent "weapons of mass destruction?" Were you shocked that he had no plan to secure the peace after achieving military victory? Once entangled, were you surprised that it took years of blood and treasure to set things right?

Then why are you comfortable watching this President stampede the country into the remodeling of 18% of our economy in search of non-existent "savings" that cannot possibly come from expanding the menu of government entitlements? Will you feign surprise when it becomes undeniable that Congress has no idea how to pay for the new benefits being proposed?

Don't get me wrong. Maybe a majority of Americans really do want every citizen to be taken care of according to his needs while "the rich" are forced to pick up the tab according to their ability. Many other countries work that way, although the definition of "rich" has a way of expanding as quickly as the entitlements. And maybe we do want wise central planners telling our doctors how to treat us. But before we enshrine this into law, doesn't it make sense to have an honest debate?

Here is how my dictionary defines "insurance."

Insurance - coverage by a contract binding a party to indemnify another against specified loss in return for premiums paid.

Compare this to the definition of the word "welfare."

Welfare - financial or other assistance to an individual or family from a city, state, or national government.

As Congress attempts to remake the healthcare industry, which are we talking about - insurance or welfare?

Health insurance - like fire insurance and life insurance - is a financial product sold by underwriters who offer a menu of services with prices based on an actuarial analysis of risk. The average premium paid for coverage has to be higher than the average payout for covered services or else the underwriter goes broke. Health insurance does not magically deliver "free benefits." Even if coverage comes through your employer, the premiums paid could have otherwise gone into your paycheck. Plans vary from high deductible coverage of only the most severe catastrophes to gold plated reimbursement for every sneeze and sniffle. Medical services are not "rationed" by insurance companies, they are contractually provided as specified in the product you or your employer buys. Some employers buy fancy plans and others cheap out depending on what kind of employees they need to attract.

Welfare is the ultimate in "free benefits." It is run on a pay-as-you-go basis. Plans are structured by community activists, not actuaries. Payouts are usually based on need, although middle class welfare programs are often the most expensive. Of course welfare has to be rationed because there is no price mechanism to balance supply and demand, no need to generate profits, and the provider can't go out of business - although California is testing that proposition. Rationing has nothing to do with what recipients "deserve," it comes from the fact that government treasuries are not infinite.

Once we agree to speak plain English, is it so disastrous to take the time to carefully consider what we're getting into? Do we really want Congress to pass a 1,000 page trillion dollar medical welfare bill that guarantees every American free healthcare regardless of their ability to pay? Are we willing to let recession-battered Federal and State governments go deeper into debt to support this? Are we ready to turn most doctors into civil servants so we can set their salaries? And are we prepared to raise everyone's taxes a little bit today and a lot tomorrow to pay for it all?

If you are a current recipient of medical welfare - namely Medicare or Medicaid - are you willing to share your benefits by having a fixed amount of services spread over an additional 45 million people? Please don't pretend that Medicare is not welfare, we agreed to speak English. If Medicare were really "insurance" with premiums set by actuaries, then why do both tribes agree it is destined for bankruptcy? You say it's because the nation is aging? Insurance companies don't go broke when their customer base grows, they make more money. And if national aging is the cause of Medicare's ultimate bankruptcy, how are things going to be improved by adding another 45 million people to the rolls who can't even afford bare-bones insurance?

Telling the truth is fundamental to running a democracy. Calling things what they are is integral to telling the truth. We'd better get started if we hope to pass policies that don't themselves need to be "reformed" before the ink is dry.

Bill Frezza is a partner at Adams Capital Management, an early-stage venture capital firm. He can be reached at bill@vereverus.com. If you would like to subscribe to his weekly column, drop a note to publisher@vereverus.com.