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  OBAMA’S REFORMS

  As I write this, the pressure is on the Obama administration to do something. Underinsured Americans and their underfinanced local and state governments are all looking to Washington for a way out of this national health care mess.

  The political debate has become as frenzied as it was the last time a Democratic president proposed a major health care reform. President Clinton’s attempt in the early 1990s, led by First Lady Hillary Clinton, failed to make it far in Congress. That effort was brought down in part by the very effective “Harry and Louise” ads, sponsored by insurers, showing a middle-class couple despairing over the bureaucratic complexities of Clinton’s plan. Now we have Obama’s opponents charging that he will convene “death panels” to grant or withhold treatment for gravely ill Americans. This is a gross misrepresentation of the legislative proposals and amounts to nothing more than a scare tactic.

  The truth is, Obama’s proposals at most would add a federal health insurance program only as an alternative to the private system we already have. We could all keep our family doctors and avoid bureaucrats, staying far from the reach of any “death panel.”

  Ignore all that political noise. Obama’s commitment to comprehensive health care reform is a good sign. It puts him ahead of his predecessor in this regard. But will he make sure that his proposals are fiscally responsible and sustainable—and not just for ten years? A study commissioned by the Peterson Foundation has shown that while many of the health care reform proposals being considered by the Congress don’t pay for themselves even over ten years, the financing gap worsens beyond the ten-year time frame. In the final analysis, any effort to expand coverage without transformational reforms that significantly shrink the federal financial hole and seriously reduce the rate at which our total costs as a percentage of the economy are growing would be imprudent.

  My greatest fear is that the Obama administration and Congress will enact universal health care coverage without making a significant down payment on the $38 trillion of unfunded Medicare benefits that we already have, and without ensuring that the plan will actually contain total health care costs. Yes, we need comprehensive health care reform. However, any such reform should help us get out of our fiscal mess while improving the equity and outcomes of today’s system. Those goals are not always so obvious in the wonderland of Washington.

  We must avoid any temptation to add a new wing onto our existing health care house (system), which is already structurally unsound and headed for foreclosure. That is what some are proposing in Washington, and it’s not only imprudent, it’s irresponsible.

  Our nation got into deep trouble by promising more health care than it could deliver. That approach has given Americans one of the most expensive systems in the world with among the least impressive results. My greatest hope is that we have begun to understand the predicament we are in and will come together to fix the system.

  The outline of a reform program is clear. The hard part is finding politicians who have the courage to make the tough choices, resist the sweet siren songs of lobbyists, and do what is right for our country rather than for their careers. They need to make tough choices and stick to them even though the right choice may not be popular. After all, that is what true leadership is all about.

  If we can find good leaders, transform our health care system, and adequately finance it, we will have come a long way toward creating a more promising fiscal future. That takes me to the next important issue we have to figure out together: revenues. On to the next chapter, and a topic you’ve been waiting for—our tax system!

  Seven

  COLLECT MORE

  REVENUE—MORE FAIRLY

  Who likes taxes? I don’t, and I would bet that you don’t either. We can agree on that, though I’ll have to work hard to make you agree on a few other things in this chapter.

  The past fifty years have seen a reduction in federal income tax rates, but it would be a mistake to conclude that this makes us a low-tax society. In some combination or other, we pay federal income and payroll taxes (e.g., for Social Security and Medicare), state income and sales taxes, and local sales and property taxes. To complete the list of what we give to various governments, you would have to toss a number of other payments in the pot—excise taxes, tariffs, duties, fees, premiums, and so on. Think about that cable/phone/Internet bill that was supposed to be $99 per month. By the time you get done with all of the added fees, the bill has gone up by 10 percent or more. And let’s face it, we indirectly pay corporate taxes, too, to the extent companies raise prices to offset them.

  And so it feels as if we’re getting hit with a tax everywhere we turn, which is somewhat ironic for a country that since its founding has shown a marked distrust for government’s ability to tax us honestly. Today’s system, complex and opaque as it is, heightens that mistrust. Instead of charging us fairly for services rendered, the federal government seems to be trying to confuse us and trick us out of money. They don’t really care if we don’t understand how and why we’re being taxed. They just want us to fill out the forms and fork over more money. Since we can’t even be sure we’ve prepared the forms correctly, we naturally suspect that we’ve ended up paying too much.

  But it’s my job to tell it to you straight, and here it is: In the aggregate, we actually aren’t paying enough. As I pounded home in earlier chapters, we are not even close to paying for what government spends today, much less what it has promised for tomorrow—and this shortfall is growing dramatically.

  I’m talking about our federal tax policies when I say that. State and local governments are generally required by law or their constitutions to balance their budgets. But the federal government is not, and takes full advantage of that huge loophole.

  The freedom to spend money they don’t have allows our leaders in Washington to play all kinds of con games. Their biggest lie is when they keep on spending but tell us they have “cut” taxes (Washington word alert). They haven’t cut them at all. They have just borrowed the money and deferred the taxes to later generations, with interest—to Americans who are too young to vote and may not have been born yet. It’s the worst kind of buy now, pay later plan. It’s also a massive form of taxation without representation.

  As I started writing this chapter, in April 2009, I was both gathering information for my own returns and reviewing reports of the antitax “Tea Party” demonstrations taking to the streets around the country. April 15 is always a great day for tax protests, but at this point in our history those tea parties looked out of place. On April 15, 2009, Americans actually were paying less in total taxes than most other people in the industrialized world and, thanks to the Bush cuts, less than we recently had been. All those demonstrators gave cable TV something to cover, but they had little basis for complaining about today’s overall federal tax levels. At the same time, they had plenty to complain about with regard to out-of-control spending.

  We have to stop lying to ourselves. To get our fiscal house in order, we have to fix not only our system for spending money, but our system for bringing it in. In other words, tax reform is a key element of our efforts to restore our nation’s financial health.

  You’re not going to like this, but we need more revenues, and more ways of collecting them, not fewer—and I’m going to propose a new kind of tax later in the chapter. Just know at the start that what I suggest will be a lot simpler, fairer, and more competitive than what we have now.

  OUR SYSTEM IS TOO COMPLEX

  I usually prepare my taxes myself, without help from an accountant or one of those programs designed to help you complete the forms. During my tenure as comptroller general, I urged senior members of the executive and legislative branches, including elected officials, to do the same. It’s the best way I’ve found to show the powers that be how desperately our tax system needs reform. Unfortunately, people didn’t generally take up my suggestion, not even the chairmen of the tax-writing committees in the Congress. When I proposed it to t
hen Senate Finance Committee chairman Chuck Grassley (R-IA), his answer was short and sweet: “I do not accept the challenge.”

  I can’t say I entirely blame him. Today, we have a system that is so mind-numbingly complex that it’s almost impossible for the average taxpayer to comply with the law.

  If you have any itemized deductions at all, just try wading through all the various forms and schedules that the IRS now requires. Form 1040 started out as four pages in 1913 (too long even then!), and now it can grow to the size of a fashion magazine before you’re through making all the calculations and documenting your financial life. You can read every dense line of instructions and still not be sure you’ve arrived at the correct figure for taxes due.

  If the forms themselves are not bad enough, the Internal Revenue Code that they are based on has grown to encyclopedic size. Today’s Internal Revenue Code is over 3,500 pages in length, up from fifteen in 1913. Add to the pages in today’s code the thousands of additional pages and other guidance issued by the IRS. The code is so complex primarily because it outlines what is and what isn’t taxable, at what times, in what amounts, and at what rates. This is even more difficult than you may think, because our tax law includes so many special tax preferences, otherwise known as loopholes, that people and businesses may be eligible for.

  OUR SYSTEM IS UNFAIR

  Tax preferences take many forms. They involve deductions, exemptions, exclusions, accelerations, credits, and carryovers, just to name a few. Is your head spinning yet? All of these provisions are the result of the executive branch or the Congress—or somebody—attempting to promote certain types of behavior. Maybe it was fashionable at one time to promote home ownership, savings, research and development, or employer-provided health care—you can find breaks for all of these things in the tax code. Then there are the breaks for certain farmers, insurers, contractors, and a long list of special interests—that is, just about anybody with influence in Washington and enough money to hire an imaginative lawyer and effective lobbyist.

  All these preferences serve to complicate the tax code and reduce revenue so much that our basic tax rates are higher than they might otherwise be. Believe it or not, the federal government loses over $1 trillion in revenue a year due to these tax preferences.

  The largest tax breaks might surprise you—or even benefit you. (See figure 8.) Coming in at number one in annual losses, with about $288 billion in 2008, is health insurance—that is, the income taxes and payroll taxes that most Americans do not pay on employer-provided health insurance. This preference subsidizes the health care of well-paid individuals who have high marginal tax rates, but, as I previously noted, it doesn’t provide a dime of help for near-poor workers who lack employer-provided health insurance. This preference also encourages eligible workers to load up on health insurance simply to take advantage of the special tax breaks that come with these benefits. Shouldn’t this tax preference at least be limited to the cost of a reasonable level of coverage?

  The second-biggest tax break comes from the variety of savings incentives in the Internal Revenue Code. There are many, and they total over $120 billion in annual losses. While we want to promote savings, as I have already shown you, our tax incentives don’t work. After all those breaks, we still have the lowest savings of any major industrialized nation.

  Figure 8 Value of selected tax preferences, 2008. These tax preferences cost a lot of money, but, in many cases, they benefit the wealthy rather than the middle and lower income classes.

  The third-biggest tax preference is the state and local tax deduction, which you get unless you pay the Alternative Minimum Tax (AMT), like I do. That amounts to $74 billion in annual losses.

  Coming in at number four is the $67 billion in annual losses from the home mortgage interest deduction. You can argue that the deduction is appropriate since, to some, home ownership is the American Dream. At the same time, shouldn’t there be more reasonable and regional limits on the size of a mortgage that qualifies for a deduction? For example, you could peg the deduction to the maximum conforming loan offered by one of the federal mortgage companies (Fannie Mae or Freddie Mac), an amount that varies by geographic area.

  I could go on and on listing tax preferences, and they would get more and more obscure. Do you and I take full advantage of them? Do some of us take too much advantage of them? I was the chief auditor of the U.S. government for almost ten years and I’ve been a CPA for decades. But can I say my hand-prepared tax returns were correctly calculated every year? Well, I believe they were, and I can assure you that I completed them to the best of my knowledge—and with plenty of frustration.

  I don’t know about yours, but around the Walker household, tax preparation day is the worst time of the year. Mary is in charge of collecting receipts and forms, and I’m in charge of calculations and paperwork. The process never works—how shall I put it?—tranquilly. Something’s always missing; something’s always mixed up. In all, it’s just not a very pleasant experience for either of us, and I don’t think we’re the only American family that would admit that.

  In 2009 I took a break. I’ll admit that I had a CPA firm do my 2008 taxes. That year I was based part of the time in D.C. and part of the time in New York. My primary residence was in Mt. Vernon, Virginia, yet I traveled all over the country. As a result, I had to apportion my income for state tax purposes. To put it simply, I needed help figuring out which tax collectors were due what based on the various state residency laws and other tax rules. However, in 2010 I plan to pick up the pencil and do my own taxes again. And, as always, it won’t be a pleasant experience.

  THE PATH TO TAX REFORM

  If we Americans simply paid the taxes we owed, it wouldn’t come close to solving our fiscal problems, but it would make a dent. In the fiscal year ending September 30, 2008, for example, the federal government collected $2.6 trillion in revenue, at least $300 billion short (based on a 2001 IRS estimate) of what should have been paid. This is the so-called tax gap. In some cases, the nonpayment was the result of mistakes; in some, it was illegal evasion. All in all, that’s not a bad record when you consider that Americans report their income and pay their taxes voluntarily, with limited real enforcement by the government.

  All the same, the tax gap between what should be paid and what actually is paid creates inequities. It means that the most honest Americans are subsidizing those who aren’t. While $300 billion might be a fairly low percentage of federal receipts, it’s still a lot of money. Don’t let the trillion-dollar-plus annual deficits make you think otherwise.

  We’ve reformed the tax system before. Most recently, in 1986, President Reagan signed a law that reduced our top tax rate on individual income from 50 percent to 28 percent. There was a higher 33 percent rate that simply ensured that higher-income taxpayers paid 28 percent on all their taxable income. That law also cut tax loopholes and preferences, most notably those related to interest payments in credit card loans and a number of real estate tax shelters. It also raised business taxes. All of these changes were designed to allow the IRS to collect roughly the same amount of money despite lower marginal tax rates.

  Since then, not surprisingly, the top individual rate has crept back up to 35 percent. In addition, many preferences made their way back into the code between 1986 and 2008, and with them, another seven hundred pages. Yes, our tax system is probably more complex these days than it was before 1986, and it’s getting bigger and more complex every year.

  Now we have to go back to basics again. The least we can do is simplify the tax system according to the Reagan model: Keep the rates as low as possible, broaden the tax base by cutting preferences, and make the rules easier for us to comply with and for the IRS to enforce.

  I know, I know. You hear calls for tax reform all the time. Every new administration comes to office promising it. President Obama ordered his economic advisers to come up with a simpler tax system by the end of his first year. Former Fed chairman Paul Volcker is heading a group to ma
ke related recommendations. He is extremely capable and credible, so I look forward to seeing what they come up with. Unfortunately, President Obama has complicated things by promising tax cuts to middle-class Americans and special tax breaks to small businesspeople, students, first-time home buyers, and others. He also said that he would never raise taxes for individuals making less than $250,000 a year. If you believe that, then you are very gullible, because the math doesn’t come close to working if President Obama means what he says about fiscal responsibility.

  There is nothing unusual about Obama’s approach. American presidents almost from the start have had to tax and give tax relief simultaneously—a task all the more challenging as demands on government services have increased. President Lincoln imposed the first U.S. income tax in 1862 to help pay for the Civil War. That levy was repealed a decade later, and in 1895 the Supreme Court struck down Congress’s attempt to revive it.

  The income tax returned in 1913 as a result of the Sixteenth Amendment to the U.S. Constitution, which allowed Congress to collect the tax without apportioning the revenue among the states. It’s been with us ever since and probably always will be. It was supplemented by the Social Security payroll tax beginning in 1935 and the Medicare payroll tax in 1965.

  That 1913 law levied a 1 percent tax on net personal incomes above $3,000. There was an exception: If you made more than $500,000, you paid a 6 percent surtax. This was controversial at the time but seems modest compared to current tax rates—and so simple. By the way, $3,000 and $500,000 in 1913 are equal to about $65,000 and $11,000,000, respectively, in 2009. Under the federal tax system of 1913, I would pay only 1 percent of my income to the federal government. Instead, even though I’m not a wealthy person, I paid almost 30 percent of my income to the federal government alone in 2008, and that excludes the employer portion of Social Security and Medicare taxes. It also excludes state and local taxes.